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Basic Logic for Ben Bernanke

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Friday, 03 September 2010 05:03

Since reporters feel the need to report nonsense from the Fed chairman without presenting anyone pointing out the obvious, BTP will fill the gap. The NYT reported on Ben Bernanke's testimony before the Financial Crisis Inquiry Commission.

It notes Bernanke's statement that in 2003-2004 it was not clear that the housing market was in a bubble and that by the time it was clear, it was too late for the Fed to do anything without seriously harming the economy. Of course it was clear as early as 2002 that the housing market was in a bubble, but more importantly, Bernanke's claim that the Fed could not act until it was clear is absurd.

The Fed always acts in an uncertain environment. For example, Alan Greenspan raised interest rates in anticipation of inflation on numerous occasions. The logic of this action was that it was worth slowing the economy and raising the unemployment rate rather than risk an increase in the rate of inflation. In effect, this action assumes that the certainty of higher unemployment from raising interest rates is better than the risk of higher inflation.

Had the Fed acted to burst the bubble in 2003-2004, the risk would have been that it temporarily depressed house prices by scaring people about excessive prices and limiting the exotic mortgages that were boosting demand. By contrast, if it had acted correctly in preventing the growth of a dangerous bubble, it would have prevented the worst downturn in 70 years.

Any serious weighing of the benefits and risks of bursting the bubble in 2003-2004 would have surely come down in favor of bursting the bubble. The Fed's decision not to burst the bubble was one of the most disastrous failures of monetary policy in history.

Comments (6)Add Comment
only game in town
written by scott, September 03, 2010 6:22
Though Greenspan was a coward, the housing bubble was the only thing driving the economy then. All other sectors were lagging. There was little manufacturing or anything else outside of those related to housing. This is an easy claim to make since our low taxes on executives had hollowed our our manufacturing base. But, presumably keeping rates low were trying to stimulate other sectors of the economy.

I don't expressly disagree, but perhaps other arrows were in the quiver. One, would be to improve reporting on home financing. When a house is sold, the sales price is reported through MLS and that's what appraisers use to do comps. However, when unconventional financing is used, those values are supposed to be adjusted accordingly. If we had some adjustment based on interest only loans, ARM's and other distorting loans much of the bubble could have been diffused. And, we'd have low interest rates which should drive investment in other sectors. Again, this would require higher taxes on outsized salaries.
Regulatory policy
written by bakho, September 03, 2010 8:05
The Fed did not have to burst the housing bubble with monetary policy. Regulatory policy would have been a better tool. However, Bush and Greenspan were both actively promoting the housing bubble, not trying to burst it.

Bernanke totally ignored regulatory steps that would have tightened lending standards or provided consumers with more protection from the greedy mortgage loan sharks. Better regulation would have halted the worst of the abuses and moderated the meteoric rise in housing prices.
...
written by skeptonomist, September 03, 2010 9:48
Encouraging trick mortgages was the Fed's policy and so was encouraging high leverage and "financial innovation", meaning CDS's. It is unrealistic to expect humans to reverse themselves and admit that their favored economic policies have had the wrong effects. The problem is the excessive faith in the Fed and monetary policy which has prevailed over the last 50 years or so. Does it really make sense to entrust the control of the economy to bankers?
Speculating in a house
written by Scott ffolliott, September 03, 2010 3:52
Leverage is in fact speculation. Therefore when you borrow money to invest you are no longer investing you are speculating.
Bernanke is a nice man
written by Scott ffolliott, September 03, 2010 3:57
Bernanke is a nice man who got where he is today by going along to get along. He is like almost all of us so let's only be as hard on him as we are on ourselves.
...
written by keynes42, September 03, 2010 10:03
When the Fed recognized the housing bubble, Chairman Bernanke contends it was too late to do anything without causing serious harm to the economy. What would have been more harmful than what has happened? And, if this Fed with all their analytic tools and brains cannot spot a bubble of such biblical proportions, tell me what are we getting for our money?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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