“So, I think it will take a while for scholars to decide exactly what role easing monetary policy had in contributing to the financial crisis. I would not argue with the idea that a long period of low interest rates does contribute to the buildup of leverage and may have touched off a housing bubble.”, Federal Reserve Board Chair, Janet Yellen, February 27, 2014
“The truth about the Fed’s key role in contributing to the U.S. housing bubble/bust and financial crisis has now been revealed by the new Fed Chair. I commend her for telling the truth. Chairman Bernanke denied that the Fed’s pre-crisis monetary policies were to blame (see below).”, Mike Perry, former Chairman and CEO, IndyMac Bank
Excerpt from Chair Janet Yellen’s Testimony to the U.S. Senate Committee on Banking, Housing, and Urban Affairs: The Federal Reserve Board’s Semiannual Report on Monetary Policy and The U.S. Economic Outlook for The Year; February 27, 2014:
Senator Toomey: On the risk side of this equation, I know you did mention some of the things you are looking for, many people believe that last decade the unusual monetary policy including maintaining negative real interest rates for an extended period of time, at the short end of the curve anyway, contributed significantly to the housing bubble that later burst, of course. Do you agree that that was a contributing factor? And secondly, among the risks that you look at, as we hopefully move to normalcy, which ones concern you the most? And then I’ve got one last, really short question.
Chair Yellen: So, I think it will take a while for scholars to decide exactly what role easing monetary policy had in contributing to the financial crisis. I would not argue with the idea that a long period of low interest rates does contribute to the buildup of leverage and may have touched off a housing bubble. But, I think on the regulatory side and the supervision side there were also failings that contributed importantly to the crisis. We are watching very carefully for the development of any such excesses. We are very focused on…
Here is a video clip which takes you directly to the segment, available here: http://www.c-span.org/video/?c4486685. In the full video it is approximately 1:32:23 in. It is Sen. Pat Toomey (R-Pennsylvania) questioning Chair Yellen.
Excerpt from Blog Posting Statement #58, September 26, 2013:
Mr. Bernanke (Comments to the FCIC): “Even if you believe that the Fed’s monetary policy was a contributor to the bubbles, it should be noted that even people who are most critical of the Fed’s policy acknowledged that it was only….it was not a large mistake. It was a percentage point or two relative to, say, what the Taylor rule, which is the standard measure of interest rate policy is…if you have a situation where a relatively small mistake…if it was a mistake, I’m just accepting that hypothesis…leads to the biggest financial crisis since World War II, I mean, what does that say?”
Mr. Taylor (“of the Taylor Rule”): “Figure 1 shows that the actual interest-rate decisions fell well below what historical experience would suggest policy should be. It thus provides an empirical measure that monetary policy was too easy during this period (2002 – 2005), or too ‘loose fitting’, as the ‘The Economist’ puts it. This deviation from the Taylor rule was unusually large; no greater or more persistent deviation of actual Fed policy had been seen since the turbulent days of the 1970s.”
“Who is right here? Mr. Taylor’s arguments make sense to me and are backed by empirical data. Mr. Bernanke’s comments to the FCIC are not under oath and while I found them to be generally very forthcoming and accurate, I have noted on this blog I felt his FCIC comments re. Fed monetary policy/interest rates were not. I believe they were designed to protect the Fed. Read the excerpts below from Mr. Taylor’s book and from Mr. Bernanke’s 2009 conversation with the FCIC below and decide for yourself. Mr. Taylor’s book has been lauded by famed monetary economist Anna Schwartz, and former Secretary of Treasury; State, and Labor George P. Shultz.” Mike Perry, former Chairman and CEO IndyMac Bank
Excerpt from Blog Posting Statement #54, September 24, 2013 (discussing an April 2009 WSJ OpEd entitled: “From Bubble to Depression?”, co-written by Nobel Economist Vernon L. Smith and researcher Steven Gjerstad):
“During the 1976-79 and 1986-89 housing prices bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, ‘leaning against the wind,’ helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the feds-fund rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.”
“With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-to-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since ‘owners’ equivalent rent’ is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.”
“With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off…As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued.”