Blog Department – January 26, 2012

Blog Department – January 26, 2012

Wall Street Journal headline (Friday, January 13, 2012):

Little Alarm Shown at Fed at Dawn of Housing Bust

U.S. home prices peaked in May 2006 according to the S&P Case-Shiller home price index, and have since fallen 33%. The fall took over a year to gain momentum and was not precipitous until midway through 2007. The Great Recession began in December 2007.

Just released transcripts show the Fed underestimated the extent to which the housing boom had strained the financial-services industry, particularly through exotic mortgage securities. Further, Fed officials misgauged the potential for housing problems to spill over into the broader economy.

Highlights of the transcripts follow:

Fed officials offered praise for outgoing Fed Chairman Alan Greenspan, who attended his final Fed meeting in January 2006. Timothy Geithner, then president of the Federal Reserve Bank of New York and now U.S. Treasury Secretary, playfully offered this forecast about Mr. Greenspan's legacy: "I think the risk that we decide in the future that you're even better than we think is higher than the alternative." Mr. Greenspan's reputation subsequently was tarnished by the financial crisis.

In his second meeting as chairman of the Federal Reserve in May 2006, Ben Bernanke heard a Fed governor warn about the nation's mortgage market. But Mr. Bernanke described the cooling of the housing boom as a "healthy thing." "So far we are seeing, at worst, an orderly decline in the housing market," he said. In March 2006, Bernanke had stated: "Again, I think we are unlikely to see growth being derailed by the housing market."

A Fed staff report June 2006 indicated: "We have not seen—and don't expect—a broad deterioration in mortgage credit quality." Also in June 2006, Timothy Geithner reported: "We see a pretty healthy adjustment process under way… The world economy still looks pretty robust to us." Further, at a meeting in December 2006, Geithner opined: "Our recent financial-market data don't, in my view, provide a convincing case for a substantial increase in the probability of a much weaker path for growth going forward."

Finally, December 12, 2006 Bernanke declared: "Like most people around the table, I think that a soft landing with growth a bit below potential in the short run looks like the most likely scenario."

A handful of Fed officials warned of trouble, most notably Susan Bies, a former banker who served as a Fed governor from 2001 until 2007. In May 2006, she warned that households were taking on so much debt that they might be vulnerable to financial shocks, such as layoffs or medical problems. She expressed dismay about the exotic mortgages that banks were offering to borrowers, particularly those in which debt grew, rather than got paid off, over time. But Susan and the handful of others were the exceptions.

Lessons

The transcripts provide ample evidence of the shortsightedness of the nation's top economic policy makers. In so doing, they support our contention that economic (and market) projections are very difficult to formulate and are terribly unreliable. In this case, the "guilty" parties had impeccable credentials and were supported by large staffs of well-paid analysts and experts. Yet, they generally failed to foresee a very negative watershed event in U.S. economic history.

To pull our punches a bit, we note that very few economists, either inside or outside the Fed, imagined at the time that such a steep housing decline [33%] was possible. Nonetheless, we can learn additional lessons. First, we need to be ever mindful of the profligacy, lax regulation, and outright fraud which preceded the housing bust and mortgage security crisis and got the U.S. in so much economic trouble. Human greed, self-interest, and unethical conduct have not gone away. In this regard we note the millions being spent for an on-going campaign by U.S. financial institutions to "water down" (some would say emasculate) increased capital requirements and much tighter regulation passed in July 2010 as the Dodd-Frank Wall Street Reform and Consumer Protection Act. Second, we also need to keep a healthy, detached skepticism about the quality and effectiveness of government and about pronouncements of government officials, politicians, and business leaders. Finally, we must keep in mind that at present there has yet been a changing of the guard at the Fed, nor any real jailing of the bad actors of the 2008 financial crisis. Thus, a back-sliding and repeat are not out of the question.

Back to Market Reviews


		Blog Department – January 26, 2012
		Wall Street Journal headline (Friday, January 13, 2012):
		Little Alarm Shown at Fed at Dawn of Housing Bust

		U.S. home prices peaked in May 2006 according to the S&P Case-Shiller home price index, and have since fallen 33%. The fall took over a year to gain momentum and was not precipitous until midway through 2007. The Great Recession began in December 2007. Just released transcripts show the Fed underestimated the extent to which the housing boom had strained the financial-services industry, particularly through exotic mortgage securities. Further, Fed officials misgauged the potential for housing problems to spill over into the broader economy. Highlights of the transcripts follow: Fed officials offered praise for outgoing Fed Chairman Alan Greenspan, who attended his final Fed meeting in January 2006. Timothy Geithner, then president of the Federal Reserve Bank of New York and now U.S. Treasury Secretary, playfully offered this forecast about Mr. Greenspan's legacy: "I think the risk that we decide in the future that you're even better than we think is higher than the alternative." Mr. Greenspan's reputation subsequently was tarnished by the financial crisis. In his second meeting as chairman of the Federal Reserve in May 2006, Ben Bernanke heard a Fed governor warn about the nation's mortgage market. But Mr. Bernanke described the cooling of the housing boom as a "healthy thing." "So far we are seeing, at worst, an orderly decline in the housing market," he said. In March 2006, Bernanke had stated: "Again, I think we are unlikely to see growth being derailed by the housing market." A Fed staff report June 2006 indicated: "We have not seen—and don't expect—a broad deterioration in mortgage credit quality." Also in June 2006, Timothy Geithner reported: "We see a pretty healthy adjustment process under way… The world economy still looks pretty robust to us." Further, at a meeting in December 2006, Geithner opined: "Our recent financial-market data don't, in my view, provide a convincing case for a substantial increase in the probability of a much weaker path for growth going forward." Finally, December 12, 2006 Bernanke declared: "Like most people around the table, I think that a soft landing with growth a bit below potential in the short run looks like the most likely scenario." A handful of Fed officials warned of trouble, most notably Susan Bies, a former banker who served as a Fed governor from 2001 until 2007. In May 2006, she warned that households were taking on so much debt that they might be vulnerable to financial shocks, such as layoffs or medical problems. She expressed dismay about the exotic mortgages that banks were offering to borrowers, particularly those in which debt grew, rather than got paid off, over time. But Susan and the handful of others were the exceptions. Lessons The transcripts provide ample evidence of the shortsightedness of the nation's top economic policy makers. In so doing, they support our contention that economic (and market) projections are very difficult to formulate and are terribly unreliable. In this case, the "guilty" parties had impeccable credentials and were supported by large staffs of well-paid analysts and experts. Yet, they generally failed to foresee a very negative watershed event in U.S. economic history. To pull our punches a bit, we note that very few economists, either inside or outside the Fed, imagined at the time that such a steep housing decline [33%] was possible. Nonetheless, we can learn additional lessons. First, we need to be ever mindful of the profligacy, lax regulation, and outright fraud which preceded the housing bust and mortgage security crisis and got the U.S. in so much economic trouble. Human greed, self-interest, and unethical conduct have not gone away. In this regard we note the millions being spent for an on-going campaign by U.S. financial institutions to "water down" (some would say emasculate) increased capital requirements and much tighter regulation passed in July 2010 as the Dodd-Frank Wall Street Reform and Consumer Protection Act. Second, we also need to keep a healthy, detached skepticism about the quality and effectiveness of government and about pronouncements of government officials, politicians, and business leaders. Finally, we must keep in mind that at present there has yet been a changing of the guard at the Fed, nor any real jailing of the bad actors of the 2008 financial crisis. Thus, a back-sliding and repeat are not out of the question.

		Back to Market Reviews