Fed States That Housing Boom in US Caused by World Wide Low Long-Term Interest Rates

The excerpts below from an article in the WSJ, gives the Fed’s arguments as to why the housing boom in the US was caused by low long term rates earlier this decade. It is difficult to know the correct answer to this problem because we do not have the Fed’s perch. However, it should be apparent to everyone that the world capital markets are becoming more integrated and other countries are playing a larger part then during previous decades. This entire boom/bust issue will give academics something to debate for a long time.

Federal Reserve Chairman Ben Bernanke, responding to critics who contend the Federal Reserve's low interest rates earlier this decade helped create a housing boom and bust, said global factors that held down long-term interest rates world-wide were a more important factor.

Mr. Bernanke told lawmakers at a House hearing on the nation's housing slump that while Fed policy does work in part by influencing asset prices, "I think the primary factor leading to increases in house prices -- not only in the U.S., but in many countries around the world -- was the generally low level of [inflation-adjusted] long-term interest rates in global capital markets." . . . .

. . . . Between early 2001 and June 2003, the Fed reduced short-term interest rates to 1% from 6.5%. In a series of moves beginning in June 2004, it started raising rates, reaching 5.25% in June 2006. From early 2002 to mid-2005, the 10-year Treasury yield, the primary determinant of long-term mortgage rates, generally fluctuated around 4%. Mr. Bernanke said that as the Fed "lowered interest rates to 1% and raised them gradually, mortgage rates did not respond very much." (my emphasis)

Mr. Bernanke's remarks echo those of his predecessor Alan Greenspan in Mr. Greenspan's recently released memoir and related interviews. "I find this issue that the Federal Reserve created the housing bubble just utterly devoid of any awareness of who created all the other bubbles," Mr. Greenspan said in an interview last week with The Wall Street Journal. Many countries have seen home prices rise more than in the U.S., in particular Britain and Australia, whose central banks didn't lower rates as far as the Fed did.

Mr. Bernanke was a Fed governor from August 2002 to June 2005. Over that period, he not only backed Mr. Greenspan's low-rate policy, he also provided theoretical and empirical justification for it in speeches and research.

Some economists say Mr. Bernanke and Mr. Greenspan are minimizing the Fed's contribution to the housing boom. Thomas Lawler, a housing-finance consultant in Vienna, Va., says the Fed's low rates helped both subprime and adjustable-rate mortgages gain market share from fixed-rate mortgages. ARMs, he said, grew from just 10% of mortgage originations in 2001 to almost a third in 2004.

Brian Sack, who worked with Mr. Bernanke at the Fed and is now at forecasting firm Macroeconomic Advisers, points out that expectations of short-term rates help determine long-term rates. The 10-year Treasury yield was about a percentage point lower with the Fed's easy policy than if the federal-funds rate, its main target for short-term interest rates, had remained around 4.5% to 4.75%, he said. He said that the Fed intended to boost housing at the time, because the rest of the economy was so weak.

Both men say it is harder to attribute the continued increase in home prices in 2005 and early 2006 to the Fed. (my emphasis) A new study by economists Jonathan Wright of the Fed and David Backus of New York University attributes the continuance of low long-term rates during that period to lenders' willingness to accept a lower premium for lending over long, rather than short, periods due to "some combination of diminished macroeconomic and financial-market volatility, more predictable monetary policy, and the state of the business cycle."