What drives house prices?
Ben Bernanke ended his speech in Atlanta yesterday by presenting two charts. Each one has house-price appreciation in various countries on the y-axis. In the first, it’s charted against monetary policy; in the second, against capital inflows.
Bernanke’s point is clear. In the case of the first graph, it’s that low interest rates didn’t cause the housing bubble: look at all those countries north-east of the USA on the chart, with greater house-price appreciation and tighter monetary policy. Rather, look to the second graph for a more credible explanation — when a country is running a large current-account deficit (when capital is pouring in from abroad), house prices tend to rise a lot. When a country is running a large current-account surplus (when it’s sending its own money abroad), by contrast, house-price appreciation tends to be modest.
So why, then, does Bernanke spend so much of his speech talking about underwriting standards and mortgage regulation? Those countries with enormous house-price appreciation, like New Zealand and France, didn’t have particularly weak mortgage underwriters or exploding ARMs. But the point here is that Bernanke is making a power grab:
The best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates…
The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by-institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach.
I’m actually sympathetic to Bernanke here. While weak underwriting might not have been a major cause of the housing bubble, it certainly served to exacerbate the systemic consequences of the bubble bursting. If the pain of falling house prices is felt mainly by individual homeowners, rather than by the banks who lent to them, then you don’t end up having to bail out the entire banking system at enormous public expense.
But I’m also worried about the implications of Bernanke’s second graph. The US continues to run an enormous current-account deficit. When that comes to an end, are we going to have yet another downward plunge in home prices?