Bernanke’s fearful asymmetry

January 5, 2010

saft2.jpg – James Saft is a Reuters columnist. The opinions expressed are his own —

Ben Bernanke may minimize the role of monetary policy in the housing debacle, but he minimizes two key factors: the effect of low rates and the Fed’s policy of cleaning up after but not popping bubbles had on risk-taking.

In what amounts to a defense of his own and Alan Greenspan’s legacy, Bernanke maintains that low interest rates didn’t cause the bubble, which he says required a regulatory rather than monetary solution.

“Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages,” Bernanke said in Atlanta over the weekend.

And where, I wonder, did borrowers get the idea that these new-fangled mortgages were good for them and that double-digit house price increases would continue? Greenspan famously sang the praises of mortgage innovation and floating rates for house buyers, while both he and Bernanke missed the bubble and downplayed its potential impact almost all the way to the bottom.

Even more to the point was the Fed’s asymmetrical response to bubbles: doing nothing to pop them on the way up, and dropping rates to ease the pain in their aftermath. So the Fed did after the dot-com crash and so it did again, in spades, after the housing bust.

The Fed under Greenspan, who seemed to believe that markets were not just efficient but somehow magical and whose direction of monetary policy during his term was largely consistent with that point of view, allowed the bubble to form.

No amount of retro-fitting the Taylor rule on different variables will change that.
Bernanke now acknowledges that he might be forced to use the blunt force of interest rates against future housing bubbles, but his speech seems designed to leave the reader with the impression that higher rates are a last worst choice.

So it seems that Greenspan’s asymmetry has been made a bit more even by Bernanke, though given the experience of the last few years, that is still pretty scary. The incentives and attitudes, at least toward financial innovation, are still there and so is the belief that the Federal Reserve will be there to ease the pain if another bubble pops.

IT’S NOT “WHAT CAN I AFFORD?”, IT’S “WHAT CAN I EARN?”

Bernanke makes the argument that the effect of lower rates pales in comparison with the impact of products that defer payments or allow borrowers to keep payments lower in exchange for taking more risk.

I think it’s not hard to argue that the Federal Reserve, as an interest rate setting body, had a bigger impact on house prices during the brave new world period of heavy securitization than perhaps it had when Fannie, Freddie and their non government-backed competitors were smaller.

But it’s important to understand that this impact had at least two important parts. The first Bernanke addresses; low interest rates as an enabler for house buyers who might not otherwise  be able to reach for a given house. But the second is at least as important. Low interest rates almost certainly had a huge impact on the providers of capital, especially those providers of capital to the financial markets, as opposed to  traditional bank financing of mortgages.

“What Bernanke seems to be overlooking in his exoneration of ultra-low rates was the impact they had on the world’s bond managers,” Barry Ritholz, CEO and director of equity research at research firm Fusion IQ in New York, wrote on his blog .

Those people, and I know because I was interviewing them throughout the period, were reaching for yield. They had badly thought out targets that had been put together during periods of higher inflation and they wanted to be able to meet them still despite a low overall rate structure.

That unmet need — for an 8 percent return in a 3 percent world — was met magically but only temporarily by structured finance. Is that the fault of low interest rates? Not strictly speaking, but it is in substantial part the fault of the Fed, which wrote cheap insurance for risk takers, praised their innovations and cleaned up after their messes.

Low rates in a world of asymmetrical monetary policy are all the more potent and all the more dangerous.
Still, better regulation is called for and without it higher rates in isolation would be dangerous and destructive.

Based on Bernanke’s latest speech, I am not guessing that we will get either effective regulation or preemptive interest rate rises.

The practical implication, for those of you interested in more than who is to blame, is more bubbles.

8 comments

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Bernake and Greenspan refuse to take any responsibility. The borrowers borrowed and that’s their story and they are sticking to it. Lax regulation and that’s that.
Every student of economics knows that banks create money by lending and the Fed is responsible for money supply. Mortgage innovations were voodoo behind the fall and the Fed applauded the innovation. The banks and the triple A rated junk bonds sunk the economy. Oh yeah, and the Fed’s responsible for the health of the banking system too. I don’t remember the consumer being helped out under TARP. Stock Market crash in 1987 led by Alan Greenspan’s tight monetarypolicy. Raising interest rates in 1990 led to the recession of 1991. Raising interest rates through 2000 led to the recession of 2001. Raising interest rates 17 times in 2006 and 2007 led to the soft depression of 2008-2009. Never mind the bubbles — LBO and junkbonds in the 80′s, tech stocks in the 90′s, and housing in the 2000′s; he Fed saw them; if the economy is growing and no one appears to be getting hurt — the Fed is see no evil, speak no evil, hear no evil. There’s and old axiom in bankruptcy,the managment team that got you into trouble is not the team that will get you out of it. It is also true of economist and the Fed who can’t recognize their role and that they are the problem.

Posted by JMRAG | Report as abusive

US housing will continue to fall in 2010 as strategic foreclosures, currently 25% of total foreclosures, rises. Why stay in a mortgage when your neighborhood is renting at 1/3 the cost of your monthly mortgage? Read a wild California foreclosure story at http://storyburn.com

Posted by voomies | Report as abusive

There are two kinds of corruption in this world — the first is the petty, third world variety of bribery and graft and everyday pay-offs, and the second is the American kind. The American kind is where the powerful, the well-connected, the wealthy, and the conniving manipulate the laws and regulations of society to their benefit. It’s a take from the poor, give to the rich game.

Just look at the contemporary American landscape : fraudulent mortgages cheered on by the central bank, rampant college loan gouging, Wall Street’s manipulation of investment algorithms, tax cuts for the wealthy, tax exemptions for politically active churches, hegemonic health insurance rackets, thinly veiled protection schemes, exclusionary charter schools supported by federal dollars, federal support for the coal industry, and so on.

This is the sort of corruption the head of the FBI meant when he said that it was undermining Americans’ faith in their nation’s institutions. He was not talking about Bernie Madoff and his ilk, as bad as they are. When Madoff got caught, I simply learned not to trust Madoff. But when Greenspan and Bernanke smile on a system that wipes out peoples’ life savings, forecloses on their homes, and lays them off by the millions, whom should I mistrust? The entire Federal Reserve and regulatory system that allowed it to happen, that’s who.

There is no trust between the average American and ANY of the nation’s institutions any more. It’s gotten so bad that it has even extended to the vaunted, bloated, inept U.S. military and the intelligence apparatus that supports it. Where where they on 9-11? Why did they let bin-Laden escape? What WMD? The Iraq War. Why didn’t the generals dig in their heels and ask, WHY?

The word for the American situation is quite simple. Decline. When you no longer have the support of the people you have an ungovernable nation. Things will only get worse.

Posted by IntoTheTardis | Report as abusive

“…doing nothing to pop them on the way up.”
This is an attribute of greed.
This nation has internalized and accepted the forces of greed, avarice, corruption and dishonesty; along with, incompetence and insensitivity. The Fed is the enabler.

Posted by Jonesy | Report as abusive

no no no…bernake’s a big fat liar! (so is greenspan.)

what really happened was: the 30 year fixed rate mortgage (at a reasonable interest) was put beyond the reach of ordinary borrowers! to get one of those you had to have sterling credit. for people having less than sterling credit there were adjustable rate no money down interest only balloon loans. generally lead by their noses into a profitable arrangement for banks and mortgage fixers!

people are desperate for decent housing. no one wants to live in a noisy roach infested broom closet and pay ridiculous rents to viscous landlords! thus the banks have a built-in sucker market. and there’s one born every minute!

now there are just two laws of american capitalism: (1) never give a sucker an even break and (2) there’s one born every minute!

now that you know that you should be able to see clearly that american capitalism is 100% USBS. every: ad, deal, offer, arrangement, bargain, and sale “provided” to people who are not ‘connected’ is a lie!

every time one of these balloons pops you can see this as clear as day (if only for a moment). then the liars come back to start the ball rolling again. look-out, suckers!

now, you’d think the american people would have learned this after nixon & reagan, the savings and loan crisis, and the recessions in the 70s and 80s, and the off-shoring of their jobs; but they haven’t. maybe they’re just too ‘slow’.

Posted by jborrow | Report as abusive

better version:

no no no…bernake’s a big fat liar! (so is greenspan.)

what really happened was: the 30 year fixed rate mortgage (at a reasonable interest) was put beyond the reach of ordinary borrowers! to get one of those you had to have sterling credit. for people having less than sterling credit there were adjustable rate no money down interest only balloon loans.

people are desperate for decent housing. no one wants to live in a noisy roach infested broom closet and pay ridiculous rents to viscous landlords! thus the banks have a built-in sucker market. now there are just two laws of american capitalism: (1) never give a sucker an even break and (2) there’s one born every minute!

now that you know that you should be able to see clearly that american capitalism is 100% USBS. every: ad, deal, offer, arrangement, bargain, and sale “provided” to people who are not ‘connected’ is a lie!

every time one of these balloons pops you can see this as clear as day (if only for a moment). then the liars come back to start the ball rolling again. look-out, suckers!

now, you’d think the american people would have learned this after nixon & reagan, the savings and loan crisis, and the recessions in the 70s and 80s, and the off-shoring of their jobs; but they haven’t. maybe they’re just too ‘slow’.

Posted by jborrow | Report as abusive

Now who do the Federal Reserve people work with? The banks,dumbhead. They couldn’t have been wrong, could they? Just blame someone who can’t talk back, or better, someone who has died. We don’t expect a Government man to actually take responsibility. It is kind of fun watching them fall on their fannies, isn’t it.

Posted by fred5407 | Report as abusive

I think he is telling the truth, but only part of it. Borrowers were lent the money because banks were playing us all for greedy suckers (which we are) knowing that when the bubble would finally pop, congress and the feds would enact policies to make them whole, while leaving homeowners upside down on their debt. In other words, they created a world where they could lock in $5 worth of sales on $2 worth of product. And what popped the bubble? Oil, intentionally.

Posted by Soothsayer | Report as abusive