What Was the Role of Monetary Policy in the Crisis?

Fed Chairman Bernanke gave a speech at the annual American Economic Association meeting in Atlanta on Sunday, arguing that global imbalances should be blamed for causing the housing bubble, not monetary policy. The counter argument is basically that interest rates brought down to one percent in 2003, making it cheaper for banks, mortgage originators, and individuals to buy homes. Without this, there wouldn’t have been enough money in the system for the housing boom. Bernanke counters that the boom started before the cheap money surge:

After some years of slow growth, U.S. house prices began to rise more rapidly in the late 1990s. Prices grew at a 7 to 8 percent annual rate in 1998 and 1999, and in the 9 to 11 percent range from 2000 to 2003. Thus, the beginning of the run-up in housing prices predates the period of highly accommodative monetary policy. Shiller (2007) dates the beginning of the boom in 1998.

Instead, he blames and influx of cash from overseas investors, particularly China, that pushed up sales prices and thus asset values. Bernanke concludes that global imbalances were the main cause. However, even he admits at least some blame belongs on his shoulders:

On the other hand, the most rapid price gains were in 2004 and 2005, when the annual rate of house price appreciation was between 15 and 17 percent. Thus, the timing of the housing bubble does not rule out some contribution from monetary policy.

Bernanke was a Fed Board Governor during the boom years and took over as chairman during the bubble, maintaining Greenspan’s hands off bubble policy. It is natural that he’ll want to point fingers in other directions. The question is, would the global imbalances have been so severe if the Fed had left interest rates a pre-dot-com bust levels, or followed the Taylor Rule to lift rates up faster after quantitative easing?

At the very least both imblances and easy monetary policy contributed to the crisis. But I would argue that these alone aren’t to blame. The crisis was made by these factors, plus the Basel II capital regulations and FASB mark-to-market accounting rules skewing the securitization process, decades of support for GSEs and policies promoting decreased lending standards for low-income families, and moral hazard created by implicit government too-big-to-fail guarantees distorting risk management on Wall Street. Understanding the housing bubble and crisis requires a very wide view and hyperinclusive perspective.