asset bubbles

Simone Baribeau

Brad Sherman, a Democratic representative from California, wants you to pay more for your home.

Mr Sherman today objected to the FHFA’s plan to roll back the temporary increase in the conforming loan limits put in place during the housing market crash.

“Nothing could destroy this recovery more than a double dip in home prices,” he told Edward J. DeMarco, Acting Director of the FHFA, the group that controls Fannie Mae and Freddie Mac, the government sponsored enterprises, at a hearing

Simone Baribeau

In which US cities are home prices likely to fall?

One measure is to look at the amount home prices have fallen, relative to the increases in their rental prices. Moves in rental prices tend to represent fundamental changes in the value of a property (people are paying only what it’s worth to stay there) rather than bubble-induced speculation about the future value of the property. In markets where there are bubbles, eventually, home prices should fall back in line with rental prices. 

Simone Baribeau

Can bubbles be predicted?

Donald Kohn, the outgoing Fed vice chairman, told an ECB meeting today, “Judging when an asset is getting away from its fundamental value is almost impossible.” (via Reuters).

It’s a step away from William Dudley, New York Fed president, calling for the Fed to take a more proactive approach in addressing asset bubbles. But if, as Mr Kohn says, you can’t identify them, you certainly can’t act against them. (Mr Kohn also warned, according to Reuters, that trying to do so would lead to “more volatility in output and inflation,” though it’s hard to imagine more volatility in output than we saw at the end of the last bubble.)

So how hard are housing price bubbles to identify? Looking at US housing prices over the past few decades, it’s not immediately obvious why a bubble would be difficult to identify. Housing prices may stray from rental prices, but in the long run, they return to the rental levels. (And why wouldn’t they? If houses were actually becoming more valuable in a given city, both housing and rental prices would rise).

Here’s nationwide home prices (Case Shiller 10-city) compared to rents since 1987:

Prices didn’t move far from the rental levels before returning until the recent run up. And then they skyrocketed. And then (un)predictably, they collapsed. Perhaps there’s no city that has a more perfect model of stable housing prices until the recent bubble than Miami. Was it that surprising that prices fell after that run up in housing prices (without a simultaneous increase in rents?) 

Simone Baribeau

The Chicago Fed today put out a rather unusual paper discussing the art and science of risk management. It concludes that too much focus was put on the science of risk management, rather than the art.

More and more, the ‘art’ of using informed intuition to navigate complicated risk landscapes was giving way to the ‘science’ of statistical models. 

Simone Baribeau

At what point were Federal Reserve members obligated to warn about the risks a housing bubble posed to financial stability?

Ben Bernanke, then a Fed governor, spelt it out in a meeting in 2004, according to a recently released transcript. Fed members were periodically asked questions about perceived and actual risks to financial stability, he said, specifically citing a housing bubble as an example:

One’s inclination is to answer by painting a benign picture so as not to cause unnecessary public concern. On the other hand, financial conditions do change, and it’s our collective responsibility both to monitor those changes and to communicate truthfully to the public what we see.

Of course, truthful communication depended on what they knew and when they knew it. Nothing in the transcripts indicates that FOMC members were unduly concerned with the price of housing. It’s not that they didn’t periodically talk about housing bubbles in meetings or that strong evidence of a bubble wasn’t presented to them. 

Simone Baribeau

Who’s afraid of depressing asset prices by raising overnight rates?

Alan Greenspan has repeatedly said that raising overnight rates wouldn’t have been effective in mitigating the housing bubble. But it turns out that at least one member of the FOMC worried in a 2003 meeting that that was exactly what would happen should the Fed raise rates too quickly. 

Robin Harding

The Bank of Japan is not going to let the government foist an explicit inflation target on it without a fight. In a fascinating speech given in New York yesterday BoJ governor Masaaki Shirakawa argues that inflation targets are one reason that central banks allowed asset price bubbles to develop. For good measure he suggests that the world learned the wrong lessons from Japan’s deflation – and implies that US monetary policy in the 2000s was too loose as a result.

Mr Shirakawa’s argument:

Second, some political, economic and social dynamics influenced central bankers, and it became difficult for them to conduct monetary policy based on factors other than the inflation rate. This mechanism is quite subtle. The logic that price stability is a precondition for economic stability and that the independence of the central bank is necessary for price stability, became gradually but firmly established in the 1990s. At the same time, the granting of independence naturally called for the strengthening of accountability. An easily identifiable benchmark was desired. The framework which best fulfilled such needs was inflation targeting. However, under an inflation targeting regime, the debate tends to center on the relationship between the target inflation rate and the actual or expected inflation rate.

As a result, the cost of justifying adjustments in monetary policy becomes quite high in the eyes of central bankers, when such adjustments are aimed to deal with imbalances which appear in forms other than price indices. Economists focused their attention to the linkage between the output gap and the inflation rate, while awareness toward financial imbalances was limited.

 

By Bernard Simon

The Bank of Canada has signalled it is likely to raise interest rates in the next few months in response to unexpectedly strong domestic growth, including a housing boom that has shown signs of developing into a speculative bubble. 

Simone Baribeau

Homeprices resume their fall after recent gains after the tax credit was set to expire.

Ben Bernanke, Federal Reserve chairman, earlier today cited “residential and nonresidential construction” as a headwind to the “moderate” economic recovery. But he also said that consumer spending will be boosted by “a gradual pickup in jobs and earnings, the recovery in household wealth from recent lows, and some improvement in credit availability.”

Household wealth is, of course, comprised of many types of assets, including retirement portfolios and other equity and bond investment holdings. But one of its major components is home values.

So is that portion of household wealth likely to grow? See the somewhat downbeat graph. 

Simone Baribeau

William C Dudley, New York Fed president, earlier this week called for central bankers to use the ‘bully pulpit’ to pop asset bubbles. Though Ben Bernanke, Fed chairman, has suggested that the Fed may be ready to consider addressing asset bubbles (until recently considered too difficult to identify to address), it was the first time that a Fed official spelt out which tools the Fed would use. Central bank officials have often used the red-herring that changing interest rates wouldn’t be effective in leaning against bubbles. (Sure – but aren’t there other tools?)

According to an interesting follow-up interview on NPR today, Mr Dudley tells Planet Money that he doesn’t think there is any “appreciable difference” between his views and those of Federal Reserve chairman Ben Bernanke.

Mr Bernanke hinted in his February testimony to Congress that the Fed – which had previously appeared not to see addressing asset bubbles as part of its mandate – may be on the verge of doing so, saying that there is no “obvious bubble” in the US economy but, if there were “then the response probably would depend on which asset it was, what part of the economy it was.” He went on to say that the Fed would “have to see what tools” it had to address it.

It turns out, of the tools Mr Dudley mentions, the bully pulpit – having central bank officials publicly talk about the bubble – is the first one he lists.