Canada's Housing Bubble

May 01, 2010 Joshua Zumbrun Bloomberg

The president of the Federal Reserve Bank of Atlanta told fellow policy makers in 2004 that the central bank’s low interest rates may be contributing to surging home prices, according to transcripts of their meetings.

“The substantial run-up in house prices, which we have followed in Florida and also see in the populous Northeast and West Coast of the United States, may be at least partially attributable to unusually low mortgage rates influenced by our very accommodative policy,” then Atlanta Fed President Jack Guynn told the Federal Open Market Committee on Dec. 14, 2004, according to transcripts released yesterday.

Economists including John Taylor of Stanford University, a former Treasury undersecretary, have said that low interest rates under former Fed Chairman Alan Greenspan helped fuel the housing boom and bust that precipitated the recession. Ben S. Bernanke, the current chairman and a Fed governor in 2004, has disagreed, saying in a January speech that the central bank’s policy of maintaining a low target rate shouldn’t be blamed for the housing bubble.

“The direct linkages, at least, are weak,” Bernanke said. “House prices began to rise in the late 1990s, and although the most rapid price increases occurred when short-term interest rates were at their lowest levels, the magnitude of house price gains seems too large to be readily explainable by the stance of monetary policy alone.”

Home Prices

While the Fed held interest rates at 1 percent from June 2003 until June 2004, the rise in home prices accelerated, eventually leading to the crash in valuations that preceded the financial crisis. The annual increase in home prices reached a record 20 percent in July 2004, according to the Standard & Poor’s Case-Shiller 10 City Composite Home Price Index. The index hit a peak in June 2006.

Policy makers in June 2004 raised the federal funds target to 1.25 percent from 1 percent, the first of 17 consecutive quarter-point increases over two years, stopping at 5.25 percent.

The Fed releases FOMC transcripts after five years.

Other policy makers also raised concerns about home prices during meetings in 2004. On Sept. 21, then-Boston Fed President Cathy Minehan said consumers are “willing to take saving rates to record lows in the wake of substantial appreciation in housing prices. Clearly, this could turn around and is a potential source of downside risk.”

On Nov. 10, Gary Stern, president of the Minneapolis Fed, reported to the committee on a meeting his bank held partly to look at “a potential bubble in house prices.”

‘Credit Pendulum’

Stern told the FOMC that “a couple of the lenders did say that they thought the credit pendulum had swung too far. They felt that credit conditions had become too easy, and they were anticipating some potential difficulties going forward -- presumably in somebody else’s shop!”

During 2004, the share of subprime originations in the mortgage market more than doubled. In 2004, 18.5 percent of mortgages were subprime, compared to 7.9 percent in 2003, according to Harvard University’s “State of the Nation’s Housing” report, citing data from Inside Mortgage Finance.

Then-Fed Governor Edward Gramlich in May of 2004 said in a speech about “Benefits, Costs and Challenges” of subprime mortgage lending that “while the basic developments in the subprime mortgage market seem positive, the relatively high delinquency rates in the subprime market do raise issues.”

Risks of Collapse

Greenspan in an Oct. 19, 2004, speech raised the risks of a collapse in home prices, saying “these concerns cannot be readily dismissed.”

“Should home prices fall, we would have reason to be concerned about mortgage debt; but measures of household financial stress do not, at least to date, appear overly worrisome,” Greenspan said.

In March 2004, Guynn also warned of speculative excess in housing.

“A number of folks are expressing growing concern about potential overbuilding and worrisome speculation in the real estate markets, especially in Florida,” Guynn said.

“Entire condo projects and upscale residential lots are being pre-sold before any construction, with buyers freely admitting that they have no intention of occupying the units or building on the land but rather are counting on ‘flipping’ the properties -- selling them quickly at higher prices,” he said.

Guynn, who retired as head of the Atlanta Fed in October 2006, didn’t respond to messages seeking comment.

Perplexed by Speculation

In June 2004, central bank officials were perplexed by speculation in housing and rising home prices in the course of discussions that resulted in an increase in borrowing costs, according to the transcripts.

Stephen Oliner, then Fed associate research director, told the FOMC on June 30, 2004, that the ratio between rents and prices deviated from historical trends and wasn’t explained by “fundamentals,” according to the transcripts.

“I don’t want to leave the impression that we think there’s a huge housing bubble,” Oliner said. “We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there’s a part of the increase that is hard to explain.”

At the December meeting, Guynn said the home-price boom required a review.

“The risks associated with the run-up in house prices probably deserve further study and thought as we decide how to posture policy,” said Guynn.

--Editors: James Tyson, Christopher Wellisz

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