Tags: housing | bubble | inflate | narayana kocherlakota

How I Helped Inflate the Housing Bubble

How I Helped Inflate the Housing Bubble
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Tuesday, 14 June 2016 02:47 PM Current | Bio | Archive

People are still trying to figure out who was responsible for the run-up and subsequent collapse of U.S. housing prices that spawned the 2008 financial crisis. Some, for example, say it's the fault of the Federal Reserve, which kept interest rates low to combat the weak economy and low inflation of the early 2000s.

Actually, I have an admission to make: I should take some of the blame.

Let me start by noting that Fed story doesn't quite fit the facts. Land prices sharply accelerated in the five years starting in 1996, when the central bank's short-term interest-rate target was between 4.75 percent and 6.5 percent — hardly low, especially given that the economy was entering recession toward the end of that period.

Something of importance, though, did happen in 2005: My wife and I bought a house in Minneapolis (this was several years before I became president of the Minneapolis Fed). The price seemed high, but we figured we'd be fine in the Twin Cities, which historically hadn’t seen much in the way of housing booms or busts.  We thought that prices might not keep rising, but they wouldn't fall all that much either. The interest rate on our mortgage, which was between 5 percent and 6 percent, didn’t play a big role in our willingness to overpay.

But we turned out to be wrong about Twin Cities housing prices. As part of our move to Rochester, where I now work as a professor of economics, we recently sold that house.  Including money spent on renovations over the years, our capital loss came to about 45 percent of the 2005 purchase price. Back when we bought the place, I would have said that such a loss was completely impossible.

I wasn’t alone in making this mistake. All around the country in the mid-2000s, people were buying — or choosing not to sell — at prices that probably seemed high. Many of them probably thought like I did about the future evolution of housing prices. Like me, they were wrong.

Such collective mistakes drive housing bubbles. They recur throughout history — the earliest records of real estate bubbles go back at least to the Roman Empire. I’m highly skeptical of any country's ability to design a financial system that will eliminate such mistakes. 

Rather, policy makers must be better prepared when booms and busts do happen — for example, by being even more aggressive with monetary and fiscal stimulus in the event of a sharp downturn in asset prices.  On the bright side, they did much better last time than in the 1930s. Still, there's plenty of room for improvement.

Narayana Kocherlakota is the Lionel W. McKenzie professor of economics at the University of Rochester. He served as president of the Federal Reserve Bank of Minneapolis from 2009 through 2015. To read more of his insights, GO HERE NOW.

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(Bloomberg View) -- People are still trying to figure out who was responsible for the run-up and subsequent collapse of U.S. housing prices that spawned the 2008 financial crisis. Some, for example, say it's the fault of the Federal Reserve, which kept interest rates low to...
housing, bubble, inflate, narayana kocherlakota
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2016-47-14
Tuesday, 14 June 2016 02:47 PM
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