What caused the housing bubble? In general, the short answer you’ll get to that question is “Alan Greenspan kept interest rates too low for too long”. I’m not going to argue with that, but I wouldn’t argue with another point made by Matthew O’Brien of the Atlantic, either:
Alan Greenspan is still to blame. Just not for the reason most people think.
Where the Fed really failed was as a regulator. It could have gone after the predatory lending in the subprime world, if it had wanted to. At least one Fed governor suggested doing so. Greenspan rebuffed him. Counter-factuals are always tricky, but if the Fed had clamped down on the endemic fraud in the mortgage market, it’s not difficult to imagine the run-up in housing prices being much more muted. After all, if the problem had been low interest rates, prices should have skyrocketed across the board. That prices only skyrocketed for housing tells us that something peculiar was going on there, namely an abdication of any regulatory oversight.
Greenspan, while occasionally warning of the risk, felt that technological advances had created a “new economy”, an economy less susceptible to downturns. He wanted to make sure this new economy was funded. In light of what we know now, comments like these comments made by Greenspan in 2004 are particularly horrifying:
WASHINGTON — Federal Reserve Chairman Alan Greenspan said Monday that Americans’ preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.
In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said.
“Overall, the household sector seems to be in good shape,” Greenspan said.
And if that doesn’t curl your hair…
While borrowers can refinance fixed-rate mortgages, Greenspan said homeowners were paying as much as 0.5 to 1.2 percentage points for that right and the protection against a potential rate rise, which could increase annual after-tax payments by several thousand dollars.
He said a Fed study suggested many homeowners could have saved tens of thousands of dollars in the last decade if they had ARMs. Those savings would not have been realized, however, had interest rates shot up.
“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” Greenspan said.
Why regulate against something when you think it’s a good idea? If Greenspan’s credit bubble fueling interest rate policies were the fuel for housing bubble, Greenspan’s love of “financial innovation” helped grease the wheels.