The NYT reports that the Fed folks are trying to wash their hands of responsibility for the housing bubble, claiming that it would have been wrong to raise interest rates in 2003 and 2004 to head off the bubble. While it is arguable whether the inevitable pain from a housing bubble collapse is greater than the cost of the slow growth that would have resulted from raising interest rates, these were not the only two options. The Fed could have acted aggressively to try to specifically target the housing bubble. The most obvious mechanism would have been to use the Fed's enormous megaphone to call attention to the fact that house prices had hugely diverged from long-term trends. If Fed Chairman Alan Greenspan had regularly used his congressional testimonies and other public appearances to call attention to the unprecedented run up in house prices, it is difficult to believe that it would not have had any impact on the decisions of homebuyers and lenders. Instead, Greenspan did the exact opposite, deriding claims that there was anything unusual in the increase in house prices. He even encouraged homebuyers to take out adjustable rate mortgages. The Fed could also have used its regulatory powers to curb some of the worst abuses in the subprime market. Greenspan resisted efforts by Edward Gramlich, a governor of the Federal Reserve Board, to increase regulation back in 2003. Greater regulation also would have helped to stem the run-up in prices and would have prevented many of the foreclosures that the country will see in the next couple of years.
--Dean Baker
