Thursday, December 11, 2008
More Greenspan Loving: Is Everyone On Crazy Pills?!
I am getting increasingly frustrated by some economists' attempts to deny that the housing bubble had anything to do with the )#$#4 negative real interest rates that Greenspan foisted upon us...during the exact period when housing prices exploded. What is particularly annoying is when these Greenspan defenders say things that are simply not true.
Take Casey Mulligan, whom I really like by the way, over at Cato Unbound. (Incidentally, I am starting to really love their format. They really take advantage of the Internet. Go Wilkinson!) Mulligan is taking Larry White to task for thinking the negative real rates--not seen since the 1970s, mind you, when I assume even Mulligan would admit the Fed messed with the real economy--might have spurred a jump in home prices.
Mulligan goes through some neoclassical analysis of the rational impact of short-term rates on housing prices. OK fair enough; I may come back to that in a future post. But then he says:
To this, all I can say is, "What the hell are you talking about, Prof. Mulligan?!"
Seriously folks, look at this chart:
So if by "not low" he meant "the lowest they have been in the 35 years for which the St. Louis Fed keeps records," then OK I see his point.
In fairness, maybe he means inflation-adjusted mortgage rates weren't low during the housing boom. But at the very least he could have clarified that.
But this just goes to show that when people start throwing evidence at you for why Greenspan couldn't possibly have caused the housing bubble, be sure to first make sure what they're saying is even true. Then, once you've verified that they're not saying the opposite of reality, you can go ahead and decide if it affects your opinion of Greenspan.
Take Casey Mulligan, whom I really like by the way, over at Cato Unbound. (Incidentally, I am starting to really love their format. They really take advantage of the Internet. Go Wilkinson!) Mulligan is taking Larry White to task for thinking the negative real rates--not seen since the 1970s, mind you, when I assume even Mulligan would admit the Fed messed with the real economy--might have spurred a jump in home prices.
Mulligan goes through some neoclassical analysis of the rational impact of short-term rates on housing prices. OK fair enough; I may come back to that in a future post. But then he says:
Perhaps Professor White would argue that market participants expected short term interest rates to remain low for much longer than a couple of years. If so, he is on shaky ground. First, such a claim is at odds with long-term interest-rate data. As I indicated in my article, long-term mortgage rates were not low during the housing boom. It’s not hard to find commentary from those years recognizing the low short-term rates were not expected to last.
To this, all I can say is, "What the hell are you talking about, Prof. Mulligan?!"
Seriously folks, look at this chart:
So if by "not low" he meant "the lowest they have been in the 35 years for which the St. Louis Fed keeps records," then OK I see his point.
In fairness, maybe he means inflation-adjusted mortgage rates weren't low during the housing boom. But at the very least he could have clarified that.
But this just goes to show that when people start throwing evidence at you for why Greenspan couldn't possibly have caused the housing bubble, be sure to first make sure what they're saying is even true. Then, once you've verified that they're not saying the opposite of reality, you can go ahead and decide if it affects your opinion of Greenspan.
Comments:
Bob,
I don't know how good your French is, but there is an economist named Vincent Benard with a blog called Objectif Liberte . He and I have corresponded a little and he has done some analysis identfying two determining factors for a housing boom. 1) Excessive land use regulations and 2) Low interest rates.
Europe, and especially England, are interesting cases because they have had several booms/busts although the most recent is the largest.
By the way, he speaks English quite well.
I'm coming around on the interest rate thing, but I strongly agree with Benard that home supply restrictions are a necessary precursor to a housing boom.
I don't know how good your French is, but there is an economist named Vincent Benard with a blog called Objectif Liberte . He and I have corresponded a little and he has done some analysis identfying two determining factors for a housing boom. 1) Excessive land use regulations and 2) Low interest rates.
Europe, and especially England, are interesting cases because they have had several booms/busts although the most recent is the largest.
By the way, he speaks English quite well.
I'm coming around on the interest rate thing, but I strongly agree with Benard that home supply restrictions are a necessary precursor to a housing boom.
"maybe he means inflation-adjusted mortgage rates weren't low during the housing boom"
Sorry for being confused, but if one takes into consideration inflation, wouldn't that make the interest rates even LOWER? As in: interest rates minus inflation rate equals real interest rate. No?
Sorry for being confused, but if one takes into consideration inflation, wouldn't that make the interest rates even LOWER? As in: interest rates minus inflation rate equals real interest rate. No?
James,
" wouldn't that make the interest rates even LOWER? "
Yes, but inflation has been changing over time. Inflation during the boom hovered in the 2-4% range, so real Fed targets ran in the -1/-3% range. Inflation during the late 70s may have been running at 10-15%, so if Fed targets back then were 10-12%, then the Real rates would be 0/-3%.
If you look at actual historical data and do the math, the real rate doesn't look a whole lot like the nominal rates in Dr. Murphy's graph.
" wouldn't that make the interest rates even LOWER? "
Yes, but inflation has been changing over time. Inflation during the boom hovered in the 2-4% range, so real Fed targets ran in the -1/-3% range. Inflation during the late 70s may have been running at 10-15%, so if Fed targets back then were 10-12%, then the Real rates would be 0/-3%.
If you look at actual historical data and do the math, the real rate doesn't look a whole lot like the nominal rates in Dr. Murphy's graph.
Dr. Murphy,
One impression you get by talking to actual businessmen (in banking and otherwise), is how much they believe short-term thinking rules financial markets. So when short-term rates drop, banks may have incentives to lend recklessly, even if they believe those rates are not sustainable (i.e., its unsustainable capital consumption, but unlike ABCT, there is full knowledge that it isn't sustainable).
I'm not sure what the cause of this short-term mentality is, but many businessmen believe it to be extremely wide-spread in publicly-traded companies. I'm sure this is partially due to principal-agent problems: executives (who are often paid according to performance, whether in shares, options, or just bonuses) can increase sales and then jump-ship before the bottom falls out. Shareholders can do the same in a liquid market.
A specific case that I'm aware of was a local bank where the executives had "poison-pill" severance packages, and the board was very concerned about their quarterly earnings (as they were expecting to be bought by a larger bank at some point in the near future). As a result, they took advantage of low interest rates, made unsustainable loans, and the executives pushed for them to be bought out by a larger bank in order to cash in on their severance packages.
One cause may be the structure of corporate governance (which is of course largely set by state and federal law). Nonetheless, the information asymmetries that allow this sort of behavior would be a problem in a completely free market as well.
One impression you get by talking to actual businessmen (in banking and otherwise), is how much they believe short-term thinking rules financial markets. So when short-term rates drop, banks may have incentives to lend recklessly, even if they believe those rates are not sustainable (i.e., its unsustainable capital consumption, but unlike ABCT, there is full knowledge that it isn't sustainable).
I'm not sure what the cause of this short-term mentality is, but many businessmen believe it to be extremely wide-spread in publicly-traded companies. I'm sure this is partially due to principal-agent problems: executives (who are often paid according to performance, whether in shares, options, or just bonuses) can increase sales and then jump-ship before the bottom falls out. Shareholders can do the same in a liquid market.
A specific case that I'm aware of was a local bank where the executives had "poison-pill" severance packages, and the board was very concerned about their quarterly earnings (as they were expecting to be bought by a larger bank at some point in the near future). As a result, they took advantage of low interest rates, made unsustainable loans, and the executives pushed for them to be bought out by a larger bank in order to cash in on their severance packages.
One cause may be the structure of corporate governance (which is of course largely set by state and federal law). Nonetheless, the information asymmetries that allow this sort of behavior would be a problem in a completely free market as well.
Brian,
You're right about why inflation-adjusting matters, but keep in mind we're talking about mortgage rates here. We don't know what the inflation-adjusted 30-year mortgage rate was for any mortgage granted after 1978. Presumably the average expected inflation rate in 1980 was lower than that same variable in 2003, but we really can't "check the data" to see.
You're right about why inflation-adjusting matters, but keep in mind we're talking about mortgage rates here. We don't know what the inflation-adjusted 30-year mortgage rate was for any mortgage granted after 1978. Presumably the average expected inflation rate in 1980 was lower than that same variable in 2003, but we really can't "check the data" to see.
Grant,
I have talked with a guy who works on Wall Street (I think) and he said that during the housing boom, he re-ran the Black Scholes formula on some asset his firm was discussing, and plugged in a 200-point increase in short-term rates. It blew up the position they were considering. He brought it to the attention of his colleagues, and they didn't think it was a big deal.
I have talked with a guy who works on Wall Street (I think) and he said that during the housing boom, he re-ran the Black Scholes formula on some asset his firm was discussing, and plugged in a 200-point increase in short-term rates. It blew up the position they were considering. He brought it to the attention of his colleagues, and they didn't think it was a big deal.
Bob,
You're right. I was over simplifying.
I'm not actually sure what relevance real interest rates have in an analysis of home prices. Changing the nominal interest rate by 1% will have a much bigger effect on the PV of a payment stream than 1%. That is assuming 100% financing, no taxes, no insurance, I could afford 12% more house under a 30yr if rates fall from 6% to 5%.
Cross-price elasticity of demand muddies this simple calculation for the market as a whole, but using real interest rates seems to be kind of pointless to me.
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You're right. I was over simplifying.
I'm not actually sure what relevance real interest rates have in an analysis of home prices. Changing the nominal interest rate by 1% will have a much bigger effect on the PV of a payment stream than 1%. That is assuming 100% financing, no taxes, no insurance, I could afford 12% more house under a 30yr if rates fall from 6% to 5%.
Cross-price elasticity of demand muddies this simple calculation for the market as a whole, but using real interest rates seems to be kind of pointless to me.
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