Fed missed the housing bust

Chip Somodevilla/Getty Images

(MoneyWatch) Who would want a detailed, public record of our business decisions? Unfortunately, if you are an esteemed Fed governor, you must confront your exact words from meetings that occurred 5 years ago. The central bank released 1,566 pages of transcripts from each of the Fed's eight monetary policy meetings in 2007, which is customary. What is not customary, of course, is that 2007 was the year that one would have hoped that our most esteemed bankers would have gotten the drift that there was something rotten in the nation's housing market.

Clearly Chairman Ben Bernanke would like to take back this January 2007 comment: "The housing market has looked a bit more solid, and the worst outcomes have been made less likely." Or his June remarks, which may have been a "bit" of an understatement: "A bit of cooling in the financial markets might not be an entirely bad thing." Bernanke is not alone in his misjudgment of the economic and financial industry landscape. Outgoing Treasury Secretary Tim Geithner, who in 2007 was the NY Fed president, said "Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things." Oops!

There was one Fed governor who nailed the situation. Janet Yellen, who at the time served as the San Francisco Fed president, expressed the danger that loomed in June 2007: "I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst."

Yellen's prescience is reminiscent of Brooksley Born, the late 1990s chairman of the Commodity Futures Trading Commission, who was the only regulator who saw the danger of over-the-counter derivatives, the vehicles that a decade later would contribute to the financial crisis. The big difference in 2007 was that Yellen was not the lone voice and she was not bullied by her colleagues.

Still, Yellen could not rally the other central bankers to her cause. In September 2007, she reiterated her concerns: "A big worry is that a significant drop in house prices might occur in the context of job losses, and this could lead to a vicious spiral of foreclosures, further weakness in housing markets, and further reductions in consumer spending. ... at this point I am concerned that the potential effects of the developing credit crunch could be substantial." Yellen is currently the Vice Chair of the Board of Governors of the Federal Reserve System and if she was seen as a potential successor to Ben Bernanke prior to this release, these comments beef up her chances in a big way.

Eventually, the Fed did recognize the magnitude of the problem, but as is often the case, the governors were late in their diagnosis and remedies. That's why so many economists are worried about the central bank's ability to withdraw its easy monetary policy when the U.S. economy improves. With the current low level of inflation (running below the Fed's target of 2 percent on a year-over-year basis) and the high level of unemployment, the Fed will keep buying bonds and pushing money into the system until further notice. But will the Fed be able to predict when its time to stop?

Right now, economic growth is stuck in a low gear of about 2 percent annually, but when it reaccelerates, perhaps due to an uptick in global growth or a housing sector that perks up, the Fed could once again be behind the curve. When that happens, inflation will re-emerge; bonds will finally see the much-predicted sell-off; and the Fed will likely cringe when future transcripts are released.

This week, evidence of housing's recovery will continue to trickle in. There's little doubt that 2012 was the year that housing bottomed nationally. Prices were up about 6 percent; existing and new home sales rose by about 15 percent each; and housing starts increased 28.1 percent.

While this is good news, the housing crash created quite a hole. Prices are still down about 30 percent from the peak and even with the big jump in starts, 2012 ranks as the fourth lowest year since the Census Bureau started tracking starts in 1959 (the three lowest years were 2009 through 2011).

Meanwhile, the third straight week of gains brought two of the three U.S. stock indexes to their highest levels since December 2007. As the nation prepares for Inauguration Day, here's a tidbit: President Obama's first term was good for investors, with stocks up over 70 percent.

-- DJIA: 13,649 up 1.2 percent on week, up 4.1 percent on year (4 percent below all-time high of 14,164, reached in 10/07)

-- S&P 500: 1,485, up 1 percent on week, up 4.2 percent on year (5 percent below all-time high of 1,565, reached in 10/07)

-- NASDAQ: 3,134, up 0.3 percent on week, up 3.8 percent on year (still a whopping 38 percent below all-time high of 5,048, reached in 03/00)

-- February Crude Oil: $95.56, up 2.1 percent on week

-- February Gold: $1,687, up 1.6 percent on week

-- AAA nat'l average price for gallon of regular gas: $3.31

THE WEEK AHEAD:

Mon 1/14: MLK Day: U.S. markets closed/Inauguration Day

Tues 1/15:

Google, IBM, Johnson & Johnson, Texas Instruments, Verizon

8:30 Chicago Fed National Activity Index

10:00 Existing Home Sales

Weds 1/16:

Abbot Labs, Apple, McDonald's

9:00 FHFA House Price Index

Thurs 1/17:

3M, AT&T, Microsoft, Xerox

8:30 Weekly Claims

10:00 Leading Indicators

Fri 1/18:

Proctor & Gamble, Weyerhaeuser

10:00 New Home Sales

[dynariffic]

I believe that there were agents in Government as well as the Mortgage Industry, Banking Industry and Wall Street that ABSOLUTELY KNEW THIS WAS GOING TO HAPPEN WAY BEFORE IT ACTUALLY WENT BUST. They all colluded to steal every penny they could from Middle Class and Low Income Americans.

[cbsblogger]

Yes they knew what they were doing and they knew they were the tail wagging the dog. They rigged it so that taxpayers would soon be on hook for their bailout, and that they would use the proceeds for compensation and to buy up public assets from now indebted bankrupt cities and a squeezed federal government.

These SxBs should be facing a gallows instead of continuing to pull the strings of government for the benefit and reward of their little corrupt greedy club. You be certain there was a good reason they were once thrown out of the temple. It's because they work against the common good instead of for it.

Instead their minion keep us at each others throat blaming it on the left or right.

[jtmarlin100]

Good for you, Jill Schlesinger, for going through the transcripts. They aren't much use unless someone peruses them in the light of the aftermathematics. I believe we are in a zero-bound monetary policy purgatory since 2008 until we understand why we are in it.

[bundush]

No one there knew about the crimes going on in those industrys till 2007? You know this is a lie and Obama was not the the POTUS.

If this is really true that they did not know, then America has the dumbest people on Earth sitting in leaders seats.

But we know what we really had were the biggest crooks in there.

[ThereAreNoReserves]

Blaming this on Republicans or Democrats is exactly what the shareholders of the Federal Reserve Corporation want you to do. That's how they keep the focus off of themselves — the people's true enemy. The FED didn't "miss" the housing bubble, the created it and they popped it.

A debt based money system of necessity creates booms and busts. The booms are debt/credit expansion. Then, since the interest to pay these debts is not created and put into circulation along with the principal, the bust comes because the terms of the loans are impossible because the interest required to satisfy the debt does not exist. The people call it a recession or depression while to the bankers it is consolidation. Credit created under the fractional reserve banking system is consolidated and converted into hard assets.

[davidd5063]

There hasn't been a significant uptick in inflation in 30 years, and yet the GOP manages a recession, each one worse than the last, and each one based on a housing bubble right under the Fed's noses every time they win office. Couldn't be that the Fed is composed mainly of inherited wealth trust fund babies that only care about other trust fund babies like themselves now could it? Yes, you KNOW that's the case. There won't even be a threat of inflation when the Fed starts working on the next housing bubble for the GOP - just wait for them to bribe the ignorant with a paltry tax cut for working people and TRILLION DOLLAR DEFICITS for our children.

[hypnotoad72]

Most of us in the peanut gallery knew their supply-side bailouts and other giveaways to the supply-side (at the expense of the demand-side) wouldn't actually fix anything... but it's funny how the rightwingers blame it all on Obama, when Bernanke and others were first brought in by Bush. Maybe they'll admit that one day, but they always act as if Bush did not wrong...