Former Fed chairman Alan GreenspanKEVIN LAMARQUE
U.S. Federal Reserve officials worried in 2005 about the risks a housing bubble could pose to the U.S. economy but ended the year hopeful a steady round of interest-rate increases would keep the problem in check, transcripts released Friday showed.
The documents suggest the Fed, in hindsight, may have been too complacent about an overheated housing market that helped spark the worst U.S. financial crisis and deepest recession since the 1930s.
"I think whatever froth there is in the housing market is becoming contained at this stage, and it's getting contained largely because mortgage rates have moved up and are beginning to have an impact," then-Fed chairman Alan Greenspan said at the central bank's Dec. 13, 2005, policy-setting meeting.
"If we can contain the presumptive housing bubble, then we have a really remarkable run out there," he said.
Mr. Greenspan had always held that spotting bubbles in advance was an impossible task, and in July, 2005, he famously referred to "signs of froth in some local markets" but stopped short of declaring whether home price trends had overshot nationally.
That year, the Fed was in the midst of a steady round of monetary tightening and it raised short-term interest-rate target by a quarter of a percentage point at each policy meeting.
By December, some policy makers - including Mr. Greenspan - had begun to think that the round of tightening was nearing its end, and the consensus was that the housing market was beginning to cool.
"I offer one more piece of evidence that I think almost surely suggests that the end is near in this sector," Fed Board economist David Stockton said as he briefed policy makers at their December meeting, referring to the housing sector. "While channel surfing the other night, to the annoyance of my otherwise very patient wife, I came across a new television series on the Discovery Channel entitled Flip That House."
He went on to say that only time would tell whether the TV show and other signs were just a "head fake or are the start of our long-awaited slowdown in this sector."
Mr. Greenspan had little difficulty convincing his fellow committee members that rates should be raised a bit further. The committee agreed, and overnight rates were set at 4.25 per cent.
As it turned out, the Fed continued to raise rates through the first half of 2006. Housing prices also continued to rise, and did not peak until mid-2006.
Analysts have faulted Mr. Greenspan for keeping rates too low for too long in the early 2000s, fuelling the housing bubble whose collapse helped plunge the United States into the Great Recession.
In Mr. Greenspan's view, the Fed was better off standing by to mop up after bubbles. Attacking a potential bubble with rate hikes could damage the broad economy, he argued.
Current Fed Chairman Ben Bernanke, who was on the Fed Board during the first half of 2005, had made the same point years earlier, suggesting in 2002 that trying to pop asset bubbles with monetary policy is akin to performing brain surgery with a sledgehammer.
While Fed officials generally still agree rates are not the proper way to prevent damaging bubbles, a shift in thinking has taken place since the financial crisis struck.
There is now broad agreement that the Greenspan-era regulatory regime was too lax and that more forceful oversight could head off destabilizing increases in asset prices.
Legislation enacted last year that rewrote rules for Wall Street envisioned exactly that, giving the Fed new regulatory powers and creating a new council to oversee financial stability.
Interestingly, Mr. Greenspan foreshadowed a similar approach in comments at the November, 2005, meeting of the Fed's policy-setting Federal Open Market Committee.
"Are we dealing solely with the prices of goods and services, or do asset prices enter into the evaluation?" he asked. "If we decide, as I have a suspicion that future FOMCs will eventually come to decide, that asset prices are a relevant consideration - not necessarily to capture bubbles or what have you, but to try to mould a level of financial stability that cannot be achieved without advertence to asset prices - I suspect that that particular process will be coming on stream."