Fed was slow to connect dots on housing crisis

by
January 13, 2012
By Binyamin Appelbaum / New York Times News Service

WASHINGTON — As the housing bubble entered its waning hours in 2006, top Federal Reserve officials marveled at the desperate antics of homebuilders seeking to lure buyers.

They laughed about the cars that builders were giving to buyers. They laughed about efforts to make empty homes look occupied. They laughed at a report that one builder said inventory was rising “through the roof.”

But the officials, meeting every six weeks to discuss the health of the nation’s economy, gave little credence to the possibility that the faltering housing market would weigh on the broader economy, according to transcripts that the Fed released Thursday.

Instead they continued to tell each other throughout 2006 that the greatest danger was inflation — the possibility that the economy would grow too fast.

“We think the fundamentals of the expansion going forward still look good,” Timothy Geithner, then president of the Federal Reserve Bank of New York, told his open market committee colleagues when they gathered in Washington in December 2006.

By then the economy had started to contract by at least one important measure, the level of gross domestic income, and by the end of the following year the Fed had begun its desperate struggle to prevent the collapse of the financial system and the onset of the first full-fledged depression in almost a century.

Some officials, including Fed governor Susan Bies, suggested that a housing downturn actually could boost the economy by redirecting money to other kinds of investments.

And there was general acclaim for Alan Greenspan, who stepped down as chairman at the beginning of the year, for presiding over one of the longest economic expansions in the nation’s history. Geithner suggested that Greenspan’s greatness still was not fully appreciated, an opinion now held by a much smaller number of people.

The transcripts of the 2006 meetings, released after a standard five-year delay, clearly show some of the nation’s pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with supervising. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken.

“It’s embarrassing for the Fed,” said Justin Wolfers, an economics professor at the University of Pennsylvania. “You see an awareness that the housing market is starting to crumble, and you see a lack of awareness of the connection between the housing market and financial markets.”

To read more, visit: http://www.bendbulletin.com/article/20120113/NEWS0107/201130410/

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