Missing the Housing Bubble

oopsThe Federal Reserve released FOMC transcripts from 2006. Yes, 5 years after the fact you too can find out what actually went on in the FOMC meetings.

In a nutshell, the Fed missed the housing bubble and it's impact on the economy.

Tim Geithner expressed confidence that "collateral damage" from housing could be avoided.

Most of the transcripts reveal a frightening embarrassment, especially now Treasury secretary Timothy Geithner praising now debunked former chair Alan Greenspan. Believe it or not the FOMC was worrying about inflation.

Matthew Yglesias points out we haven't seen nothin' yet. Wait until the transcripts are released for 2008 and 2009. Only then will we know the level of Fed foolishness.

It's only in the second half of 2008 that the monetary situation goes haywire, inflation expectations plunge, and the whole economy goes to crap. It then takes a looooong time for expectations to get back to the usual level and when they do so instead of delivering us a spurt of "catch-up" inflation the Fed lets them drop again. More recently, we've been back to a more-or-less stable level but with no catch-up. In my view, it's all that stuff that constitutes the screw-up that the Fed should be lambasted for. The damning transcripts are the ones from late 2008 and all of 2009. We haven't seen those transcripts yet because the Fed loves its secrecy and lack of accountability and Congress doesn't want to know the truth. But I'm not sure Ben Bernanke, Tim Geithner, and the others were in fact making any major mistakes in 2006 beyond underestimating how inept they would be in the fall of 2008 and the winter of 2008-9.

That said, it was not the housing bubble per say, but the mortgage backed securities, derivatives, built around it all that caused the global financial crisis. There were actually three distinct events, the housing bubble, the recession and the global financial crisis, all coming together to bring about the worst economic environment since the Great Depression.

What is more frightening is the awareness that securitization was a problem yet nothing happened. Federal Reserve Governor Susan Bies:

A lot of private mortgages that had been securitized during the past few years really do have much more risk than the investors have been focusing on.

This Seeking Alpha post lays out a host of graphs to prove the trade deficit actually staved off recession in 2005. It shrank enough to mask collapsing new construction activity.

The boom in residential construction was in large part financed by large external deficit. We borrowed money from the Chinese (and Germans and Japanese) to build a bunch of homes in the United States.

However, the way you borrow money from other countries is by running a trade deficit. As residential construction shrank, so did the trade deficit. This provided the economic offset that kept the economy from going into recession in 2005 as residential construction rolled over.

By the beginning of 2008 though other sectors of the economy – notably non-residential construction and manufacturing, were beginning to weaken. This tipped the economy into recession.

The New York Times went through the transcripts and there are more juicy pickins'.

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

The officials laughed about the cars that builders were offering as signing bonuses, and about efforts to make empty homes look occupied. They joked about one builder who said that inventory was “rising through the roof.”

Believe this or not, Ben Bernanke was the one who saw it coming the most. Why he wasn't more assertive is anyone's guess.