Housing Warning from Federal Reserve Board Governor:

Via The Housing Bubble Blog:

"The Federal Reserve has no intention of preserving all of the recent gains in home price values, said Federal Reserve board governor Donald Kohn on Thursday. If real estate prices begin to erode, homeowners should not expect to see all the gains of recent years preserved by monetary policy actions,' Kohn said in a speech."

"In his remarks, Kohn attacked the popular 'Greenspan put' theory that Fed policy would always protect investors from sharp asset market drops while doing nothing to restrain these markets when prices rise. 'This argument strikes me as a misreading of history,' Kohn said. 'Conventional policy as practiced by the Federal Reserve has not insulated investors from downside risk,' he said."

"'Whatever might have once been thought about the existence of a 'Greenspan put,' stock market, investors could not have endured the experience of the last five years in the United States and concluded that they were hedged on the downside by asymmetric monetary policy,' Kohn said."

"'The same consideration apply to homeowners: All else being equal, interest rates are higher now than they would be were real estate valuations less lofty; and if real estate prices begin to erode. Homeowners should not expect to see all the gains of recent years preserved by monetary policy actions,' Kohn said."

Am I misinterpreting, or does the bolded quotation mean that the Fed has raised short-term interest rates higher than it would have otherwise in order to prick the housing bubble? [Which means, assumedly, that the Fed won't STOP raising rates until housing prices decline?]

Lou Minatti (mail) (www):
"Am I misinterpreting, or does the bolded quotation mean that the Fed has raised short-term interest rates higher than it would have otherwise in order t prick the housing bubble?"

That is exactly what he said. But the most important point of his statement is that the Fed will not act to prop up housing prices in Bubbletopia. That being California, Arizona, Nevada, Florida, Mass and the DC area. Ya'll are on your own. The Fed didn't bail out the dot com speculators, even though they lost $8 trillion, and there is no reason for them to bail out housing speculators.
3.16.2006 10:58pm
Lou Minatti (mail) (www):
BTW David, I think the subject line should read like this:

Fed to Real Estate Speculators: Drop Dead.

I am glad the mainstream blogs are finally picking up on this. What took ya'll so long? :-) The popping of the housing bubble will be one of the major news stories for a long time to come.
3.16.2006 11:07pm
Save that crap for craigslist, "Lou".
3.16.2006 11:42pm
Lou Minatti (mail) (www):
Hey, I have an online stalker. Cool!
3.16.2006 11:48pm
Joel B. (mail):
Either way, this is not good news for sound monetary policy. Monetary policy should absolutely not be dictated by the idea of "well uh certain asset classes are rising in value too quickly." If there is inflation there is inflation the money supply ought to be tightened. If there is not inflation than why ought interest rates be higher than they otherwise need be? In any event, the Fed's virtually irrelevant in setting interest rates. The Ten Year Note is at 4.69% up not a whole lot from its low. Regardless of what the Fed is trying to do, if it's trying to raise the cost to borrow, in general, they seem to be failing. (Except that is for Credit Cards fixed to the prime rate. No surprise there of course.)
3.16.2006 11:48pm
TallDave (mail) (www):
No, I think he's saying interest rates are high because valuations are high, not because of Fed action. Hence, the "all else being equal."

I do think AG's endorsement of ARMs a couple years ago was intended to strengthen the Fed's hand, though. With an inverted yield curve, it's painfully obvious the Fed is pushing on a string here, at least in regard to long-term rates.
3.16.2006 11:52pm
TallDave (mail) (www):
To elucidate, I think he's saying there is a risk premium. Not sure I necessarily agree.
3.16.2006 11:57pm
LawProfCommentator (mail):
How would higher real estate prices cause higher interest rates?
3.17.2006 12:05am
But [b]the Fed DID bail out the Hedge Funds[/b] (Wall Street Insiders and the moneymen to the richest Republicans) in 2000 (or so) during the so-called "liquidity crunch." I never believed there was any reason not to let the big boys suffer like the ordinary investor (but then I didn't go to Princeton). The fed saved then (and their bankers, I suppose) thus initiating the carnage that caught the rest of us (but not the very, very rich and their advisors).
3.17.2006 12:15am
Don't flatter yourself, "Lou". I come here to get away from the infantile bubblehead vs. housinghead ravings on CL.
3.17.2006 12:16am
The bolded quotation does seem to suggest that the Fed has raised interest rates higher in part because of the housing bubble. It's not a reaction to higher inflation in the housing component of the CPI because the CPI (since the early 80s) uses a rental equivalent price for owner-occupied housing and rents have not increased nearly as much as real estate prices.

However, I think it's a bit of stretch to say that the Fed won't stop raising rates until housing prices decline. Perhaps the old "leaning against the wind" metaphor might be more accurate.
3.17.2006 12:25am
TallDave (mail) (www):

Risk premium. If valuations are unreasonably high, financing them is riskier, and interest rates on loans using that value as collateral higher.

Think of it like a loan to purchase dot-com stocks in early 2000.
3.17.2006 12:34am
I think TallDave is right - the Fed has, in the past, rather consciously avoided mentioning the housing market as a direct influence on its rate hikes, and it seems very unlikely that Kohn would suggest otherwise. On the other hand, the cost of borrowing for prospective homeowners and builders is elevated, and this risk premium tends to have a followthrough effect on other rates as well.
3.17.2006 1:32am
Ron Hardin (mail) (www):
The interest rate is an output from the economy, not an input from the Fed.

The Fed has decided to add new money, or take money away,
at some rate decided every so often, based on leading indicators of inflation.

They buy or sell debt to do this, and the interest rate
rises (or falls) to the ``target'' as the economy responds.

That's the actual causality order once the operation of leading indicators of inflation is included in the calculation.
3.17.2006 5:02am
Steve Waldman (mail) (www):
"Am I misinterpreting, or does the bolded quotation mean that the Fed has raised short-term interest rates higher than it would have otherwise in order to prick the housing bubble?"

I think that you are misinterpreting. Kohn is acknowledging that a wealth effect and equity extraction from housing means that there is more liquidity in the system than there otherwise would be, so the Fed has to tighten more than it otherwise would have to counter incipient consumer inflation.

Fed tightening may or may not lead to erosion of home values, and Kohn is saying that the Fed won't prevent that, there is no "Bernanke put" on home values. But if there is a secret policy to intentionally "prick the bubble", it's still secret. Official policy, for better or worse, is not to second-guess markets on asset prices, and I don't think Kohn's remarks qualify as even a hint of a revision.
3.17.2006 5:58am
John (mail):
Mortgage rates are a function of money supply and demand for credit. The Fed's role in setting its short term rate doesn't have much to do with it.
3.17.2006 9:48am
LawProfCommentator (mail):
Perhaps Kohn is saying the CPI is low, but inflation is showing up in asset prices,so short-term rates are being raised to tame that inflation. If so he's not saying exactly that we're trying to prick the bubble, but he is saying that we're concerned about inflation in asset prices, which is practically almost the same thing.
3.17.2006 9:51am
Raw_Data (mail):
I think you misinterpret.
Of course you have been hoping for a crash for quite a while so every bird is the arrival of spring.
3.17.2006 10:33am
Lou Minatti (mail) (www):
Sure you do, "Enoch".

"Enoch", since you don't believe there is a bubble and that housing in California is priced rationally, why do you get so angry and defensive when people discuss this subject? It seems rather silly to rudely attack people on a message forum for no good reason, "Enoch", especially when you are so certain of your opinion. Are you afraid that critically discussing the real estate market will cause housing prices to crash, and if you attack enough people to shut them up a crash can be avoided?

Chill out, "Enoch". Let us "bitter renters" and crazy "bubbleheads" continue with our delusions. You know that housing prices can only go up, and a 80/20 no-doc interest-only option ARMs are safe ways for regular folks to purchase those $600,000 tract houses. Right, "Enoch"?
3.17.2006 10:53am
Well "Lou", since I have advanced none of the arguments you attribute to me, I shan't bother to defend them.
3.17.2006 4:38pm
The vast majority of you folks are misinterpreting Kohn's remarks. Steve Waldman is correct. Kohn is restating the often-stated Fed policy. The Fed does not try to prick bubbles or manage asset prices. It is not part of its mandate (low inflation, low unemployment, and low interest rates). But, there is a wealth effect when asset prices rise more paridly than incomes. Then demand also rises strongly and thus interest rates are set higher than they otherwise would be. This is no mystery. Its standard monetary policy 101. Its been repeated ad nauseum by FOMC members. (Note though, the Bank of England and the Economist magazine do not share this view of Monetary polciy 101).
3.18.2006 1:34am