I had planned on a 4 part series, but Leamer’s 2007 presentation to the Federal Reserve really deserves a thorough review in its own right, so I am going to devote this entire post to that.
Really appreciate this post. I think foiling Leamer's models with what we know now and drawing out the logic errors present in his analysis is one of the more effective methods for communicating the challenges in the housing market.
One thing I'm still curious about is the specific mechanisms that changed in the 2007 to 2009 time-period beyond interest rates. What exactly was done to so severely curtail lending? What conversations were had? What assumptions/arguments? Is this primarily a Fannie/Freddie issue? I'm trying to grapple with where do we go from here.
Documenting the change is challenging. There were a series of regulatory changes implemented over time (Ability to Repay, Fed guidance on subprime lending in 2006, Regulation Z, Dodd-Frank, CFPB, etc.) the change in standards clearly happened very quickly over the course of 2008, which shows up in the average credit score on originations. There were also a lot of informal pressures. You read things like Hank Paulson's memoir, and just every single intuition was aimed at tightening.
In a way, it's like looking at a victim who got hit by a bus and asking which broken bone was the one that did him in. That's the question skeptics want answered, and there is no answer to that question.
Third chew: I'm not sympathetic to predictions about recessions and boom that do not explicitly model central bank behavior. Now I agree that housing is more sensitive to Fed policy than most sectors so what is going one there deserves special attention in Fed decision making but ultimately it's only one input (as is the unemployment rate) into what the Fed should be doing to inflation.
Off topic. I was in econometric class in graduate school with Leamer. My recollection of him was of him and the teacher discussing econometrics while the rest of us wondered what was going on. Brilliant and opinionated.
Second chew: Around 2005-6 inflation expectations WERE running above target so maybe the Fed should have been trying to restrain them. by 2007-8, however, expectations were much closer to target so at THAT point there was less need to be pushing or pulling on inflation.
Agreed. My current way of thinking is that the economy was mildly too hot in 2004-2005. I forgot to include it in the post, but in the context of a perpetual regional housing shortage, maybe the metric for "running too hot" should be the cyclical displacement that happens in the housing deprived cities. The Fed should target the price of a U-Haul out of LA - only half joking. In 2004-2005, the only reason the hot economy was disruptive was that a hot economy requires 100,000s of people to move out of NYC, LA, Boston, and San Francisco, and so many people were doing that that it created bubbles in AZ, NV, and FL. I think you could make the argument that that determines our maximum growth rate now, though it chafes me to say that because it means accepting lower long-term economic growth because of regional housing policy.
Then, from 2006-2007 the Fed was marginally too tight, but not disastrously so. Increasingly, I have come to view 2008 as an interaction between the extreme tightening of lending standards at the federal agencies and Fed policy. I'm not sure the Fed could have counteracted the severe spending and wealth shocks that were caused by the mortgage crackdown, but they certainly didn't try to.
"The Economy was mildly hot so we had to kill housing production AND credit access for the next decade" is my summation of Fed policy after years of reading Sumner and you.
I'm wondering if Leamer and other people at the Fed looked at the cratering of housing starts from 2006 through the 2010s as proof of success. Is it on tape anywhere? I have noticed, but have not read, the CATO working paper that claims there is no housing crisis--either in terms of available units or affordability, which is an incredible position to argue.
Lots to chew on here but to start with let's distinguish Fed policy that might trigger a financial crisis from dealing with a crisis when it hits. I'm much less certain that the Fed was doing anything wrong before August/September 2008 than afterward.
Really appreciate this post. I think foiling Leamer's models with what we know now and drawing out the logic errors present in his analysis is one of the more effective methods for communicating the challenges in the housing market.
One thing I'm still curious about is the specific mechanisms that changed in the 2007 to 2009 time-period beyond interest rates. What exactly was done to so severely curtail lending? What conversations were had? What assumptions/arguments? Is this primarily a Fannie/Freddie issue? I'm trying to grapple with where do we go from here.
Thank you!
Documenting the change is challenging. There were a series of regulatory changes implemented over time (Ability to Repay, Fed guidance on subprime lending in 2006, Regulation Z, Dodd-Frank, CFPB, etc.) the change in standards clearly happened very quickly over the course of 2008, which shows up in the average credit score on originations. There were also a lot of informal pressures. You read things like Hank Paulson's memoir, and just every single intuition was aimed at tightening.
In a way, it's like looking at a victim who got hit by a bus and asking which broken bone was the one that did him in. That's the question skeptics want answered, and there is no answer to that question.
Third chew: I'm not sympathetic to predictions about recessions and boom that do not explicitly model central bank behavior. Now I agree that housing is more sensitive to Fed policy than most sectors so what is going one there deserves special attention in Fed decision making but ultimately it's only one input (as is the unemployment rate) into what the Fed should be doing to inflation.
Definitely.
Off topic. I was in econometric class in graduate school with Leamer. My recollection of him was of him and the teacher discussing econometrics while the rest of us wondered what was going on. Brilliant and opinionated.
Second chew: Around 2005-6 inflation expectations WERE running above target so maybe the Fed should have been trying to restrain them. by 2007-8, however, expectations were much closer to target so at THAT point there was less need to be pushing or pulling on inflation.
Agreed. My current way of thinking is that the economy was mildly too hot in 2004-2005. I forgot to include it in the post, but in the context of a perpetual regional housing shortage, maybe the metric for "running too hot" should be the cyclical displacement that happens in the housing deprived cities. The Fed should target the price of a U-Haul out of LA - only half joking. In 2004-2005, the only reason the hot economy was disruptive was that a hot economy requires 100,000s of people to move out of NYC, LA, Boston, and San Francisco, and so many people were doing that that it created bubbles in AZ, NV, and FL. I think you could make the argument that that determines our maximum growth rate now, though it chafes me to say that because it means accepting lower long-term economic growth because of regional housing policy.
Then, from 2006-2007 the Fed was marginally too tight, but not disastrously so. Increasingly, I have come to view 2008 as an interaction between the extreme tightening of lending standards at the federal agencies and Fed policy. I'm not sure the Fed could have counteracted the severe spending and wealth shocks that were caused by the mortgage crackdown, but they certainly didn't try to.
"The Economy was mildly hot so we had to kill housing production AND credit access for the next decade" is my summation of Fed policy after years of reading Sumner and you.
I'm wondering if Leamer and other people at the Fed looked at the cratering of housing starts from 2006 through the 2010s as proof of success. Is it on tape anywhere? I have noticed, but have not read, the CATO working paper that claims there is no housing crisis--either in terms of available units or affordability, which is an incredible position to argue.
I’ll have one more post on Leamer.
Yeah, that Cato paper is something.
Lots to chew on here but to start with let's distinguish Fed policy that might trigger a financial crisis from dealing with a crisis when it hits. I'm much less certain that the Fed was doing anything wrong before August/September 2008 than afterward.
*Charlotteans