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Peter Crabb: Economists feud over easy money and the housing collapse

George Bernard Shaw once said, “If all economists were laid end to end they would not reach a conclusion.”

A speech by Federal Reserve Chairman Ben Bernanke this month sparked what is likely to be a classic debate between economists. It will be decades before economists arrive at anything near a consensus on what caused the housing crisis.

Part of the reason: It has yet to end.

Last week Colleen LaMay wrote in the Idaho Statesman that although foreclosure rates for Ada and Canyon county houses fell 9 percent in December, as many as 30 percent of homeowners are “upside-down” on their mortgages — owing more than their homes are worth. Thus, the housing problem remains — here and around the country.

The most recent U.S. data from the National Association of Home Builders shows there is about a seven-month inventory of homes for sale. This means that at the rate homes are currently selling it will take seven months to exhaust the supply.

While this supply is much lower than 12-month figure posted in January of last year, it is well above the five-month average supply in 2005, the boom year for housing.

This so-called “housing bubble” was the subject of Chairman Bernanke’s speech. Bernankespoke Jan. 3 at the annual meeting of the American Economic Association in Atlanta. The title of the speech was “Monetary Policy and the Housing Bubble,” addressing the question of whether or not an excessively easy monetary policy by the Federal Reserve in the early 2000s led to a bubble in house prices.

Bernanke concludes that the answer is no, presenting evidence that counters any link between easy monetary policy — which means low interest rates — and higher home prices. In the evidence presented he references the work of economist John Taylor from Stanford University.

Taylor was quick to respond, writing an editorial piece for The Wall Street Journal showing how the chairman had incorrectly applied his theories and misinterpreted the evidence.

Brad DeLong from the University of California at Berkeley chimed in soon after, supporting Bernanke. On his blog, he said that even if Professor Taylor was correct, the impact of low interest rates on house prices is 6 percent at most — much smaller than the 50 percent drop in prices many regions of the U.S. have seen.

Of course, other economists have found support for Taylor, showing that there is at least a significant contribution from low interest rates.

To date, the financial markets support Bernanke in the debate. Low interest rates continue and housing prices remain low. Even though monetary policy is looser than it was in 2005, housing prices have not rebounded.

But this is due in part to other actions by the Federal Reserve and the U.S. Treasury — specifically, the government takeover of mortgage-guarantee companies Fannie Mae and Freddie Mac.

The debate between economists will therefore continue until more convincing evidence comes to light. But the question is hard to test empirically unless the government removes the subsidies to housing prices. With this interference in the market, testing theories of causal effects is nearly impossible.

They will have to keep laying economists end to end if they continue interfering in the markets we study.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.

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