In a recent speech to the American Economic Association, Fed Chairman Bernanke offered his explanation of the causes of the housing bubble. Mr. Bernanke contends that easy money in the early years of this decade did not cause or even significantly contribute to the housing bubble. He also contends that the housing bubble was caused by a global savings glut and the growth in non-traditional mortgage products-option ARMs, Alt-A mortgages, and negative amortization loans. Mr. Bernanke ran through simulations and mortgage statistics, and he even broke out fancy equations. His explanation was very academic in nature.
But Chairman Bernanke has his head in the sand. His explanation of the housing bubble is naive. Of course, the growth in non-traditional mortgages contributed to the housing bubble, but this was a symptom of the Fed’s easy money policies. Investors and banks alike were being forced to take exorbitant risks to earn a decent return. Who would have bothered originating and investing in toxic mortgages if a decent return was available on T-bills? The banks likely knew what they were getting into, but they had been conditioned, based on 20 years of Fed policy, to expect an easy-money bailout as soon as things started to get ugly. And look where we are today, back on the easy-money train. There has been more pain in the banking sector during this crisis than during the last, but banks were once again bailed out. The Fed chairman does not fully appreciate the dangers of ultra-loose monetary policy. We need hawks at the Fed, not ostriches.