The origins of a housing credit bubble; Monday-morning quarterbacks are finding plenty to blame for the creation of a housing credit bubble that has dramatically brust. While there's a growing laundry list of causes, there appears to be emerging consensus on some primary drivers, such as monetary ploicy and the unchecked expansion of mortgage credit by non-banks. This two-part series examines the details

Mortgage Banking, Sept, 2008 by Robert Stowe England

Gramley is not alone in pondering the role of former Fed Chairman Greenspan. Indeed, as the market meltdown reached a crescendo on March 16, 2008-just before the Fed engineered the rescue of Bear Stearns & Co. Inc. by JPMorgan Chase & Co., both based in New York--there was a rising chorus of naysayers blaming the Federal Reserve and Greenspan for lowering the Federal Funds Rate too low (to 1 percent) in 2003 and keeping rates too low for too long. Indeed, the chorus of critics has swollen, and it is still singing "You Done Me Wrong" to its old friend Greenspan.

Economist David Jones, chairman of Investor Security Trust Co., Fort Myers Florida, and president and chief executive officer of DNJ Advisors LLC, Denver, agrees that the Fed's interest-rate policy is "obviously one of the key factors" in the housing boom that ran from 2002 to 2006. "[We] can all do extremely well in our analysis with hindsight," Jones says, noting that the same people who heaped praise on Greenspan in the past are the same people now critical of him in hindsight. "In the circumstances he was operating in in 2003 and 2004, there was a very weak economic recovery under way," Jones says.

In his conversations with Greenspan, Jones recalls that the former Fed chairman expressed concern at the time about deflation and the dangers it posed, as seen in the recent experience of Japan, "where their asset price bubbles in real estate and stocks burst in the late 1980s and then they had more than a decade during the 1990s of recurring recession and inflation," he says.

Concerned that the U.S. economy might falter and sink into deflation, the Fed under Greenspan's leadership "did move the overnight funds rate to a 46-year low of 1 percent and kept it there for roughly a year," Jones says. The timing of the low interest rates sent house prices soaring, he concludes.

Jones contends that the rise in housing prices should be labeled a "boom" and not a "bubble," while the expansion in housing credit is "clearly a bubble."

Jones agrees with Greenspan's contention at the time that housing is, to a major degree, regional. Thus, while some places had spectacular housing booms--California, Nevada, Arizona and Florida--many regions did not have a boom.

"We had a credit bubble that supported a housing boom," he says. Monetary policy should not be blamed as the sole cause, he adds. "I think you can say that low interest rates are generally a necessary condition for a massive housing credit bubble, but not a sufficient condition," Jones explains.

Greenspan's defense

While Greenspan declined a request for an interview to respond to critics of his low-interest-rate policy, he has provided through articles, a lengthy blog and interviews a number of defenses and justifications for his actions at the helm of the Fed. The first hint of a defense appeared in his March 17 Financial Times article titled "We Will Never Have a Perfect Model of Risk."

In that article, he wrote, "The current financial crisis in the U.S. is likely to be judged in retrospect as the most wrenching since the end of the Second World War," putting the current global financial fallout as the biggest crisis in 60 years. While admitting the scope of the crisis, Greenspan finds the cause of the problem rooted in the failure of risk management at financial institutions.