BT : Fed transcripts stoke debate on interest rates

Business Times - 05 May 2010

Fed transcripts stoke debate on interest rates

They may also fuel discussion on Fed's role in housing crisis

(WASHINGTON) In 2004, the US Federal Reserve began a slow and steady march towards higher interest rates, a quarter-point at a time. Many economists have questioned whether the Fed's deliberate approach to tightening monetary policy, from exceptionally low rates in the aftermath of dot-com bust in 2000, allowed a dangerous housing bubble to develop.

On Friday, the Fed released 917 pages of transcripts of discussions among policymakers in 2004 that may provide new fodder for the debate on the Fed's role in the housing crisis, according to economists who have begun to study the materials.

Fed chairman Ben Bernanke has argued forcefully that lax regulation - in particular, a failure to rein in the growth of exotic mortgages and the accompanying decline in underwriting standards - was to blame for the bubble, not the Fed's setting of short-term interest rates.

Transcripts of the Federal Open Market Committee's eight meetings in 2004 - released on Friday under a Fed policy providing for annual release of the transcripts after a five-year lag - have offered support to both camps' claims.

The transcripts show that in early 2004, officials at the Fed, then led by Mr Bernanke's predecessor Alan Greenspan, faced a situation similar to the one they confront today.

Following the dot-com bust, the central bank had lowered its benchmark interest rate to an exceptionally low level - one per cent by June 2003 - as the economy muddled through what turned out to be a brief recession. For months, the Fed had been saying that interest rates would remain low for 'a considerable period'.

By January 2004, members of the committee hinted that an interest-rate increase was on the horizon. In May, that hint became a strong signal and in June, the Fed began a series of steady, incremental rate increases - 17 in total - that brought the signature fed funds rate to 5.25 per cent by June 2006.

Mr Bernanke, then a governor of the Fed, argued against dropping the 'considerable period' language, but his argument did not prevail at first.

'A good rule of thumb is to try to look as if you know what you're doing even if you're not entirely sure,' Mr Bernanke said at the January meeting, adding that the bond markets were not convinced that economic conditions merited a rate increase.

'I would rather wait until March and the presumption that we will see at least one good payroll number by then,' he said.

At the March 2004 meeting, the transcripts show, several Fed officials expressed strong concerns about housing.

'A number of folks are expressing growing concern about potential overbuilding and worrisome speculation in the real estate markets, especially in Florida,' said Jack Guynn, then the president of the Federal Reserve Bank of Atlanta.

'Entire condo projects and upscale residential lots are being pre-sold before any construction, with buyers freely admitting that they have no intention of occupying the units or building on the land but rather are counting on 'flipping' the properties - selling them quickly at higher prices.'

Later in that meeting, Mr Bernanke said the Fed was ill-equipped to try to identify asset bubbles, much less prick them. 'The history of using the monetary policy instrument rate for correcting financial imbalances is a very chequered one, to say the least.'

In the June 2004 meeting, Stephen Oliner, a Fed researcher, cautioned that housing prices appeared to be out of line.

'I don't want to leave the impression that we think there's a huge housing bubble,' Mr Oliner said. 'We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there's a part of the increase that is hard to explain.'

At that meeting, Mr Bernanke supported Mr Greenspan, saying it was best for the Fed to be 'embarking on a programme of gradual rate increases but remaining alert and ready to adjust in response to incoming information'.

By November 2004, with the tightening several months under way, policymakers were still uncertain about how to interpret the run-up in the housing market. Gary Stern, then president of the Minneapolis Fed, said that at a meeting the bank sponsored on housing activity, 'there was little overall concern about a bubble in house prices and little anticipation of a major correction in house prices in the near term'.

Henry Chappell, an economist at the University of South Carolina, said the transcripts demonstrated uncertainty above all.

'I'm not one to blame too much of what happened with the panic, crisis and recession on monetary policy,' Mr Chappell said. 'My feeling is the Fed can't control the price of housing. What it controls, over a long time frame and somewhat indirectly, is the average level of prices in the economy.' - NYT

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