New documents from 2005 show that the Federal Reserve openly discussed the situation in the housing market in 2005 and several members characterized the situation as “unsustainable” or as a “bubble”.  Some of the presentations made in the data are very intricate and show that the Fed was deeply concerned about an impending credit crisis and a potential collapse in residential housing prices.  The following from Calculated Risk nicely sums up the thinking at the time:

Atlanta Fed President Jack Guynn:

“There is the housing situation, which we talked about for a long time yesterday afternoon. As I’ve been reporting for several meetings, some of our markets, especially those in coastal areas of South Florida and the Florida panhandle, are experiencing a level of building activity and price increases that are clearly, in my view, unsustainable. Nearly every major Florida city now has experienced increases in the double-digit range, and some, like Miami, Palm Beach, Sarasota, and West Palm, have been reporting increases in housing prices on a year-over-year basis of between 25 and 30 percent. While our discussion yesterday did not seem to indicate a consensus on a national housing bubble, based on past experience I’m reasonably comfortable characterizing the housing feeding frenzy in some of our markets as being a bubble or a near bubble.

For example, the number of major projects planned or under construction in Miami now totals 114, most of which are high-rise developments. That includes 61,000 condo units—eight times the number that were built in the last decade—and a total of 100,000 new parking spaces. I know we don’t have any process for introducing exhibits into the record, but I’d like to pass Dave Stockton this pictorial of the new projects in Miami, so that he can continue to worry a little bit along with me. [Laughter]

My supervision and regulation staff thinks this is an accident waiting to happen in our area. And while the local market excesses probably do not represent systemic national risk, the shakeouts could have serious regional consequences. My bank supervision staff points out that housing-related credit risks to our bank lenders are not so much from defaults on permanent mortgage financing that we talked about yesterday, but rather from lending for land acquisition, development, and construction. The ugly picture we have seen before—and that they think we may very likely see again before long—goes something like this: the drying up of sales of new units; the painful decision of developers to go ahead and complete the construction of additional units to make them saleable, further depressing the market; and speculators who had hoped to see big capital gains walking away or defaulting on their contracts, giving their properties back to the lender. Perhaps it’s because of where I sit, but I am less comforted than some of my colleagues about the housing situation. …

CHAIRMAN GREENSPAN. Let’s take a break for coffee.”

You can review the entire document here.  It’s full of various presentations and evidence showing that the Fed knew there was a bubble and still did not take the proper risk management measures to try to alleviate the problems.  What’s even more worrisome is that the Fed openly acknowledges that these sorts of events can lead to catastrophic economic outcomes, yet here we are implementing another policy of “keeping asset prices higher than they otherwise would be”.  Do these people never learn?


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • LZ

    Does alchemist need risk management? Guess not.

  • Zebra

    well, do the Fed or government even care? Bailout is people’s money, not theirs. They only need to make sure people are cheered up and happy so they can get the vote.

  • prescient11

    isn’t it somewhat reassuring that they were aware of the situation. at least they weren’t completely blind.

    how’s that copper holding up, eh? so far so good, although probably due for a hard correction.

  • spek

    Dr. Michael Burry’s op/ed in the NYTimes back in April 2010,

    “ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. “Everybody missed it,” he said, “academia, the Federal Reserve, all regulators.”

  • Steve

    What should they have done? Fixing corrupt leanding standards and MBS’s is a no brainer, but what else? Honest curiosity here; I just like to know what critics would have done if they were in charge.

  • Brian

    Yeah, once the bubble is already in place, what exactly is the solution? Capital controls? The best outcome they could hope for at that point would be to prick the bubble earlier so we save all the damage from bad loans in 2006 and 2007. But if they prick the bubble themselves, don’t they just end up getting all the blame for “causing” the problems instead of being able to blame it on the market?

    The scary thing is we talk about how to avoid these bubbles or stop them once we see them coming, but in reality it only took 3-4 years for it to form. Thats an awfully short period of time to be able to realize there is a problem and act on it before the damage is already done.

  • Erin

    Sheila Bair gave testimony in January 2010 indicating that the Federal Reserve knew back in 2000 there were problems in the subprime mortgage market. Sounds like lots of people knew. Sheila Bair said:

    “Problems in the subprime mortgage market were identified well before many of the abusive mortgage loans were made. A joint report issued in 2000 by HUD and the Department of the Treasury entitled Curbing Predatory Home Mortgage Lending noted that a very limited number of borrowers benefit from HOEPA’s protections because of the high thresholds that a loan must exceed in order for the protections to apply. The report also found that certain terms of subprime loans appear to be harmful or abusive in practically all cases. To address these issues, the report made a number of recommendations, including that the FRB use its HOEPA authority to prohibit certain unfair, deceptive and abusive practices by lenders and third parties. During hearings held in 2000, consumer groups urged the FRB to use its HOEPA rulemaking authority to address concerns about predatory lending. Both the House and Senate held hearings on predatory abuses in the subprime market in May 2000 and July 2001, respectively. In December 2001 the FRB issued a HOEPA rule that addressed a narrow range of predatory lending issues.”

  • Lorne Marr

    This is like a black humour comedy. I mean, how can we expect him to say: Right, I knew it all the time and I didn’t do nothing to stop it”! But in the light of the these new documents, I have the impression that these economists in FED don’t actually know what they’re doing with the economy in the long term. Actually, they seem to know that nobody does.