Economics

Fed Study Vindicates Fed

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Did inaccurate productivity data cause the housing bust? That's the interesting but tortured conclusion of James A. Kahn, a Yeshiva University economics professor and former vice president of the Federal Reserve Bank of New York, in this study [pdf].

"Productivity Swings and Housing Prices," Kahn's New York Fed paper, assigns "primacy to fundamentals and only a supporting role to bubbles and credit market irregularities." His model shows that productivity shifts correlate well (though not perfectly) to house prices since 1965.

But what Kahn is actually assigning primacy to is the misstating of fundamentals. "Housing market participants were slow to perceive the most recent decline in the rate of productivity growth because the data released through mid-2007 gave little indication of it," Kahn writes. "Subsequent revisions of the data made it clear that productivity had in fact begun to decelerate in 2004."

This is important because Kahn refers repeatedly to the "optimism" productivity gains instilled in buyers and lenders throughout the boom period. To the obvious objection that nobody out there is looking at productivity figures before buying a house, Kahn notes that these are only "estimates of how participants' expectations evolved over time." And it's understandable that if you're doing better professionally you're going to be more ambitious in your purchases. But his argument is that productivity data were overstated at the time, and real gains were much lower than estimated. That is information John Q. Homebuyer would have at his disposal: You don't need to wait for statistics from the Labor Department to know how much you're getting paid for goofing off at work.

Kahn's conclusion:

With the resurgence in productivity that began in 1995, market participants began to see stronger income growth-not from working longer hours or having a second household income, but on a per hour basis. As individuals became more aware that this stronger growth was attributable to technological progress and that it might be sustainable, they grew more optimistic about their future income, and this optimism directly influenced their willingness to pay for housing. Such optimism would likely have been shared by lenders, who viewed mortgages as less risky insofar as income and house prices were growing more rapidly than before.

A decade later, however, signs emerged that the new period of high productivity growth would not be as long-lived as the post-World War II episode, which had lasted more than twenty-five years. As buyers and lenders began to recognize this, the same process that caused prices to rise and credit conditions to ease began to work in reverse. The expected income growth did not materialize and new buyers entering the market were less willing to pay high prices; thus, prices of houses purchased in recent years failed to grow as expected. Foreclosures began to increase as early as 2005, and lenders became more cautious.

More persuasive is Kahn's demonstration that productivity changes can have a "multiplier" effect. Given price-inelastic supply and demand, this means that "in times of above-average economic growth, house prices can grow faster than income (and faster than rents) for periods of many years, even decades."

But there's a big factor left out here: the Fed Funds rate. During the historic period Kahn covers, the Fed Funds rate never went below 3 percent, except once: from October 2001 to May 2005, the exact period of the housing bubble's formation and growth. (It is, of course, back down there now, as part of the Fed's failed effort to revive the economy.) That doesn't prove interest rates were the bubble culprit, and Kahn provides some welcome ideas and nuance. But to say interest rate manipulation had only a supporting role in this decade's real estate madness requires a lot more explaining than Kahn has done here.

Nice try, though.

Read more objections in the comments to this story.

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  1. A bit of context on Jim Kahn’s excellent research on productivity gains and the private-sector causes of most of the “great moderation”:
    http://www.theatlantic.com/doc/200904/economic-policy
    http://www.dynamist.com/articles-speeches/nyt/expansion.html

  2. Thanks, Virginia. On the off chance that you and I are not alone on this thread, I recommend both pieces. (I really dug your Chris Anderson review too.)

    Is it required that I believe in the Great Moderation? I’ve spent the last 20 years as an emancipated adult in these here United States, and my experience indicates there are periods when money falls out of the sky (1995-2001 and 2004-2006, all dates rough estimates), and that those alternate with periods of hard living and little reward (1989-1994 and 2006-present, all dates rough estimates). Even correcting for personal variables, I believe I’ve been through two very-hard-to-deny booms and at least two busts.

  3. KAAAAAAAHHHHHHHHHHNNNNNNNNNNNN!!!

  4. Kahn notes that these are only “estimates of how participants’ expectations evolved over time.”

    So let’s see. An economic measure which is irrelevant and unneeded to the average Johnny on the street, turns out to be irrelevant and unneeded to the average Johnny on the street. Because he already knows what his pay check says.

    Or is it that Johnny still can’t read? What a dope!

    Meanwhile, pay no attention to that Uncle Sam-like creature behind the curtain.

  5. Tim,

    I’m not sure where you’re coming from with this post, or where you’re trying to go. Are you attempting to claim that the jury is still out on the housing bubble and its precise causes? If so, you need look no further than your final paragraph.

    The truth is that reports issued by regional federal reserve banks are intentionally boring, confusing, and devoid of meaningful information. I’m honestly at a loss as to what information you could have derived from this report that is worth knowing or repeating.

    Either you are much, much smarter (and better informed) than I am, or you are unwilling to acknowledge your inability to understand fed-speak. If the latter is the case, you would do best to simply come to terms with your own ignorance. By repeating this crap without questioning it, you are validating it and giving it legitimacy. The truth is that most fed-speak is just blatantly false.

    You can write me off as stupid or uninformed if you want to, but I’m willing to stand by my statements here. If you clarify exactly what useful information you believe you have derived from this (or any other) regional fed report, I am confident that I can rebut you. All you really need to know about the fed can be found in this clip:

    http://www.youtube.com/watch?v=PXlxBeAvsB8

  6. How about assigning much of the blame for the housing bubble to the fact that anyone who could fog a mirror had the opportunity to get a mortgage on almost any house they wanted and the FED was a big part in both supplying the money and letting the lenders it supposedly regulated accomplish this. And today the same FED appears to think that protecting the large politically connected lenders from the consequences of their incompetence/criminality is their sole priority.

    The FED is nothing but a government sanctioned bankers cartel.

  7. I’d rather be paid in fucking salt. Or seashells. Something physical darn it! Bankers are stealing my money every minute of every day.

  8. Housing market participants were slow to perceive the most recent decline in the rate of productivity growth because the data released through mid-2007 gave little indication of it,” Kahn writes. “Subsequent revisions of the data made it clear that productivity had in fact begun to decelerate in 2004.

    Why isn’t the delayed reaction of the housing market due to the loosening of loan standards and practices? If the same or even a smaller paycheck will allow you to buy the same or even a bigger house, then wouldn’t that explain the disconnect between housing and productivity?

  9. new buyers entering the market were less willing to pay high prices

    We ran out of (next-greater) fools?

  10. the Fed Funds rate never went below 3 percent, except once: from October 2001 to May 2005

    Osama caused the housing bubble.

  11. Why isn’t the delayed reaction of the housing market due to the loosening of loan standards and practices?

    Not that I disagree, but if the Fed is providing funds so cheap, wouldn’t that bring more of a devil-may-care attitude to lenders? “So a few more loans fail. Big Whoop. We’ll just get some more cheap dough from the Fed.”

  12. We ran out of (next-greater) fools?

    Is that possible?

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