Saturday, September 01, 2007
Fed Gets `F' for Failures on Housing
By Scott Lanman and Vivien Lou Chen
Aug. 31 (Bloomberg) -- Federal Reserve policy makers underestimated the role that housing plays in triggering recessions and merit an `F' grade for their failure, said Ed Leamer, director of an economic forecasting group at UCLA.
``Something's wrong here,'' Leamer wrote in a paper presented to a conference in Jackson Hole, Wyoming, attended by Chairman Ben S. Bernanke and other Fed officials. ``Housing is the most important sector in our economic recessions, and any attempt to control the business cycle needs to focus especially on residential investment.''
Housing is vulnerable to ``persistent'' trends that, once under way, are difficult to restrain, Leamer wrote. The Fed ought to have raised interest rates more aggressively to head off the ``bubble'' in home prices that grew from 2003 to 2005 and should have lowered rates by now, he said.
``What I'm calling for is monetary policy which at this point in the cycle would be stimulative because you're trying to keep the housing sector from crashing'' even further, Leamer said in an interview before attending the economic symposium.
House prices in some U.S. cities may fall by as much as half as the housing bust continues, according to an earlier paper delivered to the conference, which is organized by the Kansas City Fed. Yale University professor Robert Shiller, who wrote the article, said the slump in home values could be ``much more'' than the 15 percent drop in the last housing recession.
Slump in Prices
Leamer said in an interview today at Jackson Hole that some former ``hot markets,'' such as pockets of California, may see declines of 30 percent to 40 percent.
So far, the Fed has refrained from reducing its benchmark interest rate, using other tools to ease tightening credit conditions.
Bernanke and his team lowered the discount rate, for direct loans to banks, by half a percentage point on Aug. 17. The main target rate remains at 5.25 percent. Officials acknowledged in their statement that risks to economic growth had ``increased appreciably.'' They next meet Sept. 18, where investors anticipate they will lower rates at least a quarter point.
The Fed chief said earlier in his opening speech to the conference that the Fed ``will act as needed'' should a sustained tightening in credit threaten the economy.
Leamer is an economics professor at the University of California at Los Angeles who heads UCLA Anderson Forecast, which is located at the UCLA Anderson School of Management. It is funded separately from the university.
In his paper, Leamer said ``highly stimulative'' monetary policy helped stoke a ``hot'' housing market. The Fed cut its benchmark rate to as low as 1 percent by June 2003 from 6.5 percent.
Now, a slide in sales and prices leaves the economy with ``a weak housing market and contractionary monetary policy,'' he wrote. ``Grade: F. I am really disappointed in your performance,'' he wrote.
``Economists and policy makers have been very neglectful in understanding the role that housing plays in the business cycle,'' Leamer said in the interview. ``The key sector for the business cycle is the housing sector and it ought to be a target for fed funds policy.''
Residential construction has subtracted from economic growth for six straight quarters, the longest streak since 1982, and lopped 0.6 percentage point off the expansion in the three months through June.
``This is an event which I think to a large extent was preventable,'' Leamer said.
He still judged that the U.S. economy will avoid a recession because of continued job growth. ``It doesn't look like manufacturing is positioned to shed enough jobs to generate a recession. And without the job loss, expect the housing adjustment to be shallower but more long-lasting.''
``The best time to fight the housing cycle with tight monetary policy is when the wave is starting to rise, not when it is cresting,'' Leamer wrote. ``The worst time to stimulate the economy with loose monetary policy is when the wave is starting to rise. That is going to make the crest all the higher, and the crash all the more catastrophic.''
He added that there's ``very little possibility that a rate cut would make much of a difference'' at this point. ``Once the wave has peaked and is crashing, there is not much that can be done to quiet the waters.''
To contact the reporters on this story: Vivien Lou Chen in San Francisco atLast Updated: August 31, 2007 17:37 EDT ; Scott Lanman in Washington at