One downside to President Obama not nominating Larry Summers for Fed chairman is that it deprives the Senate of an obvious opportunity to investigate the role of US housing policy in the housing collapse and subsequent financial crisis. As Charlie Gasparino wrote yesterday: “The myth promoted by President Obama and his minions in the media is, of course, that economic deregulation pushed by Republicans and President George Bush caused the meltdown.”
The reality, as AEI’s Peter Wallison highlights in a WSJ op-ed today:
There is no doubt what really happened. Between 1997 and 2007, HUD’s affordable-housing policies under two administrations built an enormous mortgage bubble—nine times as large as any bubble in modern history—and when this bubble collapsed, it caused a 30%-40% decline in housing prices. This left homeowners who had limited financial resources and no equity in their houses unable to refinance or sell, causing an unprecedented number of mortgage defaults. Shocked by these numbers, investors fled mortgage-backed securities, making them useless for short-term financing by financial institutions like Lehman. The result was a panic and a financial crisis.
One of those two administrations that Wallison mentions is the Bill Clinton administration in whose Treasury department Summers served, including as Treasury secretary. Senate Republicans would have likely pressed Summers on the mistakes of Clinton housing policy and the lessons that should have been learned. Of course there is no reason the subject cannot be raised with any eventual Fed nominee given the central bank’s role as financial regulator and since many GOPers think a too-loose Fed monetary policy also contributed to the housing boom.
I would also add that housing prices only fell about 10% from mid-2006 through 2008. An interesting counterfactual is what would have happened housing prices had the Fed not engaged in a passive tightening in 2008, which almost surely greatly worsened the economic downturn and Wall Street turmoil, and instead engaged in aggressive easing, including unconventional monetary policy if necessary. If only the Fed has been targeting the level of nominal GDP back then.