December 10, 2015
Matt O’Brien used his column this morning to take Obama to task for failing to fill vacant postions on the Fed’s board of governors. I agree with O’Brien with one major exception.
O’Brien refers to the Taper Tantrum in the summer of 2013, when mortgage and other long-term interest rates soared after Chair Ben Bernanke indicated the Fed would soon begin to taper its quantitative easing program. He sees the market reaction as partly a result of the composition of the Fed’s board of governors, which included two Obama appointees not fully committed to growth promoting policies. He argues that the tantrum unnecessarily slowed the housing market and growth.
I would disagree with the first part of this story. As we know, economists have a hard time seeing housing bubbles, but we were starting to see the beginnings of one at the time of the tantrum. House prices were rising very rapidly, especially in the bottom third of the market. According to the Case-Schiller tiered price index, in the period from April of 2012 to August of 2013 house prices in the Phoenix market had risen at a 32.6 percent annual rate. In the Las Vegas market they had risen at 44.0 percent rate and in the Atlanta market at a 47.5 percent annual rate.
These markets were badly depressed as a result of the crash, so large increases were a good thing, but on the other hand, it’s not hard to see that a market rising at a 47.5 percent annual rate will soon be in bubble territory. And, we were seeing evidence of bubble behavior. People were giving up their day jobs and buying up homes to fix-up and resell. In many cases this involved maxing out on their credit cards or whatever other type of credit they could use.
We should all know by now that this story ends badly, but one of the big dividends of the Taper Tantrum was that it quickly dampened these extraordinary rates of price increase. In the year from August of 2013 to August of 2014 prices in the bottom tier of the Phoenix market rose by 8.8 percent. In the Las Vegas market they rose by 10.5 percent, and in the Atlanta market by a comparatively modest 21.7 percent, less than half the previous pace.
Preventing the rebirth of housing bubbles in these markets was a very good thing in my book. I will add the qualification that high interest rates is not my preferred way of bursting bubbles. The first recourse should be talk, as in using the Fed’s bully pulpit, coupled with its research, to warn the markets of rising bubbles. Janet Yellen did this successfully in the summer of 2014 when she used congressional testimony to warn of bubbles in social media companies, biotech stocks, and junk bonds. She did not follow through with subsequent warnings, but all three markets did take a hit in the weeks following her testimony.
For some reason most economists reject the idea of having the Fed talk down bubbles. I guess it is considered impolite. This seems more than a bit bizarre given the enormous damage done by bursting bubbles compared with the virtually costless effort to talk them down.
Of course the Fed also has substantial regulatory powers which can be used to curb bank lending to support bubbles. This is also a policy option that should be pursued before deliberately slowing the economy with higher interest rates.
Anyhow, I was not happy to see the economy slowed by the Taper Tantrum, but I was very happy to see that it prevented the growth of another bubble. It is unfortunate that almost no one knows this story — I guess it is difficult for reporters to get access to the Case-Shiller data on the web.
Addendum
The Wall Street Journal’s housing reporter Nick Timiraos was very much on top of the rapid run-up in house prices pre-Taper Tantrum and the impact that Bernanke’s comments had in slowing the pace of price appreciation. See here, here, and here for example. (There are others.) So I was mistaken in saying that the impact of the Taper Tantrum on heading off an incipient bubble had been almost completely overlooked. Certainly Timiraos was putting this case out there in a very visible place. On the other hand, it makes it even more remarkable that this aspect of the Taper Tantrum is not more widely recognized.
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