Fed Chairman Responds to Critics on Its Role in Housing Boom and Bust

In responding to critics who contend that the Federal Reserve's low interest rates earlier this decade helped create a housing boom and bust, Federal Reserve Chairman Ben Bernanke, said global factors that held down long-term interest rates worldwide were a more important factor. 
 
At a House hearing on the nation’s housing slump, Mr. Bernanke told lawmakers that while Fed policy does work in part by influencing asset prices, "I think the primary factor leading to increases in house prices -- not only in the U.S., but in many countries around the world -- was the generally low level of [inflation-adjusted] long-term interest rates in global capital markets." 
 
Treasury Secretary Henry Paulson told the same panel that a group comprising the Treasury, the Fed, the Securities and Exchange Commission and the Commodity Futures Trading Commission is reviewing accounting and valuation of derivative investments, "particularly for complex, narrowly traded products that become difficult to price in times of stress." 
 
Many Wall Street firms have made big bets on sub-prime mortgages -- home loans to borrowers with sketchy credit -- by investing in complex securities backed by those loans. As defaults on sub-prime mortgages have mounted, the value of those investments has plunged, worsening a credit crunch in the housing market. 
 
The multia-agency group is also examining financial institutions' liquidity, risk-management practices and their treatment of credit products, as well as the role of credit-rating agencies in structured-finance products, he said. The working group may come up with recommendations to alter regulation or policy in certain areas. 
 
Mr. Paulson said innovation in the capital markets often "moves ahead of regulation and policy," and that there may be a need to strengthen certain areas in which oversight is lax or ineffective. 
 
Mr. Bernanke's remarks reflect those of his predecessor Alan Greenspan in Mr. Greenspan's recently released memoir and related interviews. "I find this issue that the Federal Reserve created the housing bubble just utterly devoid of any awareness of who created all the other bubbles," Mr. Greenspan said in an interview last week with “The Wall Street Journa”. Many countries have seen home prices rise more than in the U.S., in particular Britain and Australia, whose central banks didn't lower rates as far as the Fed did. 
 
Mr. Bernanke was a Fed governor from August 2002 to June 2005. Over that period, he not only backed Mr. Greenspan's low-rate policy, he also provided theoretical and empirical justification for it in speeches and research. 
 
Some economists say Mr. Bernanke and Mr. Greenspan are minimizing the Fed's contribution to the housing boom. Thomas Lawler, a housing-finance consultant in Vienna, Va., says the Fed's low rates helped both sub-prime and adjustable-rate mortgages gain market share from fixed-rate mortgages. ARMs, he said, grew from just 10% of mortgage originations in 2001 to almost a third in 2004. 
 
Brian Sack, who worked with Mr. Bernanke at the Fed and is now at forecasting firm Macroeconomic Advisers, points out that expectations of short-term rates help determine long-term rates. The 10-year Treasury yield was about a percentage point lower with the Fed's easy policy than if the federal-funds rate, its main target for short-term interest rates, had remained around 4.5% to 4.75%, he said. He said that the Fed intended to boost housing at the time, because the rest of the economy was so weak. 
 
Both men say it is harder to attribute the continued increase in home prices in 2005 and early 2006 to the Fed. A new study by economists Jonathan Wright of the Fed and David Backus of New York University attributes the continuance of low long-term rates during that period to lenders' willin