In mid-2005 I wrote a piece that I knew would be controversial at RealMoney: Real Estate’s Top Looms. I had debated about writing it sooner, but delayed, because the momentum felt wrong. But by mid-2005, I concluded that the negative arb that investors in residential real estate had could not persist for long. Markets that rely on capital gains tend to get capital losses.
So, when a friend of mine pointed me to the 2005 FOMC Transcripts this morning, I naively decided to look at the transcript closest to my June 2005 piece (graphs here) on the residential real estate markets to see what they were thinking then. It was a two-day session, and they spent the whole first day on the… residential real estate markets!
Intrigued, I read the whole first day of that session, and skimmed the rest. There were a few things that impressed me:
- The lighthearted attitude that the FOMC took in the meeting. Laughter was frequent. That doesn’t impress me, given the seriousness of the task entrusted to them. I know we are Americans, for whom nothing is truly serious, but the transcripts annoyed me with the frequency of humor in the midst of a serious situation.
- They had three staff economists present contrasting views on residential real estate, but they were all optimistic compared to what eventually happened.
- The Presidents and Governors spent too much time with minutiae of modeling.
- They also spent too much time on arguments that were the equivalent of wish-fulfillment.
- They also spent too much time on the price-to-rent ratio, which is a bogus concept. Better to turn everything (bond manager style) into spreads — look at the difference between rental yields versus mortgage yields.
- They spent too much time on what they could learn from Ag land prices to give them wisdom on urban land prices.
On the whole, I felt that our FOMC was not well-equipped intellectually to consider the concept of an asset bubble. There was a genuine unwillingness to consider that monetary policy could have an impact on asset prices — we only have to worry about goods price inflation and unemployment! Don’t give us another ball to juggle!
This set of statements from Ph. D. economist members of the FOMC helped confirm to me that the neoclassical view of economics, which biases people toward the idea that nothing ever matters — market structure is irrelevant, is wrong. We might do better to staff the FOMC with random selection via social security numbers.
Did they consider the increasing level of indebtedness on residential real estate, or the effects of short term finance? Not in any significant way.
Some people criticized me in 2005 for being too dismissive of the FOMC. How can you be so bright, and this group of distinguished people on the FOMC be so dumb in your opinion? Because they have the wrong theory on monetary policy. The idea that monetary policy if properly implemented could assure prosperity was a bad goal. Good monetary policy is not enough, and most concepts of good monetary policy leaned toward loose monetary policy.
Basic concepts like level of indebtedness were neglected in favor of other less demanding measures. No wonder the residential real estate boom went foul.