Bernanke: There's No Housing Bubble to Go Bust
Fed Nominee Has Said 'Cooling' Won't Hurt
By Nell Henderson
Washington Post Staff Writer
Thursday, October 27, 2005
BEN S. BERNANKE DOES NOT think the national housing boom is a bubble that is
about to burst, he indicated to Congress last week, just a few days before
President Bush nominated him to become the next chairman of the Federal
U.S. house prices have risen by nearly 25 percent over the past two years,
noted Bernanke, currently chairman of the president's Council of Economic
Advisers, in testimony to Congress's Joint Economic Committee. But these
increases, he said, "largely reflect strong economic fundamentals," such as
strong growth in jobs, incomes and the number of new households.
Bernanke's thinking on the housing market did not attract much attention
before Bush tapped him for the Fed job Monday but will likely be among the
key topics explored by members of the Senate Banking Committee during
upcoming hearings on his nomination.
Many economists argue that house prices have risen too far too fast in many
markets, forming a bubble that could rapidly collapse and trigger an
economic downturn, as overinflated stock prices did at the turn of the
century. Some analysts have warned that even a flattening of house prices
might cause a slump -- posing the first serious challenge to whoever
succeeds Fed Chairman Alan Greenspan after he steps down Jan. 31.
Bernanke's testimony suggests that he does not share such concerns, and that
he believes the economy could weather a housing slowdown.
"House prices are unlikely to continue rising at current rates," said
Bernanke, who served on the Fed board from 2002 until June. However, he
added, "a moderate cooling in the housing market, should one occur, would
not be inconsistent with the economy continuing to grow at or near its
potential next year."
Greenspan has said recently that he sees no national bubble in home prices,
but rather "froth" in some local markets. Prices may fall in some areas, he
indicated. And he warned in a speech last month that some borrowers and
lenders may suffer "significant losses" if cooling house prices make it
difficult to repay new types of riskier home loans -- such as interest-only
Bernanke did not address the possibility of local housing bubbles or the
risks faced by individual borrowers or lenders in a slowing market.
But if Bernanke is confirmed as Fed chief, and if the housing market slows
more than he expects, he would be unlikely to use the central bank's power
over short-term interest rates to prop up falling housing prices for the
sake of individual homeowners, according to comments he has made in numerous
speeches and statements in academic papers.
Rather, he has argued for many years that the Fed should respond to rising
or falling prices for stocks, real estate or other assets only if they are
affecting inflation or economic growth in an undesirable way. Thus, he would
advocate cutting interest rates if a reversal in the housing market sharply
dampened consumer spending, triggering job losses or a fall in inflation to
very low levels.
Lower interest rates encourage consumers and businesses to borrow and spend,
spurring economic growth and hiring. That would also make it less likely
that very low inflation could turn into deflation, an economically harmful
drop in the overall price level.
Bernanke believes "the Fed's job is to protect the economy, not to protect
individual asset prices," said William Dudley, chief economist for Goldman
Sachs U.S. Economics Research.
That view mirrors Greenspan's. He and Bernanke have both said it is
unrealistic to expect the Fed to identify a bubble in stock or real estate
prices as it is inflating, or to be able to pop it without hurting the
economy. Instead, the Fed should stand ready to mop up the economic
aftermath of a bubble.
Greenspan, for example, has rejected suggestions that the Fed should have
raised interest rates in the late 1990s sooner or higher to slow soaring
stock prices. He says the Fed got it right after that boom by cutting its
benchmark rate deeply in 2001, in response to falling stock prices, the
recession and the Sept. 11 terrorist attacks.
After Bernanke joined the Fed board in 2002, as the economic recovery
remained sluggish and job cuts continued, he vocally supported Greenspan's
strategy of lowering the benchmark rate further and holding it very low
until mid-2004, when it was clear that both job growth and the economic
expansion were solid.
Bernanke also warned in a November 2002 speech that the Fed would act
aggressively to prevent deflation, which had devastated the economy during
the Great Depression that followed the 1929 stock market crash.
A former chairman of Princeton University's economics department, Bernanke
earned academic renown for his research on the Fed's role in causing the
After the 1929 crash, the Fed mistakenly raised interest rates to protect
the value of the dollar, which was then pegged to the price of gold,
Bernanke wrote in an October 2000 article in Foreign Policy. The higher
rates contributed to surging unemployment and severe price deflation. The
Fed then made things worse by not acting to counter the credit crunch that
resulted from the collapse of the banking system in the early 1930s.
"Without these policy blunders by the Federal Reserve, there is little
reason to believe that the 1929 crash would have been followed by more than
a moderate dip in U.S. economic activity," Bernanke wrote.
In late 2000, looking ahead to the possibility of a sharp fall in then-lofty
stock prices, Bernanke concluded, "history proves . . . that a smart central
bank can protect the economy and the financial sector from the nastier side
effects of a stock market collapse."
And in words that might come to mind if housing tanks, he said the economic
effects of falling asset prices "depend less on the severity of the crash
itself than on the response of economic policymakers, particularly central