Hummel, Henderson, the Fed, and the Housing Bubble
By Robert Higgs • Saturday April 18, 2009 5:09 PM PDT • 12 Comments
My old friends Jeffrey Rogers Hummel and David R. Henderson continue to argue that the Fed had little or nothing to do with fueling the housing bubble during the first five or six years of the present decade. Their latest article along these lines appears in Forbes. This is the third rendition of their argument that I have read, and I am no more persuaded now than I was previously.
Hummel and Henderson base their argument mainly on the claim that the Fed was not an engine of inflation between 2001 and 2006 because the rate of growth of the monetary base and the rate of growth of various monetary aggregates were declining during that period. Indeed, they were declining. Computing the rates of growth for the December value relative to the preceding December value, I find the rates to be as follows for the monetary base: 2001, 8.7%; 2002, 7.5%; 2003, 5.8%; 2004, 5.0%; 2005, 3.6%, and 2006, 2.9%. The rates of growth of M2, computed on the same basis, were as follows: 2001, 10.3%; 2002, 6.3%; 2003, 5.0%; 2004, 5.7%; 2005, 4.0%; and 2006, 5.4%.
It does not follow, however, that simply because these (and other monetary) rates of growth were declining, the Fed bore no responsibility for fueling the housing bubble. If we begin at a high rate of growth, as indeed we did in 2001, then rates may fall and still be “inflationary” in their effect on certain asset markets. Consider, for example, that during the entire period from the fourth quarter of 2000 to the fourth quarter of 2006, real GDP rose by only 14.9%, whereas during the same period (December-to-December monthly figures being used) the monetary base increased by 38.3% and M2 by 42.7%—or, by 2.6 times and 2.9 times as much as real GDP, respectively.
In pondering the Hummel-Henderson thesis, I keep coming back to various analogies, such as this one: I walk onto the street and I’m hit by a car going 50 mph; the next day, I walk out and I’m hit by a car going 45 mph; and, being a slow learner, I walk out during the next three days and I’m hit in daily succession by cars going 40 mph, 35 mph, and 30 mph. After five days, I am pretty nastily banged up, but Hummel and Henderson come along to comfort me by informing me that my being hit repeatedly cannot actually have hurt me because each day the car that hit me was going slower than the one that hit me the day before.
Hummel and Henderson also continue to endorse Alan Greenspan’s story that the real culprit was a surge in foreign savings that was invested in large part in housing-related securities, such as Fannie and Freddie’s bonds. I confess that I have never understood this story. In order to invest in securities of any kind, foreigners need to acquire dollars. And all dollars ultimately come from the Fed, because every dollar consists of either a circulating Federal Reserve note or a dollar deposit account subject to a variety of Fed controls. Was the Fed really powerless to “sterilize” the inflow of foreign savings? Or did it simply not attempt to offset this inflow, which it might have done by, for example, selling securities on the open market or by increasing required bank-reserve ratios?
In raising these questions, I assure my readers that I harbor no ideological or personal animus whatsoever against Jeff Hummel and David Henderson. Indeed, I love each of them as I would love a brother (which, in a sense, each of them is to me). I am puzzled by their persistence in attempting to persuade us with a story seemingly aimed at vindicating the Fed (while insisting, however, that, all things considered, the world would be better off without this central bank). I continue to believe that the Fed deserves a major part of the blame for the housing bubble because, however we tell this whole sorry story, our interpretation must inevitably include a plausible answer to the question: where’d the money (i.e., the dollars) come from?
Tags: Economics, Federal Reserve, Housing, Money and Banking 
And like a lot of big brothers, you keep stripping these two naked and sending them out in the street without a fig leaf to hide behind.
I think I’ll start calling them “the naked guys”.
Greg Ransom | Apr 18, 2009 | Reply
This is the “savings glut” theory. It is nonsense. Only the Fed creates dollars. That any “economist” could be taken in by this nonsense shows the terrible state of the profession.
Independent Accountant | Apr 18, 2009 | Reply
Well, the housing bubble was world-wide, simultaneous, and a lot larger in many countries around the world than in the US (e.g.: The Netherlands, Britain, France, Spain, Australia, Japan ... a chart, with link to a story on this The Economist). ISTM that ...
* Saying Greenspan was responsible for all of that is giving him a whole lot of credit.
* Saying all the central banks in all these different countries became inept in the same way at the same time is calling on quite a coincidence.
* Something systematic happening world-wide (perhaps lowering long-term interest rates) would satisfy Occam’s Razor.
Of course I don’t know, because I’m not an expert ... but since they disagree with themselves all over the place on this, apparently they don’t know either. Which is the sort of situation when one best applies Occam’s Razor.
Jim Glass | Apr 22, 2009 | Reply
Saying all the central banks in all these different countries became inept in the same way at the same time is calling on quite a coincidence.
But it doesn’t seem a stretch to say that all the central banks thought: 1. putting less money into play would slow economic growth, 2. the great danger in putting so much money in is inflation, 3. price indexes were not going up much, so 4. inflation wasn’t a problem, and 5. the increase in the money supply was about right.
After all, didn’t just about everyone believe this when the good times were rolling?
Roger Sweeny | Apr 23, 2009 | Reply
Higgs, Hummel, and Henderson, all of whom are also very good friends of mine, are using the Quantity Theory of Money as hindsight analysis. This model is the correct one. Unfortunately, Greenspan and the Fed OMC did not use it rigorously enough in the early part of the decade as foresight policy. If the Fed would take an iron-clad vow to keep the price level, as measured by a good price index, flat stable, with exactly a long-run zero rate of increase, inflation would have been stopped and the housing bubble would have had the CO2 sucked out of it. That said, it seems to me that Higgs is being too blase about the Fannie Mae-Freddie Mac-Barney Frank real effect. That could have taken place even without the low rate of inflation that aggravated it. Furthermore, the F-Ms and B-F are still with us, with B-F having even more power than he had when the Republicans wrecked the political economy.
We are right on track for an economic and political Disaster!
Richard Timberlake | Apr 23, 2009 | Reply
But it doesn’t seem a stretch to say that all the central banks thought...
True. But to find central banks across four continents coordinated in making the same error indicates a fundamental problem lager than and apart from “Greenspan”.
Jim Glass | Apr 23, 2009 | Reply
But to find central banks across four continents coordinated in making the same error indicates a fundamental problem lager than and apart from “Greenspan”.
True. I think the way “Greenspan” factors in is that:
1. The U.S. economy had done amazingly well by historical standards. A conventional wisdom developed that a good deal of the credit for that belonged to Greenspan. When Stephen (no relation?) Glass published a story in The New Republic about Wall Streeters who had an actual shrine to Greenspan, no one seemed to realize that he had made it all up. It actually seemed plausible. So if you were a central banker, and you did things similar to what the Fed was doing, maybe you could get results similar to what was happening in the U.S.A.
2. Greenspan came into the Fed with a reputation for being “conservative.” If even he was willing to allow large increases in money, it couldn’t be overly expansive.
Roger Sweeny | Apr 24, 2009 | Reply
I think the Fed’s are only responsible for the slow down in the growth. If analysis showed that from 2001 the slow down has begun then what measures did the fed take to improve the economic growth.
Collin Paul
HowMuchHomeCanIAfford.org | Sep 21, 2010 | Reply
I agree 100% with Collin.
Dennis "DennisKnows" Marshall | Sep 22, 2010 | Reply
I read this blog and I appreciate your Hummable and Henderson base their argument mainly on the claim.
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Kevin
Bank Savings Account Interest Rates
Bank Savings Account Interest Rates | Oct 19, 2010 | Reply
The housing bubble was created by a lack of regulation in the loan market and by the greed of Wall Street. The unregulated MBS market is what really killed us.
Alex Aurora Co Apartments Manager | Oct 25, 2010 | Reply