Given his popular image as the "maestro" of monetary policy, it is unsurprising that Federal Reserve Chairman Alan Greenspan's retirement in January 2006 provided the occasion for scholars to assess the Fed's performance during his term of office. Political conservatives--led by Milton Friedman (2006)--who gave generally positive reviews despite complaining about Greenspan's disdain for monetary rules, cited declines in both inflation rates and their standard deviations, and the fact that increased price stability did not come at the expense of gross domestic product (GDP). On the other hand, progressives focused on how Greenspan's policies affected social justice. One critic, E. Ray Canterbery (2006), portrayed Greenspan as a libertarian ideologue whose actions benefited wealthy financial interests at the expense of average citizens. Moreover, Thomas Palley (2005) pointed out that Greenspan's policies aided in the creation of what he called "new business cycles," which are characterized by debt-fueled consumer spending, deindustrialization, chronic trade deficits, and preemptive strikes against inflation.
Palley also noted that another feature of today's business cycles is a more enduring burden experienced by some groups as a result of Federal Reserve policy. In the past, most people who shouldered the costs of macroeconomic adjustment were only temporarily affected. For instance, when the Fed engineered an economic slowdown, business owners earned lower profits and their laid-off employees collected unemployment insurance while both groups felt assured that normal times would return. Today, the pain caused by Fed tightening may be permanent since decisions to curtail production or outsource work are often irreversible. Similarly, some financial contract holders may also experience lengthy dislocations as a result of Fed policy. As explained in this paper, many families will lose the homes they financed with exotic mortgages through foreclosure as a result of Federal Reserve interest rate increases.
Following a historical sketch of recent behavior in housing and mortgage markets, the paper attempts to determine responsibility for the financial distress experienced by these households. Although the mortgagees themselves, mortgage brokers, banks, and hedge funds are all somewhat to blame, I find the Federal Reserve's role in allowing household financial fragility to develop and then knowingly sacrificing the well-being of already-disadvantaged people to combat inflation morally unjust. (1) For this reason, the Fed should be responsible for restoring already-incurred losses and should enact measures to prevent household financial imbalances from reoccurring.
Recent Trends in Housing and Mortgage Markets
One of the most controversial developments in the U.S. economy recently has been the explosive appreciation in home prices. The Office of Federal Housing Enterprise Oversight's (OFHEO) index for the United States increased by nearly one-third from 2004 to the second quarter of 2006, and the quarter-to-quarter annual percentage change in prices, which averaged just below 7 percent during 2002 and 2003, rose to 10.71 percent in 2004 and 13.30 percent in 2005. (2) The latter increase prompted Greenspan's now-famous discovery of "froth" in the housing market in May of that year. Moreover, these figures understate the price changes in some local markets like Honolulu and Napa, CA, where prices increased approximately 20 percent since the beginning of 2005. However, prices began to decline in mid-2006 with the National Association of Realtors reporting a 3.5 percent decline in existing home prices from January to November 2006 as sales volume fell 11.5 percent.
The housing market has been a source of both economic benefit and potential disaster. Now estimated to employ nearly one in ten U.S. workers directly or in related industries, housing has been one of the main drivers of the U.S. job market, and the borrowing made possible from rising home values financed a consumption binge that helped keep the U.S. economy afloat from 2003 to 2006. And, despite the fact that the housing market has undergone a...