The Fed Chair thinks the problem wasn't the Fed's low interest rates. He says the Fed just did not have enough power.

The grimmest news of the new year has to be the fact that Fed chairman Ben Bernanke still has no clue about the causes of our financial crisis or what measures need to be undertaken to avoid another crisis.



Bernanke gave a speech yesterday at the Annual Meeting of the American Economic Association that did two things. First, he exonerated Alan Greenapan's low-interest rates from blame for the housing bubble, arguing that the housing bubble began before the Fed pushed interest rates low and that the size of the bubble cannot really be explained by monetary policy alone.



Perhaps more importantly, however, Bernanke makes the extraordinary claim that regulatory and supervisory policies would have been effective means of addressing the run up in housing prices. What makes this claim so extraordinary is that it completely ignores the fact that regulatory and supervisory policies weren't just ineffective at popping the housing bubble—they were actively fueling it.



"Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short-term interest rates," Bernanke said.



Bernanke argues that exotic mortgages and rubbish underwriting standards that he thinks are "the key explanation" for the housing bubble. But he ignores the fact that these "alternative mortgage products" were created in response to regulatory pressure to expand home ownership. It wasn't just lenders and borrowers who were focused on minimizing the initial payment—that was the policy of the government of the United States.



Banking regulation and supervision in the late nineties and early years of this decade were largely driven by a particular ideology adopted by both presidents Bill Clinton and George Bush—the ideology that flourished under the rubric "The Ownership Society." The regulators who worked for their administrations pushed, cajoled and required banks and mortgage lenders to create and spread the types of mortgages that later turned out to be so toxic.



In particular, the government went to war against two of the biggest barriers to home ownership: accumulating funds for a down payment and the complex documentation that accompanied getting a mortgage. The Bush administration addressed this with both legislation and arm-twisting. It signed into law the American Dream Downpayment Fund, aimed at helping low-income families own homes by subsidizing their downpayments. It issued challenges to lenders to "close the homeownership gap" by loosening lending standards. It celebrated lenders who did this.



In June 2002, Bush announced the downpayment subsidy on a tour of Atlanta's Pryor Road area, where new housing developments were replacing rundown housing projects. He described its goal in religious terms:

It means we use the mighty muscle of the federal government in combination with state and local governments to encourage owning your own home. That's what that means. And it means -- it means that each of us, each of us, have a responsibility in the great country to put something greater than ourselves -- to promote something greater than ourselves.



And to me, that something greater than yourself is to love a neighbor like you'd like to be loved yourself.

The next day, speaking at the Department of Housing and Urban Development, Bush got much more specific about his goals—providing housing subsidies, reducing paperwork and eliminating down payments. Here's the key part of the speech directly from HUD's website (emphasis added):

Well, probably the single barrier to first-time homeownership is high down payments. People take a look at the down payment, they say that's too high, I'm not buying. They may have the desire to buy, but they don't have the wherewithal to handle the down payment. We can deal with that. And so I've asked Congress to fully fund an American Dream down payment fund which will help a low-income family to qualify to buy, to buy. (Applause.)



We believe when this fund is fully funded and properly administered, which it will be under the Bush administration, that over 40,000 families a year -- 40,000 families a year -- will be able to realize the dream we want them to be able to realize, and that's owning their own home. (Applause.)



The second barrier to ownership is the lack of affordable housing. There are neighborhoods in America where you just can't find a house that's affordable to purchase, and we need to deal with that problem. The best way to do so, I think, is to set up a single family affordable housing tax credit to the tune of $2.4 billion over the next five years to encourage affordable single family housing in inner-city America. (Applause.)



The third problem is the fact that the rules are too complex. People get discouraged by the fine print on the contracts. They take a look and say, well, I'm not so sure I want to sign this. There's too many words. (Laughter.) There's too many pitfalls. So one of the things that the Secretary is going to do is he's going to simplify the closing documents and all the documents that have to deal with homeownership.

In September, Bush again addressed the topic at the "White House Conference on Increasing Minority Homeownership." (Steve Sailer fortunately preserved the speech before it vanished from the website of the White House.) Here's what Bush said:

To open up the doors of homeownership there are some barriers, and I want to talk about four that need to be overcome. First, down payments. A lot of folks can't make a down payment. They may be qualified. They may desire to buy a home, but they don't have the money to make a down payment. I think if you were to talk to a lot of families that are desirous to have a home, they would tell you that the down payment is the hurdle that they can't cross. And one way to address that is to have the federal government participate.

You can pretty much randomly pick any speech that Bush gave on housing during the early years of his administration and find this sort of thing. But the point isn't just to finger Bush as a culprit—it's to point out that it wasn't a lack of regulatory response that allowed the housing bubble to inflate. The regulatory action was a key inflator of the bubble.



This is why Bernanke's view is so disturbing. He urges "stronger regulation" but shows no awareness of the culpability of regulations for the bubble. Or, more charitably, he only acknowledges that the regulatory response was inadequate rather than wrong headed.



"The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter," Bernanke writes.



But it wasn't execution that got bungled. It was the entire regulatory plan to increasing home ownership and closing the ownership gap that was wrong from the start.



Of course, bankers and mortgage lenders and home buyers contributed to the housing bubble through errant faith in rising home prices, greed and occasional fraud. But the mistakes and crimes of individuals and financial institutions would not have lead to a crisis without the homogenizing effect of regulation. The errors of ideology and quest for power among regulators were imposed on everyone. The regulators were the key source of systemic risk that created the housing bubble, fed the mortgage boom and made the crash so widespread and catastrophic.



This blindness to regulatory fault suggests that regulatory and supervisory policies adopted in response to the crisis will, at best, be ineffective means to avoid a future crisis. But it shouldn't be that surprising. Almost no one—whether they run companies or government agencies—can be counted on to correctly identify their own mistakes and learn the right lessons from any failure. The market deals with this by not requiring anyone to learn anything—it simply creates losses at firms that make mistakes. The market knew the Time Warner merger with AOL was a disaster long before Gerald Levin. But regulators have no recourse to market corrections, so their own mistakes have no corrective.



The worst part about all of this is that the inability to recognize a crisis caused by regulatory failure—as opposed to one caused regulatory laxity—means that men like Bernanke will push for stronger regulations and supervision—and therefore more market homogenization and less competitive experimentation. And a few years from now, we'll be writing this same damn thing all over again.