Did the Fed Really Cause the US Housing Boom?

As the graph below shows, there has been a boom in the sale of new, single-family homes in the US since the late 1990s.

In recent weeks, common wisdom bandied about on financial talk shows is that this housing boom was somehow caused by Federal Reserve Chairman Greenspan’s reduction in short-term interest rates during the years 2000-2004.

But is this reasonable?

Might there not be some other explanation?

Consider Demographics Rather Than Interest Rates

The thing that strikes me about the graph of new home sales (besides the boom of the late 1990s) is that the addition of new homes to the US housing supply has been more or less stable for over thirty years, fluctuating around only 600,000 new homes a year.

New Home Sales Began To Take Off in the 1990s
New Home Sales Began To Take Off in the 1990s

In 1999, the stock of single family homes in the US was about 112 million units. That means that the supply of new homes, for over thirty years, was less that one percent of the number of homes in use at the end of the century.

New Immigrants and Internal Migrants Need Homes

Compare this to the statistics on legal immigration, which, since the end of World War II, has grown from about one million a year, to over nine million a year by 2000. See the graph in the article, “America Grows With Legal Immigration“.

Over the same period, there has been a flood of internal migration, away from decaying cities in the Northeast and the Rust Belt, towards the New South and the Southwest, and from inner cities to the suburbs as people fled forced bussing following the civil rights movement of the sixties. All this has created a demand for new homes.

Furthermore, homes grow old and become obsolete. The tiny homes of Levittown built after World War II seem cramped and a bit tacky for life styles of the 1990s. A modest retirement bungalow in Florida, built in the 1960s is not what today’s Baby Boomers imagine for their golden years.

Demographics and obsolesce were forces powerful enough to have caused the economy to break out from a long-term pattern of only modest increments to the housing stock, as long as money for mortgages was readily available.

And the money was definitely there.

Trade Deficits, Franklin Raines, and Ditech.com

Given the latent demand for new housing, all that was required to spark a building boom was ample mortgage money at low interest rates.

This became available, not because of the largess of Fed Chairman Greenspan, but rather because of a growing trade deficit that poured vast sums into the bond market — now directed primarily towards mortgages. Trade deficits were not caused by the Federal Reserve, but rather by America going off the gold standard in 1971 and by Congressional policies favoring globalization and free trade.

For a generation, growing trade deficits have forced bond prices up and long-term interest rates down. (See: “Trade Deficits Have Depressed Bond Yields For 20 Years.“)

This flood of mortgage money was aggressively pushed upon consumers, led by Franklin Raines of Fannie Mae and by commercial banks creating asset-backed securities. (See: “ABS Bonds Replace Agency Securities: Q3 2005“.)

No one who has been subjected to the TV ads of Ditech.com can doubt the forcefulness with which mortgage came to be marketed to the public.

Inflation and a Crash in Stock Prices

Besides demographic pressures, demand based on obsolescence, and easy mortgage money, that final push needed to fire a housing boom came from inflation (understated in government figures) and a dismal stock market. (See: “Fiddling the CPI“, “Homes Are America’s Piggybanks“, and “Home Equity Beats Stock Investment 1995-2004“.)

All of these forces, taken together, seem a more likely explanation for the housing boom of the last decade than the policies of the Federal Reserve regarding short-term interest rates.

But then, of course, a thriving industry of fed watchers seem to think that the Federal Reserve Chairman is responsible for almost everything that happens in the US economy. (See: “Can the Fed Really Manage Inflation?“).

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