History does sometimes repeat itself. Unfortunately, the emphasis on short-term time periods and results has produced fear and ignorance about the current housing and credit markets. As Jay Brew told readers of the September issue of Focus Forum, "There is a whole generation of loan officers who have never done a workout."
Bernanke Explores Home Financing Trends Since 1890
There also is a whole generation of bank executives and board members that lacks the historical perspective to understand and assess the current problems in the housing sector and the credit markets. A tiny few can put current developments into the perspective associated with the home financing crisis. One of the few who does is Federal Reserve Chairman Ben S. Bernanke. In a recent speech, he examined housing finance trends over more than a century—since 1890.
Of course, while most community bank managers and board members lack his academic foundation, they share Bernanke's overall view of the recent housing and credit market woes. "The financial turbulence we have seen had its immediate origins in the problems in the subprime mortgage market, but the effects have been felt in the broader mortgage market and in financial markets more generally, with potential consequences for the performance of the overall economy."
Bernanke Repeats the No-Bailout Mantra
They are familiar with Bernanke's oft-repeated sentiments that "it is not the responsibility of the Federal Reserve—nor would it be appropriate—to protect lenders and investors from the consequences of their financial decisions." They also are familiar with the broad brush stroke statements by Bernanke and the Fed that developments in financial markets can have broad economic effects felt by many outside the markets, and the Fed must take those effects into account when determining policy.
Such vagueness aside, it is possible to garner a better understanding of the Fed and Bernanke. Of course, as the markets gyrate to every piece of economic news, Bernanke has become the scapegoat for many in the investment community and for the media's financial celebrities who clamor for the Fed to take increasingly drastic actions in lowering short-term rates. They are baffled by the Fed's behavior. They should not be.
Listen to Bernanke's Clear-Speak
Unlike his predecessor, Alan Greenspan, who specialized in convoluted sentence structures and lengthy, obfuscating statements, Bernanke offers easy-to-follow statements in clear and jargon-free sentences. It is difficult to understand why bankers and market participants rely so heavily on the media's interpretation of Bernanke's pronouncements when his statements are so easy to understand.
Community bankers should closely study Bernanke's speech on Aug. 31 at the Federal Reserve Bank of Kansas City's "Economic Symposium" held in Jackson Hole, WY. In that speech, Bernanke offered a classic economic overview on "Housing, Housing Finance, and Monetary Policy" to that gathering of macroeconomic elites. Unfortunately, the print and electronic media cherry-picked a few phrases to focus on the Fed's next move. That's too bad because the speech offered historical perspective and, more importantly, a look into the way Bernanke views events and approaches the relationship of the housing markets, credit markets, and economic policy. He noted that "as our system of housing finance continues to evolve," it is important to understand the various ways the markets and economic events impact one another.
Mortgage Credit Is Less Dependent on Fed Funds Rate
For those who believe a change in the fed funds rate is a panacea for housing and credit market problems, Bernanke's views might sound heretical. In his speech, Bernanke clearly stated that "the availability of mortgage credit today is generally less dependent on conditions in short-term money markets, where the central bank operates most directly." In short, the Fed's lowering of the fed funds rate will have minimal impact on the dislocations in the mortgage markets.
Bernanke Outlines the Relationship of Housing Cycles to Business Cycles and Recessions
Turning to the impact on the economy, he stated that most estimates based on statistical historical trends "suggest that, because of the reduced sensitivity of housing to short-term interest rates, the response of the economy to a given change in the federal funds rate is modestly smaller and more balanced across sectors than in the past."
Bernanke pointed to the "Federal Reserve's large econometric model of the economy, which implies that only about 14% of the overall response of output to monetary policy is now attributable to movements in residential investment, in contrast to the model's estimate of 25% or so" since the 1930s. As a result, he said there has been a "reduced synchronization of the housing cycle and the business cycle during the present decade."
Bernanke also addressed the patterns associated with recessions. He noted, "In all but one recession during the period from 1960 to 1999, declines in residential investment accounted for at least 40% of the decline in overall real GDP." The sole exception—the 1970 recession—"was preceded by a substantial decline in housing activity before the official start of the downturn."
A major change, though, has occurred in the past decade. Bernanke stressed that in contrast to previous patterns, "residential investment boosted overall real GDP growth during the 2001 recession."
Bernanke noted that pattern may not be operating in the current economic environment. Such observations indicate Bernanke is as grounded in the current economic reality as he is in historical trends and mathematical economic models.
Consumer Spending Can Be Fueled or Hindered by the Housing Market
Bernanke also explored the impact of the downturn in housing finance and residential construction on consumer spending. "Perhaps the most significant effect of recent developments in mortgage finance is that home equity, which was once a highly illiquid asset, has become instead quite liquid, the result of the development of home equity lines of credit and the relatively low cost of cash-out refinancing."
Bernanke explained that tapping into home equity "should allow households to better smooth consumption over time." The smoothing—due to the greater liquidity of home equity—"should reduce the dependence" of consumer spending on current income. That looser relationship between consumer spending and consumer current income "should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate.
"On the other hand, the increased liquidity of home equity may lead consumer spending to respond more than in past years to changes in the values of their homes," Bernanke stated. One question does remain open to debate: Has the development of home equity loans and easier mortgage refinancing "increased the magnitude of the real estate wealth effect—and if so, by how much?
Skip the Innocuous Sound-bites and Focus on the Bank's Strategic Plan
Like every Fed chairman preceding him, Bernanke summarized his views in an innocuous statement: "The interaction of housing, housing finance, and economic activity has for years been of central importance for understanding the behavior of the economy, and it will continue to be central to our thinking as we try to anticipate economic and financial developments." Despite such overarching and bland statements, Bernanke's speech on Aug. 31 and his other statements and speeches provide insight into his views of the markets, the economy, and the Fed's role and its limitations in crafting monetary policy.
Bernanke's clear-speak is a product of a sturdy intellectual framework that is grounded in a long-term perspective but is flexible enough to operate in a changing business and economic environment. Community bankers and board members need to plant the bank's health and growth in a similar framework—namely a well-crafted strategic plan that permeates and drives short-term actions to create long-term value.