Rise and Fall of Real Estate Values: Who Controls the Ride?

In September 2007, Alan Greenspan, former Chairman of the Board of Governors of the Federal Reserve System (the Fed), explained on The NewsHour with Jim Lehrer (September 18, 2007) that "we've had a bubble in housing." He also spoke on the television show 60 Minutes with Lesley Stahl (September 13, 2007) in the wake of the subprime mortgage and credit crisis in 2007, saying, "I really didn't get it until very late in 2005 and 2006."

It is interesting that Greenspan did not "get it" because he essentially started it. He lowered rates and kept them down during President Clinton's administration and continued to do so during the second Bush administration and that practice is a major reason for the current problems in the real estate market.

Greenspan was able to get away with the rate reductions because government indicators showed that inflation was under control. However, these indicators are skewed because the government measures only core inflation, which does not count food and energy cost increases, causing economists to say that "Core inflation makes sense only for people who don't eat or drive" (Cooper 2007). It also ignores selected items for other reasons; for example, the increase in the cost of cars is not counted because it is claimed that cars are always improving.

Nevertheless, beginning in the 1990s there was a reason many manufactured items did not increase in cost: the influx of goods made in China. With the cheapest labor costs in the world, China began exporting items at prices well below those for anything manufactured in the United States. This forced many companies to either go out of business or make their products overseas. As a result, prices for many items went down, even if the cost of other items increased. The average, however, made it appear that inflation was relatively low.

All these factors gave the government an excuse to keep rates down for a prolonged period of time and eventually housing prices started to escalate. Typically, when Americans want to buy a house, they look at the monthly payment that fits their income, not the price of the property. So if interest rates are lowered, prices are bound to eventually increase. Figure 1 and Table 1, based on data from the Fed, tell the story of how rates were changed. Figure 1 shows the rates since 1990. In 1994 and also during 1997 and 1998, rates were historically low, but they decreased to their lowest in more than 40 years in 2002-2004.