2 Ignored Impacts of “Too Low, Too Long”

The Fed’s drastic reduction in interest rates following the Dot-Com stock market bust is often described as “Too low, too long.”

The policy is blamed by some for triggering the housing bubble and by many for amplifying the bubble.

In addition to the basic point about cheaper money spurring higher home prices, I think the policy had 2 ignored consequences.

1) Refinancing Bust Spurred Subprime Boom

20% of all homes with mortgages were refinanced in 2003.

Boom. The huge refinancing boom in 2003 also created a hiring and profit boom in the mortgage industry.

Retrench? As the number of refinancings returned to earth, the enlarged mortgage industry looked for new business to replace the lost refi business.

Roaming army. It was as if an army of underemployed mortgage professionals were searching for new lands to conquer.

New territory. Some expanded into subprime. For example, some large traditional mortgage companies added subprime products after the refi boom.

The number of subprime mortgages skyrocketed in 2004 and 2005.

If the Fed hadn’t lowered rates so low, the boom in refinancings would have been a bit smaller, the army of new mortgage professionals it created would have been smaller and, likely, the shift toward subprime mortgages after the bust in refinancings would have been a bit smaller as well.

2) Increasing Interest Rates Increased Buyer Mania

Some people blame the bust, or at least the timing of the bust, on the higher interest rates in 2006 and 2007. There’s a lot of truth to that.

Cheap money. The monthly payment would be significantly higher with higher interest rates no matter the price of the home. The higher rates made homes, in essence, more expensive.

More mania. People, however, don’t usually talk about how increasing Fed rates so slowly from the summer of 2004 to the summer of 2006 contributed to the mania.

It’s a good time to buy. The mortgage industry was constantly hammering the point that interest rates were historically low and they wouldn’t last forever.

Sword of Damocles. When the Fed started to slowly increase the Fed Funds rate in the summer of 2004, many homebuyers thought mortgage rates would soon take off.

Mortgage rates didn’t actually increase much until fall 2005 but from the time the Fed started to increase the Federal Funds rate in the summer 2004, a lot of people felt they would miss out on the lowest interest rates in modern history if they didn’t buy a home soon.

FOMO. With rapidly rising home prices and now with most people expecting higher interest rates, many felt they would be priced out of the market forever if they didn’t buy their home soon.

Federal Reserve Policy Made Bubble Worse

It’s no secret that real estate is especially sensitive to changes in interest rates. Rates low enough to boost the general economy will often cause real estate booms.

It appears, “Too low, too long” exacerbated;

  1. The subprime boom, and
  2. Home buyer mania.

Considering all impacts, a more stable Fed policy would have destabilized the housing market less and likely could have greatly reduced the real estate boom and bust and the damage caused.