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mortgage risks and the housing market. Members and staff had difficulty develop-
ing a consensus on whether housing prices were overvalued and “it was hard for
many FOMC participants . . . to ascribe substantial conviction to the proposition
that overvaluation in the housing market posed the major systemic risks that we
now know it did,” according to a letter from Fed Chairman Ben Bernanke to the
FCIC. “The national mortgage system might bend but will likely not break,” and
“neither borrowers nor lenders appeared particularly shaky,” one presentation ar-
gued, according to the letter. In discussions about nontraditional mortgage prod-
ucts, the argument was made that “interest-only mortgages are not an especially
sinister development,” and their risks “could be cushioned by large down payments.”
The presentation also noted that while loan-to-value ratios were rising on a portion
of interest-only loans, the ratios for most remained around . Another presenta-
tion suggested that housing market activity could be the result of “solid fundamen-
tals.” Yet another presentation concluded that the impact of changes in household
wealth on spending would be “perhaps only half as large as that of the s stock
bubble.” Most FOMC participants agreed “the probability of spillovers to financial
institutions seemed moderate.” 
As one recent study argues, many economists were “agnostics” on housing, un-
willing to risk their reputations or spook markets by alleging a bubble without find-
ing support in economic theory.  Fed Vice Chairman Donald Kohn was one.
“Identification [of a bubble] is a tricky proposition because not all the fundamental
factors driving asset prices are directly observable,” Kohn said in a  speech, cit-
ing research by the European Central Bank. “For this reason, any judgment by a cen-
tral bank that stocks or homes are overpriced is inherently highly uncertain.” 
But not all economists hesitated to sound a louder alarm. “The situation is begin-
ning to look like a credit-induced boom in housing that could very well result in a
systemic bust if credit conditions or economic conditions should deteriorate,” Federal
Deposit Insurance Corporation Chief Economist Richard Brown wrote in a March
 report. “During the past five years, the average U.S. home has risen in value by
, while homes in the fastest-growing markets have approximately doubled in
value.” While this increase might have been explained by strong market fundamen-
tals, “the dramatic broadening of the housing boom in  strongly suggests the in-
fluence of systemic factors, including the low cost and wide availability of mortgage
credit.” 
A couple of months later, Fed economists in an internal memo acknowledged the
possibility that housing prices were overvalued, but downplayed the potential im-
pacts of a downturn. Even in the face of a large price decline, they argued, defaults
would not be widespread, given the large equity that many borrowers still had in
their homes. Structural changes in the mortgage market made a crisis less likely, and
the financial system seemed well capitalized. “Even historically large declines in
house prices would be small relative to the recent decline in household wealth owing
to the stock market,” the economists concluded. “From a wealth-effects perspective,
this seems unlikely to create substantial macroeconomic problems.” 