One of the root causes of the financial crisis

For all the talk about identifying root cause lately, as the financial crisis lurches to-and-fro like a drunken sailor stumbling back to his room after a night out on the town, there is a dearth of discussion about one of the most important of the lot - the inflation statistics.As shown above, if home prices were included in the inflation data instead of the nefarious OER (owners' equivalent rent), we'd see that "core inflation" is now settling in at about minus 4 percent and that today's short-term interest rates of two percent in the U.S. are quite inappropriate.

Of course the "inappropriate" label could be just as easily applied to the 2003-2004 period when rates were at one percent - that's when the seeds of this crisis were sown.

The BLS has a new webpage up defending their methodology (see item #2 for OER):

Common Misconceptions about the Consumer Price Index: Questions and Answers

This was discussed here previously (see Maybe economic theory is wrong) and on my To Do list is a closer look at how inflation over the last few decades would look if OER were replaced with mortgage payments (using the prevailing home prices, 30-year mortgage rates, and standard down payments at the time) rather than just home prices as shown in the chart above.

Not a whole lot different is my guess.

If not for OER, what policy makers would have more easily recognized earlier in the decade was that home ownership costs were soaring and the only way people could afford to buy real estate was to take out one of those wacky no-money-down, negative-armortization loans or lie about their income to secure a mortgage payment they couldn't afford.

That realization back in 2003 might have made things a little less traumatic today.