April 30 (Bloomberg) -- Federal Reserve officials were perplexed by speculation in housing and rising home prices in the course of discussions that resulted in an increase in borrowing costs in June 2004, according to transcripts of their meeting.

Stephen Oliner, then Fed associate research director, told the Federal Open Market Committee on June 30, 2004, that the ratio between rents and prices deviated from historical trends and wasn’t explained by “fundamentals,” according to transcripts of FOMC meetings released today by the central bank.

“I don’t want to leave the impression that we think there’s a huge housing bubble,” Oliner said. “We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there’s a part of the increase that is hard to explain.”

While the Fed held interest rates low from June 2003 until June 2004, the boom in home prices accelerated, eventually leading to the crash in valuations that preceded the financial crisis. The annual increase in home prices reached a record 20 percent in July 2004, according to the Standard & Poor’s Case- Shiller 10 City Composite Home Price Index.

Policy makers in June 2004 raised the federal funds target to 1.25 percent from 1 percent, the first of 17 consecutive quarter-point increases over two years, stopping at 5.25 percent.

The Fed releases FOMC transcripts after five years.

Speculative Excess

In March 2004, then-Atlanta Fed President Jack Guynn warned of speculative excess in housing.

“A number of folks are expressing growing concern about potential overbuilding and worrisome speculation in the real estate markets, especially in Florida,” Guynn said.

“Entire condo projects and upscale residential lots are being pre-sold before any construction, with buyers freely admitting that they have no intention of occupying the units or building on the land but rather are counting on ‘flipping’ the properties--selling them quickly at higher prices,” he said.

Minutes of the FOMC meeting in March 2004 showed policy makers discussed speculation in housing markets in some parts of the country.

That speculative activity suggested “the possibility that house prices might be moving into the high end of the range that could be consistent with fundamentals,” minutes of the meeting said.

Subprime Loans

During 2004, the share of subprime originations in the mortgage market more than doubled. In 2004, 18.5 percent of mortgages were subprime compared to 7.9 percent in 2003, according to Harvard University’s “State of the Nation’s Housing” report, citing data from Inside mortgage finance.

Fed Governor Edward Gramlich in May of 2004 said in a speech about “Benefits, Costs and Challenges” of subprime mortgage lending that “while the basic developments in the subprime mortgage market seem positive, the relatively high delinquency rates in the subprime market do raise issues.”

Issuance of mortgage-related securities, another cause of the financial crisis, reached a peak of $3.07 trillion in 2003, up from less than $500 billion in 1996, according to data from the Securities Industry and Financial Markets Association.

Fed Chairman Alan Greenspan in an Oct. 19, 2004 speech raised the risks of a collapse in home prices, saying “these concerns cannot be readily dismissed.”

“Should home prices fall, we would have reason to be concerned about mortgage debt; but measures of household financial stress do not, at least to date, appear overly worrisome,” Greenspan said.

To Contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

Last Updated: April 30, 2010 13:12 EDT