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November 25, 2007 | economicprincipals.comSo unexpected was his sentiment that at first I thought I had misheard. The speaker, a well-respected market commentator who was carving the turkey, said that gradually following George W. Bush down the "worst ever" path into history might be Alan Greenspan.
Bush was one thing; none of us around the table that evening would disagree. But Greenspan? He is more accustomed to the adulatory treatment accorded him last week by an anonymous Financial Times diarist, who relied on commentary from an embattled market participant for this Observer item:Not everyone can be as prescient as Alan Greenspan, the former US Federal Reserve chairman, who warned of "irrational exuberance" years before the internet bubble finally burst. Take, for example, his successor, Ben Bernanke. His reading of the still-unwinding fall-out from the US subprime crisis has been less than astute, according to some commentators.
In a recent note to clients, Merrill Lynch economist David Rosenberg selected a series of quotes from Mr. Bernanke this year that might already haunt him. On February 14, for instance, he noted that "some tentative signs of stabilization have recently appeared in the housing market." Then, on March 28, he said "the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."
On May 17, the message was still relatively sanguine. "We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect any significant spill-over ... to the rest of the economy or the financial system," said the Fed chairman. And this, on June 5, shortly before the credit squeeze hit: "Fundamental factors -- including solid growth in incomes and relatively low mortgage rates -- should ultimately support the demand for housing. and at this point the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or financial system."
Even now, as investors grimly await hundreds of billions of dollars of losses on subprime debt and warnings of a recession mount, the Fed still proclaims optimism and warns against expecting rate cuts. A case of irrational calm, perhaps?
But suppose you turn this story on its head. After all, the narrator is a mouthpiece for one of the principal offenders in the subprime mess, a firm still hoping for a bailout. (Merrill Lynch already has sacked its CEO). But if Greenspan was so prescient, why did permit the housing bubble to get so out of hand, before retiring as chairman of the Federal Reserve Board in 2006?
Suppose, as my friend expects, that the credit crunch is just beginning, that the worst is yet to come. Suppose that Bernanke is still in the throes of finding out just how great is the mess that had been left him by his predecessor, the Maestro. Suppose, too, that Greenspan is working overtime to protect his reputation, and is scarcely a disinterested source of information and commentary.
Suppose, in other words, that Greenspan had been right when in December 1996, when he raised the specter of "irrational exuberance;" right, too, in facilitating the remarkable boom of the late 1990s; but wrong in thinking that central bankers don't have to worry about preventing asset bubbles. Markets around the world dropped sharply on his remarks that day -- until traders recognized that he had said just the opposite of what they had feared; that in fact he did not intend to take away their bowl of punch. (The Standard & Poor 500 Index had gone up 34 percent the year before, and would climb another 20 percent in 1996.)
Greenspan asked, "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" He added, "We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability."
So the S&P soared 31 percent in 1997 (after a famous Business Week cover story asserted that Greenspan now believed that the US economy had entered a "new era" of enhanced productivity; 26 percent in 1998, and 20 percent in 1999. In March 2000, the market peaked. By January 2001 the economy was sliding into a recession. Congress cut taxes; the Fed cut rates to as low as 1 percent in 2003. The recession proved to shallow and relatively short-lived.
But those record low interest rates kindled the housing bubble.
To be sure, the last fifteen years have been wild and crazy times. The end of the Cold War, a decade of depression in Japan, the gold rush in the former communist countries, an impeachment trial in the United States, China's entry into global markets, the Asian financial crisis (and the meltdown of Long Term Capital Management), the specter of Y2K computer glitches, the deadlocked election of 2000, the European slowdown following monetary union, the 9/11 attacks, the invasions of Afghanistan and Iraq, the enormous US tax cuts on the eve of war. Hardly did Greenspan have a free hand. Yet, especially after 2001, he was a willing handmaiden of economic policies that have since turned out to be disadvantageous.
The question of the moment is not so much one of rampant banker greed -- Fortune asked the other day "What Were They Smoking?" -- as one of failed regulation. As recently as April 2005, Greenspan himself was touting the rapid developments in securitization that permitted US banks to write nearly a trillion dollars of subprime mortgages and sell them in impenetrable packages to financial institutions around the world.
Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country .... With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. ... [W]here once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.
Today hardly anyone knows with any precision who owns what, much less what particular assets, once rated triple- and double-A, are worth today. Estimates of the necessary write-downs run as high as $200 or even $300 billion. The situation is reminiscent of the savings and loan crisis of the late 1980s, except that then it was decentralized S&Ls and the developers to whom they lent who bore the brunt. This time the biggest banks are at risk, some of them of outright bankruptcy; pension funds, here and abroad, will report substantial losses; and, of course, tens of millions of individual homeowners will feel the pain. Only a fraction will lose their homes to foreclosure.
The darkest possibility was hinted at last week by Paul A. Samuelson, of the Massachusetts Institute of Technology, at 92 still the greatest public policy economist of the age, writing in the International Herald Tribune:
All through the years of the Great Depression, Wall Street publicists and President Herbert Hoover would repeatedly declare: 'Recovery is just around the corner.' They were wrong. And history repeats itself....
As one of the economists who helped create today's new-fangled securities, I must plead guilty. These new mechanisms both mask transparency and tempt to rash over-leveraging....
The situation is not hopeless. New, rational regulations that discourage predatory lending and rash borrowing could help a lot. Also, as we learned during the Great Depression, the government's Treasury and its central bank must be both lenders of last resort and spenders of last resort. Speculative markets will not stabilize themselves....
Watch developments closely. If America's Christmas retail sales fail badly -- as they could when high energy prices and high mortgage costs pinch consumers' pocket books -- then be prepared to accelerate credit infusion by central banks on the three main continents.
The crisis will pass, of course, though maybe not before the next election. The lengthy period of suspense contributes to the atmosphere of danger. What's needed now -- besides forbearance and alacrity in keeping with the situation -- is narrative coherence in the broadest sense.
The last dozen years have been a spell-binding chase of one thing after another. It is easy to lose track of the broad outlines of what has happened in the world. The Cold War ended, and sovereign states beyond the United States and Europe began to grow -- China, India and Russia especially rapidly.
Yet every American war since the Revolution has ended with a memorable recession, with the interesting exception of World War II, which saw the emergence of a new sort of on-going confrontation that included Korea and Vietnam. Perhaps the frenzied decade that followed the end of the Cold War will bring a return to form, as an over-stimulated American economy finally settles on a new horizon.
September 24, 2007 | Online Journal
Manias, panics, and crashes are the consequence of an economic environment that cultivates cupidity, chicanery, and rapaciousness rather than a devout belief in the Golden Rule." --Peter L. Bernstein, Foreword to Manias, Panics, and Crashes (4th ed.) by C. P. Kindleberger
"In a crisis, discount and discount heavily." --Walter Bagehot (1826-1877), British economist
"The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting." --William McChesney Martin (1906-1998), Fed Chairman (1951-1970)
"The dysfunctional state of American politics does not give me great confidence in the short run.'' --Alan Greenspan, Fed Chairman (1987-2006)
The mismanagement of money and credit has led to financial explosions over the centuries. The causes, cures and consequences of such financial catastrophes are most often repetitive. Indeed, such financial collapses are usually the result of the unbridled greed and cupidity of financial operators and of the lack of necessary supervision by public institutions designed to protect the public and the common good.
For example, after the October/November 1907 financial crisis in the United States, the idea initially advanced by banker Paul Warburg to establish a partially private and partially public Federal Reserve System of banking was finally adopted in 1913. The Fed thus became the lender of last resort for banks that find themselves in an illiquid position. It was only after the stock market crash of 1929, however, that the Securities and Exchange Commission (SEC) was established, in 1934.
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But even with institutions and regulations in place, when they are inoperative, corrupt or ill-adapted, financial crises can still occur. And the current financial crisis is there to remind us of this fact.
On September 18, the Fed showed some panic and announced a larger than expected half percentage point cut in both the federal funds rate and in the discount rate, and this after having slashed its discount rate by a half point on August 17, in order to facilitate borrowing by America's largest banks and to facilitate the bailout of their affiliates and other operators, such as hedge-funds, caught in the sub-prime loans crisis. In so doing, the Bernanke Fed is following Bagehot's advice for aggressive discounting in a situation of financial crisis. The only problem is that Bagehot's rule calls for the central bank to lend copiously in times of critical credit stringency . . . but at a high rate of interest. By lending to troubled lenders at reduced preferential rates, the Fed is acting as their "government," i.e. subsidizing their risky loans operations and taxing anybody else who holds American dollars. It is not only attempting to make them more "liquid," but also more "solvable" and less likely to fail.
This raises three interesting questions. First, who pays for the bailout of U.S. financial institutions? Second, what are the longer-run consequences of the massive bailout undertaken by the Fed? And third, why did the Fed let the financial situation deteriorate to such an extent that an entire sector of the economy is being clobbered and its collapse is threatening the whole economy?
First, we must consider that the U.S. dollar is still a key reserve currency, although losing ground to the euro, and it is still being held in massive amounts by most central banks in their foreign reserves, and also by private banks, commercial and economic entities and individuals around the world. For example, in early 2007, foreign central banks alone held some two and a quarter trillion in U.S. dollars reserves, which represented about 66 percent of their total official foreign exchange reserves, with a bit more than 25 percent being held in euros.
Since the dollar is losing its purchasing power, both in absolute and relative terms, central banks and other foreign investors have been "taxed" by the American Fed's policy of benign neglect regarding the dollar. In real terms, the seigneurage tax on foreign holders of the dollar can be measured by taking the difference between the annual rate of depreciation of the dollar vis-à-vis major convertible currencies and the short-term rate of interest on these reserves. For example, if the annual rate of depreciation of the dollar is 5 percent and the short-term rate of return on U.S. T-bills is 4 percent, central banks are losing some $22.5 billion. Since private foreigners hold more than two trillion in short-term dollar denominated debt, the net annual loss of foreign holders of U.S. dollars can easily reach $50 billion a year. The conclusion is easy to see: Not only have foreigners been heavily financing the large U.S. government's deficits over the last six years, but they are now being called upon to help finance the generous bailout of American financial institutions.
Investors both abroad and in the U.S. know that official inflation figures are tilted on the low side for many people, essentially because they are designed to reduce the weight given in the indexes to goods and services whose prices increase the fastest, but also because housing costs and asset prices are only partly taken into consideration. This could explain why inflation expectations are on the rise, even though official inflation figures do not register an increase in inflation. Too much easy money as experienced over the last few years at first fuels asset inflation, but sooner or later it shows its ugly head in the prices of all commodities and in the prices of all goods and services. With the current drop of the dollar, Americans can be expected to pay more for a lot of items, such as fuel and food. This will translate to a lower standard of living.
Already, the price of gold, the price of oil and the prices of other commodities are on their way up and can serve as inflation bellwethers. The behavior of long-term interest rates that incorporate inflation expectations is also a good indicator of future inflation. With the Fed printing money and increasing the money supply on a high scale as if it were dropping money from a helicopter, thus the nickname of Fed Chairman Ben "Helicopter" Bernanke, short-term interest rates will drop for awhile, but long-term interest rates will be edging up, unless a deep recession steps in.
Secondly, a massive bailout as the Bernanke Fed has undertaken raises the question of moral hazard present in any massive central bank rescue intervention, after it has failed to properly regulate the risky activities of the banks it supervises. Indeed, by accepting mortgage-backed securities as collateral for huge more or less longer-term loans to American banks and brokers, at reduced interest rates, the Fed is in effect rewarding the very institutions which acted the most irresponsibly over the last four or five years, while saving its own face for having failed in its regulatory mission. The message is loud and clear: American financial institutions can indulge in creating "innovative" risky artificial credit instruments, shifting the risks to unsuspecting borrowers and investors while reaping juicy fees and rewards, and when things turn sour, as can be expected, the Fed will come to their rescue and bail them out with cheap and extended loans. That is a good way to carelessly encourage greedy and out-of-control financial institutions to create successive disorderly and disruptive financial crises.
Indeed, the Bernanke Fed is presently taking the pain of the consequences away from financial institutions that acted irresponsibly, and for some, as former Fed Chairman Alan Greenspan has said, which have acted criminally. This is a clear case of moral hazard.
If old regulations are not implemented or if no new regulations are put into place, such a massive bailout will insure that American financial institutions will continue in the future to pursue the fast buck in creating risky artificial capital, without due regard to the risks involved for small borrowers and small savers, while the Fed will take responsibility for shifting losses partly on itself but mainly to holders of American dollars. In effect, the Fed is suspending market discipline for the big financial players it puts under its protection, while letting market discipline crush small homeowners and small investors who bought now foreclosed houses on shaky mortgages or who invested their savings in fraudulent and risky collateralized debt obligations (CDOs). That is the net result of applying Bagehot's rule only in part.
The third question is why both the Greenspan and the Bernanke Fed did not remove the punch bowl of easy money and easy credit sooner when things began getting ugly in the sub-prime mortgage market during the 2003-2007 period. Why did they appear paralyzed and do nothing? Former Fed Chairman Alan Greenspan has an easy and self-serving explanation. Before 2003, he was afraid of an onset of deflation and that is why the Fed brought its key lending rate to 1 percent (from June 2003 to June 2004) for only the second time in history. He also says that there was too much "global savings" around the world and that is what pushed interest rates down. This is a sleight of hands explanation, because if globalization and global savings kept inflation low and long-term interest down, short-term interest rates and money supply increases were under the Fed control at all times. The Fed had no obligation, after 2003, to keep real short-term interest rates so negative for so long. Indeed, as the Bush administration was cutting tax rates to enhance its 2004 reelection prospects and was spending money like a drunken sailor in wars waged in remote lands, the Fed should have taken the contrary route to counterbalance the fiscal impetus this created for the macro economy. In other words, it should have taken the punch bowl away. It did not.
As a consequence, mortgage debt as a percentage of disposable income in the U.S. is at the highest level it has been in 75 years, reaching 100 percent, while consumer debt has risen to its highest level in history. All this makes the economy more vulnerable than it has been since the 1929-39 depression. Another consequence of this binge of easy money has been the frenzy of leveraged buy-outs and industrial concentration that we have observed over the last few years.
Finally, let's put the cherry on the cake. Indeed, there is a most disturbing piece in former Fed Chairman Alan Greenspan's recent memoirs (The Age of Turbulence) and in the explanations he gave in interviews granted to promote his book, and it is his confession that while he was chairman of the Fed he actively lobbied Vice President Dick Cheney for a U.S. attack on Iraq. If this was the case, it was most inappropriate for a central banker to act this way, especially when he had other things to do than lobbying in favor of an illegal war. Does it mean that Mr. Greenspan was an active member of the pro-Israel Lobby within the U.S. government and joined the Wolfowitz-Feith-Abrams-Perle-Kissinger cabal? It would seem to me that such behavior would call for an investigation.
Indeed, to what extent was the pro-Israel Lobby responsible for the Iraq war and the deficits it generated? Already, polls indicate that 40 percent of American voters believe the pro-Israel Lobby has been a key factor in going to war in Iraq and that it is now very active in promoting a new war against Iran. This figure is bound to rise as more and more people confront the facts behind this most disastrous and ill-conceived war. Indeed, how many wars can this lobby be allowed to engineer before being stopped? And, to what extent can the current financial turmoil in U.S. and world markets be traced back to the influence of this most corrosive lobby?
Caroline Baum had an interesting take on Greenspan's new book "The Age of Turbulence" in Memoir Shows Dangers of Irrational Book Advances.For someone who made headlines with his every utterance -- even if no one could agree on what he had said -- Alan Greenspan offers few newsmaking moments in his eagerly awaited memoir, "The Age of Turbulence".For someone who supposedly believes in the free market, except of course when it comes to the Fed itself, that quite a statement. The criticisms of Bush, the Republican budgets, the war over oil, and his belief in subprime loans all smack of attempts to lay the blame elsewhere for the credit debacle that is about to unfold.
Sure, his criticisms of the Bush administration (for its "out-of-control spending"), Republicans in Congress (they "lost their way," "swapped principle for power" and "ended up with neither") and the Iraq War ("largely about oil") provided weekend fodder for the media.
While Greenspan calls his book a detective story, there isn't much in the way of suspense. Greenspan's words are as measured as they were in his communications as Fed chairman. Now as then, they seem designed to create an effect rather than to unveil the wizard behind the curtain.
Greenspan, who reportedly received an advance of more than $8 million for this memoir, seems eager to stave off criticism for keeping short-term rates too low for too long in 2003 and 2004, stoking a housing bubble in the process. He was aware of
reduced credit standards on subprime mortgage loans, he says, "but I believed then, as now, that the benefits of broadened home ownership are worth the risk."
More interesting than the book, however, is Greenspan's whirlwind promotion tour of it. On the Today Show Greenspan says U.S. not headed for recession.
Former Federal Reserve Chairman Alan Greenspan said on Monday the United States appears set to weather the bursting of a housing bubble without falling into recession.Greenspan is a Contrary Indicator
But in a separate interview with CNBC Television, he warned that the Fed has to be careful to avoid stoking inflation with any future policy moves. "It's very clear that the trade-offs between inflation and growth have altered," he said. "The Fed has to be more careful about inflation now than it did when I was chairman."
Greenspan, in an interview in the Dutch newspaper NRC Handelsblad on Monday, warned inflation will rise to about 5 percent in Europe and the United States.
[Mish comment: Price inflation is a lagging phenomenon]
"The normal inflation level is closer to 5 percent than the current 2 percent," Greenspan said, adding that the 5 percent level fitted an economy with a "paper" standard where the currency is not linked to gold.
[Mish comment: That is an incredible statement. There is absolutely no such thing as a "normal inflation rate". Inflation is an expansion of money and credit and one reason money expands is the government spending hundreds of billions of dollars more than it collects in taxes. There is nothing "normal" about spending more money than you make for decades. When consumers do it they eventually go bankrupt. When the government does it, the Fed willingly prints more money.]
The memoir has already drawn attention for the comment the Iraq war is "largely about oil." He said on Monday his comments should not be seen as questioning President George W. Bush's emphasis on Saddam Hussein's arsenal as the justification for invading.
"I'm not saying that they believed it was about oil. I'm saying, it is about oil and that I believe it was necessary to get Saddam out," he said.
[Mish comment: This is another incredible statement. How can the war be about oil if those who started the war did not do so over oil? The statement makes no sense. But yes, the war was about oil, and revenge, and ideological stupidity.]
After warning about irrational exuberance in 1996, Greenspan embraced the "productivity miracle" and "dotcom revolution" in 1999. Mid-summer of 2000 Greenspan fell in love with his own analysis and was worried about inflation risks. Shortly thereafter the Greenspan Fed embarked on an incredible campaign slashing interest rates to 1% in panic over deflation.
Greenspan is now trumping up the idea that credit conditions are like 1998. I talked about this in No Greenspan, Conditions are NOT Like 1998.
On May 21,2006 Greenspan said housing prices won't fall nationally. That prompted me to write Greenspan Predicts Housing Bust.
History shows Greenspan was worried about Y2K problems (slashing interest rates and adding fuel to the dotcom bubble). Y2K went off without even minor glitches.
In 2001 Greenspan pleaded with Congress to adopt Bush's $1.35 trillion tax cut. Greenspan's rationale was the government would run huge $5.6 trillion surpluses over the subsequent decade after the cuts. It's right here in the Testimony of Chairman Alan Greenspan Before the Committee on the Budget, U.S. Senate January 25, 2001.
The key factor driving the cumulative upward revisions in the budget picture in recent years has been the extraordinary pickup in the growth of labor productivity experienced in this country since the mid-1990s.Greenspan has been wrong at every critical juncture in his career. So now when Greenspan is warning of inflation just as he was in Summer of 2000, fears should be anything but inflation.
The most recent projections from the OMB indicate that, if current policies remain in place, the total unified surplus will reach $800 billion in fiscal year 2011, including an on-budget surplus of $500 billion. The CBO reportedly will be showing even larger surpluses.
The sequence of upward revisions to the budget surplus projections for several years now has reshaped the choices and opportunities before us. Indeed, in almost any credible baseline scenario, short of a major and prolonged economic contraction, the full benefits of debt reduction are now achieved before the end of this decade--a prospect that did not seem likely only a year or even six months ago.
But if inflation is the fear, then why is Bernanke on a shock and awe campaign surprising the markets with half point cuts first in the discount rate and second in the Fed Funds rate, during options expiration week in consecutive months?
Greenspan on the Comedy Channel
Click here to see Greenspan and Jon Stewart.
Kevin Depew on Minyanville had this interesting take on the show.
Alan Greenspan's whirlwind book promotion tour finally landed him on Comedy Central. We particularly enjoyed this quote:What Greenspan is admitting is the Fed has no idea what it's doing. As a result the Fed always seems to be chasing its own tail in a sequence that keeps creating bigger and bigger bubbles.
Greenspan: "I've been dealing with these big mathematical models of forecasting the economy, and I'm looking at what's going on in the last few weeks. … If I could figure out a way to determine whether or not people are more fearful or changing to more euphoric, and have a third way of figuring out which of the two things are working, I don't need any of this other stuff... Forecasting 50 years ago was as good or as bad as it is today. And the reason is that human nature hasn't changed.
- Yes, if only there was a way to model transitions in social mood from euphoric to fearful and from fearful back to euphoric... if only.
- Greenspan's unwitting acknowledgment that if he could "figure out a way to determine whether or not people are more fearful or changing to more euphoric" then he could throw away his other models is precisely why those models he, and other economists, rely on are powerless at predicting future outcomes.
- When social mood supports credit expansion, as it has for the better part of two decades, then the kind of central bank policy practiced by Alan Greenspan indeed looks "Maestro"-like.
- When social mood no longer supports credit expansion, however... well, just ask Japan.
Here is another interesting exchange from the Daily Show:
Stewart: When you lower the interest rate and drive money to the stocks, that lowers the return people get on savings in a bank.
Greenspan: Yes, indeed. Yes, indeed.
Stewart: So they've made a choice -- we would like to favor those who invest in the stock market and not those who invest in the bank; that helps us.
Greenspan: That's the way it comes out but that's not the way to think about it.
Stewart: It seems to me that we favor investment but we don't favor work. The vast majority of people work and they pay payroll taxes and they use banks. And then there's this whole other world of hedge funds and short betting and...it seems like craps. And they keep saying, "No no no, don't worry about it, it's free market, that's why we live in much bigger houses. But it really isn't, it's the fed, or some other thing, no?"
History Will Be The Judge
History will not be kind to Greenspan. He was wrong about every critical pronouncement for his entire career and no amount of whitewashing can change that. So forget the book, just play the video. You won't waste $20-$35 bucks and the latter will be far more entertaining.
Mike Shedlock / Mish
Suddenly, a Fed chief who was so beloved by the bulls and so revered by the financial markets, is being portrayed as feeble, old and demented.
"He should shut up already," tends to be the hue-and-cry of the Cramers, Kudlows and — oh yes — the Kedroskys.Now that Greenspan is advising Pimco, and to paraphrase the Kedroskys of the world: "It’s purely a marketing tactic. He can’t imagine not being in the spotlight."
To which I say, "So what?" That’s why most money managers and others go on TV!
"But he’s undermining Bernanke," the newfound Greenspan critics say.
Oh, please. He’s not undermining anybody. Ben Bernanke’s suddenly out of favor because rates haven’t moved lower and the newly uncensored Greenspan, now doing biz with the likes of Pimco’s Bill Gross, can finally take off the blinders and see the financial world for what it really is: getting riskier by the day.
The beat goes on…
November 19, 2007 | Gazeta Mercantil (Brazil)
On attempting to assess the extent of the economic damage wrought by the ongoing U.S. housing market bust, one has to be reminded of the story about Chou En-Lai, the former Chinese premier. When asked for his assessment of the French Revolution, he replied that, two hundred years on, it was still too early to draw definitive conclusions. So too appears to be the case with the current unraveling of the U.S. housing market. We are simply too close to the event to draw definitive conclusions.
It is not too early, however, for us to know that the present U.S. housing bust has no precedent in U.S. economic history over the past seventy years. For U.S. home prices at the national level are now already declining at an annual rate of more than 5 percent. And, with massive unsold housing inventories and with the scheduled resetting of Adjustable Rate Mortgages, there is every indication that home prices will continue to decline by between 5 and 10 percent a year over the next two years. Not since the Great Depression will we have seen as large and as sustained an erosion of the primary source of U.S. household wealth, which almost certainly will damage the global financial system and will have a negative bearing on consumption behavior.
It is also not too early to apportion major part of the blame for the current housing bust to Alan Greenspan's Federal Reserve. For it was his Federal Reserve that allowed home prices to run up by an extraordinary 80 percent between 2000 and 2006, thereby setting the stage for today's housing market bust. While all of this was happening, Mr. Greenspan kept insisting that it was very difficult for the Federal Reserve to identify asset price bubbles and that in any event, it was not the appropriate role of the Federal Reserve to target asset prices even were it to determine that there was a bubble.
Seriously compounding the ill-effects of extraordinarily low interest rates, the Federal Reserve irresponsibly allowed an unprecedented relaxation in mortgage lending standards.
Worse still, despite Mr. Greenspan's increasingly vociferous protests to the contrary, the Federal Reserve must take responsibility for having initiated the housing price bubble. It did so by cutting interest rates aggressively in the wake of the bursting of the NASDAQ bubble in 2001 by a full 550 basis points to as low as 1 percent. It subsequently went on to take its sweet time to normalize those interest rates as the economic recovery got underway and as the housing market bubble barreled on.
Seriously compounding the ill-effects of extraordinarily low interest rates, the Federal Reserve irresponsibly allowed an unprecedented relaxation in mortgage lending standards. It did so by turning a blind eye to the freewheeling originate-to distribute practices of the increasingly important non-bank mortgage originators. Those entities came to account for almost half of all mortgages originated in 2006 and, not holding those mortgages for very long, they had little incentive to ensure that those mortgages performed well till maturity.
It is very difficult to understand why the Federal Reserve did not exercise its authority under the Home Ownership Protection Act to reign in those non-bank originators, which were patently making loans with very high loan-to value ratios to un-creditworthy borrowers that had little chance of being repaid. The Federal Reserve's inaction is all the more inexplicable given the very magnitude of those egregiously sub-standard loans. Between 2004 and 2006, a total of U.S.$1.2 trillion in sub-prime loans were extended, which we now know all too well pose a real threat to the stability of the global banking system.
Far from reigning in irresponsible mortgage lending, Mr. Greenspan championed the financial innovations that facilitated such lending on so large a scale. Rather than seeing sub-prime lending and Adjustable Rate Mortgages as a danger, Mr. Greenspan enthusiastically embraced them as a means to promote an “ownership society”, in which households formerly deemed to lack creditworthiness could now buy homes. He also championed the associated securitization of mortgages as an efficient means to spread risk despite the blatant lack of transparency of the securitized loans.
As estimates of the probable sub-prime lending losses to the financial system steadily rise to the U.S.$250 billion range, Mr. Greenspan's reputation as a maestro central banker has begun to get tarnished. How much harsher will history's judgment of Mr. Greenspan's tenure as Fed Chairman be should the current severe housing downturn lead to a nasty recession, as it has done in as many as eight of the ten post-war recessions.
Hopefully, history will cast doubt on a number of the misguided tenets that Mr. Greenspan held so dear to his heart. Gone will be the days when central bankers cavalierly ignore major asset price developments. And gone will be the days when they shirk from their responsibility to ensure that there is the minimum of regulatory frameworks that might ensure the proper functioning of the mortgage market.
Desmond Lachman is a resident fellow at AEI.
August 25, 2006 | Economist's View
If you look at the most leading of the indicators on housing, stuff like new home sales and applications for permits, they're off more than 20 percent from a year ago. If that translates into an equivalent fall in residential investment, we're talking about a fall from 6 percent of the G.D.P. to 4.8 percent. And this may be only the beginning; I wouldn't be surprised to see housing investment drop below its pre-bubble norm of 4 percent of G.D.P., at least for a while.
Add to this the likely effect of a housing bust on consumer spending and you've got a direct hit to G.D.P. of, say, 2.5 percent or more. That's bigger than the slump in business investment that led to the 2001 recession. And the main reason the 2001 recession wasn't as deep as some feared was that the Fed was able to engineer... a housing boom. What will the Fed do this time?
Maybe rising business investment and a declining trade deficit will soften the blow. But it's remarkably easy, playing with the numbers, to come up with scenarios in which the unemployment rate rises above 6 percent by the end of 2007. That's not a prediction, but it's well within the range of possibilityComments
Movie Guy says...
Krugman - "home prices ... are now falling in much of the country"
Is that really true?
I don't believe it. Regardless...I will move past that minor point.
While the economist, analyst, and blogger piling on is occurring with the issue of housing, I find it a bit odd that so many are whining over excessively high housing prices which are now balancing downward and interest rates rising to levels whereby excess activity can be reigned in.
What is the big deal? We're only seeing evidence that the Greenspan/Fed method of recovery marketing using the housing prop was an exercise that could not sustain the U.S. economy. Now, who is really surprised that housing asset pricing is being driven back down?
Where were all these alarmed voices on the way up, early on when it was obvious what the Greenspan plan was? I remember a time when only a few of us were raising hell over Greenspan's marketing comments to the American public to jump on variable rate loans. Back then, we had people in all three camps challenging our concerns.
Bottom line, housing was played. Game is ending. Move on. Find something else to prop up the U.S. economy while real wages, real compensation, and median income continue to slide. Find something else to balance the U.S. trade and current account deficits.
Do whatever you have to do to mask the real problems a little longer, if that is your game.
In the end, though, some serious-minded adults will have to step up and deal with the artifical vehicles by which all of the problem masking has been undertaken.
Housing? Handwringing? Alarm? Give me a break.
The whole idea was stupid from the start. One big con.
What's the next plan?
January 27, 2006 | zealllc.com
January 31st, 2006 marks the end of a financial era. The long-time Chairman of the Federal Reserve, Alan Greenspan, will retire after 18 years at the helm of the United States’ central bank. Widely lionized at the pinnacle of his career, Greenspan’s legacy will profoundly affect investors worldwide for many years to come.
As Greenspan’s tenure as the most powerful man in the financial universe is debated among investors today and historians tomorrow, his many decisions will be dissected and evaluated. But I fear most of this debate will overlook the most foundational and crucial issue. Before Greenspan’s actions are considered, the very notion of the Fed itself ought to enter the limelight.
The Federal Reserve is not a capitalistic entity compatible with free markets. Instead it functions just like the miserably failed old-school command-and-control Communism model. The core philosophy of the Fed and its Federal Open Market Committee that controls short-term interest rates is that mere mortals meeting in secret like a conspiracy cabal are better suited at setting the price of money than the free markets.
Regardless of who leads the Fed, the whole organization exists because price controllers, no different from those in 20th century Russia, think they alone can divine the price at which the supply of savings equals the demand for savings. The price of money, or interest rate, leads savers to decide how much of their income to save and debtors to decide how much of someone else’s savings to borrow.
Out of all the goods and services available on the planet, the price of money is probably the most important one to ensure is not manipulated. Interest rates act as signals to direct capital from unproductive uses to productive ones, which helps build great wealth for nations when the free markets dictate interest rates. But when manipulators try to artificially manipulate interest-rate signals, capital is misappropriated and wasted leaving nations poorer.
Bubbles are the ultimate case in point. Whenever too much paper money floods into a financial system, which is the inevitable result of artificially low interest rates, it floods into some class of goods or services or investments and inflates prices far beyond where they would be if interest rates were set by free markets. It is ironic as the destination of this excess capital determines whether it is good or bad in investors’ minds.
When artificially-low-interest-rate-driven excess money floods into technology stocks or tract houses in suburbia, Americans rejoice and think it is a great thing until the resulting bubbles inevitably burst and wreak great pain. But if this same excess money drives up the prices of general goods and services and commodities like gasoline, the inflation is considered bad. Indeed the Greenspan Fed spent much time trying to jawbone money into inflating politically correct assets like houses instead of politically incorrect ones like commodities.
So before we delve into Greenspan’s record on monetary inflation and interest rates, realize he is as far away from being a free-market capitalist as one can possibly be. He is a Communist-style elitist who believes that the price of money and even money supplies should be centrally planned as if by the Communist Politburo. This is no less ridiculous than the idea of the Fed mandating the price of every dinner, every pair of shoes, or every book sold in America. History has proven time and time again what an asinine idea central planning truly is.
So how did Alan Greenspan, price fixer and market manipulator, do in his years at the Fed? His record is mixed. Initially he showed some constraint and tried to fight inflation, the scourge of the middle class, but five or six years into his run he started to embrace and nurture inflation. Amazingly in monetary growth terms he wasn’t a great deal better than the horrible Fed chairmen of the 1970s, Arthur Burns and William Miller.
Recent CommentsThe damages done by Greenspan's Fed Reserve to US economy are huge....
I'm an octogenarian. Not in my memory, until Bill Clinton and...
I'm an octogenarian. Not in my memory, until Bill Clinton and Greenspan, has retired holders of high offices criticized, commented on or denigrated those who succeeded them. We know that Clinton is devoid of class. But I expected better of Greenspan. Wall Street should tell him to SHUT UP!
01-APR-05 | Washington Monthly
Sen. Harry Reid (D-Nev.) may have been a trifle harsh in describing Alan Greenspan as "one of the biggest political hacks in Washington." But Greenspan is a good distance from the heroic figure depicted by most of the media. If there was a decisive moment in the debates over Bush's tax cuts in 2001, it was when they were endorsed by Greenspan.
Yet they, and Bush's subsequent tax cuts, have been primarily responsible for the deficit that Greenspan now so piously bemoans. My guess is that he was motivated on the tax cuts not so much by political loyalty as by a desire to be reappointed by Bush, the same reason he supported the very opposite program, Clinton's deficit reduction in 1993. He got his reward. He was reappointed by both presidents.
While the nomination was widely expected, it is noteworthy that Clinton reappointed Greenspan six months in advance of the expiration of the Fed chairman's current term, and ten months before the presidential elections. The early announcement was intended to allay concerns within the political establishment and business circles that the question of Greenspan's appointment might become the subject of partisan debate during the election campaign, thereby rattling the stock and bond markets.
With last week's announcement, Clinton has sent a clear signal to Wall Street that Greenspan will have a free hand to pursue the economic agenda that has enriched the top 10 percent of the population beyond their fondest dreams, regardless of the ups and downs of election polls and the ultimate result of the vote next November. As one unnamed White House official said, “If you know how both sides wanted to resolve it, why not resolve it rather than let unwarranted speculation accumulate?”
The Federal Reserve chairman—often described by the media as the most powerful man in America—controls monetary policy using a variety of means, most notably the setting of interest rates, to determine the amount of money in circulation and its cost. This, in turn, profoundly influences the decisions made by corporations—whether to invest or cut back, to hire workers or lay them off.
The book has merits--it is blessedly lucid on how the Fed works and how Fed-heads think--but there is within it a great disconnect. I was thinking about this when I got a note from a former U.S. senator who groused about "the phenomena of high-level public officials 'bravely speaking out' after they have left office." He scored Mr. Greenspan as "perfectly free to have spoken out about the need for the President to veto more spending bills on numerous occasions when he was testifying in public." My correspondent says Mr. Greenspan's "total silence" while in office does not exactly qualify as "bravely speaking out."
The former senator has a point. It can be summed up as: Now you tell us? It doesn't take courage to speak clearly when no one can hurt you. It takes guts to be candid when candor can earn powerful enemies.
John Lennon, Alan Greenspan, and Mortgage "Alternatives"
12/21/2005 5:16:59 PM
The major stock indexes finished slightly higher on Wednesday (Dec. 21).
If he's in public and his lips are moving, Alan Greenspan's words are treated with reverence. If you're in a room full of economists, to cite The Chairman is like quoting John Lennon in a room full of potheads -- case closed, you win the argument. And from Greenspan's perspective, the truly cool part is how each new pronouncement from him about a topic -- pick a topic, any topic -- seems to push the previous one down the memory hole, never to be brought up again.
Unless you read this page, that is.
Consider, for example, his February 2004 speech to the Credit Union National Association, when Greenspan made these remarks:
"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage... the traditional fixed-rate mortgage may be an expensive method of financing a home." ...."Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade..." Now, he didn't tell lenders to offer "alternatives," and he didn't tell borrowers to go get adjustable-rate mortgages. He didn't have to. The Chairman knew that he simply needed to imply it; in turn the media minions inferred it, and did the work for him.
Well, "so what" is the explosion in adjustable-rate, interest-only, and negative-amortization mortgages over the past two years. Isn't that pretty much what the revered chairman asked for, you say? Yes indeed, that's what you just read above. But yesterday (Dec. 20) brought new words to be revered, in a press release from the Fed's Board of Governors (et. al.). They informed the world that they're "concerned" that "interest-only mortgage loans" present "unique risks," especially because
"these products… are being offered to a wider spectrum of borrowers, including subprime borrowers and others who may not otherwise qualify for more traditional mortgage loans."
God rest ye merry gentlemen, let nothing you dismay; the all-wise chairman did give "Guidance" on this very day.
Yes, this so-called guidance is locking the barn door after the horse is out. Not for nothing did Bob Prechter focus on real estate in his December Elliott Wave Theorist. His language is as plain as it can be, and so are the unique charts he presents.
Do not ever say that the desire to "do good" by force is a good motive. Neither power-lust nor stupidity are good motives -– Ayn Rand.... There is nothing more frightening than active ignorance. -– Goethe .... If humanity cannot live with the dangers and responsibilities inherent in freedom, it will probably turn to authoritarianism - Erich Fromm...
The Greenspan Era: Lessons to be Learned in the Future:
This weekend's global central banker powwow at Jackson Hole sets off what will surely be at least five months of Greenspan - "the greatest central banker of all-time" - pomp and adulation. I will anxiously await the public release of this weekend's papers from "The Greenspan Era: Lessons Learned." They will be worth storing away for later reflection. His legacy has already become favored pundit subject matter, although I find much of the commentary misplaced.
No discussion of Greenspan's possible legacy will stand the test of time without addressing the momentous financial sector developments nurtured under his watch. Ultimately, I expect that he will be judged most by the success or failure of the Financial Sphere he cultivated, sustained and endorsed. Curiously, I have yet to read or listen to any comments regarding the unprecedented buildup of debt under The Greenspan Regime. He has operated for too long as undisputed Master and Commander of what has evolved into today's massive and unwieldy global pool of speculative finance. Disconcertingly, his impending exit will coincide with increasingly vulnerable U.S. Mortgage Finance and Credit Bubbles.
Under Mr. Greenspan's watch, Total US Credit Market Debt (TCMD) ballooned from (using year-end 1986) $9.8 Trillion to $37.3 Trillion (380%). As a percentage of GDP, TCMD expanded from 220% to 318%. Rest of World (ROW) holdings of US Financial Assets increased from $1.18 Trillion to $9.72 Trillion, or 826%. ROW holdings of US Credit Instruments increased 900% to $4.88 Trillion, including holdings of GSE securities which grew from $22 billion to $826 billion.
During Chairman Greenspan's tenure, Commercial Bank Assets expanded 332% to $8.713 Trillion, including a 624% increase in Mortgages. The Bank Asset "Security Credit" expanded 475% to $216 billion. The Liability "Fed Funds/Repo" increased 500% to $1.023 Trillion, while Deposits expanded 270% to $5.14 Trillion. Over this period, M3 Money supply inflated 280%. When it comes to Greenspan's legacy, one must note that Total Mortgage Debt expanded 404% to $10.774 Trillion, with Home Mortgage borrowings up 480% to $8.282 Trillion.
No group has so luxuriated in Mr. Greenspan's leadership than Wall Street. Security Broker/Dealer Assets have increased more than ten-fold, from $185 billion to $1.941 Trillion. Broker/Dealer holdings of Credit Market Instruments jumped from $66 billion to $443 billion (670%). On the Liability side, Security Repos ballooned from $36 billion to $623 billion. Security Credit jumped from $84 billion to $777 billion.
Almost walking distance from the Marriner S. Eccles Federal Reserve Board Building, Fannie and Freddie perpetrated one of history's greatest Credit expansions. On Greenspan's watch, GSE Assets ballooned 830%, from $346 billion to $2.872 Trillion. Agency MBS (some included in GSE assets) surged 670% to $3.55 Trillion. Outstanding ABS exploded from $75 billion to today's more than $2.70 Trillion (and counting!). I saw no indication that Greenspan had any problem with the GSEs when they operated as marketplace liquidity backstops in 1994, 1998, 1999, 2000, 2001 and 2002, emboldening the blossoming speculator community in the process. Allowing GSE debt and MBS liabilities to surpass $6 Trillion is at or near the top of a list of serious blunders unbefitting of a lionized chief central banker.
When attempting today to gauge his legacy, it is fundamental to appreciate that there was a momentous transformation of finance, at home and then abroad, under Greenspan's prolonged reign. Not since Benjamin Strong (in the 1920s) has one man's ideas, brilliance, personality, and personalization of policy had such a profound impact on the nature of financial (and, thus, economic) activities. It is no exaggeration to state that Alan Greenspan is the father of "contemporary Wall Street finance," having nurtured and accommodated a marketable securities-based Credit system from its infancy some 18 years ago. The loan officer, banking system, and borrowing for business investment were supplanted as the prominent creators of finance by a New Paradigm securities, "structured finance", and asset-based financial apparatus. At the same time, Fed open-market operations and bank reserve requirements were relinquished as purveyors of system liquidity. The benign bank loan was cast out as an anachronism, replaced by myriad "sophisticated" securities, instruments, derivative contracts, and leveraged speculation. The US securities markets evolved into The Global Fountainhead of Liquidity Overabundance.
The Greenspan Federal Reserve's move to transparently pegging short-term interest-rates - slashing them aggressively to mollify heightened systemic stress, while invoking market-pleasing gradualism when moderating accommodation - played a profound role in mitigating the risk of leveraged speculation. The upshot was an energized Credit system with a powerful expansionary (inflationary) bias, as well as a financial system and economy relatively easily stimulated by rate cuts and public assurances. The downside of such a haphazard policy "regime" is that at some point along the way it becomes virtually impossible to face the consequences of taking away the punchbowl.
In today's Jackson Hole speech, Mr. Greenspan stated, "The Federal Reserve System was created in 1913 to counter the recurrent credit stringencies that had so frequently been experienced in earlier decades." From my reading of history, recurring Credit-induced booms and busts were the impetus for the creation of a U.S. central bank. The Fed was created specifically to undertake the regulation of Credit, most importantly acting against the propensity for unchecked finance to propagate speculative Bubbles and their inevitable agonizing busts. It was not until later, under New York Fed President Strong, that a more activist approach to countering "stringencies" and sustaining prosperity was deemed operative.
Many are today comparing Mr. Greenspan to the legendary central banker William McChesney Martin. Well, I have read much about Mr. Martin, his distinguished career, his statesmanship, and his unassailable integrity. I feel as if I have come to know him - Bill Martin is a friend of mine. Mr. Greenspan is no McChesney Martin. The essence of Chairman Martin - exemplifying the worthy tradition of central bankers generally - is one of conservatism (in the monetary sense) and caution. Mr. Martin was a straight-talker and sincere public servant and statesman. He erred on the side of prudence and stability.
Truth be told, Mr. Greenspan is a monetary policy radical. He presided over the greatest expansion of speculative finance in history, including a Trillion dollar hedge fund community, bloated Wall Street firm balance sheets approaching $2 Trillion, a $3.3 Trillion repo market, and a global derivatives market surpassing an unfathomable $220 Trillion. During the late-nineties, when leveraged speculation was heavily infiltrating the financial system, he became the leading proponent of the "New Economy." He became a powerful advocate of derivatives and Wall Street finance, all the time avoiding any discussion of the impact these new financial instruments and practices were having on Credit growth, marketplace risk perceptions, speculation, asset prices and the underlying structure of the economy.
Greenspan has stood idly as our Current Account Deficit has ballooned to almost $800 billion annually, with foreign central banks accumulating several Trillion dollars of claims on our economy. He watches as crude approaches $70. And now he warns us against the scourge of "protectionism," an inevitable response to the gross global imbalances his activist inflationary policies have fostered. He ignored the most reckless of mortgage lending Bubbles, and now warns us that prices and wealth/income ratios may not be sustainable. Worse yet, he is arguably guilty of committing the ultimate in central banker derelictions by targeting household mortgage borrowings as the primary mechanism for his post-technology Bubble "reflationary" policies (policy error begetting ugly error). The "greatest central banker" incited history's greatest real estate borrowing and speculating Bubble, a legacy our financial system and economy will have to live with for decades.
There is today a joyous consensus view that Greenspan's policy of not preempting asset Bubbles as they inflate - but rather being well-prepared for acting aggressively when they burst - is pure policymaker genius. Well, bull markets do fashion abundant "genius." Let there be no doubt, however, that the inevitable housing bear/bust will expose the grievous policy flaw of mitigating one Bubble by inciting an only larger one. Greenspan's use of the leveraged speculating community as a policy tool was also a grave mistake. There will come a day of policy reckoning.
I earlier today watched former Fed Vice-Chair Alan Blinder on Bloomberg television responding to a question in Jackson Hole: "Has Greenspan been lucky or good?" Dr. Blinder, answering reasonably, stated that while Greenspan has enjoyed his fair share of luck, it is too much to Credit good fortune for 18 years of success. Good enough. But I do believe strongly that the secret to Mr. Greenspan's "success" has been the Financial Sphere's capacity for uninterrupted (and previously unimaginable) Credit expansion. While our Fed chairman avoids the important issues related to Credit growth and excess, not for a moment does he take his eye off the ball. Greenspan can Credit the economy's flexibility and resiliency, but the reality of the situation is that our Fed Chairman has relished in his capacity over 18 years to sustain both Credit expansion and speculative excess. I believe this extraordinary power has much more to do with the epic "Wall Street finance" Credit boom than it does with adept policymaking.
In so many ways, Chairman Greenspan's legacy is conjoined with Wall Street Finance. Does "structured finance" work over the long-term, or are a Trillion dollar hedge fund community, $3 Trillion of ABSs, upwards of $6 Trillion of GSE exposure, and $220 Trillion of derivatives the residual of the type of crazy Credit Bubbles that have occurred every once in awhile throughout financial history? Will derivative hedging and dynamic trading strategies function as expected during the inevitable bouts of financial stress, dislocation, deleveraging and panic? And what is the prognosis after a doubling of mortgage debt in seven years, with all the attendant financial excesses and economic distortions?
The Achilles heel of such a highly leveraged, speculative and liquidity-dependent Credit system is the necessity for uninterrupted liquidity and "continuous" market trading/pricing. Mr. Greenspan provided both positive assurances and the marketplace liquidity backdrop. In a system that creates increasingly untenable systemic risk that is amassed by highly leveraged speculators, it was Greenspan the convincing salesmen that could extol the virtues of "unbundling" and transferring risk to "those most able to manage it." But can they? Ironically, it is his cleverly crafted "risk management" policy approach - not surprisingly, given significant billing in today's speech - that many view as the culmination of his years of accomplished policymaking.
"Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and the sometimes asymmetric costs or benefits of particular outcomes, the paradigm on which we have settled has come to involve, at its core, crucial elements of risk management. In this approach, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path. The decision makers then need to reach a judgment about the probabilities, costs, and benefits of various possible outcomes under alternative choices for policy."
The eventual failure of such ostensibly sound policy doctrine is dictated by Credit and speculative dynamics. In The Age of Securities-based Credit Systems, when Bubbles become pronounced - significantly impacting financial stability and economic vulnerability - policymakers will naturally view the cost of a bursting as unacceptably high (Dr. Bernanke going so far as to ridicule the "Bubble poppers"). Policy mistakes will tend to elicit additional compounding errors, and there will be over time a tendency to condone excess and pander to the powerful securities trading community. There is, then, in discretionary "risk management-based" decisionmaking, a dangerous propensity to act in a manner that nurtures catastrophic Bubbles. Or, in a metaphor Mr. Greenspan was known to employ back in the 1960s when he discussed causes of the Great Depression, there is a strong predilection for the Fed to repeatedly place "Coins in the Fuse-box." It is his incomparable aptitude - as the Master of Where, When and how Aggressively to Place the Coins - that is most deserving of his legacy.
And, in regard to Lessons to be Learned, at the top of the list is the necessity for strict term limits for the Fed Chairmanship. It is a disservice on many levels when one individual so completely dominates policy and public discourse, especially over a lengthy period. This is especially true for Fed Chairmen that - in "good times" - lack sufficient oversight and effective checks and balances. Then, when boom turns bust we will be faced with the dilemma of politicians meddling in monetary management.
When it comes to asset Bubbles, it is incumbent upon the Federal Reserve to endeavor to identify them early and have effective tools to temper Credit and speculative excess as early in the boom process as possible. The Fed's first mandate must be to maintain financial stability over the short, intermediate and long-term. Such a mandate cannot escape the challenging task of monitoring excesses and implementing disciplinary measures to repress behavior at odds with long-term system stability.
I suggest that the most important Lesson to be Learned from the Greenspan Era is the necessity for the Federal Reserve to regulate Credit, both liquidity extended throughout the real economy as well as leveraging within the financial sector. There is today no appreciation that an Unfettered Financial Sphere is incompatible with effectively functioning pricing mechanisms throughout the Economic Sphere. Additionally, Asset inflation, Current Account Deficits, and over-liquefied speculative markets should be recognized as primary contemporary indications of loose monetary conditions (minimal "core-CPI" notwithstanding). Policymakers must also take a cautious approach to financial innovation, certainly including major changes in the nature of financial institutions and intermediation, instruments, market processes and practices.
Mr. Greenspan is heralded for his early identification of changes in the real economy (the so-called productivity boom) that he and others presumed afforded the Fed ample slack to accommodate accelerated growth. Yet profound Financial Sphere developments - and with them greater marketplace liquidity, Credit Availability and attendant speculative proclivities - beckoned for restraint. The Greenspan legacy should rest upon his failure to effectively manage financial innovation, along with his weakness and incapacity for ever taking away the punchbowl. He has left many things, including his replacement, in most unenviable positions.
The Credit Bubble bulletin
Opinion pieces and speeches by EPI staff and associates.
THIS PIECE ORIGINALLY APPEARED IN SPRING 2001 ISSUE OF DISSENT MAGAZINE.
The Politically Talented Mr. Greenspan
by Jeff Faux
A few short days after Bill Clinton vacated the White House this January, Federal Reserve Board head Alan Greenspan publicly endorsed the new tenant's $1.6 trillion tax cut. Democrats who had been convinced by both Clinton and Greenspan to give paying off the debt priority over education, health, and other social investments were "shocked" and "stunned" to hear the chairman brush aside concerns that the government would have to borrow money in order to finance George W's largesse, 40% of which would go to the richest 1% of Americans. The New York Times announced that we had entered the "Greenspan-Bush" era, following the "Greenspan-Clinton" era, in which the president of the United States came to be the junior partner in the management of the U.S. economy.
The story of the Greenspan-Clinton relationship has been embellished into a charming tale of an "odd-couple" policy-wonk romance in which the brilliant, shy economist teaches the economic facts of life to the brilliant, party-going president. The typecasting doesn't quite fit reality. Not only is Greenspan a well-known Georgetown partygoer, his reputation as a scholarly economist is not as heavy among his peers as the business press would have us believe. In his recent generally worshipful biography of Greenspan, Bob Woodward reports that "the Chairman's language was highly idiosyncratic, often not fully grounded in the data."* At the meetings of the Federal Open Market Committee, the Ph.D.s in the room "would be nearly rolling their eyes as the chairman voiced his view about how the economy might be changing."
A closer look at the Greenspan-Clinton era suggests that the chair's genius stems more from his political talents than his economic insights. Thus, on the basis of dubious economics and weak history, he convinced Bill Clinton to give top priority to the elimination of the deficit, as opposed to the public investments in education, health, and infrastructure that Clinton had promised the Democratic faithful in his campaign. In effect, Clinton spent much of his presidency shortchanging the Democratic Party's constituency so he could pay down the debts run up by his two Republican predecessors. As a result, George Bush II is the lucky recipient of a massive fiscal surplus, which he fully intends to use for military spending and tax cuts to promote the interests of the Republicans' higher-income clientele.
As Woodward reports, Greenspan argued that federal deficits would ignite inflation, frightening Democrats with the memory of the late 1970s, when double-digit increases in consumer prices enabled Ronald Reagan to drive Jimmy Carter out of the White House. What Woodward doesn't tell us is that Greenspan's dire warnings were not supported by economic evidence. Other than in wartime, there is no clear relationship between federal deficit spending and inflation.
Moreover, the economic scenario of an overheated peacetime economy triggering a politically unacceptable wage-price spiral has never happened in modern times. Every major episode of inflation that cut short growth over the last century has been triggered either by war or increases in global oil prices. The last price flare-up was generated by a short-lived panic in oil markets when the 1990 Gulf War was launched. It was also the shock of suddenly rising global oil prices-not runaway economic growth-that sparked the inflation of the 1970s. The previous price run-up was kicked off by Lyndon Johnson's refusal to raise taxes to pay for the Vietnam War. The inflation spell before that was ignited by the Korean War, the one before that by the lifting of price controls after World War II, and the one before that, by the impact of World War I.
Greenspan is unlikely to be ignorant of this history. Therefore, an explanation for Greenspan's behavior that better fits the facts is that his underlying motive was to restrain federal domestic spending, rather than contain impending inflation. Greenspan is, after all, an ideological conservative, an early acolyte of the social Darwinist novelist Ayn Rand and Ronald Reagan's choice for Fed chair. Greenspan was also from Wall Street and has been trained to view the stock market as the fundamental measure of the country's economic health.
Conventional wisdom holds that Clinton had no choice but to accept Greenspan's view of the world. Had he not, the Fed would have raised rates in mid-1996 when the unemployment rate dipped below the 5.5 percent to 6 percent area that Greenspan had previously claimed to be the inflationary trigger. Higher rates would have killed the Clinton expansion just before the reelection campaign, repeating the mistake Greenspan made when his monetary policy forced a recession on George Bush I just before the campaign of 1992. You don't make that mistake twice in a row if you want to be reappointed as chair of the Fed, which Greenspan was in 1996.
So Greenspan was bluffing. Clinton understood what all this budget cutting was doing to the Democratic agenda and complained to his staff that they had become "Eisenhower Republicans." But each time he wavered, his treasury secretary, Bob Rubin, former chair of Goldman Sachs, reminded him of the risks of a Wall Street reaction if Greenspan was right. In the end, Greenspan won all the political chips. The Clinton years saw a decline in social investment as a share of the nation's income, and by the end of the 1990s, his administration became a champion of eliminating the entire national debt--a position that would have been hooted out of the Democratic Caucus a few short years before. During his presidential campaign, Al Gore told the Wall Street Journal that if a recession came, instead of pumping up government spending he would cut it, "Just as a corporation has to cut expenses when revenues fall off, and that sometimes turns out for the long-term benefit of the company." This put the Democratic standard-bearer somewhat to the right of Herbert Hoover.
That Greenspan was more interested in cutting federal spending than he was worried about inflation explains what seems to many a mystery in his shifting attitude toward the stock market boom of the late 1990s. After publicly suggesting in 1996 that "irrational exuberance" had made the market dangerously overvalued, Greenspan then shut up and proceeded to accommodate a speculative frenzy that drove up share prices of companies with no profits and little prospects to outrageous heights. Between June 1996 and June 2000, the Dow rose 93% and the NASDAQ 125%, and the overall ratio of stock prices to corporate earnings reached record highs. Greenspan stood by as stock market hucksters in the guise of objective analysts hyped worthless paper in fly-by-night boiler rooms, on national television, and in thousands of newsletters to gullible customers, who were able to leverage their gambling with easy credit supplied by the Federal Reserve.
Greenspan's story is that his mind was changed about the market's overvaluation when he became convinced that the new economy was generating higher rates of productivity, which he said explained the absence of inflation. Increased productivity would not only keep prices from rising, it would in time power future profits high enough to justify the booming share prices. But the higher rates of productivity only began to appear in 1996, which was much too early in the process for anyone, much less the chair of the Federal Reserve, to believe that the economy had arrived at a new plateau of permanently higher efficiency.
Moreover, in 1999, Greenspan initiated a series of interest rate hikes, when inflation was even slower than it was in 1996 and productivity was growing even faster. In addition to his rote reference to the specter of inflation, Greenspan indicated that he had finally decided to do something about the overpriced stock market. But why was it necessary to slow down the entire economy because speculators had driven up the price of corporate shares? A much better and safer way would have been to use his authority to restrict credit to the stock market by requiring higher "margins," that is, down payments on the purchase of stock. By 1999, margin debt in the stock market had reached the heights it held just prior to the market meltdown in 1987.
A number of market observers, including financier George Soros and Stanley Fischer, deputy director at the International Monetary Fund, advocated that the Fed let the air out of this credit boom by raising margin requirements. But Greenspan refused this more sensible strategy. At his confirmation hearing before the U.S. Senate Banking Committee in 1996, he said that he did not want to discriminate against individuals who were not wealthy and therefore needed to borrow in order to play the stock market. Given that people who use margin leverage to buy stock are typically wealthy by any reasonable standard, this is a weak rationale for favoring higher interest rate policies that would cause unemployment and personal bankruptcies among lower- and middle-income working people.
His refusal to raise margin requirements suggests that Greenspan's goal was not to lower share prices. Rather, it was to raise profits to levels that would justify the high stock prices. Obviously, a stock's price-earnings ratio can be lowered by changing either side of the ratio by reducing prices or raising earnings. Given that the economy was already at high levels of productivity and close to full capacity, there was little room to raise profits through more economic growth. But a dose of unemployment might help squeeze labor costs. Thus, Greenspan's raising of the interest rates can be seen not so much as a "pre-emptive" strike against a phantom inflation, but a rather desperate effort to avoid a market decline by raising the earnings of investors through lowering the earnings of workers.
It is widely known that the government's labor cost index, rather than its consumer price index, is the Greenspan Fed's favored indicator of inflation potential. Moreover, Greenspan himself observed publicly on a number of occasions that the anxiety of American workers over losing their jobs was a critical factor in keeping wages down during most of the 1990s. By 1999, tight labor markets (plus an increase in the minimum wage) were beginning to raise wages. Slowing down the economy was a way of weakening workers' resolve to demand more pay.
Today, it looks like Greenspan's gamble failed. The stock market began to tumble in the first half of 2000, not because labor costs were rising, but because limits of investor credulity were finally reached. The business press, which a year before was proclaiming the 30-year-old dot-com executives as pioneers of the new economy, was now ridiculing the public for having believed that the stock of companies that would never make a profit could go up forever. The new economy, as one Wall Street Journal writer put it, now looks like an old-fashioned credit bubble." In the second half of that year, consumers whose debt-to-in-come ratios were at record highs, began to pull in. Christmas sales flopped, and by early January Greenspan reversed himself and lowered interest rates.
About that same time, just after the Supreme Court appointed him president, George W. Bush began forecasting a "Clinton" recession. But the blame for a downturn will be hard to pin on the absent Clinton. So George W. better watch out. Having cost Bush's father the presidency and Bill Clinton his political soul, Alan Greenspan is at the top of his game. If the next year gives birth to a growing economy, it will be named after him. If it's a recession, it will be named for his junior partner in the White House.
*Maestro: Greenspan's Fed and the American Dream (Simon and Schuster, 2000)
Jeff Faux is president of the Economic Policy Institute.
Saddam got in trouble because one moment he would cut production to support the Palestinians and the next moment he would pump the maximum allowed. Up and down movements in prices are destabilizing events for the oil industry. Palast reports that a Council on Foreign Relations report concludes: Saddam is a “destabilizing influence . . . to the flow of oil to international markets from the Middle East.”--Paul Craig Roberts
By Paul Craig Roberts
09/19/07 "ICH" -- -- Former Fed Chairman Alan Greenspan’s memoir has put him in the news these last few days. He has upset Republicans with his comments on various presidents, with George W. Bush getting the brickbats and Clinton the praise, and by saying that Bush’s invasion of Iraq was about oil, not weapons of mass destruction.
Opponents of Bush’s wars welcomed Greenspan’s statement, as it strips the moral pretext away from Bush’s aggression, leaving naked greed unmasked.
It is certainly the case that Iraq was not invaded because of WMD, which the Bush administration knew did not exist. But the oil pretext is also phony. The US could have purchased a lot of oil for the trillion dollars that the Iraq invasion has already cost in out-of-pocket expenses and already incurred future expenses.
Moreover, Bush’s invasion of Iraq, by worsening the US deficit and causing additional US reliance on foreign loans, has undermined the US dollar’s role as reserve currency, thus threatening America’s ability to pay for its imports. Greenspan himself said that the US dollar “doesn’t have all that much of an advantage” and could be replaced by the Euro as the reserve currency. By the end of last year, Greenspan said, foreign central banks already held 25 percent of their reserves in Euros and 9 percent in other foreign currencies. The dollar’s role has shrunk to 66 percent.
If the dollar loses its reserve currency status, the US would magically have to move from an $800 billion trade deficit to a trade surplus so that the US could earn enough Euros to pay for its imports of oil and manufactured goods.
Bush’s wars are about American hegemony, not oil. The oil companies did not write the neoconservatives’ “Project for a New American Century,” which calls for US/Israeli hegemony over the entire Middle East, a hegemony that would conveniently remove obstacles to Israeli territorial expansion.
The oil industry asserted its influence after the invasion. In his book, Armed Madhouse, BBC investigative reporter Greg Palast documents that the US oil industry’s interest in Middle Eastern oil is very different from grabbing the oil. Palast shows that the American oil companies’ interests coincide with OPEC’s. The oil companies want a controlled flow of oil that results in steady and high prices. Consequently, the US oil industry blocked the neoconservative plan, hatched at the Heritage Foundation and aimed at Saudi Arabia, to use Iraqi oil to bust up OPEC.
Saddam got in trouble because one moment he would cut production to support the Palestinians and the next moment he would pump the maximum allowed. Up and down movements in prices are destabilizing events for the oil industry. Palast reports that a Council on Foreign Relations report concludes: Saddam is a “destabilizing influence . . . to the flow of oil to international markets from the Middle East.”
The most notable aspect of Greenspan’s memoir is his unconcern with America’s loss of manufacturing. Instead of a problem, Greenspan simply sees a beneficial shift in jobs from “old” manufacturing (steel, cars, and textiles) to “new” manufacturing such as computers and telecommunications. This shows a remarkable ignorance of statistical data on the part of a Federal Reserve Chairman renowned for his command over numbers and a complete lack of grasp of offshoring.
The incentive to offshore US jobs has nothing to do with “old” and “new” economy. Corporations offshore their production, because they can more cheaply produce abroad what they sell to Americans. When corporations bring their offshored production to the US to sell, the goods count as imports.
Had Greenspan bothered to look at US balance of trade data, he would have discovered that in 2006, the last full year of data, the US exported $47,580,000,000 in computers and imported $101,347,000,000 in computers for a trade deficit in computers of $53,767,000,000. In telecommunications equipment the US exported $28,322,000,000 and imported $40,250,000,000 for a trade deficit in telecommunications equipment of $11,883,000,000.
Greenspan probably has given offshoring no serious thought, because like most economists he mistakenly believes that offshoring is free trade and learned in economic courses decades ago before the advent of offshoring that free trade can do no harm.
For most of the 21st century I have been pointing out that offshoring is not trade, free or otherwise. It is labor arbitrage. By replacing US labor with foreign labor in the production of goods and services for US markets, US firms are destroying the ladders of upward mobility in the US. So far economists have preferred their delusions to the facts.
It is becoming more difficult for economists to clutch to their bosoms the delusion that offshoring is free trade. Ralph Gomory, the distinguished mathematician and co-author with William Baumol, past president of the American Economics Association, of Global Trade and Conflicting National Interests, the most important work in trade theory in 200 years, has entered the public debate.
In an interview with Manufacturing & Technology News (September 17), Gomory confirms that there is no basis in economic theory for claiming that it is good to tear down our own productive capability and to rebuild it in a foreign country. It is not free trade when a company relocates its manufacturing abroad.
Gomory says that economists and policymakers “still are treating companies as if they represent the country, and they do not.” Companies are no longer bound to the interests of their home countries, because the link has been decoupled between the profit motive and a country’s welfare. Economists, Gomory points out, are not acknowledging the implications of this decoupling for economic theory.
A country that offshores its own production is unable to balance its trade. Americans are able to consume more than they produce only because the dollar is the world reserve currency. However, the dollar’s reserve currency status is eroded by the debts associated with continual trade and budget deficits.
The US is on a path to economic Armageddon. Shorn of industry, dependent on offshored manufactured goods and services, and deprived of the dollar as reserve currency, the US will become a third world country. Gomery notes that it would be very difficult—perhaps impossible—for the US to re-acquire the manufacturing capability that it gave away to other countries.
It is a mystery how a people, whose economic policy is turning them into a third world country with its university graduates working as waitresses, bartenders, and driving cabs, can regard themselves as a hegemonic power even as they build up war debts that are further undermining their ability to pay their import bills.
Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan Administration. He is the author of Supply-Side Revolution : An Insider's Account of Policymaking in Washington; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice.
Alan Greenspan's Legacy
Greg’s Note: Was Greenspan a Republican? Or did he lean to Democrat? Fred Sheehan scathes these two questions below. Tell me what you think: email@example.com
Whiskey & Gunpowder
October 5, 2007
By Fred Sheehan
Braintree, Massachusetts, U.S.A.
Greenspan Was Never a Republican — He Was an Opportunist
Ex-Federal Reserve Chairman Alan Greenspan has discovered the Republicans fall short of his standards. He is finding it difficult to break a smile on his The Age of Turbulence publicity tour. Greenspan “glumly” told The New York Times he is “very disappointed” with the Republicans. They ran an out-of-control budget. (In that, he is right.) “They swapped principle for power.” Greenspan expressed “remorse” that the Republicans followed his advice to lower taxes in 2001. They should have placed “safeguards against surprises.” The real problem was Congress. It did not place safeguards around Alan Greenspan. Despite the common claim that he has been a “life-long Republican,” he was never anything of the sort. He has been a lifelong opportunist.
In February 2000, the last year of the Clinton administration, Greenspan appeared before the Senate Banking Committee. He recommended the government use the federal budget surplus to pay down the national debt. The chairman amplified: “The growth potential of our economy under current circumstances is best served by allowing the unified budget surpluses…to materialize, thereby reduce Treasury debt held by the public.” Meaning: We should direct budget surplus dollars to reduce the federal debt. (This is accomplished by government-initiated purchases of U.S. Treasury securities.) The salient circumstance was that Clinton was not proposing a tax cut.
One year later, Greenspan worked for new management — the Bush administration. President Bush wanted a tax cut to kick off his tenure. Greenspan marketed the tax cut as fiscally responsible, given recent surpluses. His advice was rendered on Jan. 25, 2001, to the U.S. Senate Committee on the Budget. The Wall Street Journal reported the next day: “Giving a big boost to President Bush, Chairman Alan Greenspan reversed his long-held view and said he now sees room for significant tax cuts in the federal government’s financial future…. [O]ver the coming decade, the latest budget surplus numbers show not only room for reductions, but even a need.” The New York Times on the same day: “Alan Greenspan, the Federal Reserve chairman, gave his blessing today to a substantial tax cut…. In a clear shift from his previous position that reducing the national debt should be the focus of fiscal policy, Mr. Greenspan said improvements in the economy’s long-term potential and the swelling surplus projections had ‘reshaped the choices and opportunities before us.’”
In his testimony, Greenspan expressed concern “that continuing to run surpluses beyond the point at which we reach zero or near-zero federal debt brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private (more technically nonfederal) assets.” Of the 10,000 most likely problems the government should consider, this was not one of them. Over $5 trillion in the hole, the possibility of eliminating the federal debt ranked behind that of Venus crashing into Mars. (In January 2001, the Congressional Budget Office had projected the federal budget surplus would reduce the government debt by $5.6 trillion over the next 10 years. This gem of infinite interpolation gave Greenspan the cover he needed. In 2002, the CBO reduced its surplus estimate by $5.3 billion.)
Whether his audience scratched their heads at Greenspan’s flight of fancy, another statement should have awakened their curiosity. Greenspan prefaced his tale of woeful surpluses by discussing “recent projections… [which] make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade. This is in marked contrast to the perspective of a year ago, when the elimination of the debt did not appear likely until the next decade.” The Nasdaq had fallen 43% from its March 10, 2000, peak. Tax revenue had risen from 12.5% of personal income to 15.4% during the boom years. In 2000, this 2.5% increase equaled $237 billion — precisely the same as the total 2000 budget surplus. It suited Greenspan’s purposes to express mystification during testimony: “We still do not have a full understanding of the exceptional strength in individual income tax receipts during the latter 1990s.”
Greenspan could not have been blind to the source of the budget surpluses: capital gains, exercised stock options, and bonuses. These tributaries had dried up. Without these flows, his fear of paying down the national debt, or even running a balanced budget, made no sense. And while Alan Greenspan could claim that paying down the debt was a bad thing, it is a tribute to the man that his audience accepted such a silly pretense approvingly.
The Greenspan campaign for renomination in 2004 kicked off its media blitz on Feb. 11, 2003. The Boston Globe reported that Greenspan viewed Bush’s (new) tax cut plan with a chilly reception: “Greenspan… used the opportunity to admonish the federal government for losing its ‘fiscal discipline.’” In the chairman’s words, a “return to fiscal discipline should be instituted without delay.” That was the stick; on Feb. 12, Greenspan offered Bush the carrot. The Wall Street Journal reported: “Federal Reserve Chairman Alan Greenspan muted his initially chilly reception of President Bush’s tax cut plan, offering more praise for eliminating taxes on dividends and playing down the near-term consequences for the federal deficit.” (Emphasis added.) President Bush announced that he would reappoint Greenspan for a fifth term on Feb. 22.
On April 30, mission accomplished and Bush now bound by the reconfirmation, the chairman slithered back: “Alan Greenspan…told Congress today that the economy was poised to grow without further large tax cuts, and that budget deficits resulting from lower taxes without offsetting reductions in spending could be damaging to the economy. Opponents of the large tax cut favored by President Bush took Mr. Greenspan’s testimony as support of their position.” (Emphasis added.) The dissembling was obvious; yet no one questioned Greenspan’s motives.
On April 21, 2005, the chairman’s bewildering tax and federal budget advice came full circle. At a Senate Budget Committee meeting, Democratic Sen. Paul Sarbanes of Maryland pursued a ragged thread in the Greenspan tapestry. The senator contended that Greenspan’s endorsement of the president’s 2001 tax cut was the “green light” that George Bush needed. Greenspan replied that he had not “specifically” endorsed the tax cut plan. The chairman claimed: “You will not find anywhere in the public record that I supported the  tax cut.”
Reading the Jan. 25, 2001 speech today (available for anyone to judge on the Federal Reserve Board of Governors Web site), his support is obvious. He was rooting for a tax cut.
This civil servant had made false assertions to the people’s elected representatives before. When a vote to balance the budget loomed early in Clinton’s presidency, Greenspan said a Fed study showed a balanced budget would reduce interest rates. The Fed had conducted no such study. Greenspan testified to Congress in 1993 that tapes of Federal Open Market Committee meetings were destroyed after summaries were written. Thus, no transcripts existed. He later admitted to Banking Committee Chairman Henry Gonzales that he had known for years transcripts were kept, but only remembered when a “senior staff member jogged my memory in the last few days.”
Back to Sarbanes, Greenspan deflected the criticism with a tried-and-true tactic: flattery. Greenspan revealed “an alternative program of tax cuts and spending increases then proposed by the Democratic Party’s leadership would have achieved the same desired reduction in surpluses.” Now we have it. He had not specifically endorsed the Bush tax cut. Yet he also told Sarbanes that he, “like many economists,” had been wrong about the surpluses he warned of in 2001. So why was he endorsing the Democrat’s program if he had been wrong about the motivation for promoting a tax cut? We will never know. Greenspan had triumphed once again using another tried-and-true tactic: confusion.
In The Age of Turbulence, Greenspan praises Bill Clinton and criticizes George Bush. This has been good publicity for his book, but misdirected. He is not turning his back on the Republican Party; Greenspan’s only allegiance is, as it has always been, to himself.
December 12, 2007 | WSJAlan Greenspan writes on “The Roots of the Mortgage Crisis” in the opinion pages of today’s Wall Street Journal. Below, economics bloggers react.
Now, we all know what Greenspan is up to here, don’t we? Greenspan—the most revered Fed Chairman of all time, except by the gold-bugs, economic Cassandras and short-sellers who fruitlessly fought his easy money policy for nearly 20 years—wants desperately not to be blamed for the housing bubble that his easy money policy caused. – Jeff Matthews
The Fed did what it needed to do in 2003 to keep the economy moving forward, but that doesn’t mean the policy could not have been improved. In any case, the policy, however necessary, had subsequent consequences that Greenspan seems unwilling to take responsibility for. In addition, the role that his laissez faire attitude may have had in blocking regulatory interventions that might have prevented or attenuated the crisis is conveniently omitted from the story Greenspan tells. Was the crisis his fault? I wouldn’t go that far. Could he have done more to prevent it or reduce its severity? Here I think the answer is yes. – Mark Thoma
I once described Alan Greenspan as being “like a man who suggests leaving the barn door ajar, and then - after the horse is gone - delivers a lecture on the importance of keeping your animals properly locked up.” I was talking about Greenspan’s support for the Bush tax cuts, followed by his lectures on fiscal responsibility. But it also applies to what he’s saying now about the subprime crisis. – Paul Krugman
The boom in U.S. housing prices was pretty much par for the global course, and it’s not obvious that a higher Fed funds rate would have prevented it or even slowed it down noticeably. That said, however, the main reason why the housing bust seems to be much worse in the U.S. than elsewhere is surely those ARMs – which, as Greenspan concedes, were a function of low short-term interest rates. They allowed many people to buy houses they couldn’t afford, which in turn created a massive solvency crisis. … The housing bust (if not the housing boom) is Greenspan’s legacy, and it would be nice if he were a little more honest about it. - Felix Salmon
It makes for a nice story. Capitalism triumphed all over the world, and then proceeded to eat itself. And the U.S. is no longer the supreme arbiter of its own fate — it is now just another pawn moved about by far greater forces. And thus, Fed policy can’t be blamed for inciting the current turmoil. There’s a part that Greenspan is leaving out, however: his own role as a cheerleader for ARMs. In a speech to the Credit Union National Conference in February 2004, he lavished praise on adjustable rate mortgages, and in effect told American consumers that they were being financially imprudent by not signing on the ARM dotted line. – Andrew Leonard
Greg’s Note: Former Fed chair Alan Greenspan can be seen everywhere you look. He’s been in the press more lately than the current chairman. Whiskey contributor Fred Sheehan is gobbling up all the Greenspan coverage he can get and has noticed how much credit this maestro deserves for the problems the economy has been through. It appears there is enough to fill a book. Enjoy, and send your comments here: firstname.lastname@example.org
Whiskey & Gunpowder
December 20, 2007
By Fred Sheehan
Braintree, Massachusetts, U.S.A.
While Humpty Dumpty Sat on a Fence
IN THE DEC. 12, 2007, WALL STREET JOURNAL, Alan Greenspan warned readers that the mortgage crisis was “an accident waiting to happen.” This was already true and obvious when he was Federal Reserve chairman. He chose not to act. His recent article rationalizes the inactivity of the Fed during both the stock market and housing bubbles:
“After more than a half century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. There was clearly little the world's central banks could do to temper this most recent surge in human euphoria, in some ways reminiscent of the Dutch tulip craze of the 17th century and South Sea Bubble of the 18th century.”
When he was chairman, Greenspan testified before Congress as the voice of the central bank (“We at the Federal Reserve…”). Yet several members of the Federal Open Market Committee (FOMC) would have acted aggressively to attack asset inflation and prick the stock market bubble in 1998. The chairman dismissed both activities as beyond the mandate of central bank policy. Transcripts of the Federal Open Market Committee tell the story of committee members with an understanding of the terrors to come. (Since FOMC transcripts after 2001 have not been released to the public, Greenspan’s behind-the-curtain discussion of the housing bubble has yet to be revealed.)
By late 1997, the chairman was convinced stock market prices simply reflected improved productivity. Given this, there was no stock market bubble. Thus, the markets did not need to be considered when surveying inflation. (As background, the NASDAQ rose 21.6% in 1997, 39.6% in 1998 and 85.6% in 1999.)
At the Dec. 16, 1997, FOMC meeting, Jerry Jordan, president of the Cleveland Fed, had a different opinion: “Some board members referred earlier to the dichotomy between the prices of services and the price of goods. That clearly is the case, but the notion of dichotomy also has to be applied in the case of asset prices… I was reading some material about the operations of the FOMC in the early 1930s.”
Jordan then draws a conclusion from the Fed’s myopic concentration on the steady price level of goods and services during the 1920s: “I think it's a useful reminder of what can go wrong if we are too narrow in thinking about the words ‘inflation’ and ‘deflation’... What do we mean by the word ‘inflation’? Clearly, it cannot refer simply to the current price of goods...”
Greenspan, speaking a few minutes after Jordan, thought, “Something very different is happening.” The “something” Jordan identified was never addressed by the chairman: “[W]e keep getting reams of ever-lower CPI readings that seem outrageous in the context of clearly accelerating wages and an ever-tighter labor market… I was startled by this morning’s CPI report. We cannot keep getting such numbers and continue to say that inflation is about to rise.” Jordan had just told Greenspan that inflation was out of control: It was Microsoft, rather than mayonnaise, that was inflating.
At the March 31, 1998, FOMC meeting, Michael Prell, a Federal Reserve staff economist, reviewed current conditions:
“The gravitational pull of valuation may no longer be operating. The P/E ratio for the S&P 500 recently reached 27, based on trailing 12-month earnings, even as companies were issuing warnings and analysts were lowering their 1998 profit forecasts. In the prevailing psychological environment...the market can keep going appreciably higher on its own momentum.”
Jerry Jordan reminded the chairman: “I also continue to be concerned that we may never see the effects of monetary excesses in output prices, but rather we will see them in asset prices.”
Cathy Minehan, president of the Boston Fed, was also worried: “This speculation is fed by financial markets, which are extremely accommodative. From every perspective that we can see in our region and nationally, monetary policy is not tight; it is not even neutral. It is accommodative to an increasingly speculative environment.”
Nor was board member Susan Phillips attuned to the productivity miracle: “The situation is starting to feel a bit surreal, perhaps even unbelievable... The stock market may be too good to be true, and I must say this is the first time I have felt really uncomfortable about the market.”
The chairman’s response was mixed. He seemed to understand the economy was now driven by the stock market: “We have an economic policy that is essentially unsustainable… There is no credible model of which I am aware that embodies all of this.” Then he decided to sit on the fence: “I do not think it is appropriate to move, at this stage. Were we to do so, I believe we would create too large a shock for the system, which it would not be able to absorb quickly.” (“To move” meaning to reduce the speculative money flows by raising the fed funds rate.)
This to-and-fro continued from meeting to meeting. In March 1999, board member Alice Rivlin warned, “There is the risk that the stock market’s apparently unwarranted continued upward price march may accelerate again to even more bubbly heights, leading to a devastating crash when the bubble bursts.”
Greenspan’s reference in the Journal to the Dutch tulip craze and South Sea Bubble is interesting. Michael Prell warned the FOMC of exactly that when the stock market bubble was still inflating. At the Dec. 21, 1999, meeting, the Fed economist read from a recent prospectus in which VA Linux stated it lost $14.5 million in 1999 and expected to continue incurring significant expenses. Yet it rose 700% on the first day of trading. Prell went on: “The warning language I’ve just read is at least an improvement in disclosure, compared with the classic prospectus of the South Sea Bubble era, in which someone offered shares in ‘A company for carrying on an undertaking of great advantage, but nobody to know what it is.’”
Prell wondered “whether the spirit of the times isn’t becoming similar to that of the earlier period.” He then described how impervious speculators were to the Fed’s rate hikes:
“Earlier this year, those stocks supposedly were damaged when rates rose, because people said, quite logically, that the present values of their distant earnings were greatly affected by the rising discount factor. At this point, those same people are abandoning all efforts at fundamental analysis and talking about momentum as the only thing that matters.”
Prell might as well have read a laundry list. The enlightened members of the FOMC had lost their spark by now. Greenspan had hopped off his fence a year earlier, claiming, at the Dec. 22, 1998, meeting: “I do know that the presumption we have discussed in the last year or so that we can effectively manage a bubble is probably based on a lack of humility. As I’ve said before, a bubble is perceivable only in retrospect.”
If he had said this before, it is unrecorded. A reading of the FOMC transcripts shows this was an entirely new theory. Perhaps the FOMC meeting was his off-Broadway rehearsal. On June 17, 1999, he took his claim public, this time before Congress: “Bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”
There was only scattered resistance. A New York Times editorial expressed concern: “The new Greenspan is brimming with self-assurance. Let us hope the market does not test his new confidence.” The Maestro could do no wrong. Whatever he said must be. The stock market bubble, probably the greatest in the history of such bubbles, would burst in early 2000. It was negligible, compared with the brewing mortgage bubble. But Greenspan had learned nothing from VA Linux and was just as blind to the speculative fury engendered by negative-amortizing mortgages. He can keep writing, but nothing will stop the popping of credit bubbles blown so large by Greenspan’s Fed.
Greg’s Endnote: Greenspan may not be able to see a bubble while it is forming, but some cases are more obvious than others. We’ve already heard the warning shots of the housing market, but when the bubble truly bursts we may want to do more than just duck and cover. Click here to find out more…
Greg’s Final Endnote: Fred’s new book, Greenspan’s Bubbles, written with Bill Fleckenstein, will be published by McGraw-Hill in January 2008. You can pre-order it right now by clicking here.
One of these spells flared up during the last week in February, when Greenspan recommended that the home-owning public take a good hard look at switching from fixed-rate mortgages, under whose terms payments stay the same no matter what interest rates do, to adjustable rate mortgages (ARMs), where payments fluctuate along with interest rates--which, right now, makes close to zero sense. Interest rates are lower than they've been in 30 years, and, with all economists predicting a general economic upturn, and Bush's budget deficit and the weak dollar sucking up capital, little doubt exists that interest rates must rise, in which case, switching from a fixed-rate to adjustable-rate mortgage would be pretty costly for any family naive enough to take Greenspan at his word. The episode did not pass completely without critical notice. It was "the strangest bit of advice ever to be proffered by an American central banker," Jim Grant, publisher of Grant's Interest Rate Observer, told the San Francisco Chronicle. Then the press moved on: "Oh, it's just Greenspan."
But sometimes wacko ideas can betray deeper truths. It is tempting to ask what stake the chairman might have in trying to convince millions of people to do something so contrary to their own interest. One theory floated by Fed-watchers is that the chairman is trying to help out his classic institutional constituency, the big banks, which hold trillions of dollars in fixed-rate mortgage paper. There may be something to that theory, but there is almost certainly a deeper and more important motive behind this curious advice. Quite simply, Greenspan is trying to keep a wobbly and fragile recovery alive--and using mortgage refinancing to do it.
There are many strange things about the choppy recovery we're in, but among the most curious is that it is being fueled largely by consumer spending. Why consumers should continue to spend, and why they've done it throughout the recession, is not immediately obvious. After all, average income growth has been puny in the last few years. There's been a big falloff in jobs. Health care and tuition costs have only been going up. And the stock market has spent the last three years unsuccessfully huffing and puffing to get back to the level where it was in early 2001. Why have consumers been spending so much?
Economists have advanced two main reasons. One is that Americans have so lost their moorings that they've had few qualms about going deep into debt. That's certainly true. The average person's debt as a percentage of his income is now higher than it's ever been. But there's another reason, too: Americans have been using their homes as ATM machines, refinancing their mortgages in order to fund their spending. This, of course, makes sense. The one sector of the economy that has consistently swelled has been housing prices. This has intrigued and surprised many economists, because housing is supposed to operate in sync with the economy, expanding during flush times and contracting when things go poorly. But even in a down economy, prices have soared.
Because of these rising prices, people have felt that despite all the ups and downs in stocks and salaries, that their overall situation was okay. Homes are the biggest asset most families own, and their value has been rising nicely. For that reason, Americans have felt more comfortable buying big-ticket items, from SUVs to new computers to Disney World vacations. Much of that spending has gone right onto the VISA card. But that debt has been kept somewhat manageable by another factor in housing prices: mortgage refinancing.
With home prices rising and the Fed keeping rates low, a mortgage refinancing industry that barely existed 15 years ago exploded into one of the fastest growing sectors of the financial services industry. Last year, one-third of all homeowners used cash-out mortgages to refinance their homes, a rate roughly consistent over the past five years. Savvy investors, says Harvard economist William Apgar, are likely to have refinanced "two or three times in the last two years." Each time they do, they have either been able to lower their monthly payments, or walk away with a chunk of cash. And where does that extra cash go? The ubiquitous Ditech TV ads say it all: "I just refinanced my home and paid off my credit cards!" American homeowners have gained $1.6 trillion in cash from refinancing in the last five years, and those gains have flowed almost wholly into purchases of consumer goods. The resulting spending, says Wharton's Susan Wachter, is "propping up" the American economy.
Greenspan has played enabler to this boom. But with the Fed fund's rate at 1 percent, the chairman can't do much more to sustain it. Tens of millions of Americans have already refinanced their mortgages, and at current rates, can't be induced to do so again. This small window is closing, fast: For six months, refinancing has been tapering off, and economists expect it to narrow further--many economists have argued the gains from refinancing are likely to halve ths year. Moreover, as soon as interest rates rise (as Greenspan himself has said they will within the next year), virtually all refinancing will cease.
Greenspan's rather ham-handed effort to get them to go for ARMs, is a sign not of the chairman's own eccentricity or advanced age, but, instead, of the economy's current unsteadiness. Greenspan knows, perhaps better than anyone, that this economy is perched nervously on top of a wobbly, Dr. Seuss-like tower. Our recovery is propped up by consumer spending, which is in turn propped up by mortgage refinancing, and if that refinancing dries up before more props can be put in, the whole edifice could fall. "Since long-term interest rates cannot fall low enough to facilitate another wave of fixed-rate refinancings, he is trying to encourage homeowners to refinance one last time: fixed to ARM," Peter Schiff, president of Euro Pacific Capital in Los Angeles told the San Francisco Chronicle.
Let's assume for a moment that enough people get fooled, and the refinancing boom gets extended for another year. Then what? The real problem hits. Because if you think Greenspan's being cagey on refinancing, the truth he's really avoiding talking about is that we're in the midst of a huge housing bubble, on a scale only seen once before since the Depression. Worse, the inflated housing market is now in an historically unique position, as the motor of the rest of the economy. Within the next year or two, that bubble is likely to burst, and when it does, it very well may take the American economy down with it.
Whether or to what extent American home prices will plummet soon is open to some debate, but not much. Even the professionally optimistic housing economists employed by the real-estate industry are now admitting that the good times may be over: "What we would ask for is kind of a slow slowdown," Jeff Culbertson, president of Coldwell Banker-Northern California, told Knight Ridder at the beginning of March. Virtually every housing economist is concerned that prices may be unstable, and growing numbers are becoming outright alarmed. To understand why that is--and why warnings of a coming housing collapse haven't been front-page news--just look at the numbers.
Truth is, in most of the country there's no housing bubble. Perhaps the crucial ratio from which economists determine whether housing markets are out of whack is the ratio of home prices to annual income. In most of the country, it is modest, 2.4:1 in Wisconsin, 2.2:1 in Kentucky, 2.9:1 in Illinois.
Only in about 20 metro areas, mostly located in eight states, does the relationship of home price to income defy logic. The bad news is that those areas contain roughly half the housing wealth of the country. In California, the price of a home stands at 8.3 times the annual family income of its occupants; in Massachusetts, the ratio is 5.9:1; in Hawaii, a stunning, 10.1:1. To some extent, there are sound and basic economic reasons for this anomaly: supply and demand. Salaries in these areas have been going up faster than in the nation as a whole. The other is supply: These metro areas are "built out," with zoning ordinances that limit the ability of developers to add new homes. But at some point, incomes simply can't sustain the prices. That point has now been reached. In California, a middle-class family with two earners each making $50,000 a year now owns, on average, an $830,000 home. In the late 80s, the last time these eight states saw price-to-income ratios this high, the real estate market collapsed.
By other measures, too, the market is badly bloated. One index of housing inflation is the difference between house prices and rents. In a healthy market, driven by demand, rents and sale prices ought to track roughly together. But while sale prices have soared, rents have stayed flat; and in some of the most overheated markets, like San Francisco and Seattle, they have actually been declining. Such a gap, the economist and New York Times columnist Paul Krugman has written, suggests "that people are now buying houses for speculation rather than merely for shelter," evidence that he called a "compelling case" for a housing bubble. "Within the next year or so," The Economist argued in a May 2003 editorial, these regional "bubbles are likely to burst, leading to falls in average real home prices of 15-20 percent" across America. And, of course, in the most heated markets the drop is likely to be steeper yet.
When housing bubbles burst, they can hurt more than their sector of the economy. Studies have shown that they exercise twice the effect on consumer spending as comparable declines in stock prices. So, a 20 percent drop in housing prices would have the same, shriveling effect on the economy as a 40 percent crash in the stock market. When investors lose value in their houses, many of them pull money out of other investments, like stocks. Then, too, jobs in construction, real estate, and other fields that depend on new home sales die off.
What can Alan Greenspan or anyone else do about this? The answer is, not much. Prices are so stratospheric that even modest hikes in long-term interest rates could burst the bubble. And with federal deficits soaking up so much capital, interest rates are likely to rise as the economy heats up and demand for capital increases. Of course, Greenspan could argue for rescinding some of President Bush's tax cuts, which he's long defended, to bring down the deficit. But even that probably won't forestall a collapse in home prices.
Given the lateness of the hour, and the near-inevitability of the coming crash, there's really only one thing left for concerned citizens to do. Start assigning blame.
Fortunately, the bad actors responsible for this manic inflation are pretty easy to recognize. They look remarkably like the ones who puffed up the tech bubble in the late 90s. In both cases, the unfettered optimism of the buying public was fueled by a brokerage industry almost wholly concerned with making a sale, independent analysts with an incentive to hype prices, and major accounting fraud.
What drives most appreciation in housing prices is the universal human desire to own a slightly larger and more expensive place than one can really afford; a desire restrained in normal times by the universal desire of those who lend money to get paid back.
Getting a home loan used to be a particularly nerve-wracking and unpleasant process. A stern loan officer behind a big mahogany desk would pore over your income and credit, suspiciously probing your portfolio for weaknesses. And sensibly enough: The bank that lent you the money would have to collect on the mortgage for the next 30 years and had to make sure you were really good for it. It hired independent appraisers to make sure the price was in line. This process was a little stingy, and meant some people on the low end of the income scale couldn't buy a home and many others got less home than they might have wanted, but the system usually kept prices in check.
The one exception to this general process was mortgages sold on the secondary market. In the 1930s, Congress created the Federal National Mortgage Corporation (Fannie Mae) to encourage banks to make loans to low-income Americans by agreeing to purchase those mortgages from the banks. In 1970, Congress created a second agency, the Federal Home Loan Mortgage Corporation (Freddie Mac), to do much the same thing. By the late 1980s, these two entities, which belong to the category known as Government Sponsored Entities (GSEs), were buying up and reselling 30 percent of new mortgages and packaging the mortgages to be sold as securities.
Fannie and Freddie's market share was limited by their ability to attract investment capital. But in 1989, Congress instituted some modest-seeming technical changes that made Freddie and Fannie much more attractive to investors, and able to draw much more capital. Under the new rules, for instance, they were allowed to customize securities at different levels of risk and return to meet more precisely the demands of different sectors of the capital market. Then, too, bank regulators let pension funds and mutual funds class Fannie's debt as low-risk. As a consequence, during the 1990s, investors practically threw money at Fannie Mae and Freddie Mac, which became enormously, steadily profitable. The GSEs used the new capital to buy up every mortgage they could, and banks were only too happy to sell off the mortgage paper. The price cap on the mortgages Fannie and Freddie could insure was raised. As a result of all these changes, Fannie and Freddie went from buying mostly mortgages for low-end homes to those of the middle- and upper-middle class. And the share of the nation's conventional mortgage debt which they insure has swelled, to more than 70 percent today, double its share in 1990.
This shift has had two crucial, if under-appreciated, consequences. First, in little more than a decade, Fannie Mae and Freddie Mac have gone from handling one trillion dollars in mortgages to four trillion, with virtually no changes in oversight. Second, their dominance of the mortgage market has profoundly undermined the discipline that once kept housing prices in check.
Once banks knew they could automatically hand off the mortgages they wrote to Fannie and Freddie with basically no risk, the old incentive system dissolved. "Banks and other mortgage lenders are not watching home prices carefully because they rarely hold onto the mortgage paper they create--they just sell it upstream to mortgage investors," John R. Talbott, a housing researcher at UCLA's Anderson School of Business, has argued. "It is a dangerous situation indeed when neither home buyers nor the institutions that finance them are concerned with the ultimate price being paid for the housing asset."
In most markets, buyers and sellers rely on independent experts to bring sanity to prices. In the stock markets during the 1990s, that role had traditionally been played by stock analysts, whose opinions were famously bought off by the investment banks they worked for. Something similar has happened to appraisers, the independent contractors banks hire to determine the worth of a home for the purposes of a mortgage loan. In a recent survey conducted by the October Research Group, more than half of all appraisers said that they personally felt pressured to overstate loans, and "nearly all" said they knew a colleague who had actually done so. The pressure to inflate, October's publisher Joe Casa said, "is much worse now than it's ever been." Industry analysts have estimated that between 15 and 30 percent of houses nationally are over-valued.
It's not just the discipline of banks that keeps people from buying more than they can afford, but also the buyers' own fear and guilt. But in an environment where home prices continue to spiral up, fear and guilt are replaced by a sense that you're a fool not to buy the most house you can possibly get away with.
A particular kind of speculative frenzy ensues, captured in a recent story in The Washington Post which detailed a new phenomenon: home buyers camping out overnight for the chance to be the first in the next morning's open house, ready to buy $700,000 houses in built-out, lush-lawned suburbs like Arlington. The phenomenon has created temporary, yuppie tent cities. The story's authors interviewed several buyers in the tented line who planned to sell their purchases back into a steadily rising market, and concluded, dryly: "There is an element of speculation to the lines."
What makes the current frenzy especially dangerous is that every relevant institution has an incentive to play along. Who, after all, is likely to say stop? Not the realtors. Not the banks, any longer. Not Fannie and Freddie or the private secondary-mortgage operators, who are turning vast profits on the backs of the bubble. Certainly not the Federal Reserve or the Treasury Department, while the economy depends on a sustained housing boom.
By 2000, some acute observers, like Jane D'Arista, a former chief economist for the House Financial Services committee and now a federal funds researcher with the Financial Markets Center, had begun to warn that the situation was untenable. By 2002, a few major players, like Steve Roach, Morgan Stanley's chief economist, had picked up on the concerns about a bubble and Fannie and Freddie's sprawling influence. But Greenspan, Treasury, and GSE officials, in interviews and testimony, denied that housing inflation posed a problem. And, sure enough, in the next year, not only did the bubble fail to deflate, but it also expanded--the housing sector posted its best year ever.
Then, last summer, came a warning no one should have missed: news of major accounting fraud at Freddie Mac. In stocks, corporate accounting scandals appeared after the market plunged, too late to signal danger. But the fraudulent accounting at Freddie Mac was, or should have been, a wake-up call, though the details of this scandal were distinctly different. Instead of hiding losses, as happened at Worldcom and Enron, the accountants at Freddie Mac had been hiding embarrassingly large profits. They feared that higher-than-expected returns might incite more risk-taking and a more volatile housing market than investors in Freddie Mac would like. A number of senior executives were canned, and spooked foreign investors sold off Freddie and Fannie's debt. A sense was emerging, among politicians as well as economists, that Fannie and Freddie were not just running amok, says Tom Stanton, an attorney specializing in government sponsored enterprises, but that they "were showing a combination of high leverage, fast growth, and weak oversight of just two companies that held or guaranteed several trillion dollars of mortgages between them and posed potential systemic risk to the American economy."
Testifying before Congress on July 16, Greenspan did not discuss any of this, nor did he mention a bubble. Instead, he chose to praise the economic benefits of low interest rates and home refinancing. The boom continued unabated. By October, homebuyers were able to refinance to a 30-year fixed-rate loan with a rate of just 4.99 percent.
Still, the accounting scandals, carrying with them a vague, unsavory whiff of Enron, made reforms in the housing market impossible to ignore. Even Franklin Raines, Fannie Mae's chairman, admitted that the GSEs needed to be reined in. In the fall, the House dipped its toes into the water, with a bill that established a single regulator in the Treasury Department with broader authority to make sure the GSEs had their finances in order. At the White House's behest, the Senate Banking Committee began hearings on the same issue in February. The goal of most of the debate in Congress has so far been how to ensure the GSEs financial viability; there has been very little talk about how to reduce their role in the housing markets.
That job fell to Greenspan: Finally, on Feb. 24, testifying before the Senate Banking Committee, he came clean about the risks of the housing market, in a speech reminiscent of his 1996 warning about "irrational exuberance" in the stock market. In his familiar, glum posture, his bald head slouching low over the table, he warned that the GSEs weren't just unstable, but also posed a "systemic risk" to the economy of the United States. He suggested debt caps, to reduce Fannie and Freddie's role in the market, and urged stricter regulation.
The chairman's proposals were both brave and right, the best plan for resolving the structural problems with GSEs that's been put forward yet. But given the political situation, his reforms won't be enacted anytime soon. The day after his testimony, his suggestions were brushed off by everyone from Fannie and Freddie's chief executives to Republicans and Democrats on the Hill. Oh, it's just Greenspan.
Both political parties have bought into the idea that a vast, unfettered Fannie and Freddie are good for the country, and have only amplified the GSEs' "American Dream" rhetoric. Republicans are still invested in the deregulation of Fannie and Freddie they helped engineer in the late 1980s. Democrats, generally the party of more regulation, have historically been Fannie and Freddie's best friends, and the GSEs' lush executive suites are packed with former Democratic staffers: Raines was Clinton's director of the Office of Management and Budget, and his predecessor, James A. Johnson, a longtime aide to Walter Mondale, is now leading John Kerry's search for a running mate. In the hearings on the Hill, neither Democrats nor Republicans have seemed favorably disposed to strict regulation of Fannie and Freddie, and American Banker has concluded that the GSEs' lobbying power is strong enough that no regulatory bill will pass without their okay.
Greenspan, of course, knows all this. He knows his reform initiatives stand little chance politically right now, and he knows that even if, miraculously, they were put into place, they likely won't keep the housing market from crashing. Why even bother to bring it up? Two reasons, say Fed-watchers. First, though he didn't explicitly warn against the housing bubble, Greenspan wants to be able to claim, after the bubble bursts, that he gave fair warning, even though these warnings came at the eleventh hour. But at a less cynical level, the chairman knows that in the American political process real reforms only get put into place after a crisis and not before, but that you stand a better chance of getting them if you publicize them early.
So, why then didn't he bring these issues up even earlier? The answer may be that he simply couldn't afford to--he was relying on a supercharged housing sector to get the economy as a whole through the recession. Indeed, he still is. On the very day that he suggested his reforms of the secondary market, he was trying to squeeze a little more juice out of refinancing with his bizarre advice to consumers about ARMs. And that, ultimately, is the ironic and uncomfortable position that this economy has forced Greenspan into. To get out of the recession, he had to rely on, stay mum about, and even encourage a housing bubble. Now, that very bubble may be the thing that destroys the recovery he has sought to create.Benjamin Wallace-Wells is an editor of The Washington Monthly
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