Thursday, December 13, 2007

The Blogosphere Responds to Greenspan

Invariably, the reaction to this article by Alan Greenspan explaining the mortgage crisis as he saw it has been intense. First, here is a sample of the article...

A large segment of the erstwhile Third World, especially China, replicated the successful economic export-oriented model of the so-called Asian Tigers: Fairly well educated, low-cost workforces were joined with developed-world technology and protected by an increasing rule of law, to unleash explosive economic growth. Since 2000, the real GDP growth of the developing world has been more than double that of the developed world.

The surge in competitive, low-priced exports from developing countries, especially those to Europe and the U.S., flattened labor compensation in developed countries, and reduced the rate of inflation expectations throughout the world, including tSo much so in fact that President Bush has taken the extraordinary step of brokering a deal in which some of these ARMs will be frozen.hose inflation expectations embedded in global long-term interest rates.

In addition, there has been a pronounced fall in global real interest rates since the early 1990s, which, of necessity, indicated that global saving intentions chronically had exceeded intentions to invest. In the developing world, consumption evidently could not keep up with the surge of income and, as a consequence, the savings rate of the developing world soared from 24% of nominal GDP in 1999 to 33% in 2006, far outstripping its investment rate.

I, myself, pointed out yesterday that I believe that most of what he wrote was nonsense and an attempt to skirt responsibility. What he is creating is an intelligent sounding and sophisticated scenario, however it is, in my opinion, totally devoid of reality. First, here is how I saw the roots of the crisis. Greenspan attempts, in the article, to minimize his decision to lower Fed Funds Rates to obscenely low levels. The reality is that he can't and it won't be minimized. By lowering the rate so much, below one percent for a while, he created loose money. Loose money invariably leads to irresponsibility. That irresponsibility manifested itself in the mortgage crisis.

That is my view. Now, let's see how some of the rest of the blogosphere and beyond saw it. First, the WSJ had their own section of reactions. Here is a sampling.

1) You explicitly encouraged “risky” ARMs.

2) You say you raised interest rates but the long rate did not rise. And so it is not your fault. The issue here is nuanced.Your policy of completely telegraphed 25bp interest rate increases meant the fixed income market was on the “one and done” bandwagon from 2004-2006. You knew that the forward term premium was
getting destroyed by the policy and did nothing about it. You are also responsible for completely convincing the fixed income market that the fed policy is disjointed from commodity prices.


I also was shocked to hear Greenspan recommend that borrowers take ARM loans instead of fixed rate loans in 2004. The low fixed rates being offered in 2004 were historic, and I can’t imagine that anyone over the age of 12 thought they would remain so - especially the head of the Federal Reserve. However, the ARM loans and the low fixed rate loans did not create the problems we see today. The underwiriting standards lenders were using to qualify borrowers for these loans was definately the problem over the last 7 to 10 years...

it wasn't all criticism though...

It’s easy to sit back and criticize The Chairman, but we weren’t sitting in his chair. Why do we expect interventionist policies to cure all the market ills? There is a reason for market cycles, and in this case the easy money didn’t come from the Fed, but from Wall St. All those clever newly-minted MBAs came up with a “New Paradigm” – financing vehicles that abandoned traditional underwriting standards and generated huge fees for them...

It should be noted because I didn't point it out last time that at the height of the real estate boon Greenspan actually recommended that borrowers choose ARM's over fixed rates.

Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said.

Adjustable Rate Mortgages (ARM's) have become the subject of much controversy. So much so in fact that President Bush has taken the extraordinary step of brokering a deal in which some of these ARMs will be frozen. It is, in my opinion, highly irresponsible to make such a blanket statement recommending a mortgage product. Everything depends on the specific situation as to whether or not an ARM or a fixed rate is appropriate. While I have absolutely no use for his statement, I am not so sure that it had that much effect on the crisis. It is an ongoing debate whether or not these ARMs perpetuated or started the crisis. I am in the boat that they perpetuated it. I believe his obscene rate drop was a much more significant factor.

Now, let's sample what others on the blogosphere said. Let's look at several samples from all around the blogosphere.

In other words, Alan Greenspan wants us to believe that the most powerful Fed Chairman in U.S. history was powerless to stop the greatest housing bubble of U.S. history, despite the fact that he stood at the monetary control button that directly inflated that bubble.But he’s a Republican, and a cagey politician at that, so he’s not going to try to avoid responsibility altogether:


Thus Greenspan opens the door to an admission of what any—and I mean this literally—fool knows: that his 1% pedal-to-the-metal interest rate policy during one of the great world economic booms of all-time had everything to do with the ensuing drama.But he opens the door no further, and quickly shuts it with this whopper:

In my judgment, however, the impact on demand for homes financed with ARMs was not major.


Here's a more-clear-than-usual article by former Fed Chairman Alan Greenspan in which he makes a few important arguments:

"...bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own."

In retrospect, global economic forces, which have been building for decades, appear to have gained effective control of the pricing of longer debt maturities. Simple correlations between short- and long-term interest rates in the U.S. remain significant, but have been declining for over a half-century. Asset prices more generally are gradually being decoupled from short-term interest rates. "


Felix Salmon of pretty much eviscerates him on his lies. That said, however, the main reason why the housing bust seems to be much worse in the US 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.


While acknowledging the low U.S. interest rates set under his leadership may have contributed to the bubble in U.S. home prices, Greenspan said he felt the roots of the subprime mortgage crisis actually lie with global economic expansion.


Greenspan had what he thought were good reasons to put interest rates very low. One consequence of that was to make ARMs look more appealing to a lot of people. Greenspan could have responded to that in one of three ways. He could have ignored the ARM issue. He didn't do that. He could have tried to warn people about the risks of ARMs. He didn't do that. Instead, Greenspan encouraged people to get ARMs. I think it's never really been clear why he did that, but it was pretty bad advice and he just doesn't mention it at all during his retrospective.


he lays the blame for the crisis on almost everything else (including the collapse of the Soviet union) but for his own actions of keeping rates too low for too long as the Fed Chairman, even at times expressing helplessness.


Greenspan laments the lack of control that central banks had on long term interest rates, most of the crisis has been caused by loans taken on very low adjustable rate mortgages (ARM) which in turn fueled a rise in asset prices to bubble type levels. ARMs are marked to short term interest rates, which have a more or less direct relationship to central bank policy action.

The consensus appears to lie somewhere near my own analysis. Here is a link to the entire sampling and you can see for yourself.

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