John Mauldin defends Alan Greenspan! Why?

I hope he doesn't remove me from his mailing list because John Mauldin's Friday night e-letter is an essential part of my weekly reading schedule.

But, last week's edition contained such a remarkable piece of blather that it made me wonder if he was having some sort of a personal crisis.

Even erstwhile sychophants like Alan Blinder aren't defending retired Fed Chairman Alan Greenspan anymore.

Why would a section titled "In Defense of Alan Greenspan" show up in what is otherwise a very sensible and insightful correspondence sent out every week to a million readers (well, maybe just 999,999 this week).

Was this some sort of a cry for help?

Was this like when my cheating best friend/co-worker made the off-hand comment, "What's wrong with fooling around a little?" some fifteen years ago? There were a few rumors, but no one really believed at the time that there was any truth to them. Six months later, after his wife found out and he came home to find all his worldly possessions sitting on the sidewalk, that off-hand comment resounded in my head.

Anyway, its motivation is a mystery, but here it is:

In Defense of Alan Greenspan
Alan Greenspan is routinely blamed in many circles for creating the housing bubble. It was his keeping rates too low, we are assured, that was responsible for the run-up in home prices. Now, he probably did keep rates too low for too long, but I am not certain that we can lay the blame at his feet. He had a lot of help.

First, a point made by Peter Bernstein. Housing prices rose by almost 50% from 1998 to 2001, before Greenspan started on his rate-cutting binge. 50% in three years when the Fed funds rate was over 6% is not exactly encouragement from the Fed to buy homes. It seems people were ready to do it without low rates. So, a good part of the bubble was not due to lower rates.

And home prices continued to rise rather sharply, even as the Fed began to raise rates in 2005-6. We built 3.5 million more homes over the last ten years than the trend growth suggested we needed. They were not all built during the period of low interest rates.

While low rates did help, the bubble was aided and abetted by sloppy lending practices. It now looks like some two million people took out loans they are going to have difficulty repaying, and are likely headed for foreclosure. Rating agencies labeled these loans as AAA credits. Mortgage and investment bankers sold them to all manner of institutions.

All these culprits took advantage of the low rates, but that was not the cause of the bubble. If proper lending practices had been followed, there would have been far fewer buyers and less building, less speculation, and so on.

Greenspan, in hindsight, should have raised rates sooner, which I said at the time. And lower rates did make homes more affordable. No question about that. But to lay the blame for the housing bubble at his feet is not entirely fair. He had a lot of helpers who did the really heavy lifting.

Yes, he did have a lot of help, but, it's not as if blame is indivisible - if the words were, we can't lay "all the blame" at his feet, that's one thing. But, to say, we can't lay "the blame" at his feet is another.

This sounds a lot like "no blame" should be directed his way.

As you have read here for quite some time now, there is plenty of blame to go around in this mess - lenders, borrowers, rating agencies, etc. - but, how could the former Fed chairman be reasonably excused?

If you had to pick one single person to blame for the latest bubble bursting, Alan Greenspan has got to be in the top five on almost everybody's list.

And to offer such flimsy evidence in his defense ...

1. Yes, house prices were already rising while the stock market bubble was wending its way to its inevitable pin. According to the S&P Case-Shiller 10-City Home Price Index, in the four years prior to 2001 (not three years as noted above, at least not according to this index), home prices rose 50 percent as shown below. This follows outright declines from 1992 well into 1996 as a result of the last housing mess 15 years ago.
A 50 percent gain over four years is just over 10 percent per year, which, given the previous downturn appears to be a somewhat ordinary rebound and is certainly not evidence that monetary policy is irrelevant when it comes to home prices.

2. And those "baby step" interest rate increases in 2004-2006? They just emboldened anybody having anything to do with real estate and mortgage lending - with each new baby step at about six week intervals, everyone looked around and said, "Man, ain't this great? They're raising interest rates and home prices are still going up $10,000 a month."

Nearly everyone knows there can be up to a two year lag in interest rates affecting the broader economy (except condo-flippers, of course). One look at the chart above and two years sounds about right.

3. As for the complete omission of the Federal Reserve's regulatory role in the housing bubble, that's just unforgivable. It's like defending a criminal without ever saying where the defendant was during the crime - refusing to provide an alibi.

This Wall Street Journal story($) from a few weeks ago addressed the issue nicely:

Because of its high profile, the Fed draws disproportionate scrutiny from lawmakers and others for lapses in banking oversight, even though the Fed shares its regulatory authority over banks with the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corp. and state banking supervisors. The Fed alone, under a 1999 law, oversees bank holding companies, which control all the country's largest banks -- but not the largest thrifts. The central bank had 1,555 bank examiners as of June, down slightly from 1,578 in 1997, though the assets it supervises nearly tripled in that time to $17.6 trillion.

The Fed has failed "to provide the appropriate supervisory oversight for the major money-center banks," Harvard economist Martin Feldstein wrote in a recent opinion piece in The Wall Street Journal. The Fed, he said, believed the banks had adequate capital "because it gave far too little weight to their massive off balance-sheet" vehicles.

The Federal Reserve is one of a handful of regulatory bodies - a fact that current Fed Chairman Ben Bernanke is now painfully aware - but it has, by far, the largest megaphone.

When it comes to all matters related to money, credit, and debt, the Fed has the largest "bully pulpit" in the universe.

While the housing bubble was still inflating, what was that bully pulpit used for?

1. To move MBS origination from the GSEs to Wall Street
2. To successfully fight any substantive regulation of hedge funds
   
3. To encourage borrowers to take out adjustable rate loans
4. To praise subprime lending and other "financial innovation"
5. To repeatedly dismiss the housing bubble as just "froth"

Your honor, the defendant really deserves a better lawyer if these proceedings are to continue.