Tuesday, September 30, 2008
[This was originally published about a year ago - it's worth another look...]
After repeated requests, at great personal expense, and after a series of logistical obstacles were somehow miraculously overcome, former Federal Reserve Chairman Alan Greenspan and I sat down for an interview the other day.
Tim Iacono: Good afternoon.
Alan Greenspan: Good afternoon. My assistant tells me you've been writing about me.
Iacono: A little. Let's get right to the point. Are you responsible for the housing bubble?
Iacono: Would you care to elaborate on that?
Greenspan: There are many housing bubbles all around the world and they all have the same root cause - the fall of the Berlin Wall and the entry of hundreds of millions of low cost laborers into the global economy. This resulted in downward pressure on both inflation and long-term interest rates - we raised short-term rates in 2004 but we were powerless against the forces that kept long-term rates so low for so long.
Iacono: Is it really that simple? Long-term rates go below five percent, they don't move up when you raise short-term rates, and that's it? Game over?
Greenspan: It is much more complicated than that, but as it relates to my job as the Chairman of the Federal Reserve, it is indeed that simple. All we can do is control short-term interest rates.
Iacono: But short-term rates were an important factor in those obscenely low adjustable rate mortgages weren't they? And what about regulation in mortgage lending and your power to influence financial markets and individual investors? You spoke highly of adjustable rate mortgages and subprime lending back in 2004 - who knows how many individuals interpreted your comments as a sign of approval for those kinds of risky loans?
Greenspan: My power to influence is highly overrated. For example, Congress never listened to me when I pleaded with them to fix the entitlement problem.
Iacono: But that's an intractable problem that no one can really solve. Your comments about adjustable rate loans and subprime lending gave the green light to speculators who respected your opinion.
Greenspan: Oh I don't think so. As I said, my power to influence is highly overrated. We raised interest rates starting in 2004, but long-rates wouldn't budge - that's the real source of the problems we see in housing today - the Berlin Wall fell and hundreds of millions of ...
Iacono: Yes, yes, yes - we've been through the Berlin Wall thing. Do you take any responsibility for your role in the credit and housing market mess today? Short-term rates and lax regulation of mortgage lenders played a huge role in the housing bubble and the Fed is responsible for both - yet you keep saying "long-term rates were too low because the Berlin Wall fell".
Germany didn't have a housing bubble, mostly because lenders continued to require large down payments, and the Chinese government has repeatedly mandated higher down payments - yet you stood by and did nothing when all those "no-money-down" loans with "one percent teaser rates" were being made a few years ago. Were you unaware of these practices or did you choose to ignore them?
Greenspan: We weren't aware of what was happening in subprime lending until late 2005 or early 2006. When we did see it - very late in the game - we were surprised at some of the things that we saw.
Iacono: So, do you think you should have known how lending standards began to deteriorate earlier in the decade. It all started with Fannie Mae and Freddie Mac and their use of credit scoring and mortgage securitization and ...
Greenspan: And we fixed that problem!
Iacono: You fixed it? How?
Greenspan: By limiting the size of their portfolios. Mortgage securitization was moved to Wall Street where it belongs. Having the GSE's portfolios growing at the rate they were in 2003 posed a systemic risk and, after my pleading, Congress saw fit to reduce their role in mortgage lending.
Iacono: I thought you said your powers of persuasion were overrated.
Greenspan: Not on this occasion.
Iacono: But didn't that just leave Wall Street firms to take up where the GSEs left off? And they have no oversight at all. At least Fannie and Freddie had regulators looking over their shoulders from time to time - on Wall Street, it was like the Wild West with investment firms creating complex products that no one understood or knew how to rate.
As long as prices kept going up and profits kept rolling in, nobody asked questions. Wasn't that lack of regulation one of the major causes of the housing and credit market mess we see today?
Greenspan: When mortgage securitization was transferred to Wall Street, regulation became unnecessary. Investment firms, hedge funds, ratings agencies, and their ilk - these are all "self-regulating" entities. That's what you see today - these firms are all re-assessing risk and a new set of business practices is evolving.
People will lose money - investors and Wall Street firms have already lost a great deal of money - because of the problems we've had in the credit and housing markets.
But these are wealthy individuals - it won't really hurt them.
Iacono: What about the typical home buyer in 2005 who was swept up in the mania of rising home prices? They'll be hurt, wont' they? And they aren't wealthy. They can't just absorb the loss and go on - this will affect them for years.
With the collapse in the housing market and the decline in home prices, this looks like it's going to be just one more part of your legacy where the middle class finds itself worse off than in prior decades while the rich just get richer.
Greenspan: Young man, you simply don't understand the way modern economies work. While there are often unpleasant side effects, it is much better to allow markets go to excess from time to time than for a central bank to repeatedly stop those markets in their tracks - the economy as a whole benefits in the long run.
This euphoria that occurs from time to time - financial bubbles - these are good for an economy because even if a bubble bursts and some of the bad investments are liquidated - a process that can be quite painful for those involved - the economy and society are better off due to the advances that were achieved during the bubble.
If you examine the aftermath of financial bubbles through history, you'll see that in every case, the innovations that occurred and the technology that was left behind when the bubble burst - they leave behind a much better world.
I have been widely criticized for allowing the stock market bubble to expand and then burst a few years ago. But here we are today and broadband has never been so cheap, more people have access to more powerful, yet inexpensive computers than ever before and despite the turmoil earlier in the decade, the society has benefited.
Iacono: What benefits will the bursting of the housing bubble leave behind?
Greenspan: Well, that should be clear - entire neighborhoods have been revitalized, home building and renovation technology has been advanced, and millions of Americans who could never afford a home before are now homeowners because of innovations in mortgage finance and debt securitization.
Iacono: Hmmm... During the period when the Caine was towing targets, did you ever steam over your own tow line?
Greenspan: What? What are you talking about? I don't understand that question.
Iacono: Oops. I'm getting ahead of myself. Let's see... What about the Federal Open Market Committee meetings back around the beginning of the housing bubble - 2002 and 2003 - when interest rates were at 40-year lows? There have been comments from former Federal Reserve members that you would not tolerate dissent and that monetary policy decisions were already made prior to the policy meetings - that the meetings were just a formality.
Many analysts now think that you left short-term rates too low for too long.
Greenspan: I'm happy to dispose of this particular slander right now. We were facing the threat of deflation at that time - no one realized that you could have deflation in a fiat money system, but I did. Japan proved that it was possible and I took steps to avoid deflation - a powerful and destructive force whose danger no one else appreciated. As a result of my swift action we avoided that danger.
Iacono: But didn't you just inflate another bubble instead?
Greenspan: My unreliable staff at the Federal Reserve failed to warn me about that. But I saw the dangers at Fannie and Freddie - I was the only one to recognize that something had to be done about that. We avoided a systemic collapse that might have resulted had I not taken action.
Iacono: But weren't you distracted at the time? Didn't memories of your policy actions in 1992 - policy actions that many thought were responsible for the failed re-election campaign of George H. W. Bush - didn't these prior monetary policy actions affect your thinking in 2003? Weren't you just trying to right a wrong from twelve years before?
Greenspan: I don't recall.
Iacono: What about the inflation rate during that time - when you held interest rates at one or two percent from 2002 until June of 2004? Last year, Dallas Federal Reserve President Richard Fisher noted that the these figures were probably too low - that perhaps there really was no threat of deflation.
Greenspan: On that, my unreliable staff at the Federal Reserve failed me again. Had I been provided with accurate inflation data, interest rate policy may have been different, but after the stock market bubble had burst, I assumed command of a badly-handled ship. I tried to bring it into line.
Iacono: Didn't the late Ned Gramlich warn you of the dangers of subprime lending as far back as 2002 and didn't he propose tighter regulations and urge you to rein in the non-bank lenders?
Greenspan: I don't recall.
Iacono: Were all the members of the Federal Reserve Board disloyal?
Greenspan: I didn't say that. Some were disloyal.
Iacono: You co-wrote a report on mortgage equity withdrawal during your last year as Federal Reserve Chairman. This was your first paper in over ten years. Do you recognize it?
Greenspan: Yes, I do.
Iacono: Did you spend the better part of you last year trying to prove that home equity withdrawal due to the housing bubble would not have an adverse impact in the long run? That a reversal in mortgage equity withdrawal did not pose a threat to the economy?
Greenspan: I don't know what lies have been sworn to here, but I was trying to prove that the economy was functioning normally, but my disloyal staff failed me here too - the data was inconclusive.
Iacono: Wasn't the whole fuss over who would get blamed for the housing bubble? Weren't you told that the mess boys ate the berries? That there was no key?
Greenspan: The key was not imaginary. I don't know anything about the mess boys.
Iacono: Have you no recollection of a conversation with Ensign Bernanke in 2005? Didn't he tell you that the mess boys ate the strawberries?
Greenspan: I remember he was grateful for his transfer to the White House.
Iacono: Do you know where Ensign Bernanke is now? He's in Washington. He can be flown up here in three hours if necessary. Shall we have him testify?
Greenspan: No, I ... I don't see any need of that. Now that I recall, he might have said something about mess boys. I questioned many men, and Bernanke was not the most reliable officer.
Iacono: The defence has no other recourse than to produce Ensign Bernanke.
Greenspan: There's no need for that. He'll only tell you lies.
[Reaches for two silver balls and begins handling them]
All the officers were disloyal. They were always fighting me. If the crew wanted their shirt-tails out, they'd let them. Take the tow line ... defective equipment.
But they began spreading wild rumors about steaming in circles, and then "Old Yellowstain".
I was to blame for Maryk's incompetence. Maryk was the perfect officer, but not Queeg.
But the strawberries, that's where I had them.
I proved with geometric logic that a duplicate key to the icebox existed. I could have produced that key.
They were protecting some officer ...
Naturally, I can only cover these things from memory.
If I've left anything out, just ask me specific questions.
I'll be glad to answer them one by one.