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Was there a "global savings glut" in 1986?

Wednesday, February 10, 2010

It seems that, once again, former Fed Chief Alan Greenspan has grown tired of listening to his critics who have increasingly laid blame at his feet for the inflation of (and, more importantly, the subsequent bursting of) the nation's housing bubble a few years back that led to a credit market melt-down shortly thereafter and the ongoing global financial mess.

According to this report in Fortune, he's now putting the finishing touches on a 12,000-word essay that seeks to set the record straight regarding his culpability in the whole affair.

Central to his case is the argument that a "global savings glut" rendered the central bank powerless to effect changes in long-term interest rates when its "baby-steps" campaign to raise short-term rates began in 2004. Amongst defenders of Fed policy during this period, this is now viewed as a valiant, yet ultimately unsuccessful, effort to rein in the housing bubble before it could do any real damage.

But, looking back at the relationship between short-term rates and mortgage rates, this argument seems almost silly since, prior to the start of Greenspan's term, raising short-term interest rates had only about a 50-50 chance of pushing mortgage rates appreciably higher.
IMAGE Unless there were also "global savings gluts" back in 1986 (and, to a lesser extent, in 1972) when long-term rates showed a similar lack of response to rising short-term rates, this explanation clearly comes up short.

On the other hand, if long-term rates were unresponsive to short-term rates in the 1970s and 1980s as a result of "global savings gluts" at the time or, for that matter, any other reason, this possibility is surely something that should have factored into monetary policy during the critical 2003-2006 period.

Note that there seems to be some confusion as to whether a savings glut even existed during the early part of the last decade. Stanford economist John Taylor recently observed that, as a percent of GDP, global savings and investment have declined steadily since the 1970s, going on to comment, "There is actually no evidence for a global saving glut."

As for historical precedents, there is much to be learned by looking closely at the labeled periods in the graphic above.

As shown in area 'A' in the early-1970s, during the disastrous term of Arthur Burns (who, not coincidentally was Greenspan's mentor at Columbia University), short-term rates were raised from 4 percent to 13 percent while 30-year mortgage rates rose by just two percentage points, up from just under 8 percent to 10 percent, an even weaker response than seen during the 2004 to 2006 period.

After that, both Burns and Paul Volcker had more success pushing mortgage rates around in the late-1970s and early-1980s as shown in 'B' and 'C', however, this is surely much easier to accomplish when lending rates are in double-digits.

The more instructive comparison came in the late-1980s, after inflation had been vanquished and lending rates had begun a secular downward trend as shown in area 'D' above and enlarged below. There you have a near repeat of what happened about six years ago as the Fed Funds rate went up four percentage points but mortgage rates barely moved.
IMAGE What is also intriguing about the two periods shown above is that the spread between 30-year mortgage rates and the Fed Funds rate (in green) is almost identical - from four or five percentage points down to one percentage point when the rate raising cycle was complete.

Was there a "global savings glut" in 1986?

It is clear that long-term rates moved in near-lockstep with short-term rates early in the 1990s and again beginning in 1999 as shown in areas 'E' and 'F' in the first graphic above, but, when looking at the data prior to 1990, there is no reason to think that this pattern should have repeated.

Surely, any Fed chairman worth his salt would have considered the possibility that mortgage rates would not move higher simply because short-term rates did and, perhaps, spent a little more time looking at how regulatory changes might help tame a rapidly inflating housing bubble that was deceptively characterized as "froth" at the time.

To pass the explanation for low mortgage rates off to a "global savings glut" and, as a result, to think that Fed policy can be absolved of blame for the housing bubble would seem to be a case of carelessness at best, incompetence at worst.

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Adam said...

Thanks for this post Tim. This obviously shows at least what you say is carelessness by those in charge.

However, more likely, it could also be ideology blinding them into even looking at something like this.

Anonymous said...

The Fed's 200 PhD economists couldn't figure this one out???

Ted S. said...

Nicely done, as usual. A real eye-opener re: the pre-1990 era. What about prior to 1971? Any idea what the relationship was, say, back in the 1950s when the Fed funds rate was also close to zero?

Tim said...

Good question. The H.15 data only goes back to 1971 for mortgages but this is probably available somewhere. Off the top of my head, I don't know where but it's probably worth a quick search.

Anonymous said...

There was a global savings surfeit, but it was caused by world central bank printing. Forced savings is a concept central bankers refuse to accept, but reality does not go away simply because someone refuses to accept it.

Central banks complain about too much savings (paradox of thrift), and then make the problem worse by adding forced savings to the mix. Asset prices become leveraged bubbles as a result of forced savings creating a surfeit of savings.

AJ said...

Perhaps there wasn't a "glut" of savings, but people have always had that much savings. People always have money that they want to save or invest.

Perhaps the Fed Funds rate being so close to zero was giving all of those people a gigantic middle finger, forcing them to seek out other avenues for a return that would beat inflation. Avenues like CDOs composed of subprime mortgages...

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