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.
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.
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.