Friday, March 19, 2010
The defense of monetary policy during the gestation years of the housing bubble was reiterated (yet again) yesterday by former Fed chief Alan Greenspan in a paper(.pdf) titled "The Crisis" that is being presented today at the Brookings Institution.
While the 48 pages of text and the 18 page appendix await attention that they are unlikely to receive from me on this Friday, the contents are quite clear based on reports in the mainstream financial media and the two central points appear to be:
1. Low rates are not to blame
2. See number 1
The Wall Street Journal carries a story in the public area of their website today where Jon Hilsenrath restores some order to the recent reporting on the former Fed chairman, inserting the once-mandatory caveats that all post-2008 Greenspan stories used to carry before an image re-building campaign apparently met with some success over the last year or so:
Mr. Greenspan's reputation has been tarnished by the crisis. Widely hailed when he left office in January 2006 as one of the greatest central bankers ever, he is now blamed by many for advocating deregulation and low interest rates during the 1990s and 2000s.That's more like it - the third paragraph in - short and sweet.
In his paper, Greenspan concedes that regulation failed and that the central bank didn't see the mounting risks in the financial system, but he goes on to defend monetary policy back in 2002-2004 and blames the "savings glut" as the primary interest rate culprit, that is, the theory that short-term rates played little role in inflating the housing bubble and that the Fed was powerless over the long-term rates that did.
Does anyone still believe this?
Teaser rate ARMs didn't play an important role as the housing bubble neared its peak?
This excerpt from the New York Times piece by Sewell Chan sheds some light on this question, one that, on its face, seems to be just nonsensical, but one that has nevertheless been repeated countless times over the last fewyears.
While conceding that the low fed funds rate, the benchmark interest rate the Fed controls, made it easier for borrowers to use adjustable-rate mortgages, he said he suspected — “but cannot definitively prove” — most home purchasers would have taken out 30-year fixed-rate mortgages had the adjustable-rate ones not been available.Now, remember that the guy turned 84 not long ago, so, he's not getting any sharper as the years go by, but, this is just pitiful.
“The global house price bubble was a consequence of lower interest rates, but it was long-term interest rates that galvanized home asset prices, not the overnight rates of central banks, as has become the seemingly conventional wisdom,” Mr. Greenspan wrote.
Interestingly, the New York Times piece also has a similar third paragraph disclaimer:
Mr. Greenspan, once celebrated as the “maestro” of economic policy, has seen his reputation dim after failing to avert the credit bubble that nearly brought down the financial system.Nicely done.
Ultimately, the conclusion that the former Maestro reaches is that regulation must be improved and that banks should hold more capital, however, the issue of monetary policy is really the "elephant in the room" for both this paper and Ben Bernanke's similar defense of the Fed funds rate during the first week of the year as discussed here.
On this subject, it strikes me that the approach taken by both the current and former Fed chairmen in their recent writing is both dishonest and naive.
If, for example, back in 2001 and 2002 as interest rates were being slashed, Fed board members would have sat around their conference room table and said, "We've really got to beef up regulation because housing prices really have room to run and we don't want to just create another bubble", then there might be some merit to this defense.
But, obviously, they did nothing of the sort.
In fact, not only did Greenspan poo-poo warnings from the likes of the late Ed Gramlich about subprime lending, but he encouraged borrowers to take out adjustable rate loans as late as 2004 and praised the financial innovation of both subprime lending and credit default swaps at the very period of time that the credit market and housing bubble excesses were accelerating out of control.
It's as if both Greenspan and Bernanke are hopelessly naive about the world in which we live where people are clearly motivated by short-term gains and end up doing stupid things, behaving quite irrationally at times.
In order to even consider taking interest rates to one percent or zero over the last ten years, the first step should have been to beef up regulation, but it wasn't back then and isn't today.
This sort of defense of monetary policy - including today's freakishly low rates - is only applicable to a world of perfect actors, perfect regulation, or some combination of the two and the most disturbing aspect of the combined Greenspan/Bernanke defenses is how they both continue to demonstrate how detached they are from this reality.
Of course, none of this bodes well for the future since short-term rates have already been at zero percent for over a year as Wall Street firms continue to dream up new ways to destroy the world while, at the same time, finding time to thwart meaningful financial market reform.