By Tim Iacono, who publishes a weekly investment newsletter on natural resources and the blog The Mess That Greenspan Made
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.
6 comments
Comments are closed.
Ah, let the historical revisions (read: ass covering) games continue!
But hold on. Let me get some popcorn, a drink and a nice comfy chair first.
A wise man learns from his experience; a wiser man learns from the experience of others.
–Confucius
If you want to commit economic suicide, there is no better way than to turn the economy over to some LANie (Libertarian-Austrian-Neoliberal) zealot like Greenspan. And as is a common trait with sociopaths, these guys never learn from experience, neither their own or that of others.
Time after time after time, their policy prescriptions have been applied around the world, and time after time after time they have proven disastrous. And yet in the US, the LANies are still firmly in control.
Following the Mexican crisis in 1994, Francisco Gil-Diaz wrote an excellent postmortem. He concluded the Mexican crisis came on the heels of “regulatory failure” and “credit growth” and followed the same pattern as revealed by a study of 20 countries reviewed by Kaminsky and Reinhart (1996).
Credit Growth:
“All the sampled countries except Venezuela experienced a sharp expansion of credit to the private sector prior to the crisis’,” Kaminsky and Reinhart concluded.
Gil-Diaz points summarizes the explosive credit growth in the case of Mexico:
Mexico’s credit expansion churned out impressive numbers. From December 1988 to November 1994, credit from local commercial banks to the private sector rose in real terms by 277 percent, or 25 percent per year.
Some items provide a better understanding of the underlying trends: credit card liabilities rose at a rate of 31 percent per year, direct credit for consumer durables rose at a yearly rate of 67 percent, and mortgage loans at an annual rate of 47 percent, all in real terms.
External credit flows to the private sector went from -$193 million in 1988 to $23.2 billion in 1993.
Regulatory Failure:
As to regulatory failure, Gil-Diaz observes:
The financial sector also underwent a substantial liberalization, which, when combined with other factors, encouraged an increase in the supply of credit of such magnitude and speed that it overwhelmed weak supervisors, the scant capital of some banks, and even borrowers.
Several factors contributed to facilitate the abundance of credit: (1) improved economic expectations; (2) a substantial reduction in the public debt; (3) a phenomenal international availability of securitized debt (see Hale 1995); (4) a boom in real estate and in the stock market; and (5) a strong private-investment response.
Poor borrower screening, credit-volume excesses, and the slowdown of economic growth in 1993 turned the debt of many into an excessive burden. Nonperforming loans started to increase rapidly. A process of adjustment of the balance-sheet position of the private sector, underway by the second half of 1993, and the late adoption by some commercial banks of prudent policies were signs that nonperforming loans had exceeded reasonable dimensions before 1994.
Gil-Diaz’ concluding remarks are most fitting for the likes of Greenspan, Bernanke, Rubin, Summers, Geithner and Paulson due to their abiding common trait: They never learn from experience:
In hindsight, I now believe we have a clear idea of the origins of Mexico’s financial crisis. Its symptoms and causes, as those of other countries, provide us with valuable lessons, the most important of which is perhaps the need to observe the behavior of credit aggregates, to follow the path of real estate prices, and to achieve transparency in the disclosure of financial information. Although many of these symptoms are by now almost self evident, and although the relevant information was available at the time to the international financial community, the consensus was that Mexico was doing everything right.
http://www.cato.org/pubs/journal/cj17n3-14.html
It boggles the mind that, even though the failures of Greenspan, Bernanke, Rubin, Summers, Geithner and Paulson are all but “self evident,” they still argue that they did “everything right” and they still have their hands firmly on the levers of power.
What incentive do they have to even *consider* that they were to blame for anything? They made their nut; all that’s left is trying to protect their legacy. Should we be expecting them to enjoy self-flagellation?
I don’t think it’s mind-boggling but rather dependably human.
Of course, it’s no less destructive to those of us who have to endure the consequences of their actions.
[BTW, DS, I don’t mean this as direct criticism but just as further evidence that you have to keep pounding away at these people until they die off (and then some more).]
Also, as to alex’s point just below, I completely agree. I thought the exact same thing when reading the piece. Greenspan’s whole philosophy was that he shouldn’t interfere, and now he’s basically saying he had no opportunity to interfere (and regulate). Just more BS.
And also, alex’s point about perspective regarding genius and bad luck is standard cognitive bias among almost all humans.
Listen, very few people are masochistic, and very few people are good at self-examination. I think we know enough of Greenspan at this point to no longer expect either of him.
Irving Fisher thought long and hard about how he had been so wrong (he not only famously said stocks had reached a new plateau days before the Great Crash, but went from having $100 million to having to move in with a relative) and produced one of the most insightful analyses to date, his 1933 paper on debt deflation.
The problem is Greenspan didn’t get whacked in his wallet. Fisher’s reputation never recovered, while Greenspan is still accorded a great deal of respect and gets big consulting and speaker’s fees.
Another sign that the vested interests that benefitted from his ideology and actions are working hard to keep his brand value intact.
As Krugman has pointed out, Canada had similar interest rate policies but no disastrous housing bubble or bank regulation. What Canada did have was good financial regulation.
Apparently Greenspan is retracting his mea culpa that he made a mistake in thinking that markets could regulate themselves. He’s now involved in the standard spin offered by Masters of the Universe: all good things were due to our genyus, and all bad things were due to things beyond our control.
Perhaps Greenspan is referring to excess savings mopping up mortgage paper in the last decade. I doubt foreign governments did this before 2000.