As Alan Greenspan will once again attempt to defend his now-tarnished legacy (see Paul Krugman’s recent takedown here), I feel compelled to point out what is, in my opinion, among Greenspan’s most egregious miscalculations. It came in a speech on Sept. 26, 2005:
In summary, it is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices.
It was, apparently, inconceivable to Greenspan that home prices could decline more than 10 percent. Not exactly the out-of-the-box, expect-the-unexpected thinking one would hope for from a Fed chair (i.e. correctly identify a problem, then rationalize it away with no mention of any contingencies or a Plan B). As it turned out, even 70 percent LTVs — in many cases even lower — would wind up with mortgages that were on par with the home’s value, or even underwater. How could Greenspan — the “Maestro” — have fallen into the trap that an asset class — any asset class — could only move in one direction or correct no more than some arbitrary amount?
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