Greenspan’s Denial

Since I’ve been critical of the unstable monetary policy of Greenspan, Bernanke and the Fed for many years, I can’t help myself but to respond to Greenspan’s editorial today in the Wall St Journal, where he pleads ‘not guilty’ for causing the housing bubble. His main thesis being that since he only controlled the fed funds rate, he had little influence on longer term rates which are directly correlated to mortgage rates and it was the “decline in long term interest rates across a wide spectrum of countries” that was the “most likely major cause of…the global housing price bubble.” He specifically points out ‘global’ to further distance himself from what the Fed specifically did.

What the Fed did under his stewardship and with great influence from Bernanke in response to the 2001-2002 recession was cut rates from 6.5% in Dec ’00 to 1% in June ’03 and left them there for one year even as the economy was averaging 4% growth (including 7.5% in Q3 ’03 alone) before raising rates in June ’04 to 5.25% over time through June ’06. The 1% rate was predicated on the belief that deflationary pressures were strong and thus gave the Fed leeway to be extremely accommodative with its policy. This deflation forecast which reached its pinnacle in mid ’03 was in the face of the CRB index having already rallied by 26% off its Oct ’01 lows. The 10 yr bond yield began its fall in Dec ’00 from over 5% to a low of 3.17% in June ’03 and the average 30 year mortgage rate fell from over 7% to below 5%. It was this that set the stage for the housing bubble in addition to the artificially low rates that penalized savings and resulted in an unprecedented binge of US spending that perpetuated the boom and enhanced the wealth effect that further exaggerated the bubble.

Lever up was Greenspan’s goal for the rest of us.

The more goods Americans bought from overseas where the US trade deficit exploded, the more foreign money was parked in US Treasuries. In addition, Greenspan’s debasement of the US$ with his rate cuts in combination with the export led growth in China, India, etc.., where the US consumer became 20% of global GDP, led to the rise in commodity prices which buoyed all commodity producing nations, who then parked more money in US Treasuries, thus keeping a lid on longer term interest rates even in the face of the Fed raising rates beginning in June ’04 and thus giving the housing market further rope. Foreign holdings of US Treasuries rose 21% in ’04 and 23% in ’05.

The point being is that the seeds of the bubble were planted way before the extremes in ’06 and ’07 and longer term rates remained contained due to the ‘savings glut’ that the US consumer helped to put in the hands of overseas investors through more borrowing and spending who in turn parked it back in the US. The global search for yield began with artificially low short term rates induced by the Fed and resulted in a massive misallocation of capital through more and more risk and higher and higher leverage that of course blew up and foreign banks and consumers couldn’t help themselves either as trade and credit became more globalized. With credit (booze) free flowing, many abused it and did stupid things but it was Greenspan and Co that brought the excess credit (booze) to the party.


The Fed Didn’t Cause the Housing Bubble
WSJ, MARCH 11, 2009

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