Alan Greenspan Still Doesn't Have a Clue

On the same day that his successor signaled dramatic policy changes that would see the Federal Reserve "take away the punchbowl" before inflating yet another asset bubble, radically altering the way financial market regulators operate in the process, former Fed chairman Alan Greenspan was readying yet another in a long series of op-ed pieces aimed at defending his legacy.

He didn't cause the housing bubble, or so he says.

After yesterday's commentary by David Leonhardt at the New York Times about how the central bank had been played like a fiddle by big financial firms who took on "excessive risk" knowing that the government would be there to bail them out, you'd have thought that maybe there would be some reluctance to go forward with the editorial.

Apparently not.

Still seemingly unfamiliar with the concept of "moral hazard" where, in the words of Mr. Leonhardt, big firms can "act as if their future losses are indeed somebody else’s problem", and having only confessed to being "shocked" last year after finding a flaw in his ideological framework about how "self-interest" works in the real world, the opinion piece made it into the Wall Street Journal this morning.

Alan Greenspan still hasn't got a clue.

After a long period of relative silence since the wheels fell off the global economy last fall and as his critics grew in number, his name often cited in public opinion polls as "the one individual" most responsible for the current mess (this term, admittedly, now failing to adequately describe the extent of the problems the world now faces), his defense has become defiant, if not desperate, the most recent example being provided today:

The Fed Didn't Cause the Housing Bubble
Any new regulations should help direct savings toward productive investments.
By ALAN GREENSPAN

We are in the midst of a global crisis that will unquestionably rank as the most virulent since the 1930s. It will eventually subside and pass into history. But how the interacting and reinforcing causes and effects of this severe contraction are interpreted will shape the reconfiguration of our currently disabled global financial system.
There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.

The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages.

Not surprisingly, the "easy money" thesis is dismissed out of hand - there is nothing further about fostering a culture of debt or being overly accommodating to the slightest of financial market stumbles over a period of almost two decades, all of which surely contributed to the prevailing attitudes and conventional wisdom of just a few years ago.

Having dispensed with that, it is on to the now-familiar, "I was powerless to do anything about long-term rates" retort, as if long-term rates really played a key role in the housing bubble during its bubbliest years.

With prices having risen to nosebleed levels during the middle of the decade, who could afford to buy a house with a 30-year fixed loan?

It was the tsunami of "innovation" in financial products - Pay Option ARMs, "liar loans", MBSs, CDOs, and CDSs - all of which were blessed by the central bank, that caused nearly all the damage, not 30-year fixed mortgages.

Next comes the "savings glut" rationale for why long-term rates were such a conundrum followed by the now-familiar, "our housing bubble was just average" angle:

That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.

That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble. (The U.S. price bubble was at, or below, the median according to the International Monetary Fund.)

What follows is a rebuke of Stanford University Professor John Taylor's revisionist history (apparently, it takes one to know one) in which short-term interest rates were cited as the proximal cause for the current meltdown.

And after that, it's always handy to cite glowing criticism from someone who died back in 2006, before it became widely known just how bad things would get.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble. All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind."

That's just pathetic when you think about it...

Even after the recent admonishment from the late Milton Friedman's long-time partner Anna Schwartz as documented in "A 92-year old finger pointed squarely at the Fed", he has the chutzpah to cite favorable words from 2006.

Lastly, the question of regulation and the lack of sophistication.

It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.

However, the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living.

Before getting to the big finale, it's worth noting that the book has not yet been written on these "enhanced standards of living". It seems that standards of living in most of the world, particularly in the U.S., are one big moving target right now, a target that is generally moving in the downward direction.

Come to think of it, "enhanced" is clearly not the right word choice here - it is premature at best and, at worst, it is a sad, almost mocking commentary on the rapidly changing lives of the vast majority of people in the world.

And, in conclusion...

If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows. Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.

Maybe what the smartest economists in the world thought was "sustainable growth" wasn't sustainable at all and all that "risk taking" was just a way for bankers to enrich themselves.

People are beginning to sour on the whole idea of "prosperity", that is, if the current economic and financial market tumult is part of the package.

Comments

[Philip7:]

Thank you Mr. Iacono. As I have gotten older, the more I become convinced that money disappears if you cannot follow it's path step by step. It has become clear that there have been no "important advances in finance that enhance standards of living" in the last 20 years. These have just been upgraded versions of a shell game. The more Mr. Greenspan desperately claims that no one could have seen this coming, the less intelligent I think he is.

Mar 11 09:17 PM

[Dirk McCoy:]

I'm amazed that all the "cheap money" chicken littles aren't out in the streets en masse demonstrating over the current Fed funds target. 0-.25%? Wow, we must be setting the scene for an economic disaster of global proportions- soon, we'll have all that "unsustainable" growth that we had back in 2004, 2005, 2006, into 2007, and we'll be seeing increased standards of living around the world like we were back then. And banks will make money. And loan availability will increase. And housing prices will recover. Yes, these low short term interest rates are a real disaster, I can't believe you geniuses let it get to this back in 2002-2004, and have let it get back to this now- because now we're going to run out of oil and land and water and breathable air so much sooner!

Here's the deal: The Fed has always subsidized capital. And capital is key to investment in what you apparently consider frivolous things like broadband, and bigger houses, and international development, and technology. In other words, cheap money greases the skids of capitalism- at the expense of wealth holders who'd like to have more pricing power to charge higher interest rates to those with good (and bad) ideas.

The problem arises when the Fed listens to you and increases interest rates artificially to slow down development. But the oil bubble popped without higher interest rates, so why wouldn't have housing (or tech, or latin development, or consumer hardgoods?).

The real question is not cheap money- open your eyes, it's really cheap now, but there's not much confidence to loan, or borrow, it. The real question is this- when confidence return, how high will the Fed increase rates this time, and will they kill the next expansion in 7 or 8 years from now?

Mar 11 09:23 PM

[Dirk McCoy:]

One other thing- there is blame to be cast for this meltdown in addition to the Fed rate increases to 6%. The increase in allowable leverage, the fraud in mortgages, and the speculation and lack of accountability in derivatives. But these seem much more straight forward to address than a Fed set on attacking asset values...

Mar 11 09:25 PM

[Minlita:]

Who to Blame for America's Financial Crisis?
Americans know the “system” is not working. What we have here, is a massive failure Of Federal Governance.

Mar 11 10:03 PM

[Skeptical Ben:]

Oh, yes the Maestro. This narcissistic fraud still thinks he's the sage. EASY CREDIT CAUSED THE CRISIS. He both refused to raise interest rates above inflation, and stubbornly refused to do his job and regulate banks and brokers, as they could do better in their own self interest. And can't he hire an editor? He's still speaking in his annoying double speak, so if he's 100% wrong it will still appear he's 50% right. THE AGE OF TURBULENCE -- once again, half right, he didn't survive it, he created it (with the help of the Bush deficits)

Mar 11 10:18 PM

[Skeptical Ben:]

You're mistaken. Just like running deficits was a mistake when the country was doing well, keeping interest rates artificially low gave the economy no room to raise them. If rates weren't at zero now, folks with loans resetting would have no chance of an affordable refinance. All that zero interest money is going to the banks (and broker dealers masquerading as banks!), and they're not paying meaningful interest to depositors nor loaning money to anyone that actual needs it. Low rates now are desperation, as much of Americans realize they have little or no home equity, declining stock market holdings, shaky banks and insurance companies.


On Mar 11 09:23 PM Dirk McCoy wrote:

> I'm amazed that all the "cheap money" chicken littles aren't out
> in the streets en masse demonstrating over the current Fed funds
> target. 0-.25%? Wow, we must be setting the scene for an economic
> disaster of global proportions- soon, we'll have all that "unsustainable"
> growth that we had back in 2004, 2005, 2006, into 2007, and we'll
> be seeing increased standards of living around the world like we
> were back then. And banks will make money. And loan availability
> will increase. And housing prices will recover. Yes, these low
> short term interest rates are a real disaster, I can't believe you
> geniuses let it get to this back in 2002-2004, and have let it get
> back to this now- because now we're going to run out of oil and land
> and water and breathable air so much sooner!
>
> Here's the deal: The Fed has always subsidized capital. And capital
> is key to investment in what you apparently consider frivolous things
> like broadband, and bigger houses, and international development,
> and technology. In other words, cheap money greases the skids of
> capitalism- at the expense of wealth holders who'd like to have more
> pricing power to charge higher interest rates to those with good
> (and bad) ideas.
>
> The problem arises when the Fed listens to you and increases interest
> rates artificially to slow down development. But the oil bubble
> popped without higher interest rates, so why wouldn't have housing
> (or tech, or latin development, or consumer hardgoods?).
>
> The real question is not cheap money- open your eyes, it's really
> cheap now, but there's not much confidence to loan, or borrow, it.
> The real question is this- when confidence return, how high will
> the Fed increase rates this time, and will they kill the next expansion
> in 7 or 8 years from now?

Mar 11 10:23 PM

[Leftfield:]

Greenspan was peddling the same line in '06 (I heard him on NPR). It made me nervous then because I figured at the time that he was covering himself for some reason and his story was/is false. I'd say he knew we were about to implode.

I had refinanced in '05 and it was clear that things had dramatically changed from all other times I had gotten a mortgage. "They're handing them out like candy" I was telling people. Clearly the idea was to get the product out the door and collect commissions. Period. Obvious.

I'm leery also of the quick exit of Elliot Spitzer as NY governor Nov.'07 because, whatever his faults, he was the loudest most persistent thorn in the side of Wall St.

Now, too big to fail are lining up with their ridiculous sob stories and the Madoffs appear to be getting away with ridiculous claims that associates and families knew nothing.

Stories and coverups don't have to be that good when you're mega rich and powerful.

Mar 11 10:51 PM

[PROXIMO:]

Greenspan's op-ed pieces are a pathetic attempt to salvage a legacy that is beyond repair. Serious mistakes have serious consequences.

Mar 11 11:00 PM

[Football Geek:]

Greenspan was asleep at the wheel, and now he is
blaming others f0r his mistakes. He is prolly related to that other coward madoff. They both should be locked up for 150 years, with bread and water.

Mar 11 11:41 PM

[William Cowie:]

Mr. Greenspan, this is very, very simple. Big issues usually are. Why did banks on your watch make such stupid loans? Answer: there was too much money in the system seeking a home (no pun intended).

Who was responsible to fix that? You.

Did you fix it? No.

Did you even acknowledge there was something wrong that you needed to fix? No again.

We get it. You don't.

Please spare yourself and do what Mr. JohnAI above recommends. Trust us, you're better off if we merely forget you.

Mar 11 11:53 PM

[storm999:]

STFU -Hilarious, I may have to tattoo this on my knuckles.
On Mar 11 09:07 PM JohnAl wrote:

> Mr. Greenspan, you've destroyed lives. Don't you think it's time
> you just STFU?

Mar 12 12:21 AM

[Moon Kil Woong:]

Greenspan like Bush Jr. seems utterly oblivious to what a mess they made. The good news is that they are not here any more.

The bad news is the systems of out of control government spending, easy credit, a fed who's interest is in pleasing bankers more than managing the economy, lax regulation, and a financial system dependent on the public's cash to backstop them in downturns while screaming for complete autonomy without any proper controls on risk still exist.

In fact, it is thriving. Fannie Mae and Freddie Mac are still being backstopped by the government, issuing loans for issuing loans sake, and controlling over 40% of the market because who can compete against a juggernaut that is 40% of the market and has free government guarantees and can loose endless amounts of the public's money without even caring.

Then you have the mega banks that rather than scale back, bought up everyone they could find to insure their too big to fail policy worked and now refuse to spin off even the smallest part of themselves while holding the US hostage for money. And then Citibank has the gall to say it's profitable after using government money to write off billions last quarter and negotiate for even more government funding and loan guarantees.

No, rather than cleaning up the mess Bush Jr. and Greenspan made in the toilet which is now the US economy, we are still trying to clean the toilet without first flushing. Doing so is both messy and fruitless.

Anyone who buys Greenspan's books aside for historic or comic purposes are complete morons.

Mar 12 12:30 AM

[storm999:]

It is always in the self interest of a huckster to find a sucker. The creditors (AKA savings glut countries) were the suckers for triple A-rated MBSs, CDOs & SIVs backed by hedge fund promises and the home buyers were the suckers for the supercheap mortgage money sale.

Greenspan is completely, disingenous. He presided over the S&L crisis and LTCM 0the first derivatives crisis, then he helped usher in the era of deregulated universal banks that could play in the derivatives markets. Result: Wall St. binges itself to death within 8 years.

Greed trumps self-interest all the time. It is not in anyone's self-interest to buy a 60 inch plasma screen on their credit card at 17% but thousands do it every week. I think this kind of irrationality is built into the nervous system, similar to the mechanisms which cause addicts to crave drugs. Greed is a word that describes the emotional high someone gets from obtaining the object of desire. People get addicted to that feeling, especially the feeling of obtaining money, especially I-bankers.

Mar 12 12:30 AM

[sether:]

The invisible hand only exists to wave with one finger. Ayn Rand was a syphilitic retard. Anyone who invokes either one in defense of de-regulation and freemarketeering should be disemboweled.

Mar 12 01:33 AM

[JudeJin:]

greenspan played the role of fooling the congress and the people. he won't ever say the truth again, not until he's in the grave.

when he was not in power, he believed in gold standard.
once he was among the ruling class, he started to speak the opposite. he sold his soul to the money lords.

Mar 12 02:27 AM

[RPowers:]

When asked why he backed massive increases in federal spending under the Clinton administration, Greenspan responded that he feared that the massive inflows of capital from foreign markets would have otherwise caused (gasp) deflation. Remind you of anything? Of course, we couldn't have possibly of used this to pay off the debt, stop stealing from the SS trust fund, build out infrastructure, or any of several hundred possible uses that come to mind now.

Oh woah is us for not being able to stop those nasty Asian countries form sending us 90 pct of global capital outflows.. and of course we could also could do nothing about (or bother to notice) that we had gone into a negative savings rate. 2pct for my deposit? oh goodie!

A decent electrician knows not to wire everything together in one long serial circuit. You put in capacitors, fuses, etc. Greenspan and Co. have wired us all in line and said that now we can do nothing about it. Too big to fail? I say too stupid to continue existing. LTCM should have been a warning, instead it was the starting gun.

James Goldsmith on Charlie Rose in '94 warned us about this.... not building our infrastructure, sending our manufacturing and money overseas, and the fact that the notional value of trades in derivatives each night was more than the worlds GDP. Charlie just parroted Laura (now with Obama) Tyson and said that NAFTA was a great success and that the GATT/WTO would bring a new light to the world.... instead it has become our electric chair. The wires are still run in the form of the CDS chasm that we refuse to recognize still exists. We push money in the front door of AIG, and they drop it in the big hole that goes to their (not so secret) counterparties. UBS, Goldman, DeutscheBank, Rabo, SG, etc.

The objectivists were almost right when they followed the hollywood star struck Russian immigrant sycophant who changed her name to ayn rand and wrote novels to engratiate herself to the elites whose hinies she loved to kiss.... except we now find out that the average workers/savers are the Atlases, and Greenspan and friends are the looters/moochers.

If Greenie is right, then of course we must do what we can to stop these massive waves of cheap money from coming at us in the future. Globalism has been a disaster to the heart of our economy. Melamine laced dogfood anyone?

The amount of our debt being held by foreign govts has proven to be a noose around our necks, tightening enough that Hilary has to play nice and ask please sir, may i have another cup of money?

But don't expect anyone who is making billions without risk to suggest a change. Certainly not our private central banks share holders. Santelli was right, the Federal Reserve is no more federal than Federal Express.

Nor do I expect a word of warning from GE/Vivendi, The Mouse Network, or Rupert "i just married a chinese gal" Murdoch. They all have too much on the line to irk their communist/capitalist buddies.

Mar 12 06:52 AM

[Allan Frain:]

AG's well-articulated assertion in the 1960s that only a Gold Standard can prevent The Banks from robbing the citizens of their wealth reveals that he is not stupid, but rather malevolent.

A view of the post-Fed government/banking cartel through the same light clarifies the goings on quite well and has led to correct investment decisions throughout the bubble and its aftermath.

Attribute stupidity to those in power at the risk of misunderstanding and lost fortune.

Mar 12 09:57 AM

[Bernie M:]

Your comment that Bush and Greenspan are to blame for this are either extremely myopic or extremely ignorant. Msrs Bush and Greenspan were certainly to blame for allowing the fiasco to continue, but Bill Clinton was the one that got the ball rolling by encouraging banks to relax lending standards via the CRA in 1993. Banks securitized the toxic waste as a means of survival. Banks knew these loans had little chance of being repaid so they got them off their books as quickly as possible. The point is that there is plenty of blame to go around and to blame Bush and Greensapn only is taking an overly simplistic view.


On Mar 12 12:30 AM Moon Kil Woong wrote:

> Greenspan like Bush Jr. seems utterly oblivious to what a mess they
> made. The good news is that they are not here any more.
>
> The bad news is the systems of out of control government spending,
> easy credit, a fed who's interest is in pleasing bankers more than
> managing the economy, lax regulation, and a financial system dependent
> on the public's cash to backstop them in downturns while screaming
> for complete autonomy without any proper controls on risk still exist.
>
>
> In fact, it is thriving. Fannie Mae and Freddie Mac are still being
> backstopped by the government, issuing loans for issuing loans sake,
> and controlling over 40% of the market because who can compete against
> a juggernaut that is 40% of the market and has free government guarantees
> and can loose endless amounts of the public's money without even
> caring.
>
> Then you have the mega banks that rather than scale back, bought
> up everyone they could find to insure their too big to fail policy
> worked and now refuse to spin off even the smallest part of themselves
> while holding the US hostage for money. And then Citibank has the
> gall to say it's profitable after using government money to write
> off billions last quarter and negotiate for even more government
> funding and loan guarantees.
>
> No, rather than cleaning up the mess Bush Jr. and Greenspan made
> in the toilet which is now the US economy, we are still trying to
> clean the toilet without first flushing. Doing so is both messy and
> fruitless.
>
> Anyone who buys Greenspan's books aside for historic or comic purposes
> are complete morons.

Mar 12 10:46 AM

[Moon Kil Woong:]

Dear Bernie M:

I am not exempting anyone. I already stated that Fannie Mae and Freddie Mac are part and parcel to this mess. Sadly, they go back further than CRA although yes, CRA is a ridiculous piece of legislation that also distorted the real estate market using banks and Fannie Mae and Freddie Mac.

Furthermore, my complaint against mega banks strike at the heart of CRA. CRA in essence gave many banks the idea to become mega-banks so they could satisfy CRA and loan throughout the country, whereby making it easier to package loans spread far and wide into bundles and selling them off as bonds to clear their books. I didn't know we had to go into so much detail to explain the workings of the banking industry. So yes CRA added to the banking woes.

Even so, one can not exempt Bush Jr. or Greenspan from their faults which are vast and many. Despite strong arguments against CRA it was not the last straw that broke the camel's back. It just encouraged banks to become reckless and find creative ways to lend to unqualified homeowners and then find creative ways of purging them off their balance sheet.

I am sorry for not creating a mile long list of litanies and people who contributed to this downturn. I thought fingering Fannie Mae and Freddie Mac and big banks was enough. Admittedly, Clinton had his faults too. But, if you want to blame him for anything blame him for not vetoing the Graham Leach Bliley Act which tore down the Glass Stegall Act that protected us from the silly derivatives that were concocted recently. Sadly, even if he did veto the act, there was enough Republicans and Democrats chomping at the bit for bank campaign contributions to override him. So really, for a blog comment, I think this amount of detail is a bit much to get into.

Even with this amount of bad legislation, there was plenty of legislation for the Bush Jr. administration to enforce laws keeping banks from writing trillions in derivatives, then hiding the losses from their own stockholders. Also to prevent banks and brokerages from concocting ways to lever banks up over 30x and use insurance companies to dump their bad assets as AAA loans. Also, to prevent brokerages from saying they were solvent a week before they went bankrupt or were acquired for practically nothing with government loan guarantees.

Must I continue?

Mar 12 11:20 PM

[Mr. Big:]

Although I, too, put much of the blame on Greenspan and Bush's policies, they are not alone. The Fed may have had the biggest influence in the short end of the curve, but you wanna know who was playing at the long end? The likes of China, Japan and Saudi Arabia. China and Saudi Arabia purchased vast sums of medium to long term US Treasury bonds to support their currency pegs to the US dollar. China was especially active because they need to support double digit GDP growth so that they can catch up to the rest of the developed world.

Remember when Greenspan finally decided to jack up interest rates? Well, the result was a severely inverted yield curve. Although short-term rates were rising, the long end of the curve stayed flat because foreign investors (i.e. China) were eating up the supply. This resulted in two really dangerous situations. 1) Cheap money stayed cheap, especially mortgage rates. 2) The banks profit margins were squeezed. Banks operate well when the curve is normal. They lend at the long end (mortgages) and borrow at the short end (low cost demand deposits)and can capture the spread differential. But when the curve is inverted, this whole model breaks down. With interest margins squeezed, banks decided to leverage up their investments to get as much as they can out of little. They also moved more into complex off-balance sheet businesses because of the juicy spreads offered by the likes of securitizations and asset backed securities. The banks found a new playground and they liked it. And they liked the fact that credit rating agencies were more than willing to play along and support their activities.

Where Bush and Greenspan really dropped the ball was when they didn't stop this.... they didn't enhance regulations. In fact they did quite the opposite. They relaxed regulations. Not only that, they helped the leveraged activity by expanding Freddie Mac and Fannie Mae and any other program that helped American families get cheap money....especially mortgages. Greenspan went so far as to publically support mortgage back securities and securitizations saying that it made the markets more efficient.

As well, Bush didn't try hard enough to stop the currency manipulations. Foreign policy should have been enhanced to prevent such activity. In a way, this can be viewed as an attack on another nation. Almost like an embargo is an act of war. A blatant attempt to force a local currency to below it's fair value by pegging it to a foreign currency is an attack on the foreign currency's balance of trade. It destroys exports. It is a broader form of protectionism where it forces the world to favor the products produced by one country over another.

So, yes, I blame Greenspan and Bush. But I also blame China and the Middle East. And the banks, the insurers and the ratings agencies. In part, the people share some of the blame, but it was up to the government to stand up for the people.

But to be sure, Greenspan and Bush were not alone.

Mar 13 12:17 AM