The cause of both the housing bubble and the financial crisis was the variable rate mortgage and Alan Greenspan. Both of these have now been “fixed.” The current proposal to dissolve Fannie Mae (OTCQB:FNMA
) and Freddie Mac (OTCQB:FMCC
) is a perfect example of “fixing” a problem that was never the problem. Doing so will do further harm housing and the economy
Both finger pointing and the release of false or exaggerated information about these two GSE was Congress’s way to inflame public emotion to either attack the other party or deflect public outrage off themselves. Now, much like a prosecutor who knowingly puts an innocent man in jail and, on appeal, carries forward with his charade to keep face, congress must now carry forward on their misdirection scheme and dissolve two institutions that have been nothing but positive for America and American housing.
The Greenspan Declaration Never Issued
The following declaration, if written in 2003, would have prevented both the housing bubble and the entirety of the financial crisis. This declaration is not really hindsight; the risk at the time was widely seen and discussed by many people. Greenspan’s explanation a few years ago on why he didn’t write or issue it doesn’t really make any sense.
While the FED holds interest rates at emergency low levels (to keep the bursting stock market bubble from dragging us into another great depression), a moratorium on variable rate mortgages will be imposed; only fixed rate mortgages will be allowed for the next three years. The risk is that once we return to normal interest rates the doubling of ARM mortgage payments, which will occur during resets, will overwhelmed the housing market with sellers.
This rational declaration would have prevented both the housing bubble and the crisis. The housing bubble and crash was caused by one thing: the wide spread use of variable rate mortgages during the Greenspan low rate period from 2002 to 2005. The low ARM interest rate allowed everyone to buy twice the house they currently had (even though no one’s income increased). Prices doubled over four years as the use of ARMs went from 5% to 30% or 50% of all mortgages issued. Then the obvious occurred. Mortgage payments doubled during resets which overwhelmed the market with sellers.
Like many people I was a great fan of Greenspan. Even though at the time I saw the ARM risk and also the fallacy in his reasoning, my admiration and elevation of him made me doubt my observations. But that explains me, not him. All I can do is venture an explanation for him.
What happened to Greenspan?
In 2002 he was 76 and I think he had lost his mental footing. Simply put, he was too old. An article in the NY Times a few years ago shows this:
“Three years after stepping down as chairman of the Federal Reserve, a humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.
‘Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform.’”
Did Greenspan say, “the self-correcting power of free markets”? Did anyone notice that this statement was 100% counter to why the FED even existed?
Why the FED was created
The FED was created in 1913 after the previous forty years of unrestrained and ‘non-correcting’ free markets caused a continual series of financial disasters. The FED was created to impose rational restraints and regulations to the free market system to prevent this. Why Greenspan forgot this history and uttered his statement is unknown. But the financial crisis we experienced a few years ago is an example of what happened continuously before the FED was created. In fact the Panic of 1906, which was almost a duplicate of our crisis, was the final straw that created the FED.
The housing Bubble and financial crisis occurred because Greenspan was too old to remember that the FED existed to prevent irrational excesses of the free market. Had he remembered and written that obvious memo, no housing bubble or crisis would have occurred. All the financial institutions would all be here and no one would even be talking about dissolving or fixing Fannie Mae or Freddie Mac.
Save Fannie Mae and Freddie Mac
It seems silly to continue on the path congressional operatives created to take public attention off of their own complicity (which is basically taking election contributions from financial firms to ignore financial regulations). It’s the old “don’t look at me, look at those evil people over there” routine.
Fannie Mae and Freddie Mac have been nothing but good for America. They are not and never were the problem. For over forty years they kept mortgage interest rates 15% below what they would have been otherwise. That’s 163 billion dollars American’s saved each year. Taking it away loses a lot of consumer spending; all done so a few politicians can save face? That doesn’t make sense to me.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.