The Mortgage Crisis According To Alan Greenspan
Tim Iacono
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In an op-ed($)
appearing in today's Wall Street Journal (hat tip CB), Alan Greenspan
explains how we got into the current mess and the role the Federal
Reserve played.
After
more than a half-century observing numerous price bubbles evolve and
deflate, I have reluctantly concluded that bubbles cannot be safely
defused by monetary policy or other policy initiatives before the
speculative fever breaks on its own. There was clearly little the world's central banks could do to temper this most recent surge in human euphoria, in some ways reminiscent of the Dutch Tulip craze of the 17th century and South Sea Bubble of the 18th century.
I
do not doubt that a low U.S. federal-funds rate in response to the
dot-com crash, and especially the 1% rate set in mid-2003 to counter
potential deflation, lowered interest rates on adjustable-rate
mortgages (ARMs) and may have contributed to the rise in U.S. home
prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.
Demand in those days was driven by the expectation of rising prices -- the dynamic that fuels most asset-price bubbles. If
low adjustable-rate financing had not been available, most of the
demand would have been financed with fixed rate, long-term mortgages. In fact, home prices continued to rise for two years subsequent to the peak of ARM originations (seasonally adjusted).
I
and my colleagues at the Fed believed that the potential threat of
corrosive deflation in 2003 was real, even though deflation was not
thought to be the most likely projection. We will never know whether
the temporary 1% federal-funds rate fended off a deflationary crisis, potentially much more daunting than the current one.
But I did fret that maintaining rates too low for too long was
problematic. The failure of either the growth of the monetary base, or
of M2, to exceed 5% while the fed-funds rate was 1% assuaged my concern
that we had added inflationary tinder to the economy.
...
The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end.
That will stabilize the now-uncertain value of the home equity that
acts as a buffer for all home mortgages, but most importantly for those
held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis.
But after a period of protracted adjustment, the U.S. economy, and the
world economy more generally, will be able to get back to business.
A few comments:
Low interest rates, in and of themselves, would not have caused the housing bubble as we now know it.
Prudence would have dictated an approach where, back in 2001 or 2002, the world's second most powerful man might have said, "Look, we've got to take real interest rates to zero. Let's keep an eye on things so we don't just create another bubble somewhere else."
The bad stuff didn't start happening until a couple years later, after the Fed-sponsored transfer of mortgage backed security origination from Fannie and Freddie to Wall Street was complete and everyone joked that, "If you can fog a mirror, you can get a home loan".
2.
Once again, the complete failure to recognize a bubble early on is
glossed over in the now common bubble defense, "Can't see 'em forming,
can't pop 'em when you do see 'em". This is more evidence of why naive
economists at the nation's central bank should not be entrusted with
the power they currently possess. Had any of them pulled their noses
out of their statistical data and spent some time in the real world,
they would have seen the bubble formation clearly.
3. To say that "the impact on demand for homes financed with ARMs was not major" is just laughable.
4. To say
that "if low adjustable-rate financing had not been available, most of
the demand would have been financed with fixed rate, long-term
mortgages" is ludicrous.
5. It's nice to know that we'll eventually be able to "get back to business". Whew! Some of us were worried that this mess might turn into something more serious.
For a more reality-based (and much funnier) explanation of the roots of the mortgage mess, see "An interview with Alan Greenspan".
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This article has 4 comments:
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Pj568
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182 Comments
Dec 13 07:39 AM-
kurt walter
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409 Comments
Dec 13 04:33 PM-
CM
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8 Comments
Dec 14 11:30 AM-
SSS
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2 Comments
Dec 14 10:49 PM======================...
Unknowingly or knowingly an unholy aliance between realtor-broker-lender jacked up the home prices to stratosphere levels.
The catalyst was low interest rates. But the core issue is the percentage based profit these parties make on each transaction.
That creates the vested interested to inflate the house prices to maximize their profit.
If a house is 600K, the realtor makes 6% (36K) the broker makes 4% ( 24k), the lender makes 3% ( 18k) and the wall street firms make additional percentage on creating CDOs.
The sitting duck here is the investor who invested on these CDOs through Hedge funds.
This process of skimming went bersek on since 2003, to the extend they killed golden goose. This was aided by 'fact twisting' done by NAR and its economist who is paid to do that.
They extended the life of the bubble. The result is the woe of the house owners in USA and USA standing gone down on the eyes of global investor who are averse to dollar based assets.