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August 7, 2007
Greenspan’s ‘Adversity’ Fantasy
“We tried in 2004 to move long term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed.” Alan Greenspan, August 7, 2007.
If I am reading the above quote correctly, Greenspan – who suggested in March 2004 that adjustable rate mortgages could be a better alternative than traditional mortgages – tried to nudge long-term interest rates higher sometime in 2004. That Greenspan spent no time updating and/or clarifying his fondness for ARMs in 2004 (or anytime afterwards) may, obviously, be upsetting to those that followed his advice.
It now looks like having failed to take the steam out of housing in 2004, Greenspan quietly watched the housing market go bonkers in 2005 and early 2006 before handing the mess over to Bernanke.
On The Defensive, Mirrors in Hand
Well aware that his legacy is coming under scrutiny as the housing market goes bust, Mr. Greenspan hinted what he has said many times before. That being: the Fed doesn’t mind insane equity/housing markets so long as prices are rising.
“History tells us it’s far better to have people periodically going to excess with its adverse consequences than to try to block it off in the beginning. These adverse periods are very painful but they’re inevitable if we choose to maintain a system in which people are free to take risks, a necessary condition for maximum sustainable economic growth. We have learned to move risk from the leveraged institutions which are the major lenders in this country to those far more capable of absorbing loss. It’s why our economy in recent years has developed the flexibility to absorb severe adjustments.”
No Mr. Greenspan, the reasons why the U.S. economy has absorbed the ‘severe adjustments’ in recent memory is because the Fed has adopted the role of bailout master, the U.S. government is borrowing itself into insolvency, and foreign investors/central banks can not find any realistic alternative to USD (I am not necessarily knocking these dynamics. After all, perhaps the U.S. should ride USD hegemony for all its worth and simply default on its liabilities from a position of strength many years from now?)
A couple of others:
“History tells us it’s far better to have people periodically going to excess with its adverse consequences than to try to block it off in the beginning.”
By this logic, the Fed – whose purpose was/is to supposedly limit the ‘adverse consequences’ in question - should have never been created. Does Mr. Greenspan now support Ron Paul in his quest to get rid of the Federal Reserve Board?
“It’s why our economy in recent years has developed the flexibility to absorb severe adjustments.”
Is Greenspan suggesting that as other countries acquire larger ‘credit markets, alternative investment vehicles and derivatives’ they will also have the ‘flexibility’ to absorb the shocks? Are sophisticated and unregulated financial markets all that is really required for U.S.-style prosperity?
The point to this critic is, to reiterate, the Greenspan plan works exceptionally well when you are running the largest economy in the world and you can print USD. Otherwise things can get a little tricky when one minute foreign investors are starting to panic over a hedge fund blowup and the next your currency is nearly worthless…
In summary, Greenspan claims that doing nothing on the policy front - now being coined “maintain a system in which people are free to take risks” – and then responding quickly to any crisis is still the best way to go.
“We were overwhelmed by excess global savings that continued to press real long term rates lower.”
 In other words, ‘We tried everything to stop the housing mania from taking shape, but foreigners simply love our markets too much! Sorry about the inevitable housing bust. Here is a couple of rate cuts…please do feel free to take on some more risk.’
Your Uncle,
Al
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