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September 17, 2007
Bernanke Meet Freud

In what will hopefully be his last major media blitz, Alan Greenspan launched his new book over the weekend with Newsweek, USA Today, 60 Minutes, and countless other interviews.  Somewhat surprisingly, Greenspan’s book apparently offers some controversial views on the Iraq war, the Bush administration, and the long-term outlook for U.S. interest rates. After watching Greenspan say little of significance in his later years as Fed boss, my hat goes off to him – whether you agree with him or not at least he is saying something!

There was one part of the Greenspan ’
60 minutes’ interview that caught my attention:

He insists there's nothing he could've done to prevent today's plummeting home prices and the fact that a million families have lost their homes, and many more could. But some economists now say Greenspan actually created the housing bubble and the credit crunch by keeping interest rates too low for too long.

"Just remember we raised interest rates at every meeting from June of 2004 till I got out of office," he says.

What Greenspan forgets to mention is that every single interest rate hike since June 2004 was expected beforehand by everyone.  In other words, although Greenspan was indeed slowly taking away the punch bowel from June 2004 until January 2006, he did so only after warning party goers.  This policy, which taxed savers and gave carry traders a free ride for too long, never once impeded the decision making process of lenders and borrowers.

To counter this argument Greenspan talks about the ‘global savings glut’ rendering his rate hikes powerless. What he ignores is that volatility disappeared and credit spreads tightened in the U.S. financial markets not necessarily because foreign capital was moving into USD, but because the Fed’s actions allowed carry trades to proliferate. The theme from 2003-2007 was borrow short and go long junk; borrow short and go long emerging market; borrow short and go long anything because the Fed is out of the picture!

A quote from Volcker, noted before, is worth reiterating on this topic.  Unfortunately none of Greenspan’s interviewers cared to bring this topic up:

“I overstate it, but the traditional method of making small moves [rate hikes] has in some sense, though not completely, run out of psychological gas. Every time the interest rate goes up by a small amount [bankers] say okay, we'll raise the prime rate. Whatever you do is inadequate -- you, the Federal Reserve -- and we'll go along. We have access to liquidity at a fairly fixed federal funds rate -- the rate isn't going to change all that abruptly -- and you're not having much impact on market thinking or on market confidence in your ability to keep the money supply under control. Volcker. October 6, 1979

Greenspan is remembered as being an excellent timer of stimulus-related rhetoric and rate cuts.  But can anyone remember when Greenspan shocked the markets with a surprise rate hike?  Definitely not during his final rate hike campaign, which is why he is partially to blame for today’s mess...

Bernanke officially takes over as Fed boss tomorrow. He will, almost certainly, cut interest rates. The wording in the FOMC statement will materially change.  Market participants are uncertain what will happen; they are hedging their bets; they are not leveraging as much going into tomorrow; they are not confident of what the credit markets will look like 6-months from now; they are not sure inflationary pressures have abated; they are not sure what the dollar will do; they are...

A position Greenspan should have placed market participants in at least once as hedge fund membership dramatically expanded and the housing bubble roared during his final rate hiking campaign.





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