Dear Chairman Greenspan: Remember that cheap money?

Former Federal Reserve Chairman Alan Greenspan went before a House committee today to provide some insight on the "sources" of the current financial crisis.

One of those sources, you might suspect, would be Greenspan’s decision to keep interest rates at ridiculously cheap levels from 2002 through 2004.

Yet he mentioned nothing about monetary policy in his five-page prepared remarks. Instead, the Maestro focused on the failures of the free-market system.

Here, Greenspan explained how investors fooled themselves:

"Subprime mortgages pooled and sold as securities became subject to explosive demand from investors around the world. These mortgage backed securities being 'subprime' were originally offered at what appeared to be exceptionally high risk-adjusted market interest rates. But with U.S. home prices still rising, delinquency and foreclosure rates were deceptively modest. Losses were minimal. To the most sophisticated investors in the world, they were wrongly viewed as a 'steal.' "

He also recalled how he mused about investors' lack of concern about the level of risk they were taking in the boom days:

"In 2005, I raised concerns that the protracted period of underpricing of risk, if history was any guide, would have dire consequences."

Yet as Rep. Henry A. Waxman (D-Calif.) noted at the hearing, the Greenspan Fed "had the authority to stop the irresponsible lending practices that fueled the subprime mortgage market," but chose to let them ride.

Greenspan also expressed surprise that the Wall Street rocket scientists who designed derivative securities had failed to account for worst-case scenarios in forecasting how their lab monsters would perform:

"In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment."

So why wasn’t he raising those questions about derivatives in 2005, instead of defending them as beneficial for the financial system (and arguing against their regulation)?

More important -- and, again, missing entirely from Greenspan's explanation of the roots of the crisis -- why did the Fed maintain such a wildly easy-money policy from 2002 to 2004, when the central bank’s benchmark short-term interest rate was no higher than 2.25% the entire period (and was below 1.75% for most of that time)?

Without cheap money, the credit-market bubble could never have reached the epic size that it did.

Greenspan must know this. Admitting it, however, apparently still is a bridge too far for him.

Photo: Alan Greenspan testifies on Capitol Hill today (Mark Wilson / Getty Images)

Comments

[Ken McCue]

Greenspan kept interest rates low so "Sonny Boy" would be reelected. Since Bush was unwilling to create propserity through the usual methods (government investment), it had to be created through a shell game (borrowing). Greenspan's motive was simple--Bush was cutting tax rates and attempting to create an aristocracy of wealth, which accorded with Greenspan's idealogy (he was and is a follower of Ayn Rand). One can no more expect honesty from him than one can from any member of the Bush administration.

[BubbaBob]

It is pretty much as Ken McCue says. The US economy has not been experiencing any REAL economic growth for decades, so what else could the "maestro" do? America was not creating enough new real wealth, and real incomes were dropping, so how do you keep consumption up? Cheap credit.

I've been expecting this credit bubble to pop for a few years now (and I knew back in the 1980`s that it would eventually pop). There is no way out of the current wedgie other than radical wage and employment improvements. Massive government spending on public works projects will eventually bring things around again, but it wont be pretty in the meantime. "Supply Side Economics" was never anything more than a huge feeding frenzy for the rich. Now the party is over and it is time to pay the piper, and the caterer, and the dancing girls, and the....

[peter]

The perfect storm:

- greed,

- banking & Insurance - April 98
http://www.wsws.org/articles/1999/nov1999/bank-n01.shtml

- Internet boom/bust - feb 18 2000 - 7 year ARM become popular as people leave stocks, and move into homes(mortages - MArch 9 2007- Big dip in dow)


- the fed's ambition to keep economy expanding - greenspan just as guilty as Enron Executives - Fed rate gets
lowered 2, but 30 fixed still at 6% (4% spread for banks not bad...)
http://en.wikipedia.org/wiki/Federal_funds_rate

- Nouveau riche 3rd World Oil producing Countries - salevating at the price of oil being above $30/barrel - These countries don't want peace in the middle east - Post 9/11

- Oil Company Mergers - and reluctance to pay drilling rights - hence the mergers (10 oil companies to 6 )

-LNG the new boy on the block
http://images.google.com/imgres?imgurl=http://www.worldenergyatlas.com/Titles/Images/worldlngmap2007big.gif&imgrefurl=http://www.worldenergyatlas.com/Titles/worldlngmap2007.htm&h=333&w=550&sz=132&hl=en&start=13&um=1&usg=__OL8t9l-j7HiZoGqD8y5XJLLhMKs=&tbnid=S330hBK-lzg7fM:&tbnh=81&tbnw=133&prev=/images%3Fq%3Dlng%2Bfields%26um%3D1%26hl%3Den%26sa%3DN


- Hause of Saud http://www.the-spark.net/csart134.html

- East asian appetite for oil increasing ever so rapidly - and the need to build up their miltray to secure there oil (china - india)


I'd love to co-author a book if your interested, fiction/non-fiction; interested? It would be Syriana/The Russia House, maybe we could get Stephan Gaghan to write the screen play.

Peter

[John,Miami,Florida]

I knew that Greenspan was a socialist from about three years ago. He jumped off the bus just before it crashed into the wall. He knew what he was doing and should be castigated for his complicity to discredit capitalism and try to establish credibilty to 'other" alternative economic systems. He is a disease in our system of asset allocation and has deliberately sabotaged our monetary system in order to undermine our republic. Clearly a fiat monetary system is not in the best interests of this country. It all started when Nixon debased our money in 1971 and took our money off the gold standard and as a result began a decline in the wealth of our republic. This also coincides with the oil embargo of 1973 since if the people can't pay more wealth for the oil the oil necessarily has to go down in value. Hence, arab problems, hostage taking in Tehran, Iraq war, terrorism etc......... Need I say anymore?

[Cesar]

As long as companies have a large parts of their assets in stocks they would be susceptible to changes in the stock market. Susceptible to the ups and downs of the market. One day they would be rich and the next day could be broke.

I think that companies should not allow to be in such situation. They should only allow for an insignificant part of their money in the stock market. Only companies that are trying to raise capital quickly should get into the stock market. If a company has a new discovery or developement, but lacks capital to produce it then the investors upon knowing of the discovery would invest in the company. Once the company is well funded and the product is doing well then the company would start buying stocks back to develop a stronger condition.

Large companies should not have as much of their assets in stocks. Rather have their own assets as they develop them from sales of products and services, not from sales of stocks. The stock market is too volatile.

[Andrew Sroka]

Wow. Ken McCue's ignorance is stunning. Please let us not hold people responsible for their actions and choices. Let us put on our tin foil hats and blame the vast Bushonian Conspiracy. You really ought to read the article before you make such absolutely irrelevant comments.

[Web Smith]

After pushing for the Telecom Deregulation Act, which was really government theft of private property, in order to create the .com bubble and the need for massive amounts of money, which the Fed and its associated banks were more than happy to provide at higher interest rates, the Fed had to lower the interest rate when the bubble popped in order to replace the lost economy.

This is when the housing boom was artificially created. It has since been propped up by more interest rate cuts and legislation, but since the housing bubble was not created based on anything other than an imaginary demand, it was doomed to fail. It just took a little greed from Wall Street to push it over the edge.

http://ewebsmith.com/finance/thecause.html

[dikkiedik]

Why are so many people blaming "the rich" for all our troubles? That doesn't make any sense.

[DisFisCon]

I seriously doubt that Alan Greenspan was motivated by a desire to see Bush reelected or to push us in a socialist direction. I suspect that he just made a critical judgment error. He believed that the incentives of the few knowledgeable market players would push them toward nurturing a long-term market expansion. I don't see how he could have missed the tendencies of corporate leadership, from GM to HP, to focus on short term profitability (and those important quarterly bonuses) to practically the exclusion of all else. Why should the hedge fund traders be any different? Their compensation, in commissions, wasn't tied to long-term performance. It was tied to quickly transfering these toxic "assets" to somebody else's books as quickly as possible, to bring in cash to leverage another quick "bundle and dump" operation.

We need our leadership to be bold yet skeptical of human frailty.

It may still not be too late to fix this, but supporting these toxic assets isn't the way out. It's simply digging the hole deeper. And at the same time, we're once again lining the pockets of the thieves who threw "reasonable risk" out the window.

We need to let the free market rain a little disaster on the extremely affluent. And if I personally have to lose a hundred K or so of home value in order to make sure that these snake oil salesmen never ever get the chance to drop junk bonds, or CDO's, or whatever the flavor of the month crappy asset with a slick, untested mathematical model behind it, on an unsuspecting and trusting investing public, then so be it.

Housing prices have to drop, and the easiest path to that solution appears to lie squarely in the direction of allowing the CDO's and MBS's collapse, or at least massively deflate in value. I see the government stepping in to set rules to revalue mortgage debt to avoid foreclosure (perhaps allowing homeowners to pay a fee and "reset" their loans to a government-fixed interest rate and duration, with the remaining principal no less than $10K over the appraised value of their homes. That would decrease the risk on these loans by shedding much of the riskiest part (the part of the loan that isn't secured by actual home value), prevent disruptive foreclosures, and help quickly drop housing prices back to the point where "normal" people, unwilling to take on unreasonable debt, could afford a decent house again.

This easy credit thing has been a disaster for the country. Easy credit instantly translates to higher prices. Homes weren't the only thing affected. Prices for many big-ticket items increased dramatically over the past few years because of easy credit, including college tuition and the cost of medical treatment. The only way to back away from easy credit is to punish the creditors who have offered this temptation, punish the debtors who so willingly were tempted, and find a way to split the pain of forced bankruptcy between these two parties.

[Firebird]

How about following the law (the Constitution), and putting the power to issue money back into the hands of Congress, where it belongs? And how about making it ACTUAL money, instead of credit that is backed by nothing and can be created at will? An early draft of the Constitution gave congress the power to issue "bills of credit", but that phrase was removed, and therefore, Congress doesn't have that authority, nor the power to give that authority to the Fed.

Article 1, Section 8, Clause 5: "To coin Money, regulate the Value thereof..."

Notice that it says "coin". Federal Reserve Notes are nothing more than bills of credit, they are backed by nothing but debt, and they are illegal. And I won't even go into the fact that the commercial banking system is permitted to effectively lend money it doesn't even have.

Gee, do you think there was a reason that the framers didn't give the government the power to issue "bills of credit". If the Constitution doesn't give them the power, they don't have the power.

[Mac Stevens]

There would be no giant bankruptcies if corporate shareholders were not granted limited liability by the government. If you could only buy stock which carried a proportion of the liability as well as the chance for profit, you would carefully choose such investments and oversee them diligently. Or, you would buy bonds or other low-yield low-risk investments.

All the arguments I see that favor goverment-granted limited liability are along the lines of "it encourages investment", "it's good for the economy". Well, it encourages irresponsible investment. And when the bankruptcies come, we all seem to miss the fact that the bankruptcy is the point at which the investors dump the load on others, and pretend to be victims. Good for the economy, huh?

Take another look at this assumed "right" to purchase limited liability stock. Think about it. It contradicts your right to recover damages due.

Limited liability = limited responsibility. You'll never legislate responsibility into an entity that is fundamentally irresponsible. Think about it.

And, yes, we should not give such massive secretive power to folks like Greenspan. But that's on us, too. Greenspan is one guy. One guy. Blame yourself for giving the power.

[etfaver]

Greenspan should be imprisoned for his actions of non-action and letting Cheap MOney ride and plunge us into the mess we are in today. Because of him we are all now at risk when we want to retire.

[john Smith]

How many people know that Greenspan is on the board of the Hedge Fund of John Paulson (pls do not mistake for Henry Paulson).
The fund is up 19% for this year (when most of the market is down 40% or more). The fund was up 450% and raked billions last year by bettting on the mortgage melt down.
This year the fund shorted most of the banking stocks in UK and reaped billions.
So as Dr. Greenspan testifies and expressed his shock -- was he not aware of the short sales of the UK banks of the hedge fund he represents?
Go figure...

[Gorefan]

I remember an economics professor had something taped to his door that went like this:

"With enough data and a good model, an economist can make as good a guess as anybody else."

[John Nagle]

It's been blindingly obvious for years that there was a housing bubble. We (Downside) predicted a mortgage crisis and the collapse of Fanny Mae in 2004. Greenspan's job was to stop runaway housing inflation. He didn't do it.

I thought Greenspan understood the problem, but refrained from doing anything because of the political repercussions. But, from today's testimony, it seems that he truly believed that a free market was self-correcting, and that rational self-interest would prevent the players from destroying themselves.

History will not be kind to him.

[Caleb]

Andrew Sroka: I am a level-headed American who shares the same view as Ken on this issue and know that we are in the strong majority among those who have a brain and choose to use them. The complicity of this Bush money-grabbing machine for the wealthy has been completely in our face throughout his presidency - very thinly veiled. It seems to me you have to choose ignorance in order to not see the evidence of this in so much this presidency has done. Saldy, too many in America have never been taught the art of critical thinking nor seem to understand basic cause and effect relationships.

I think it's preposterous to suggest that the monster this planned derivatives market has become is the fault of those who got caught in the bubble. There were many bad decisions made by consumers, but those planned and conspired in creating this concoction are to blame. The writer of the article makes a great point in that Greenspan played a huge part in fueling this derivatives mortgage sham by keeping money cheap.

Looks like Andrew has resorted to the conventional Conservative tactic to discrediting other's ideas: Name Calling. No discourse, no heed to reason, just attack the other side. While I may be guilty of this too, I don't think this country is going to heal politically until we can grow up in how we can interact a little more constructively.

[Zenjon]

Greenspan claimed today he was "shocked" at the breakdown of the credit markets. I seem to remember in Casablanca Captain Renault being "shocked, shocked" to discover that gambling was going on at Rick's...("your winnings, sir.")

[Ivan Grosz]

The mortgage backed securities and credit default obligations are not traded in the regular stock market which is fluid and cannot freeze. They are traded in a second tier market with very limited participation and which can freeze in case of panic.
With mark to market accountiung rules these iliquid assets have no book value and banks and investment houses are left without capital.
A global financial disaster will follow.
Good regulatory oversight may have recognized the flaws of these new financial products and their marketing problems.

[Joe T. Plummer]

The post reads "Why are people blaming the rich.. that does not make any sense".
It makes perfect sense.
The USA economy is run by the rich and powerful elite. Can you name a poor politician? Poor and working class people do not control Wall Street or our economy. They are at the mercy of it. The rich get richer and the poor get poorer. Profit always comes before people. Business ethics is a college joke. God bless America.

[larry]

Greenspan's 17 rate hikes in 2 years killed the economy. He should co-star with Mr. Bean in a movie doing idiotic actions exuberantly that lead to disasters.

[lester]

In checking on our federal debt on the internet, I discovered that the Federal Reserve Bank holds about $5 trillion dollars out of the $10 trillion owed. Then, according to Wikipedia, debt held by the FRB is basically money that was "printed" up for the government to use without collecting taxes or borrowing the money. Wikipedia goes on to explain that this "monetized" debt expands the money supply many fold through our reserve banking system. Many people discussing the wild hyperinflation in real estate cite the low interest rates but somehow do not mention this direct infusion of trillions of de novo dollars. Since inflation is caused by excess currency produced by the FRB and since it is inflation when an old house triples in value in a few years, perhaps there is a relationship between these things. Can any economist out there explain this to me? A few days ago, Paul Krugman was asked on NPR, "Fresh Air" if the FRB was going to get the $700 billion by "printing" it up. Krugman thought that idea ridiculous. Of course not he said, the FRB will sell the government debt it has on its books to get the money!! If you'd like to check this out, go to http://en.wikipedia.org/wiki/United_States_public_debt.

[forgotten%20citizen]

Please help me to verify this. I remember when Greenspan was Federal Reserve Chairman, some people already worried about housing bubble burst and housing price would go down eventually. If I remember correctly, Greenspan response was as long as economic recovers soon enough, more people will be able to afford to buy the houses to keep the housing sustain. I did not buy it because being wage earner, even with the best pay raise would not keep pace with housing price escalation. at that time, no one explain why the housing cost kept going up when the economy was still bad . Of course, the fraudulent lending practice was one of the reason. many of us did not know definition of sub prime mortgage until 2007. It is too late. A lot sign pointed something was wrong couple years ago. Not many people bother to point and make stop

[The Hana Kid]

Blame, lets not forget who's also to blame. Can you say Bernie Frank and Chris Dodd to name two. Heck, just about the entire Senate and Congress is to blame. They're the ones who make the rules. You can't spin this one.

[Steve]

I don't remember the Los Angeles Times Real Estate Section interviewing any of the economists that were telling people that the housing bubble was real back when Greenspan said it wasn't.

[Amin]

---------Greenspan kept interest rates low so "Sonny Boy" would be reelected. Since Bush was unwilling to create propserity through the usual methods (government investment),-------

Prosperity is never created through government investment. It is created through liberty.