Greenspan and the Home Mortgage Crisis

American homeowners are not a happy bunch. First, the party began to end two years ago; next some Wall St types got caught with their pants down early this year, then home prices really took a dive. Credit vanished. Finally, as taxpayers homeowners just might be asked to bail out the very clowns that helped get them into this mess. What in the world is going on? Where did this all start?

Professor Anna Schwartz (92 and still working at the National Bureau of Economic Research) is a revered figure in central banking circles. She with Milton Friedman wrote the joint opus - A Monetary History of the United States, which revolutionized thinking about the great depression. The book was a bombshell, turning conventional wisdom upside down. What Friedman/Schwartz demonstrated was that incompetent Fed officials caused the depression, not the free market. I met Schwartz in Oct/93 as the two of us testified before the House Banking Committee. And what does she have to say now? According to Schwartz the original sin of the Greenspan Fed was to hold rates at 1% from 2003 to 2004, long after the dotcom bubble was over. "Rates of 1% were bound to encourage all kinds of risky behavior," says Schwartz.

By "risky behavior" Schwartz means that of both lenders and borrowers in the housing market, and the lenders’ Wall St counterparts. Looking for higher yields in the artificially low rate environment of ‘03 and ‘04, encouraged by politicians to direct more lending to poorer neighborhoods, encouraged by the lack of supervision (50% of subprime loans were made by state chartered but not federally supervised companies), encouraged too by Wall St, lenders increased risky subprime lending through nontraditional loans. Brokers originated the loans with little concern for quality and lenders went along as they could simply peddle the loans to Wall St underwriters who in turn packaged the loans as securities to sell to unwary investors. We all know what happened next.

Greenspan has looked to clear his name by blaming the period of artificially low rates and the bubble this created on the Asian saving glut which supposedly created stimulus beyond the control of the Fed. Schwartz says this is nonsense. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events," she says. And in fact Greenspan did not understand the situation. His skill has always been a remarkable ability to charm politicians coupled with a gift to say absolutely nothing at great length with no real position of any kind. He got where he did because of his political promiscuity; his "strength" is that he could be trusted not to rock the establishment boat, which includes maintaining a near incestuous relationship with Wall St. His skill at predicting events tied to policy change is about nil. CNBC one described Greenspan’s forecasting record as "the worst". Worth mag in 1995 said that, "...most of his predictions have turned out to be wrong." Indeed, as a private economist and a hired gun for Charley Keating’s Lincoln S&L (his fee was $40,000) Greenspan told California banking regulators that Lincoln management, "...was seasoned and expert...with a long tack record of outstanding success." He told the regulators that Keating’s S&L would pose no risk of loss to federal insurers (i.e. taxpayers). In fact, Lincoln cost the taxpayer $3 billion bucks. Keating was convicted of securities fraud, conspiracy and racketeering.

Chairman Bernanke’s intellectual honesty detaches him from the Greenspan mold yet he has for the most part carried on the tradition. His Fed remains too close to Wall St and financial institutions - responding to their needs to the detriment of the wider economy. The Fed overreacted to the crisis, misjudging the importance of financial stability to the overall economy and created a deeper inflation problem as a result. Another acquaintance of ours - Bill Poole, until recently head of the St Louis Fed, called the Bernanke-Paulson decision to take some of the banks’ diciest loans onto it own balance sheet "appalling," the worst mistake of a generation.

Well, most of us recall the Chrysler debacle of 1979. It like Bear Stearns was "too big to fail". Free market thinkers worried not that the bailout would fail but that it would work. It did, thus lowering any resistance to future flights of Wall St socialism. Of course Fed seers argued that Bear was so connected to the financial system in opaque ways that the radiating consequences would be a catastrophe. We doubt that is true. We do know that the Fed now has a mandate to be the deal makers for Wall St’s brand of socialism - socializing losses while privatizing gains.

And so the irony is that the mortgage crisis is in large part the fault of the Fed’s own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been. The only healthy recovery is to let those prices settle on their own, to let those firms which reaped great benefits now accept the consequences of their overreaching. Fed-Treasury interference in the process of price discovery will only prolong the process and increase the odds that losses are in fact dumped onto taxpayers - a very real possibility.

Robert Craven