1 Boring Old Man

The Roots of the Mortgage Crisis:
Bubbles cannot be safely defused by monetary policy before the speculative fever breaks on its own.
by ALAN GREENSPAN
December 12, 2007

… history has not dealt kindly with protracted periods of low risk premiums.

…

The root of the current crisis, as I see it, lies back in the aftermath of the Cold War, when the economic ruin of the Soviet Bloc was exposed with the fall of the Berlin Wall. Following these world-shaking events, market capitalism quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Third World.

…

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.

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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…

The Financial Meltdown Continues
September 19, 2008

Virtually the only certainty in the current financial situation is there will be more problems ahead. Those who controlled the levers of economic and financial policy neglected their greatest responsibility, which was to ensure an orderly financial market and prevent exactly the sort of collapse that we are now seeing. This was a policy failure of massive proportions, not a natural disaster.

The central problem remains the collapsing housing market. The Case-Shiller 20-City Index shows a nominal price decline of almost 20 percent over the last two years, an event that few in the financial sector apparently considered to be a serious possibility. This price decline has led to an unprecedented rate of defaults on mortgages and derivative instruments.

These defaults, in turn, have raised questions about the solvency of a large number of financial institutions. This has led to an increase in the price of risk more generally and the crisis of confidence that is currently shaking financial markets worldwide.

While there is no simple path out of this crisis, it was a crisis that could have been easily avoided. If the Federal Reserve Board had acted to stem the growth of the housing bubble before it grew to such dangerous proportions, the country would not currently be facing a recession and the prospect of a financial collapse…

Alan Greenspan had the tools necessary to rein in the bubble had he been so inclined. First, he could have imposed tighter restrictions on mortgages, as the Fed has recently done. This would have prevented many of the worst mortgages that led to the subprime crisis and helped inflate housing prices.

More importantly, he could have used his platform as Fed chairman to explicitly warn of the dangers of the housing bubble. In his Congressional testimonies and other public appearances, he could have carefully explained how house prices had diverged from a 100-year-long trend in the mid-90s.

He could have pointed out that after just increasing at the same pace as overall inflation for a century, house prices suddenly jumped by more than 70 percent, after adjusting for inflation, in the decade from 1996 to 2006. He could have shown this increase was not supported by any changes in the fundamentals of supply and demand in the housing market, nor was it matched by any remotely comparable increase in rents.

If Chairman Greenspan had pointedly made the case for the existence of a housing bubble and explicitly warned of the losses likely to be suffered by individual homeowners and the huge risks being taken by financial institutions that were heavily invested in mortgages and mortgage derivatives, it almost certainly would have been sufficient to take the air out of the bubble. As a last recourse, he could have raised rates with the explicit purpose of bringing down house prices.

Instead, Greenspan repeatedly denied the existence of a housing bubble, dismissing the warnings of the small group of economists who tried to call attention to the potential dangers posed by a housing bubble. Greenspan’s denials helped create a false confidence that allowed the bubble to continue to expand. It also helped to fuel the complacency in financial markets that led the country’s largest financial institutions to ignore potential risks and to become very highly leveraged against their capital.

Why did mortgage brokers make those obviously risky loans? Why did people take out those obviously risky loans? Why didn’t the government put a stop to it? But that’s only the beginning of the questions. Why did we allow ourselves to have these overwhelming trade deficits with the developing countries? Why did we outsource our production overseas? Why did we create a market for foreign goods that shut down American production? Why did we cut taxes and run up the National debt [to foreign countries]? How did our country which had gone through a massive depression in the 20th century actively throw away the lessons we learned then and the safeguards we’d put in place to protect us from a recurrence?

It’s called greed. It comes with the territory, just part of the machinery that makes up the human package. Kids come into the world with it, and much of parenting [civil-ization] has to do with teaching kids how to modulate it. "I want what I want when I want it." "I want more of it." "I want all of it." It’s not a relationship builder, greed. Greedy people aren’t motivated specifically to hurt others. But they do hurt others who stand in the way of getting "more of it." It’s not satisfying, because there’s always "more" to get so one never comes to a resting place. Then there’s always the problem of seeing everyone around as "greedy," out to take some [or all] of your stuff – projecting one’s own greed on others [some of whom are actually greedy too].