Greenspan wasn’t so dumb; was he lazy?
Chuck Ponzi August 6th, 2007
The action around MBS’s and other derivatives related to the housing market reminds me of an often quoted speech given by Alan Greenspan.
“This vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent… But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.”
While he didn’t do enough to prevent asset bubble from forming, at least he understands what the aftermath does. “newly abundant liquidity can readily disappear”.
It reminds me of a post I made back in the heady days of September 2005, Greenspan’s Interesting Clarity. Yes, nearly 2 years of blogging ago.
Where does this lead us? Well… we’re acting a bit like the japanese in our debt lending by accepting low risk premiums, and the longer this goes on, the greater the risk to all participants, lenders and borrowers. If liquidity were to be suddenly shored up by investors demanding a greater return for thier risk, or if percieved risk were to suddenly jump, borrowing would become much more difficult for buyers. Interest rates will increase accordingly. Even established buyers might not be able to purchase homes due to restricted risk premiums; all of which will only serve to slow the real estate market and put the power of purchasing into well qualified buyers.
It has been my assertion that the housing bubble was caused not by low interest rates, but by excess liquidity that banks could only farm out by lowering lending standards. It was this easy credit that was extended to a whole set of the population that had never before been entrusted with credit; this caused “neverending” demand. Much like college students that max out their first credit card, only to find that the payments exceed their income, many of today’s buyers will be unable to make payments in the future.
Our little “deflationary concern” may soon turn into a financial meltdown since problems tend to spiral: Increases of forced sales trigger lower prices, which triggers lower spending and more foreclosures; lower spending triggers more layoffs; foreclosures trigger financial losses for banks and MBS holders; financial losses triggers less liquidity; less liquidity triggers higher interest rates; which triggers more defaults on ARMs and HELOCs… the list of effects could go on forever. Our economy is increasingly dependent on house price appreciation, but 2 things keep these trees from growing to the sky.
1. Credit has limits, since some risk premium must be attached to borrowing money, and interest must be charged. Investor sentiment is everything here.
2. Even a leveling off will decrease construction jobs that will kick-off the above process, so increasing growth is necessary to keep the merry-go-round going.
As you can see, it is easier to predict WHAT is going to happen, opposed to WHEN it is going to happen. It was surprising to me that the housing boom ended with a consumer-led paring back of purchases, as I had expected the lending environment to tighten considerably before it did. What this likely means is that while it postphoned the inevitable crash, it will likely only amplify the severity of the downturn. As they say, the bigger they are, the harder they fall.
However, not trying to be a Monday morning quarterback, but had the FED raised rates twice more as I had hoped they would, they would have had an additional half-point lowering room when the credit event happened. The fact that they did not either says that they did not understand the extent of the credit market’s problems and attendant risk mongering, or they simply believed (and perhaps still do) believe that the credit markets can self-correct without affecting unemployment, or currency attractiveness. It may be that with the weakness exhibited by the currency, Ben B. should likely be raising rates when the world is calling for cutting them. It’s always easier to get out in front of the problem than cleaning up after the mess, but when has the Federal reserve done that since Paul Volker?
I remember reading that and thinking holy chit this guy gets it. As time moved on I couldn’t believe that it kept on going. I bought in 2002 and I thought I was buying at the peak. I thought that it would top off then because people should remember what happened in the past. Oh but it was the aerospace jobs. I warned people on my blog and on IHB that aerospace wasn’t the cause. I had my supporters but I still had many shills saying it is different this time. I will be doing an update on the jobs soon and it won’t be pretty.
Anyway it has been a while since I have posted here and I saw your comment on Padilla’s blog and thought I would come by. As always you have some great posts and now that Padilla has instant blogging the comments there are better. Like Cramer said these sheeple have no idea what is going in the credit markets and no idea what the defaults are like.
In OC for July there will be at least 1200 NODs and nearly 500 foreclosures. If the rate of increase continues which is likely August will have more foreclosures than all of 2006.
Greenspan is in no way dumb. Nor lazy. I would guess there was some desperation due to 9/11.
I think he also made a mistake about the time delay between lowering the rate and seeing its effect.
There are plenty of other anomalies in this to consider. Like in the late 80’s and early 90’s Japan was creating their own wealth effect. I was in high school and my friends wanted to learn Japanese in college; because they (Japan) were certain to domminate the buisness world. At the time I countered with the thought that banking system was completely corrupted with bad or fraudulent loans. No one believed me then.
20 Years of deflation proved me right.
Now we have China playing a similar currency/debt game. Hiding economic costs by buying up massive amounts of debt. Much of it will go bad and crash their economy. That combined with Greenspan’s tinkering will create an even bigger storm than the 80’s or 90’s busts. Not to mention some populist agenda’s that will have dire unintended results.
It sounds like some repudation of debt contracts, deflation and time will sort out the mess.
If we could really time these things we’d be rich Chuck. The only guys that seem to time these really well are guys like Mozillo who made massive insider selling; and suddenly changes his outlook. Son of a bitch.