Monday, April 7, 2008

Greenspan's Bosnia Moment

With apologies to Shakespeare, "Mr. Greenspan doth protest too much, methinks."

Former Federal Reserve Chairman Alan Greenspan has every right to attempt to continue to attempt to "defend his legacy". That he continues to refuse to accept any degree of responsibility for the current problems in financial markets are also, ultimately, his own business I guess. At the Wall Street Journal press stop, in regards to his own potential role in the current crisis, "Mr. Greenspan says he doesn't regret a single decision." The day before, in the Financial Times, Greenspan's own commentary is defiantly titled "The Fed is blameless on the property bubble"

Beyond that though, there is a bigger issue at hand here, as Greenspan himself says in the WSJ article mentioned;

the larger issue at stake, he says, is getting the lessons of the crisis right."The [wrong] evaluation of this period -- and how to avoid the problems associated with it -- will give you the wrong answers and the wrong policies"

Further, in a statement of the obvious, the article states;

If Mr. Greenspan's views carry the day, the trend toward self-policing will continue.

Previously, I discussed here how some of these views played a leading role in the excessive deregulation of this generation I'll save for another time additional discussion on the merits of Greenspan's judgement and actions in regards to market excesses or "bubbles", including the theory he currently espouses regarding the role that excess global savings may have played in the housing excesses that have led us to our current financial crisis.

For this time though, before just "moving on" to the debate, I think its important, as Mr. Greenspan himself does, to make sure that "the record" on his actions are as accurate as possible. Perhaps were not talking about the difference between dodging sniper fire and exchanging pleasantries with children in Bosnia, but none the less, lets in this case also, examine a public figures recollection vs. reality a bit closer. Again from the Wall Street Journal;

Mr. Greenspan says many of the criticisms against him are unjust. He is particularly perturbed by attacks over a 2004 speech in which he suggested that more borrowers would benefit from adjustable-rate mortgages. Mr. Greenspan says the speech merely pointed out that many people who get a 30-year mortgage move or refinance long before it matures. Eight days after giving the speech, he says, he clarified his comments to say he didn't mean to disparage 30-year fixed-rate mortgages. "I find it profoundly disturbing" that critics cite the recommendation and not the retraction."

Let us know examine Greenspan's characterization. First though, as to Greenspan's retraction, I don't doubt that he in some way mentioned fixed rate mortgages 8 days later in a positive sense, but if it was in any way meant to be a significant retraction of his thinking at the time, it sure wasn't captured as such. In fact, unlike the heavy press treatment of the original speech, the retraction doesn't appear anywhere to be found in any significant way in the press at the time. Also, there is no mention of mortgages at all in the text, via the Fed website, of the alluded to March 2, 2004 New York speech. Perhaps he made the "retraction" in response to a question, or even informally before or after the speech, but apparently it wasn't important enough to be either included in the text records of the speech or to receive any real emphasis in the media.

Getting back to the original speech (available in its entirety here) and its characterization, lets take a look here at some excerpts. Early in the speech, as is characteristic of his history of getting caught up in the euphoria of bubbles (as mentioned previously, to be discussed another time), Greenspan extols the virtues of a consumers ability to increase their debt and leverage level via the "extracting" equity from one's home;

Refinancing has allowed homeowners both to take advantage of lower rates to reduce their monthly payments and, in many cases, to extract some of the built-up equity in their homes.

Greenspan also waxes poetic on increasing debt and leverage thru the use of lower down payments. In this case, he praises lending institutions for what he describes as their decade long marked improvement in managing the risk of lower down payments;

The ability of lending institutions to manage the risks associated with mortgages that have high loan-to-value ratios seems to have improved markedly over the past decade, and thus the movement of renters into homeownership is generally to be applauded, even if it causes our measures of debt service of homeowners to rise somewhat.

After that warmup, Greenspan delves into what has, interestingly enough, become the heart of the controversy surrounding the speech, i.e. his thoughts on adjustable rate mortgages. Remember, in this regards, Greenspan now says "the speech merely pointed out that many people who get a 30-year mortgage move or refinance long before it matures." Lets see for ourselves in Greenspan's own words again;

One way homeowners attempt to manage their payment risk is to use fixed-rate mortgages, which typically allow homeowners to prepay their debt when interest rates fall but do not involve an increase in payments when interest rates rise. Homeowners pay a lot of money for the right to refinance and for the insurance against increasing mortgage payments. Calculations by market analysts of the "option adjusted spread" on mortgages suggest that the cost of these benefits conferred by fixed-rate mortgages can range from 0.5 percent to 1.2 percent, raising homeowners' annual after-tax mortgage payments by several thousand dollars. Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.

American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

Finally, to wrap up, Greenspan concludes that things are just fine in the housing sector and increasing debt levels are not an issue;

Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress.

So, Mr. Greenspan is "profoundly disturbed" and "particularly perturbed" at the media treatment of him on this speech? To use more "Greenspanism", that's even more irrational then any kind of exuberance that Mr. Greenspan holds to be completely unable to be in any way quelled via competent regulation.

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