As noted last night, Alan Greenspan has blamed the crisis on a lack of regulation rather than ultra-low rates. (You can find his Brookings institute paper The Crisis here).
While the lack of regulatory enforcement — ironically, mostly notably by the Greenspan Fed — was no doubt a large part of the problem, his exoneration of ultra low rates is belied by history.
I detail all of this elsewhere; but perhaps the impact of low rates would be more easily understandable to the Maestro if we put it into numerical bullet point form:
1. Starting in January 2001, the FOMC began lowering rates, eventually to 1%. They kept rates below 2% for 36 months, and at 1% for over a year. This was unprecedented.
2. While these rates had myriad effects, lets focus on just two: The impact on Housing, and on global bond managers.
3. Since homes are (typically) a leveraged credit purchase, lowering the cost of that credit has an inverse effect on prices — i.e., cheaper mortgages = more expensive houses. Since most people budget monthly, carrying costs are more important than actual purchase prices. Hence, a big drop in interest rates can cause a spike in home prices, with monthly payments remaining fairly similar.
Bottom line: Ultra low rates were the initial fuel sending home prices higher.
4. At the same time, bond managers were scrambling for yield. Pension funds, trusts, foundations require a certain annual gain, and without it, they have issues. Note that most of these managers by their own charters cannot purchase junk, they can only buy investment grade paper.
5. Wall Street had been securitizing collateralized debt for years. They turned credit cards, student loans, auto financing, and of course, mortgages into paper.
6. Making loans to people with weaker credit scores, lower incomes, or more debt was a risky proposition, and hence, generated higher yields for that risk. By collateralizing these subprime mortgages, Securitizers could generate higher yielding paper for the managers of bond funds. And because the rating agencies — Moody’s,, S&P, and Fitch were totally corrupt — the securitizers could purchase AAA ratings. Hence, all manner of unqualified junk paper could be sold to these funds that wrreonly allowed to purchase investment grade paper.
Here is the first point where lack of oversight comes in (vs-a-vis the ratings agencies). But we never would have gotten to that issue BUT FOR the ultra low rates.
7. The triple AAA rated junk paper sells well, increasing demand for more of it. Huge Wall Street demand for more junk to feed into the maw of the securitization beast compels all manner of non-bank lenders to issue even more sub-prime mortgages. And since they was a finite number of people who afford mortgages, they got creative with ways to make mortgages even cheaper. First came the 2/28 variable loans, with a cheap teaser rate the first two years.
Then came Interest Only (I/O), where there was no principal repayment. I called these loans “Rent with an option to default.” Lastly, we had the Negative Amortization (Neg/Am) mortgages, where the borrower paid less than the monthly interest charges, with the difference added to the principal owed. Hence, with each passing month, the mortgagee actually owed more on the house than the month before, rather than less. These loans defaulted in enormous numbers.
8. The lack of regulation of these non bank lenders was a key factor. Ironically, it was the Fed’s job to regulate them, and moving beyond irony to surreal absurdity, it was then Fed Chair Alan Greenspan who called these non bank lenders “innovators” and refused to regulate them. (This was around the same time, with rates at record low levels, when he was advising people go for variable mortgages). Their innovative business model was lend-to-sell-to-securitizers.
9. Numerous states had on their books anti-predatory lending laws. These made it illegal to make loans to people who could reasonably not afford them (nor could they charge usurious rates or excessive fees that would make defaults much more likely).
The Bush White House issued its doctrine of “Federal Pre-emption,” which essentially told the States to step out of the way of these lenders. The data shows that states with anti-predatory lending laws had much lower defaults and foreclosures than states that did not; the Federal Pre-emption significantly raised default rates in these states.
Hey, where were all those States right advocates back then? My Spidey-Sense is tingling! I suspect these new states rights people are not at all concerned with states rights at all, and are more likely little more than hypocritical partisans.
10. The lack of regulatory enforcement was a huge factor in allowing the credit bubble to inflate, and set the stage for the entire credit crisis. But it was intricately interwoven with the ultra low rates Alan Greenspan set as Fed Chair.
So while he is correct in pointing out that his own failures as a bank regulator are in part to blame, he needs to also recognize that his failures in setting monetary policy was also a major factor.
In other words, his incompetence as a regulator made his incompetence as a central banker even worse.
~~~
Class dismissed.
Greenspan’s logic, reduced:
The short term has no bearing on the long term. Just because I poisoned the community well last month doesn’t mean that all of the dead villagers you see lying around the well today are a result of what I did then. Once I put it into the well, it was no longer under my control.
oops!
Blame the poison, not the poisoner.
I agree that low rates will raise prices. And I agree that it could have “initiated” a feedback loop. But if you ask “how much did the decrease in rates contribute to increase in prices,” the answer is actually “not much.”
I knew we were in a bubble long before most people, thanks to following Dean Baker’s blog. Dean looked at price/rent ratios, mainly. But I kept thinking, “what about lower rates?” Not that it meant that prices were justified, but if it was largely lower rates, then prices might not go down until rates went up.
Then (because SWMBO wanted a house), in June 2008, I bought in a MD suburb of DC. So I was actually playing with mortgage tables. I applied this stuff to the housing bubble history I knew of. Locally, prices went up maybe 150% from 2000 to 2008. (Sorry—figures are pulled from memory.) Rates (I was using a very simple model—30 year fixed, with no down payment to make the math easy) went down from 8% to 6%. Crunching the numbers, that would translate into a 22% increase in prices (again, these numbers are IIRC), if your model assumes that a buyer just cares about monthly payments.
So: while I agree that easy money was partly to blame, as an initiator and because of chasing yield as Barry mentions, I think the main culprits are (a) lack of sufficient regulation, (b) opaque financial products, (c) screwed up incentives, all the way from mortgage brokers to heads of investment banks. (Random annoyance: why the f*** don’t mortgage brokers have fiduciary responsibility towards their clients?)
Adding: by “contribute,” I mean “contribute directly.”
This is Fed’s own paper. Greenspan has been disingenous about this for years. Anyone trading the long end of the treasury curve knows what the Fed did to the term premium. One day, I will go back, chart the intraday 10yr note yields, put FOMC decisions & Fed comments on it to show how the Fed actions were directly depressing 10yr and longer yields. Mr. Greenspan is looking for other explanations because he can not sleep at night knowing what he is responsible for. Predictability in fed policy is A MORAL HAZARD.
http://www.federalreserve.gov/pubs/feds/2007/200746/index.html Abstract: From 2004 to 2006, the FOMC raised the target federal funds rate by 4.25 percentage points, yet long-maturity yields and forward rates fell. We consider several possible explanations for this ” conundrum.” The most likely, in our view, is a fall in the term premium, probably associated with some combination of diminished macroeconomic uncertainty and financial market volatility, more predictable monetary policy, and the state of the business cycle.
WORST KEPT SECRET: Alan Greenspan will not be invited to Barry Ritholtz’s next birthday party…
He’s welcome to come!
“The Bush White House issued its doctrine of "Federal Pre-emption," which essentially told the States to step out of the way of these lenders. The data shows that states with anti-predatory lending laws had much lower defaults and foreclosures than states that did not; the Federal Pre-emption significantly raised default rates in these states.”
This thing was rigged to blow, from the top, down..the Episode was, truly, a feeding-frenzy, by Psychopaths and their followers, on the Body, and Body-Politic, of what was left of the, former, united States of America..
differently, a Wholesale Asset-Stripmining operation that was cleared-”Green means Go!”-from the Highest Levels, to level the last bulwark of Freedom on the face of the Globe, the, formerly(?), American Middle Class.
w/this: “4. At the same time, bond managers were scrambling for yield. Pension funds, trusts, foundations require a certain annual gain, and without it, they have issues. Note that most of these managers by their own charters cannot purchase junk, they can only buy investment grade paper.”
it goes, little, reported that many of those Funds’ ‘Management’ was leased out to the, very, same IBanks that were producing the G*rbage that, coincidentally, were shoved into the Funds..
past that, Who were these ‘Fund Managers’? How were they Paid? and, Why is there so little attention being paid to their Role in this Production? ~~ 11. Central Banking is Central Planning.
BR,
nice job on 1.-10. ~ though, w. 7. what’s the problem w/ I/O ’s ? from a Financial POV, at the min., they are the least expensive option–maximizing Home Interest deduction Tax incentives, lowering negative Cash Flows, and if your OCC (opp. cost capital) is lower than the face rate on the Note, it’s a given, no?
BUT…
For all those 1% rates, ALL that speculation in housing, and ALL that overbuilding.
We didnt have 1 single bit of persistent inflation. In fact, we have net deflation. The crisis of 2008 was a DEFLATION crisis. What does that say about monetary policy?
Therefore, the RIGHT TOOL was NOT higher rates. It was to regulate the downpayment (20-30%?) and fraudulent mortgages (deceptive sales practices, teaser rates, no prepayment penalties).
Dont you see how that is actually correct? “Rates” are a blunt instrument that affect ALL of the economy. Many parts of the economy were actually under-invested in during housing boom. To have higher rates would’ve increased our deflation problem, etc.
Plus its wierd that you dont see human speculation as the #1 cause of the housing bubble. We have 0% rates today. We have 3.75% 5/1 ARMs… but we dont have a bubble in housing. Why? Because the human element is missing. “Rates” dont really mean that much.
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BR: We don’t have inflation now, but we had HUGE inflation from 2001 to 2008, as food prices soared, house prices spiked, oil went up 6-fold and gold tripled . . .
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