March 12 (Bloomberg) -- “Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.”
Even if one missed the headline (“The Fed Didn’t Cause the Housing Bubble”) and the byline (Alan Greenspan) on theop-ed in yesterday’s Wall Street Journal, there could be no confusion over authorship: That “Master of Garblements” and former Federal Reserve chairman was back to defend his legacy.
Greenspan lays out his case that the Fed’s easy money policies can’t possibly be to blame for “the U.S. housing bubble that is at the core of today’s financial mess.” It is long-term interest rates that determine “the prices of long-lived assets,” such as housing, he writes. And those rates, which stayed low as a result of a “global savings glut,” are out of the Fed’s control.
Control, yes. Influence, no.
“Why not try raising short rates if long rates are too low?” asks Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “The recession was over in 2001. Why did he take so long to start to raise the funds rate?”
Greenspan is selective in arguing his case. By any measure, the overnight fed funds rate was too low earlier in the decade. The real funds rate, which is the nominal rate adjusted for inflation, was negative for three years, from October 2002 to October 2005, a longer stretch than in the mid-1970s. And we know how well that turned out.
Now we have additional evidence of the effect of negative real rates. When financial institutions are being paid to borrow, borrow they will.
Free-Money Policy
Banks and other mortgage lenders were happy to arbitrage the spread between the free money provided by the Fed and the rate they charged for an adjustable-rate mortgage. The share of ARMs as a percentage of total mortgage loans averaged 10 percent in 2001; by 2004, it was 32 percent, according to the Mortgage Bankers Association. The dollar volume swelled to more than 50 percent that year.
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