Alan Greenspan is routinely blamed in many circles for creating the housing bubble. It was his keeping rates too low, we are assured, that was responsible for the run-up in home prices. Now, he probably did keep rates too low for too long, but I am not certain that we can lay the blame at his feet. He had a lot of help.

First, a point made by Peter Bernstein. Housing prices rose by almost 50% from 1998 to 2001, before Greenspan started on his rate-cutting binge. 50% in three years when the Fed funds rate was over 6% is not exactly encouragement from the Fed to buy homes. It seems people were ready to do it without low rates. So, a good part of the bubble was not due to lower rates.

And home prices continued to rise rather sharply, even as the Fed began to raise rates in 2005-6. We built 3.5 million more homes over the last ten years than the trend growth suggested we needed. They were not all built during the period of low interest rates.

While low rates did help, the bubble was aided and abetted by sloppy lending practices. It now looks like some two million people took out loans they are going to have difficulty repaying, and are likely headed for foreclosure. Rating agencies labeled these loans as AAA credits. Mortgage and investment bankers sold them to all manner of institutions.

All these culprits took advantage of the low rates, but that was not the cause of the bubble. If proper lending practices had been followed, there would have been far fewer buyers and less building, less speculation, and so on.

Greenspan, in hindsight, should have raised rates sooner, which I said at the time. And lower rates did make homes more affordable. No question about that. But to lay the blame for the housing bubble at his feet is not entirely fair. He had a lot of helpers who did the really heavy lifting.

{ John Mauldin’s newsletter, March 21, 2008 | Continue reading }

One great puzzle about the recent housing bubble is why even most experts didn’t recognize the bubble as it was forming.

Alan Greenspan, a very serious student of the markets, didn’t see it, and, moreover, he didn’t see the stock market bubble of the 1990s, either. In his 2007 autobiography, “The Age of Turbulence: Adventures in a New World,” he talks at some length about his suspicions in the 1990s that there was irrational exuberance in the stock market. But in the end, he says, he just couldn’t figure it out: “I’d come to realize that we’d never be able to identify irrational exuberance with certainty, much less act on it, until after the fact.”

With the housing bubble, Mr. Greenspan didn’t seem to have any doubt: “I would tell audiences that we were facing not a bubble but a froth — lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.”

The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.

Were all these people stupid? It can’t be. [NSW/D Note: They must have been blind then: one year ago.] We have to consider the possibility that perfectly rational people can get caught up in a bubble. (…)

The fundamental problem is that the information obtained by any individual — even one as well-placed as the chairman of the Federal Reserve — is bound to be incomplete.

{ NY Times | Continue reading }

related { We are confronted with the twin evils of slower growth and higher inflation, while also having to fight a banging hangover that resulted from allowing financial intermediaries to party on too hard for too long }

Five Simple Steps to Becoming a Billionaire: The Greenspan Method

1. Become Fed Chairman.

2. Lower interest rates until you create an asset bubble. Hold them low until stagflation is in the air and a real estate bubble is floating.

3. Stop being Fed Chairman and release a book on how you didn’t do anything wrong and have no regrets. If possible, time it perfectly with the worst real estate market in generations.

4. Join the hedge fund which has profited more in % and dollar terms than anyone else has from your mess (which you didn’t create).

5. Build a platinum statue of your muse, Ayn Rand, and sleep with it every night.

It also helps if you are mostly unethical.

{ Long or Short Capital via The Big Picture }

videos { Greenspan on the incapacity of the Central Bank, Ayn Rand… | Greenspan on adjustable rate mortgages }

No shortage of ink was spilled last week about the Fed’s quarter-point rate cut. Yet none of it acknowledged the big elephant in the room: Why in the hell was the central bank easing the federal funds rate with (1) the dollar at a new low, (2) oil at $90, (3) gold at $800, (4) virtually every commodity on the planet going wild and (5), despite government statistics to the contrary, inflation raging?

Of course, we know why the Fed eased: because it’s worried about problems in the financial system. But nothing better illuminates the Fed’s position — between a rock and a hard place — than its rate cut last week. The Fed cannot fight inflation. It cannot provide for a decent currency. (If there’s any levity to be found in the state of the dollar, you’ll find it at the end of my column.)

The Fed’s policy is to print money, print money and print more money. That’s because of what then-Fed chief Alan Greenspan did for nearly 20 years. He bailed out every problem that came along, so we never had a small forest fire. Now we’re getting set to have a giant forest fire.

In addition, the deregulation that Greenspan routinely championed is part of the current predicament, as it allowed folks to push problems down the road for a long time. Well, down the road just might be here. (…)

I have come up with the new name for our currency ($). Henceforth, it shall be called the xera. That’s a combination of Xerox, for the piece of Xerox paper that it is; lira, which in the past was one of the world’s chronically weak currencies; and, most importantly, the fact that it sounds like zero. That is ultimately where the xera is headed.

{ Bill Fleckenstein/MSN Money | Continue reading | via Barry Ritholtz }

related { The US dollar has now lost more than a third of its value (-35%) against a basket of major currencies since Feb 2002. The decline is accelerating. }

It pains me to say this, but this time Alan Greenspan is right about housing.

Mr. Greenspan was wrong in 2004, when he sang the praises of adjustable-rate mortgages. He was wrong in 2005, when he dismissed the idea that there was a national housing bubble, suggesting that at most there was some “froth” in the market. He was wrong last fall, when he suggested that the worst of the housing slump was behind us. (Housing starts have fallen 30 percent since then.)

But his latest pronouncement — that the market rescue plan being pushed by Henry Paulson, the Treasury secretary, is likely to make things worse rather than better — looks all too accurate. To understand why, we need to talk about the nature of the mess.

First of all, as I could have told you — actually, I did — there was indeed a huge national housing bubble. What even those of us who realized that there was a bubble didn’t appreciate, however, was how much of a threat the bursting of that bubble would pose to financial markets. (…)

When two hedge funds run by Ralph Cioffi of Bear Stearns imploded last summer, it came as a huge shock to many investors, and helped trigger a market panic. But a recent BusinessWeek report shows that the funds were a disaster waiting to happen. The funds borrowed huge amounts, and invested the proceeds in questionable mortgage-backed securities.

Even worse, “more than 60 percent of their net worth was tied up in exotic securities whose reported value was estimated by Cioffi’s own team.” We’re profitable because we say we are — just trust us. That hasn’t ever caused problems, has it?

Stories like this have led to a crisis of confidence. (…) Which brings us to the rescue plan proposed by a group of large banks, with Mr. Paulson’s backing.

Right now the bleeding edge of the crisis in confidence involves worries that there may be large losses hidden inside so-called “structured investment vehicles” — basically hedge funds that borrow from the public and invest the proceeds in mortgage-backed securities. The new plan would create a “super-fund,” the Master Liquidity Enhancement Conduit, which would seek to restore confidence by, um, borrowing from the public and investing the proceeds in mortgage-backed securities.

The plan, in other words, looks like an attempt to solve the problem with smoke and mirrors.

That might work if there were no good reason for investors to be worried. But in this case, investors have very good reasons to worry: the bursting of the housing bubble means that someone, somewhere, has to accept several trillion dollars in losses. A significant part of these losses will fall on mortgage-backed securities. And given this reality, the “conduit” looks like a really bad idea.

I’d put it like this: Investors aren’t putting their money to work because they don’t know where the bad debts are. And when investors need clarity, the last thing you want to be doing is pumping out more smoke.

{ Paul Krugman/NY Times | Continue reading }