Interest Rate Roundup

Monday, February 12, 2007

Alan Greenspan responsible for all these "broken ARM?"

Yesterday evening, a debate erupted at another blog over former Fed Chairman Alan Greenspan's "bubble culpability." Did he, in fact, encourage borrowers and lenders to jump into ARMs and/or other forms of creative financing in early 2004 -- and thereby set people up for financial disaster? I'd say "Yes." Here's my post, and supporting evidence ...


Look — Alan Greenspan would never come out and say “Get an ARM loan.” But I am indeed one of those people who believe that speech was, essentially, a “call to ARMs.” It came at a time when the overall economy and job growth were relatively lackluster, and the housing market had gone about as far as it could go on fixed rate financing. So Greenspan gently nudged both lenders and borrowers in the direction of ARM financing … at absolutely the worst time in modern financial history (i.e. before a 17-hikes-in-a-row Fed tightening cycle).

Think back to the “irrational exuberance” speech — Greenspan never said: “Investors are demonstrating too much irrational exuberance.” Instead, in December 1996, he said:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”

But he never would have written that comment into a speech unless he was trying to send a message. The fact of the matter is, the Fed has been just as bad, if not worse, at economic and interest rate turning points, with advice-giving. Never forget this gem of a speech from January 2000 about how great productivity growth, the tech boom, etc. virtually ensured the economy would remain on a strong growth trajectory…

"We are within weeks of establishing a record for the longest economic expansion in this nation’s history. The 106-month expansion of the 1960s, which was elongated by the Vietnam War, will be surpassed in February. Nonetheless, there remain few evident signs of geriatric strain that typically presage an imminent economic downturn.

"Four or five years into this expansion, in the middle of the 1990s, it was unclear whether, going forward, this cycle would differ significantly from the many others that have characterized post-World War II America. More recently, however, it has become increasingly difficult to deny that something profoundly different from the typical postwar business cycle has emerged. Not only is the expansion reaching record length, but it is doing so with far stronger-than-expected economic growth. Most remarkably, inflation has remained subdued in the face of labor markets tighter than any we have experienced in a generation. Analysts are struggling to create a credible conceptual framework to fit a pattern of interrelationships that has defied conventional wisdom based on our economy’s history of the past half century.”

I’m not saying I’m perfect, of course. I’ve miffed plenty of predictions. But I simply cannot excuse the inexcusable talking up of ARMs at precisely the wrong time.


I'm apparently not the only one who won't let Greenspan live that quote down. One of my favorite bond market columnists, Caroline Baum, took him to task in a piece today called "Banks That Took Greenspan's Advice Pay the Price" An excerpt ...

"It's too soon to know the extent of the problem from all the option ARMs (the interest is optional, but the principal is not!). Only three years ago, former Fed Chairman Alan Greenspan said homeowners could have saved a heck of a lot of money had they opted for adjustable-rate mortgages during the past decade.

Ex post, that was good advice. Ex ante, it's not looking good.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed- rate mortgage,'' Greenspan said in a speech to the Credit Union National Association in Washington.

Lenders took his advice. Borrowers jumped at the opportunity. Everyone may suffer the consequences [emphasis mine]."


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