Blaming Greenspan

Alan Greenspan accepts no responsibility for the current situation:

Demand in those days was driven by the expectation of rising prices--the dynamic that fuels most asset-price bubbles. If low adjustable-rate financing had not been available, most of the demand would have been financed with fixed rate, long-term mortgages. In fact, home prices continued to rise for two years subsequent to the peak of ARM originations (seasonally adjusted).

Felix Salmon critiques this on the grounds that "the main reason why the housing bust seems to be much worse in the US than elsewhere is surely those ARMs – which, as Greenspan concedes, were a function of low short-term interest rates." There seems to me to be a more fundamental problem here. Greenspan had what he thought were good reasons to put interest rates very low. One consequence of that was to make ARMs look more appealing to a lot of people. Greenspan could have responded to that in one of three ways. He could have ignored the ARM issue. He didn't do that. He could have tried to warn people about the risks of ARMs. He didn't do that. Instead, Greenspan encouraged people to get ARMs. I think it's never really been clear why he did that, but it was pretty bad advice and he just doesn't mention it at all during his retrospective.

Comments

It seems to me that an ARM can be a good deal for you if you don't expect to own your house for more than 5-7 years. Then you can lock in a low interest rate for the duration that you need it. But does that make sense? Why would you plan to buy and sell so frequently? And wouldn't you expect housing prices to peak when interest rates are low and underperform as they go up? Maybe this strategy could work for individual investors. But when there is a large trend in the market in this direction- the result will not be favorable. I can't imagine any justification for encouraging ARMs for the general public while rates are low and it looks like a housing bubble could be developing.

Posted by mpowell | December 12, 2007 1:34 PM

..."the main reason why the housing bust seems to be much worse in the US than elsewhere is surely those ARMs – which, as Greenspan concedes, were a function of low short-term interest rates.

I'm pretty sure the the US has generally seen fewer ARMs than other countries. Generally speaking, the depth, liquidity and flexibility of the US mortgage sector (helped with largish dollops of public sector support) has meant that it's easier to get that highly desirable product known as a 30-year fixed in the US than elsewhere.

This crisis to me seems like it has very little do with with ARMs as such, and everything to do with greed, fraud, lack of risk analysis, and government-helped-along moral hazard.

Posted by Jasper | December 12, 2007 1:43 PM

It seems to me that an ARM can be a good deal for you if you don't expect to own your house for more than 5-7 years.

Not long ago I heard some big time NYC money manager on the radio saying he advises all his clients to go with adjustable mortgage products. He seemed like he was credible and genuinely knew what his talking about. His reasoning -- an unimpeachable argument as far as I can tell if it's tended for wealthy people -- is that, on average, over the long term, you're going to be paying the bank less for the use of its money with adjustable interest products.

Posted by Jasper | December 12, 2007 1:48 PM

Actually, as mentioned above, ARMs are in fact good for some people, especially if you don't plan to own for a long time. I think that the US actually has more fixed rate mortgages than a lot of other places (the UK, for example), but I could be wrong.

Posted by JAD | December 12, 2007 1:53 PM

I guess it depends on whether you can afford the risk of the increase in the rate. If you're buying the bigget home you can afford, which many people stupidly do, this is not true. If you're rich, maybe not.

I'm still not sure I agree with him, though. If you compare the return on 5-10 year bond with the return on a 30 year bond, the extra risk on the 30 year bond for the return does not make sense to an individual investor. It seems like even for those for whom the risk isn't potentially devastating, an institution with a diverse means of balancing risk is better suited to carrying 30 year fixed bonds.

Posted by mpowell | December 12, 2007 2:10 PM

"government-helped-along moral hazard."

Yeah blame the government...

What I keep hearing is that the credit markets are drying up because banks are afraid to loan to other banks. Because they don't trust their books.

This sounds like a case imperfect information.

Meanwhile what did banks do with some of the profits they accrued over the years? Reward honest, hardworking analysts? No, they dumped it into successful lobbying efforts at bankruptcy "reform" and repealing Glass-Steagall.

The US economy is socialism for the rich and the harsh, unforgiving free market for the poor.

Posted by Peter K. | December 12, 2007 2:19 PM

Getting anyone to blame Greenspan for anything is a Sisyphean task. Greenspan is an ultimate 'teflon' guy, no matter how badly he screws up he never gets blamed.

When he first became Fed Chairman in 1987, the first thing he did was tighten very hard and quick, i.e. too fast and too much. Combined with a statement by then Treasury Secretary James Baker (another teflon guy), to the extent that the dollar was too high (tight money 'says' that the Fed thinks the dollar is too low), that said that one hand of the govt was pushing and the other was pulling was the proximate cause of the stock market crash in 87. Greenspan did much better right after that then the Fed did in 1929-1932, but he got no blame for triggering it, neither did Baker.

This isn't to say that Greenspan was all in bad, someone who never screwed anything up is someone who never did anything, but he's just got some sort of weird aura about him, you know he'll never get as much as a reputational scratch.

Posted by j mct | December 12, 2007 2:55 PM

Jasper, and JAD -- Let me clarify. There's a difference between a standard floating-rate mortgage of the type which is quite common in the UK, on the one hand, and a US-style ARM, on the other.

The difference is this: in the US, the ARM is set at a fixed rate (often called the "teaser" rate) for some period of years. After that period, it resets to a *very high rate* -- something like 225bp over one-year Libor. To give you an idea, a 30-year fixed mortgage today will cost you about 5.75%, while 225bp over one-year Libor is about 6.75%. In other words, the floating-rate mortgage actually costs MORE to service than the fixed-rate mortgage, under most normal circumstances, despite the fact that it's the borrower and not the lender taking interest-rate risk.

So as mpowell notes, an ARM only makes sense if you treat it like a 5-year or 7-year mortgage and repay or refinance it before it resets.

So what, one may ask, was Greenspan talking about when he lauded ARMs? You might well ask: I don't understand at all. Clearly right now interest rates are hardly high, and yet 1-year ARM rates are still significantly higher than 30-year fixed-rate mortgages. Partly that's a function of craziness in the Libor market, but mainly it reflects the fact that ARMs are very dangerous products which borrowers should generally avoid.

Posted by Felix Salmon | December 12, 2007 4:10 PM

Greenspan could have prevented the fiasco quite easily through the regulation of bank mortgage lending practices. Requiring things like real due dillegence in regard to borrower income and proper appraisal. He also could have said that the so called insurance was a farce. (MBIA one of the biggies has insured $1 trillion in credit and has $14 billion in capital. This isn't insurance, it's a sick joke). This includes their providing short term funds to non bank mortgage purveyors. In addition he could have used his bully pulpit to point out that huge portions of these mortgage securitizations were not AAA but were in fact huge piles of shit.

Such was perfectly obvious. He instead cheered shit tsunami. Either Greeny is stupid or evil. I pick #2.

Posted by rapier | December 12, 2007 5:55 PM

he recommended ARMs because that took banks off the hook for lots of the cheap long-term debt. The Fed is a creature of the banking system. Its job is not really to help economic growth or to hold down inflation, it's to make sure that the banks don't go broke.

Posted by jjones | December 13, 2007 1:42 AM

Surely we are getting some reforms in exchange for the big bank bailout? New rules for mortgage brokers, requirements that the borrower's lawyer review the terms of the mortgage, etc.

Posted by bob h | December 13, 2007 8:14 AM

Matthew, you use language that is frankly inappropriate. The short term rates weren't low. If they were merely low there wouldn't have been a problem. The were obscenely low. The Fed Fuds Rate fell below one percent. That is outrageous. It created loose money. This created irresponsibility which filtered into the mortgage market. Of course, Greenspan must be held to account for what he did. He can write all the op eds that he wants, but the facts speak for themselves. Here is how I analyzed his piece...

http://proprietornation.blogspot.com/2007/12/alan-greenspan-tries-to-rewrite-history.html

I am a mortgage broker and thus I am in an interesting position to see the crisis. Here is how I saw its roots and aftermath...

http://proprietornation.blogspot.com/2007/11/from-boon-to-crisis-truth-about.html

Posted by Mike Volpe | December 13, 2007 11:54 AM

Serious question: I thought liberals *liked* low interest rates because that decreases the income you get from "non-work" activities. I can link the Molly Ivins columns if you like.

What's the stance? Or do y'all take a *wide stance* on interest rates, like Larry Craig?

Posted by Person | December 18, 2007 9:39 AM