Wednesday, May 05, 2010

Alan Greenspan and the housing bubble revisited

One of those brilliant financial "innovations" that helped produce the bubble-and-crash in the US housing market, which in turn helped trigger the larger financial and economic crash of 2008, was the widespread, aggressive, and often blatantly predatory marketing of adjustable-rate-mortgages that suckered too many home-buyers into unwise and eventually disastrous gambles. It is now embarrassing for Alan Greenspan to be reminded that, back when he was Chairman of the Federal Reserve, he not only blocked efforts to deal with this problem--among other problems--but was actually a cheerleader for this orgy of financial recklessness. Here is one notorious example from early 2004 (which now seems long ago):
Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said.

"Overall, the household sector seems to be in good shape," Greenspan said.

Americans have been buying homes and refinancing mortgages at a record pace in the past several years, lured by low interest rates. Most mortgages are fixed rate, so consumers can prepay when rates go down but do not face higher costs if rates rise. Under adjustable-rate mortgages (ARMs), which made up about 28% of mortgages in January, borrowers usually have lower initial rates but face the risk of higher payments if rates in the broader economy rise.

While borrowers can refinance fixed-rate mortgages, Greenspan said homeowners were paying as much as 0.5 to 1.2 percentage points for that right and the protection against a potential rate rise, which could increase annual after-tax payments by several thousand dollars.

He said a Fed study suggested many homeowners could have saved tens of thousands of dollars in the last decade if they had ARMs. Those savings would not have been realized, however, had interest rates shot up.

"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," Greenspan said. [....]
No doubt Greenspan feels it's unfair for people to keep harping on this blooper. I'm not so sure. Of course, the point is not that this one speech, by itself, somehow produced a stampede that created the whole debacle (though I have seen published discussions by allegedly serious people who appeared to believe this was the issue). Rather, this is one especially conspicuous and revealing illustration of a larger pattern of systematic failures in policy and analysis.

=> I notice that another revealing illustration of this larger pattern, also potentially embarrassing to Chairman Greenspan, has come to light. Several people picked it up, but since I can't quote them all, I'll just quote Paul Krugman's comments:

Via Ryan Grim and Matthew Yglesias, some seriously disturbing Fed transcripts. Basically, back in 2004 staff members presented data seriously suggesting a housing bubble; not only were the data disregarded, Greenspan wanted no hint of the discussion made public:
We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand.
Can’t have outsiders joining in on the debate, can we? Hoo boy.

A technical note: those charts would have been even more striking if the staffers had differentiated by regions; big contrast between Flatland and the Zoned Zone, with the latter much more clearly in a bubble.

Yes, our economy was definitely in good hands.

--Jeff Weintraub

UPDATE & RETRACTION: No, that second item I passed on was incorrect. It seems that the quotation from Greenspan was taken out of context. He did say that, but it was in the context of discussing another topic, not the housing bubble. (Ryan Grim appears to have misread that passage in the transcripts.) Apologies to Chairman Greenspan and the rest of you.

Everything about Greenspan's cheerleading for ARMs was correct.