Who, Me? Yes You!

by Peter Schiff May 15, 2009 :
When, during the invasion of Iraq, the United States Government issued its famous deck of playing cards with the 52 arch villains of the Iraqi police state, Saddam Hussein’s face adorned the Ace of Spades. If the Obama Administration wanted to engage in a similar public relations campaign for the real estate crisis, the top card should be reserved for Alan Greenspan.

Yet in a speech this Tuesday before the National Association of Realtors, Sir Alan “the-bubble-blower” claimed that his low interest rate policies in the early and middle years of this decade had no effect on mortgage rates or real estate prices. As a result, he claims no responsibility for the subprime mortgage crisis. But even current Treasury Secretary Timothy Geithner, who shared interest rate policy responsibility as governor of the New York Fed during the Greenspan regime, recently admitted that overly accommodative policy helped inflate the bubble. So what does Greenspan know that everyone else doesn’t?

His primary defense is that mortgage rates were a function of long-term interest rates which were simply not responding to the movement in short term rates, which he did control. While it is true that the flow of capital from foreign creditors with excess dollars did keep long rates low despite rising short rates, this “conundrum” was not the leading factor in the housing bubble. Although rates on thirty-year fixed rate mortgages are based on long-term bonds, by 2005 such loans had become an endangered species. The housing bubble was all about adjustable-rate mortgages with 1-7 year teaser rates primarily based on the Fed funds rate.

The rock bottom teaser rates, permitted by the 1% Fed funds rate, were the primary reason that many home buyers were able to qualify for mortgages they couldn’t otherwise afford, and in turn, to bid up home prices to bubble levels. By pushing down the cost of short-term money, the Fed enabled homebuyers to make big bets on rising real estate prices. Without the Fed’s help, few borrowers would have “qualified” for these risky mortgages and real estate prices never would have been bid up so high.

Greenspan expresses exasperation now, as he did then, that his careful nudging of interest rates higher by quarter point increments did not translate into corresponding increases in long-term rates. Unfortunately, according to Greenspan, the markets would not cooperate with his wise guidance, and to his dismay, mortgage rates fell despite his best efforts. As they say in Texas, this dog will just not hunt. If the “measured pace” of his quarter point hikes were too slow to produce the desired effect, why didn’t Greenspan jack up the pressure? With interest rates far below the official inflation rate for many years during the bubble, he certainly had plenty of room to maneuver. The claim that he was unhappy results of his rate hikes, despite his having done nothing to adjust that policy, is ridiculous.
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