Thursday, May 26, 2005

More “Irrational Exhuberance(s)”

Litany of Woes Grows–Housing, Derivatives, Agencies...
Fed Head Arsonist Yells Fire

Recent comments by Fed Head Alan Greenspan are all too reminiscent of his infamous "irrational exuberance" comment about the stock market being overvalued in a December 5, 1996 speech ( )

Today the Fed Head sees several markets/agencies, not just one, that are over-inflated and pose a potential threat to the real economy should they undergo a sharp or protracted contraction. Such machinations from Chairman Greenspan who is noted for mincing his words are unusual and merit attention.

Greenspan who has consistently maintained that there is no housing bubble took an about face at the Economic Club luncheon in NYC on May 20th when he said:"Without calling the overall national issue a bubble, it's pretty clear that it's an unsustainable underlying pattern," As the NY Times reported ( the Fed Head saw "Froth" in market with "lots of local bubbles".

Given the chairman’s penchant for obfuscation it is clear he is very concerned–"froth, local bubbles...." are not bland observations. The Fed’s press release of May 16, 2005 echoes similar concerns as it notes that for the first time regulator’s are issuing guidelines for the "red hot" home equity loan market:
( )
"The federal bank, thrift, and credit union regulatory agencies today issued guidance that promotes sound risk management practices for home equity lines of credit and loans. The agencies have found that in some cases credit risk management practices for home equity lending have not kept pace with the product's rapid growth and eased underwriting standards."

The fear is that the rise in housing prices is fueling a borrowing binge that is being pyramided back into the housing market. The Wall Street Journal reported (On the House-'As Prices Rise, Homeowners Go Deep in Debt to Buy Real Estate', May 23, 2005, By JAMES R. HAGERTY and RUTH SIMON) :
"A riskier and more aggressive way to use home equity is to plow it into investment property, as the Epsteins did. A survey by SRI Consulting Business Intelligence, a research firm in Menlo Park, Calif., found that nearly 2.2 million households used their home equity to buy additional real estate in 2004, up from roughly one million a decade earlier. "As long as there isn't a major change in the marketplace or a bubble burst, it will go up again," says Larry Cohen, director of the SRI division that does financial-services research and consulting."

Then there was the Fed Head’s oracle on the derivatives market. As Barrons reported (DC Current-"Greenspan’s Warning". May 23, 2005, Jim McTague)

"A RECENT SPEECH BY FEDERAL RESERVE CHAIRMAN Alan Greenspan, who is known in some circles as "Darth Vagueness," has left at least two money managers with nightmares of the Dark Side. So they've begun bailing out of stocks and bonds and getting into cash and Treasuries.
The two have carefully deconstructed nine pages of "remarks" that Greenspan made on May 5 about the growing risk to banks and investors posed by a possible liquidity crisis in the $220 trillion derivatives markets. Their conclusion: This was not the usual bland and indecipherable Greenspan fare, but rather a clear-cut warning of market dislocations to come.
"It was a seminal speech," says David Kotok, chairman and chief investment officer for Cumberland Advisors, Vineland, N.J., which has $745 million in assets under management. "His message is that 'We [the Fed] don't know what is going on in the derivatives markets, and we are concerned that we don't know.'" Kotok is responding by reducing his exposure to stocks

While some were dismissive of the chairman’s remarks, the idea of Greenspan not speaking in glowing terms about the derivatives markets was a shock let alone speaking ill or warning about a debacle. Greenspan has consistently championed the derivative markets.

Greenspan has also been continually warning about the risk posed by Fannie Mae and Freddie Mac to the economy and financial markets. As recently as May 19 to the Conference on Housing, Mortgage Finance, and the Macro economy at the Federal Reserve Bank of Atlanta the Fed Head said:
"Huge, highly leveraged GSEs subject to significant interest rate risk are not conducive to the long-term financial stability that a nation of homeowners requires."

It should be noted that the Government heeded Greenspan words and on May 25th. The House passed legislation to curb the portfolio’s of the two financial behemoths. The Senate is expected to follow.

To hear the Fed Head give the markets is a warning is good, but it is also hypocritical. It has been Greenspan’s policy of easy money and bailouts that have fueled the fires or speculation. We have a housing bubble because he kept interest at record lows for years to help the economy which was sufferring from the effects of the burst stock market bubble, that he created. If Fannie Mae is too big, the cause is his consistently championing free markets and his negligence in his position as ‘omnibus supervisor of the financial services industry'. As for risk in the derivatives market–he has been the derivatives market’s guardian angel, preaching the ‘good word’ to all that would listen. Hearing the Fed Head give his oracles of potential doom is like hearing the arsonist yelling fire.

When Greenspan gave his first oracle of warning in 1996 the market’s gave pause and his words reverberated around the globe. Today he issues several proclamations and there is no pause.

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