Monday, June 20, 2005

Fannie Mae Counter Punches Greenspan

Says Lax Lending Standards Cause of Housing Bubble
Cites Subprime Market–Area Fed Ignores

The Wall Street reported today ("Fannie Sees Higher Odds of Regional Busts’, Ruth Simon & John R. Hagerty, June 20, 2005) that Fannie Mae in report yet to be published "says the probability of housing busts has "risen sharply in certain parts of the country," partly because of looser lending standards."

Fannie Mae is implying that the Fed has been asleep at the switch because under its watch banks have lowered their borrowing requirements. While a variety of government and state agencies most notably the OCC (Office of Comptroller of the Currency ) monitor the banking industry it is ultimately the Fed that is the Head. Martin Mayer in The Fed (The Free Press 2001)notes such and states that the Fed is the "umbrella Supervisor" of the financial services industry that is the "first among equals regulator."

For over two years Greenspan has been on the attack sounding the warning alarm about the risk Fannie Mae and Freddie Mac’s loan portfolio’s present. Greenspan was even able to pursuade Congress to begin the process of passing legislation to curb Fannie and Freddie.

While many financial publications, several referenced on this blog, have noted that it has been the Fed’s easy money policy that contributed to the housing bubble this is the first, I know of, that says lax lending standards are also a contributing factor. Some would say that this is a moot point because it has been the Fed’s easy money policy that has led to the deterioration in credit standards. What is noteworthy is that this is arguably a counter punch from an organization under siege from Greenspan.

The Journal article notes that Fannie Mae sees several problem areas–the rise of subprime (lesser quality and less affluent borrowers) interest only loans, a rise in the loan to house value ratio to 91%, reduced documentation of the income and asset holdings of borrowers, etc..

It should be pointed out that the Fed has consistently turned a blind eye to the abuses in the subprime market as we and others have written about on numerous occassions. For example, the Fed does not monitor the market for fringe banking–a market into the hundreds of billions of dollars.

As Journal notes "The report (Fannie Mae) adds, however, that it is impossible to know whether there is a housing "bubble" until after the fact".

With all this jockeying about whether there is a bubble, or regional froth in the housing market and who is too blame will prove interesting when and if the bubble bursts. My bet is Greenspan won’t get the short end of the stick!

Thursday, June 16, 2005

Greenspeak–Fed is losing influence over markets

Greenspeak–Fed is losing influence over markets
Imbalances pose a risk that the Fed cannot manage

Recent comments by Fed Head Alan Greenspan were a shock because they appear to be an acknowledgement that he, the Fed, is finding that its ability to affect certain markets is diminishing. A big concern because the USA economy is facing major imbalances/bubbles –a budget deficit, a current account deficit, a housing bubble and more.

In speech at the IMF conference on Central Banking (June 6, 2005) the Fed Head noted that the historical relationship between short term rates, which the Fed controls, and long term rates has recently been severed ( ) :
"The pronounced decline in U.S. Treasury long-term interest rates over the past year despite a 200-basis-point increase in our federal funds rate is clearly without recent precedent. The yield on ten-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago. Moreover, despite the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period."

It should be noted that Oscar Yorda visiting scholar at the San Francisco Fed recently ( May 20, 2005) argued in the San Fran’s Economic letter; "that the Fed does influence long-term rates significantly." ( )

In his testimony before Congress, on June 9, 2005 Greenspan reiterated his concern over the diminished ability of short term rates to influence long term rates. The Fed Head then went on to note how this anomaly in long term yields was contributing to the housing bubble.

"That said, there can be little doubt that exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a "bubble" in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels."

Taken together Greenspan is saying that low long term rates (ten year yields) were helping fuel the housing bubble. That the Fed’s historical ability to influence long term rates through its primary policy tool of short term rates was not working. A steep rise in short term rates by the Fed has had no influence on long yields. In conclusion, to date the Fed has had no success in cooling the red hot housing market.

A host of arguments could be put forth against this conclusion, from questioning how much influence does the Fed really have on housing, to lower long rates are a function of lowered inflation expectations based upon the Fed’s aggressive policy of rate rises to snuff out inflation.
But the fact remains that in the face of aggressive rate rises by the Fed the housing market has and continues to rise.

To this Fed watcher this presents an unusual dilemma for Greenspan. We have a housing bubble and imbalances in several sectors of the economy as Greenspan himself admits, and the Fed finds that its policies are ineffectual?

The New York Times (‘Fed Chief Sees ‘Reasonably Firm’ Economy With Imbalances, June 9, 2005 by Edmund L. Andrews) noted that Greenspan admitted that there were imbalances and challenges ahead in his June 9, 2005 testimony to Congress:
"Today, Mr. Greenspan appeared to pay homage to those who have worried about the rising levels of debt and speculative behavior that are in part a result of the Fed's decision to slash interest rates from 2001 through June 2004."

Historically it has been the adroit moves by the Maestro himself to divert disaster through his policies and antics that have been his hallmark. When a crisis hit there was a solution. Whether it be the flood of liquidity after the 1987 stock market crash or with our most recent recession, to jawboning participants with the failure of Long Term Capital Management, to exploiting some wrinkle in the law as done with the Mexican crisis of 1994/95--Greenspan always found a way out of the mess.

Free marketeers may argue that this is all much ado about nothing. That more rate hikes are needed and that they will ultimately do their job. The Fed is still in control. Others such as myself would say that almost two decades of profligate policies under Greenspan are having their cumulative affect.

The chickens are coming home to roost and the Fed Head finds his ability to influence markets is waning. And he knows it!

Thursday, June 09, 2005

Journal--Greenspan's Medicine Creates More Problems--Amen!

In today’s (June 9, 2005) Wall Street Journal‘In Treating US After Bubble Fed Helped Create New threats’ Greg Ip notes how Greenspan’s prescription to fix the burst tech stock market bubble of 2000 may have compounded the problem:

"By many yardsticks, the Federal Reserve's response to the bursting of the stock and tech-spending bubbles in 2000 has been a remarkable success. The 2001 recession was mild and economic growth since has been brisk. Employment is up and inflation remains within the Fed's hallowed zone of price stability."

"But five years after the stock market's peak, the economy faces other threatening imbalances: a potential housing bubble, rock-bottom personal saving rates and a gargantuan trade deficit. And the Fed's post-bubble prescription bears some responsibility for all three. Fed officials acknowledge as much but say the alternatives were worse."


Ip then goes on to write how by pushing and keeping interest rates at 45 year lows the Fed encouraged individuals to spend, borrow more and not save. This spurred a housing bubble and created "mountains of debt’ for consumers and created a big IOU for the USA with foreigners.

The Journal then asks:
"After treating a bubble, how does the Fed manage the side effects of its medicine?"

Not to worry the article notes that "the Fed feels confident" it can resolve the imbalances it has created with minimal pain. This is frightening because those words have an eerie ring to the same confidence that the Bank of Japan had in late 1989 when it felt it could deflate the Japanese stock market bubble with minimal pain as well.

Mr. Ip then goes on to say that Chairman Greenspan believes, better yet, has faith, that the "invisible hand" will save us:
"Capitalist economies, Mr. Greenspan believes, always have imbalances but are also continuously reallocating resources and capital to correct them. Thus, imbalances seldom become crises. "The number of forecasts of far in excess of the number of crises that actually occur," Mr. Greenspan told a recent audience in Chicago. "There is something equivalent to an invisible hand which continuously is readdressing market imbalances to reach equilibrium.""

Now that is wishing, hoping and praying.

No one should be surprised that the Greenspan’s policy prescription to resuscitate the USA economy after the stock market crash has created even more trouble. We need only look to Fed Head’s tenure at the Fed to understand how we got here.
As we have consistently noted since the late nineties ( , ) Greenspan has been the "invisible hand" himself bailing out all that faced financial calamity beginning with the 1987 stock market crash and continuing with the burst stock market bubble of 2000. Greenspan’s prescriptions have done more than create imbalances..They created a moral hazard, a reckless cavalier attitude among CEO"S as noted by Warren Buffet and others,.....etc..

The Journal is correct that the medicine might be worse than the disease. It is. The problem is that we have had a lot of doses that go well beyond the 2000 stock market bubble bursting.

Of course Greenspan may be able to pull off another one before he leaves. But then again as a CPA I learned that ponzi schemes whether they be the case of Equitable Funding or Greenspan’s prescriptions they eventually get too big and the piper is eventually paid.

Monday, June 06, 2005

Fed Head Hypocrite at his Best!

Says Hedge Funds provide a valuable service to the market???
What about LTCM --Long Term Capital Management

Today in satellite delivered speech to the IMF conference in Beijing, China Fed Head Alan Greenspan was at his hypocritical best when in a speech about the anomaly of low long term interest rates he talked about the merits of speculators and hedge funds :

"I trust such an episode would not induce us to lose sight of the very important contributions hedge funds and new financial products have made to financial stability by increasing market liquidity and spreading financial risk, and thereby enhancing economic flexibility and resilience."

Give me a break.

In September of 1998 the world was in financial market melt down mode because of the speculative hedge fund LTCM had over-leveraged itself with third world debt, most notably Russian, and faced imminent collapse threatening to bring the rest of the financial world with it. Then NY Fed Head Corrigan cobbled a deal together by collaring all parties together in a closed room. Financial disaster was diverted for the moment. It was rumored that the Fed was extra keen to put a deal together because the daisy chain of catastrophe would get back to the big banks, which some in the market believed had not been properly supervised by the Fed. To now say hedge funds provide stability is blasphemous!

Perhaps the liquidity that the Fed Head is referring to is not market/trading liquidity, but the liquidity of easy money that has come from all of his bailouts of speculative excesses gone bust. There was the 1987 stock market crash, Mexico, LTCM, etc.. so much so that the Wall Street Journal called the 1990's the Decade of Moral Hazard. See my "The Enron Way a Creation of the Fed":

It is also hypocritical to hear the Fed talk about the service speculative hedge funds provide when he has been consistently chided Fannie Mae and Freddie Mac for their ‘supposed’ speculation....Is that because they provide liquidity to little folks in the housing market and not big rich fat cats. Not surprisingly the Fed has gone to great lengths to disrepute the claims by Fannie Mae that they provide a service to the less than well to do home buyers.... (See among others: )

To learn more about LTCM read the Cato Institute report on LTCM– ( )

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