Friday, August 26, 2005

Greenspan’s “Strongest Warning in Years”?

Resorting to Jawboning When Policy is Impotent
The Perfect Storm

Reports coming out of the Greenspan Love Fest in Jackson Hole–the conference is titled "Greenspan Era: Lessons for the future"–are consistently interpreting the Fed Head’s comments as a strong warning about asset prices and the economy. To read Greenspan’s text: .

Consider the words of Joseph Rebello of Dow Jones as reported in the Wall Street Journal, ‘Greenspan Warns on Danger of Growing Acceptance of Risk’ , August 26, 2005:

"Federal Reserve Chairman Alan Greenspan, saying the recent rise of stock
and house prices reflects an increased willingness by investors to accept risk,
warned Friday that this inclination could end badly for financial
"What they perceive as newly abundant liquidity can readily
disappear," Mr. Greenspan said in a speech at an annual conference of central
bankers. "Any onset of increased investor caution" could cause those prices to
drop and force investors to liquidate assets to repay debts. "This is the reason
that history has not dealt kindly with the aftermath of protracted periods of
low-risk premiums"
"The comments amounted to one of the strongest warnings
Mr. Greenspan has delivered about financial market risks in years. Ever since
his speech about "irrational exuberance" among investors caused markets to swoon
in 1996, Greenspan has been cautious about the way he has phrased such warnings.
In 1999, at the same central bankers' conference, he warned that the rise in
stock prices up to that point was both inexplicable and "extraordinary." The Dow
Jones Industrial Average peaked a few months later."

Whether Greenspan’s warning is his strongest in years is open to debate. What is not open to debate is the fact that Greenspan has taken it upon himself to buttress his rate rises with jawboning and increased rhetoric. For someone known for obfuscating he is certainly being direct.

It is abundantly clear that the Fed Head wants to cool things down–whether it be housing bubble or inflation.

As I have noted on several occasions–most notably with my June 9th posting–it is the FedHead himself that has created his own problems with his policy of loose money and bailouts.

A Perfect Storm
A perfect storm, one that goes well beyond the FedHead’s ability to temper, is brewing and helps explain why the Fed Head has resorted to increased jaw-boning.

Two days ago on August 24th the Wall Street Journal reported that foreign interest in derivative securities (GNMA’s,etc) linked to the housing market continues to grow in spite of rate rises and increased rhetoric about a housing bubble.

Ruth Simon, James Hagerty and James Areddy in ‘Housing-Bubble Talk Doesn’t Scare Off Foreigners’, August 24, 2005 write:

"Strong demand for mortgage-backed securities from investors world-wide is
allowing American lenders to make more loans -- and riskier ones -- in a way
that is helping prolong the boom in U.S. house prices."
"The cash pouring in
-- not only from U.S. investors but increasingly from Europe and Asia -- keeps
stoking the housing market even as the Federal Reserve Board continues to raise
interest rates, normally something that damps home prices. The market has shown
a few signs of slowing recently, and talk of a bubble has grown louder, but
prices continue to rise or remain at lofty levels as investors continue to
gobble up mortgage-backed securities and banks keep lending."

Home buyers have similarly resorted to creative financing schemes such as zero percent financing to buy homes.

Derivative securities, which Greenspan has consistently promoted and defended, whether they be new loan packages or creative instruments with teaser rates for buyers are diminishing the ability of the Fed to influence markets . They have until recently been impervious to rate rises.

The idea of global money influencing the USA economy because of exogenous factors can be directly related to our policy of open markets and free borders, something that Greenspan has promoted and defended. As the Journal notes foreigners don’t care about the bubble or Greenspan’s policy of rate rises.

Add a dash of easy money from the Fed that has lead to speculation and lower risk parameters that Greenspan has complained about. Throw in a massive deficit that came about because of President Bush’s large tax cut that Greenspan blessed and helped pass. Top it all off with a lot of hubris, unflinching faith in free markets, a moral hazard in investor’s psyche born from the Fed Head’s bailouts and you have a perfect storm.

A perfect storm that does not respond to conventional policies such as higher interest rates.

It is no wonder that Greenspan has begun to ratchet up his rhetoric. He like the rest of us is at the mercy of the market.


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