Less maestro, more ingénue | FT Alphaville

Less maestro, more ingénue

From Mr Alan Greenspan:

There are at least two broad and competing explanations of the origins of this crisis. The first is that the “easy money” policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today’s financial mess.

QED, surely.

The second, and far more credible, explanation …

Well, you can guess what comes next. A series of post-facto arguments rationalising away Greenspan’s the Fed’s guilt.

David Merkel at the Aleph blog has an excellent takedown.  As he points out, Greenspan’s argument – in a nutshell that the Fed determined that since 2002 the rates it set had no correlation to mortgage market rates – is pure obfuscation. Here’s Greenspan:

The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier — in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.

U.S. mortgage rates’ linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

Now we here at FT Alphaville do not subscribe to the view that Greenspan is solely to blame. But…

It was, of course, (not solely, but significantly) the Fed’s low interest rates that sparked the conditions necessary for such a disconnect – an event Greenspan waves away with a vague mists of time/”turn of this century” sleight of pen.  His conceit is basically that the development of  a “well arbitraged global market” was a break with the past that the Fed played no part in.

Therein the problem. Precisely because the Fed should have played a part. It should have recognised the huge macroeconomic changes afoot and it should have sought to navigate them.

Instead of which, the Fed stood passively by, nay, it saw what was happening and it recused itself. Turn Greenspan’s excuse around and it becomes a damning indictment: if the Fed realised in 2004 that it could not use its monetary policy tools to control the rapidly inflating US mortgage market, then why on earth did it do nothing for the next three years?

Related link:
Bernanke to take over the world – FT Alphaville