Friday, August 17, 2007

Greenspan: The Pot Calling The Kettle Black?

Among Alan Greenspan's most memorable sound bites as Chairman of the Federal Reserve was his description of the stock market as a symptom of "irrational exuberance." His 1996 warning was a bit pre-mature, the stock market correction didn't begin until four years later.

However, it should now be obvious that Mr. Greenspan was looking the wrong direction, as well as barking up the wrong tree, with his warning.

Rather than pointing to a market where the Fed's influence is indirect and its responsibility diffused, as it is with equities, the Chairman should have been paying a little more attention to the nation's credit markets, an area of direct influence and responsibility.

During his tenure, the flood of dollars into the banks flowing from Mr. Greenspan's printing presses sought its own level and almost immediately began floating the nation's real estate markets to levels never before dreamed.

The fuel that drove the historic inflation in residential home prices was debt, easy debt, encouraging investors to throw apparently unlimited amounts of paper dollars at tangible assets in the expectation of eternal increases in dollar values.

Just as the founding Rockefeller is said to have bailed from stocks when he received a hot tip from his shoe-shiner, so prudent investors should have limited their exposure to real-estate and real-estate lending when stories first appeared of school custodians in southern California qualifying for $500,000, no cash-down home mortgages.

As economist Robert Shiller's numbers make clear in the accompanying graph (click to enlarge), the real estate markets have a long way to go for correction. The eventual return to normal will be a matter not of days and weeks but of months and years. Every dime of that nearly $1 trillion correction will be wrung from the banks, investment banks and hedge funds—and their individual investors—that greedily lapped up the high-rates of return offered by the too-high octane mortgages.

Unfortunately, Mr. Greenspan's error is not the only cause of this difficulty, perhaps not even the largest. While the Federal Reserve provided the fuel, others set the course for the good Rocket Ship Credit using all the tools at their disposal, including cooked books and crooked applications. Investors haven't yet realized the depths to which they have been screwed by the chain of mortgage brokers, aggregators, packagers and investment houses, all of which were focused solely on their short-term profits, for which they have forfeited their reputations and long-term stability. The weaknesses deliberately baked into the subprime and Alt-A portfolios created and sold at ever-increasing velocities will not become apparent for some time yet. When they do, recriminations will follow.

While the bodies of some of the corporate small fry are beginning to litter the landscape, the carnage will include some of Wall Street's largest players before it is done.

The corrections and punishments that Congress or the regulators will eventually dish out will be too little, too late and probably, misguided. The marketplace will do a more accurate, more precise job correcting the errors as well as a delivering devastating punishment to those who lied and cheated their ways to commissions, bonuses and market capitalizations on the backs of those who now face the loss of a home.


Barbara said...

Don't you think that those who received those "no down payment, adjustable interest rate loans" should also bear some responsibility for poor planning?

Bob Leibowitz said...

You make a good point, with which I agree. Yes, each of us is responsible for our actions.

In this case, the consumers who made mistakes, whether driven by avarice, lack of experience, stupidity, inability to plan, etc., will each suffer. They will pay unexpectedly higher prices for the loans, some will lose their homes.

My point is that the number of consumers making such errors is immeasurably higher than it should be. Some of the increase is due to poor system design, more on that in a later post. Some of the increase is due to deliberate efforts on the part of the "professionals," people who gamed the system for their own rewards with complete disregard for their clients.

An analogy: My town has several traffic intersections where the accident rate is far above, by 10 to 30 times, what it should be. Are the drivers who have accidents there (as) responsible, compared to drivers at other, more normative intersections? We can parse the philosophical arguments till the end of time, their are strengths on every side. What we can certainly agree upon immediately, though, is to improve the intersections to reduce the number of accidents.

To carry it further: Suppose at several of the troublesome intersections we found people standing in the middle of the intersection, dressed with apparent authority, directing traffic with total disregard for other traffic, multiplying the fatality rate by a factor of 50, merely in order to increase their pay based upon increased traffic counts?

What burden on the driver? The engineering? The professional?

In our world, the driver is financially damaged, injured or worse, the engineer says "tut,tut," and promises to make it better someday, while the "professional moves on to a greener intersection.

The mortgage market of the past 20 years was poorly designed and allowed so-called professionals to scam billions of dollars from both the consumer and the investor.