Sunday, September 16, 2007

Alan Greenspan's View of Housing

Alan Greenspan was interviewed by the Financial Times in today's paper.

Not surprisingly, he indicated that the decline in house prices is "going to be larger than most people realize." However, he also warned that the Fed should be careful not to ease rates too aggressively because the risk of "inflationary resurgence" was greater now than when he headed the Fed.

The former Fed chairman said the current turmoil in financial markets was “an accident waiting to happen”.

He also noted that the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a “savings and loans disaster waiting to happen” because of the mismatch between their assets and liabilities. Mr Greenspan thought the issuance of asset-backed commercial paper ”is probably not going to get back to where it was.”

He also observed that collateralised debt obligations – securities that slice up and repackage loans to meet the risk-appetite of different investors – “will never get back to the levels and structures that they were, because now everybody knows you cannot price them”.

Mr. Greenspan, always enigmatic as chairman of the Federal Reserve has watched the economic world flow past him and remains aloof. He has shown long-held caution that investors are too complacent and too confident that steady economic growth will somehow be managed. Yet, it seems somewhat disingenuous to be as oblivious to today's credit market disasters that were sown by the reckless interest rate reductions that he himself orchestrated.

Let me take you back to testimony he delivered to the House Banking Committee Hearing on the Financial Services Modernization Act back in 1999:

"Technologically driven proliferation of new financial products that enable risk unbundling have been increasingly combining the characteristics of banking, insurance, and securities products into single financial instruments. These changes, which are occurring all over the world, have also dramatically altered the way financial services -- financial services providers operate in the way they deliver their products."

"In the United States, our financial institutions have been required to take elaborate steps to develop and deliver new financial products and services in a manner that is consistent with our outdated laws. Costs of these efforts are becoming increasingly burdensome and serve no useful public purpose. Unless soon repealed, the archaic statutory barriers to efficiency could undermine the global dominance of American finance, as well as the continued competitiveness of our financial institutions and their ability to innovate and to provide the best and broadest possible services to U.S. consumers."

"Ad hoc administrative responses to these market forces lead to inefficiencies and inconsistencies, expansion of the federal safety net, potentially increased risk exposure to the Federal Deposit Insurance Funds and a system that will undermine the competitiveness and innovative edge of major segments of our financial services industry."

"Moreover, affiliation with banks need not, indeed should not, create bank-like regulation and affiliates of banks. This shift in supervisory mode, which is already underway, is market driven."

Here is another interesting Greenspan quote before a Senate Committee on Banking, Housing, and Urban Affairs in 2004:

"The key to developing secondary markets was securitization, and Fannie and Freddie played a critical role in developing and promoting mortgage securitization, the process whereby mortgages are bundled together into pools and then turned into securities that can be bought and sold alongside other debt securities. Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending."

"Asset-backed securities and the secondary markets in which they trade generally provide both households and businesses with excellent access to credit at an appropriate risk-adjusted interest rate. Moreover, credit supply is far more stable today than it was because it is now founded on a much broader base of potential sources of funds. The aspiring homeowner no longer depends on the willingness of the local commercial bank or savings and loan association to hold his or her mortgage."
As the newspaper, The Australian observed: Alan Greenspan's new book is called The Age of Turbulence but the former Federal Reserve chairman has so many critics these days it might appropriately be subtitled, The One That I Caused.

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