Anatomy of a Meltdown

There is an interesting three part series in the Washington Post on the U.S. Housing Bust. Part one is called "The Credit Crisis". Of course this blog has been talking about the credit crisis for years, while most of the mainstream press was in absolute denial. Greenspan, Bernanke, and the Treasury department were also (and still are) in denial as well.

Let's start with a chart by the Washington Post showing a timeline of the bubble.



click on chart for sharper image

Myth Of The Savings Glut

The above chat perpetuates the myth proposed by Bernanke that some sort of "savings glut" was responsible for the housing boom. This is of course complete nonsense. It is impossible to have "too much savings". Furthermore, much of that proposed "savings" is in reality Chinese printing presses running like mad, selling Yuan (Renmimbi) to buy dollars. This suppressed the value of the Yuan, kept Chinese exports flowing and allowed China to maintain its currency peg. These policies are also causing the Chinese economy to overheat, and a significant factor behind the rise in commodity prices.

For more on these ideas, please see Bernanke Blames Saving Glut For Housing Bubble.

Article Excerpts Point To Damning Indictment Of The Fed

Attitudes and policies by the Fed and the treasury department are what fueled this boom, no matter what Greenspan and Bernanke say to contrary. There are some damning quotes from the article and those are what I will focus on.

May 19, 2000
Treasury undersecretary Gary Gensler says subprime loans are "a good option when the alternative is no access to credit".

This has been proven wrong in spades.

Part 1 Boom Excerpts

September 2001

The government's efforts to counter the pain of [terrorist attacks and the dotcom] bust pumped air into the next bubble: housing. The Bush administration pushed two big tax cuts, and the Federal Reserve, led by Alan Greenspan, slashed interest rates to spur lending and spending.

Low rates kicked the housing market into high gear. Construction of new homes jumped 6 percent in 2002, and prices climbed. By that November, Greenspan noted the trend, telling a private meeting of Fed officials that "our extraordinary housing boom . . . financed by very large increases in mortgage debt, cannot continue indefinitely into the future," according to a transcript.

The Fed nonetheless kept to its goal of encouraging lending and in June 2003 slashed its key rate to its lowest level ever -- 1 percent -- and let it sit there for a year. "Lower interest rates will stimulate demand for anything you want to borrow -- housing included," said Fed scholar John Taylor, an economics professor at Stanford University.

The average rate on a 30-year-fixed mortgage fell to 5.8 percent in 2003, the lowest since at least the 1960s. Greenspan boasted to Congress that "the Federal Reserve's commitment to foster sustainable growth" was helping to fuel the economy, and he noted that homeownership was growing.

There was something very new about this particular housing boom. Much of it was driven by loans made to a new category of borrowers -- those with little savings, modest income or checkered credit histories. Such people did not qualify for the best interest rates; the riskiest of these borrowers were known as "subprime." With interest rates falling nationwide, most subprime loans gave borrowers a low "teaser" rate for the first two or three years, with the monthly payments ballooning after that.

Government-chartered mortgage companies Fannie Mae and Freddie Mac, encouraged by the Bush administration to expand homeownership, also bought more pools of subprime loans.

One member of the Fed watched the developments with increasing trepidation: Edward Gramlich, a former University of Michigan economist who had been nominated to the central bank by President Bill Clinton. Gramlich would later call subprime lending "a great national experiment" in expanding homeownership.

In 2003, Gramlich invited a Chicago housing advocate for a private lunch in his Washington office. Bruce Gottschall, a 30-year industry veteran, took the opportunity to pull out a map of Chicago, showing the Fed governor which communities had been exposed to large numbers of subprime loans. Homes were going into foreclosure. Gottschall said the Fed governor already "seemed to know some of the underlying problems."

Jan. 31, 2006.

Greenspan, widely celebrated for steering the economy through multiple shocks for more than 18 years, steps down from his post as Fed chairman.

Greenspan puzzled over one piece of data a Fed employee showed him in his final weeks. A trade publication reported that subprime mortgages had ballooned to 20 percent of all loans, triple the level of a few years earlier.

"I looked at the numbers . . . and said, 'Where did they get these numbers from?' "

Greenspan said he did not recall whether he mentioned the dramatic growth in subprime loans to his successor, Ben S. Bernanke.

Bernanke, a reserved Princeton University economist unaccustomed to the national spotlight, came in to the job wanting to reduce the role of the Fed chairman as an outsized personality the way Greenspan had been. Two weeks into the job, Bernanke testified before Congress that it was a "positive" that the nation's homeownership rate had reached nearly 70 percent, in part because of subprime loans.

Greenspan: "I looked at the [subprime] numbers . . . and said, 'Where did they get these numbers from?' "

Bernanke: Two weeks into the job, Bernanke testified before Congress that it was a "positive" that the nation's homeownership rate had reached nearly 70 percent, in part because of subprime loans.

Since then Bernanke has reversed course and is now blaming the "savings glut" for the housing bubble. Greenspan, in interviews is blaming the fall of the Berlin Wall while backtracking on his endorsement of ARMs and derivatives.

Neither is willing to say what is obvious to the entire rest of the world: The Fed, in a foolish attempt to bail out its banking buddies from bad dotcom and foreign loans, took a mildly bad situation and made an international disaster out of it.

Indeed, Fed actions in 2001-2004 have brought about the very deflationistic conditions they sought to prevent. Now, in accordance with the Fed Uncertainty Principle, the Fed is seeking additional powers instead of being disbanded entirely.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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