Congress Throws Fat into the Fire
Congress could not resist throwing money at the mortgage market. In 2003, Representative Robert Ney, chairman of the House Financial Services Housing Subcommittee, proposed a bill in which first-time U.S. home buyers would be permitted to buy a house without making a down payment. Under the “zero down payment” bill, people who sought Federal Housing Administration–insured loans would be able to add the down payment and closing costs into their loan amount. Ney decried the fractured American dream: “Many people who can afford monthly payments in a home save for years to come up with the down payment.” Ney wanted Americans to buy overpriced houses “ten years earlier.” He added, “It’s good for their families and good for their communities.”63 (In 2007, Congressman Ney would be sentenced to a 30-month jail term for, among other offenses, a “longterm pattern of defrauding the public of his unbiased, honest services as an elected official.”64 Convincing the public it deserved to own houses it could not afford would have fit the description, but was not what the court had in mind.)
60 Anthony Faiola, Ellen Nakashima, and Jill Drew, “What Went Wrong,” Washington Post, October 15, 2008. Also see “Joint Statement by Treasury Secretary Robert E. Rubin, Federal Reserve Chairman Alan Greenspan and Securities and Exchange Commissioner Arthur Levitt,” dated May 7, 1998. Also see Treasury Deputy Secretary Lawrence H. Summers, Testimony Before the Senate Committee on Agriculture, Nutrition, and Forestry on the CFTC Concept, Release, July 30, 1998.
61 Husack, “Trillion-Dollar Bank Shakedown Bodes Ill for Cities.”
62 Kahn, “Former Treasury Secretary Joins Leadership Triangle at Citigroup.”
Home ownership was integrated into President Bush’s public appeal for a second term. He decided that 70 percent of Americans should own a house. (The ratio of owners to renters had been 60 to 65 percent over the past few decades.) In a July 14, 2004, reelection pep rally, he told his Waukesha, Wisconsin, audience: “Homeownership rate [sic] is at an all-time high. That’s a fantastic statistic, isn’t it? We want more people owning their own home. When you own something you have a vital stake in the future of the United States of America.”65 He made it sound like a ball game with the whole nation rooting for a .700 batting average.
Productivity of the Mortgage Bankers [T]his productivity growth really reflects higher productivity in the mortgage banking industry, … that’s real productivity.66—FOMC staffer at the December 2002 FOMC meeting
Greenspan’s “months weeks, days” refrain not only proved true but was necessary to accelerate the volume of mortgage trading. Edward N. Jones, a former NASA engineer for the Apollo and Skylab missions, was interviewed by the New York Times: “[T]he old way of processing mortgages involved a loan officer or broker collecting reams of income statements and ordering credit histories, typically over several weeks. But by retrieving real-time credit reports online, then using algorithms to gauge the risks of default, Mr. Jones’s software allowed subprime lenders … to grow at warp speed.”67 The Times reported that “speed became something of an arms race, as software makers and subprime lenders boasted of how fast they could process and generate a loan. New Century Financial [of Irvine, California,] … promised mortgage brokers on its Web site that with its FastQual automated underwriting system, ‘We’ll give you loan answers in just 12 seconds!’” In 2001, New Century originated $6.2 billion of mortgages. This rose to $42.2 billion in 2004.68
63 Susan Schmidt and James V. Grimaldi, “Ney Sentenced to 30 Months in Prison for Abramoff Deals,” Washington Post, January 20, 2007.
64 Ney was sentenced for accepting benefits from lobbyists. “Statement of Assistant Attorney General Alice S. Fisher of the Criminal Division Regarding Congressman Robert W. Ney,” September 15, 2006; www.usdoj.gov. United States of America v. Robert W. Ney. United States District Court for the District of Columbia, September 15, 2006.
65“In His Own Words,” New York Times, July 15, 2004.
66 FOMC meeting transcript, December 10, 2002, p. 16.
The efficiency gains were comparable to Henry Ford’s assembly line: “With small staffs, the companies typically sell their software to home lenders with vast networks of call centers employing hundreds of thousands of loan officers. Some big Wall Street banks and housing lenders bought the software, then developed their own systems.”69 The Times quoted Scott Berry, executive vice president, artificial intelligence (that was his actual title) at Countrywide: “Without the technology, there is no way we would have been able to do the amount of business that we did and continue to do.”70
The stripping of the standards reduced the frictional costs of trading houses: a report from the West Coast in 2002 stated: “At Californiabased Countrywide Credit, owners with existing 30-year loans at around 7% have been able to refinance at 6% without paying a dime in closing costs—‘nirvana for homeowners,’ [said] Countrywide chief executive Angelo Mozilo. Countrywide is on pace to originate $170 billion in loans this year. ‘And it’s accelerating,’ said Mozilo[.]”71
As much as Americans take pride in the private sector’s efficiency, it was the government Brunhildes that set world records: “[T]he mortgage business has been transformed into a largely high-volume national market. Instead of holding on to mortgages, lenders tend to sell them in big bundles, often through government-sponsored financial firms Fannie Mae and Freddie Mac. In turn, Fannie and Freddie in the 1990s developed automated underwriting systems that allow quick approval of mortgages. Often, customers are asked for little more than a credit report, a pay stub, a bank statement and a few tax forms. These changes turned selling mortgages into a commodity business[.]”72This was written in 2003. The request for a credit report, a pay stub, a bank statement, and a few tax forms would soon look antiquated.
67 Lynnley Browning, “The Subprime Loan Machine,” New York Times, March 23, 2007.
68“Bearish on New Century,” Grant’s Interest Rate Observer, June 17, 2005, p. 2.
69 Browning, “The Subprime Loan Machine.”
70 Ibid.
71 Sean Corrigan, Daily Reckoning, August 22, 2002; www.dailyreckonong.com. Corrigan is quoting an interview of Mozilo from the Charleston Daily Mail.
The Daily Crime Report
The daily papers were full of crime reports. Appraisal fraud was pushing the sales prices of some houses up by 30 percent: The Washington Post reported that “[n]early 75 percent of licensed appraisers interviewed as part of the ongoing National Appraisal Survey said they had felt pressure from a mortgage broker in the past year ‘to hit a certain value.’” And 59 percent reported similar pressure from a loan officer working for a lending institution or mortgage company.73 From the Wall Street Journal in 2001: “Appraisers are frequently encouraged to fudge the numbers.”74 In 2002: “Rising House Prices Cast Appraisers in a Harsh Light: Inflated Valuations Figure in More Mortgage Fraud; Buyers, Banks are Victims.”75
Greenspan’s testimony was regularly used to sell houses. David Seiders, chief economist of the National Association of Home Builders, relayed the chairman’s forecast: “The time has come to put this issue to rest. The nation’s home builders have said it … and now Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble.”76
72 John Hechinger, “The Refinancing Boom Spells Big Money for Mortgage Brokers; Huge Fees Draw the Scrutiny of Regulators and Spawn Lucrative Small Companies; From Machinist to Millionaire,” Wall Street Journal, February 24, 2003.
73 Kenneth R. Harney, “Many Appraisers Pressed to ‘Hit the Number,’” Washington Post, September 13, 2003.
74 Patrick Barta, “Is Appraisal Process Skewing Home Values? Appraisers Are Frequently Encouraged to Fudge the Numbers,” Wall Street Journal, August 13, 2001.
75 John Hechinger, “Shaky Foundation: Rising Home Prices Cast Appraisers in a Harsh Light:Inflated Valuations Figure in More Mortgage Fraud; Buyers, Banks Are Victims,” Wall Street Journal, December 13, 2002
.
Home mortgage debt increased by $800 billion in 2003, and by $1.1 trillion in 2005.77 There was no turning back. House prices had to keep rising to unburden those of houses they could not afford. Rising prices were the incentive to draw traders into the market. The mortgage machine needed to increase its production, or it would collapse.
76 “Housing Groups Refute Housing ‘Bubble,’ Laud Greenspan Testimony,” Business Wire, July 22, 2002.
77 Federal Reserve Flow-of-Funds Accounts, Z-1, Historical Data Tables.
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23
Greenspan’s Victory Lap: His Last Years at the Fed
2002–2006
That the economists . . . can explain neither prices nor the rate of interest nor even agree what money is, reminds us that we deal here with belief not science.
—James Buchan, author of Frozen Desire (1997)1
On February 27, 2002, the Senate Banking Committee attended a forecasting session conducted by Chairman Greenspan. He declared himself “guardedly optimistic” of economic growth. The politicians and the press furrowed their brows. On March 7, Greenspan’s optimism was back on track. To quote the headline from the New York Times: “What a Difference a Week Makes: After Recent ‘Maybe,’ Greenspan Now Says Recovery Is On.”2 It required the top of the crop to interpret for the Times: “A close parsing of Mr. Greenspan’s words shows a slight but nonetheless significant change in his discussion of the labor market, said Jan Hatzius, senior economist at Goldman Sachs. Last week, Mr. Greenspan said performance of the labor market ‘is’ expected to lag. This week he said this performance ‘was’ expected to lag. ‘In discussing the labor market’s deterioration, he
1 James Buchan, Frozen Desire: The Meaning of Money (London, Picador, 1997), p. 180.
2 Gretchen Morgenstern, “What a Difference a Week Makes,” New York Times, March 8, 2002.
283
presented the view that he was talking in the past tense,’ Mr. Hatzius said.” These arcane distinctions could melt down markets, though Greenspan had not yet addressed the Nasdaq bubble.
Infamous Speeches: Number One
In March 2002, Greenspan gave a speech in which he again discussed Wall Street analysts—he scolded them: “The sharp decline in stock and bond prices following Enron’s collapse has chastened many of the uncritical practitioners of questionable accounting.”3 This was spoken by the most uncritical practioner of all, and he did not sound a bit chastened. (Nor did he mention the Enron Prize for Distinguished Service.) As for this “sharp decline in stock and bond prices following Enron’s collapse,” prices had gone up. From the previous October, the Nasdaq had risen about 5 percent. This may have been a furtive attempt to blame the stock market’s problems on Enron.
Then he really let the analysts have it: “[L]ongterm earnings forecasts of brokerage-based securities analysts, on average, have been persistently overly optimistic. Three-to five-year earnings forecasts for each of the S&P 500 corporations . . . averaged almost 12 percent per year between 1985 and 2001. Actual earnings growth over that period averaged about 7 percent.”
Almost anyone with experience knew that this was true before Greenspan started serenading analysts’ forecasts in the previous decade. Given the 1985 starting date, Greenspan’s productivity charade was build on estimates that had already produced 13 years of incompetence (1985 to 1998) by the time he insisted that they proved his hypothesis. The chairman continued to lash out: “[T]he persistence of the bias year after year suggests that it more likely results . . . from the proclivity of firms that sell securities to retain and promote analysts with an optimistic inclination. Moreover, the bias apparently has been especially large when the brokerage firm issuing the forecast also serves as an underwriter for the company’s securities.”
Greenspan was by no means the only celebrity without regrets. On August 1, Glassman and Hassett asserted their credentials: “When our book, ‘Dow 36,000,’ was published in September, 1999, the Dow Jones Industrial Average stood at 10,318. The Dow closed yesterday at 8,736. What went wrong? Actually, nothing.”4
3Alan Greenspan, “Corporate Governance,” speech at the Stern School of Business, New York University, New York, March 26, 2002.
Speech Number Two
Each year, the Kansas City branch of the Federal Reserve System holds a late-summer symposium in Jackson Hole, Wyoming. The discussions are meant to be more reflective than immediate. Chairman Greenspan’s 2002 contribution is still cause for reflection. It deserves an entire chapter. It was the most lamentable speech of his career.
He claimed that the “struggle to understand developments in the economy and financial markets since the mid-1990s has been particularly challenging for monetary policymakers. We were confronted with forces that none of us had personally experienced. Aside from the recent experience of Japan, only history books and musty archives gave us clues to the appropriate stance for the policy.”5
The man who preened about his 50 years of market experience now admitted that his accumulated knowledge was useless. Since he, the FOMC, thousands of Federal Reserve studies, and the Federal Reserve models were useless, why were economists on the payroll?
The chairman continued. The Fed “considered a number of issues related to asset bubbles—that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact— that is, when its bursting confirmed its existence.”
There is little point in discussing this. He knew exactly how to prick a bubble in 1994, 1995, and 1996, but then hid in the tall grass. His memory lapse also applies to the following Jackson Hole assertion:
“The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion.”6 Again, his mid-1990s actions and statements show that he held the opposite view.
4 James K. Glassman and Kevin A. Hassett, “Dow 36000 Revisited,” Wall Street Journal, August 1, 2002.
5Federal Reserve Bank of Kansas City’s Annual Economic Symposium, “Economic Volatility,” Jackson Hole, Wyoming, August 30, 2002.
6 Ibid., p. 3.
Greenspan continued to rewrite history, his own history: “Some have asserted that the Federal Reserve can deflate a stock-price bubble— rather painlessly—by boosting margin requirements. The evidence suggests otherwise.” He clung to this “rather painlessly” qualification again and again. This had been the biggest stock market bubble in the history of the world. Nobody in his right mind would make such a statement.
The Economist commented: “[T]he correct test is not whether a bubble can be deflated without some loss of output. Rather, it is whether the early pricking of a bubble causes less pain than letting it grow only to burst later. The longer a bubble is allowed to inflate, the more it encourages the build-up of other imbalances, such as too much borrowing and investment, which have the power to turn a mild downturn into something nastier.”7
Greenspan’s speech met some resistance, but was generally accepted as gospel. Still, he may have found the Jackson Hole speech was not quite the success he had expected. He launched a two-pronged attack from the podium for the rest of the year. First, an embellishment of his “can’t see a bubble” line. Second, a new emphasis on “price stability.”
Speaking to the Economic Club of New York on December 19, 2002, the chairman rationalized his inaction from a different angle: “The evidence of recent years, as well as the events of the late 1920s, casts doubt on the proposition that bubbles can be defused gradually.”8
This contradicted the chairman’s “Gold and Economic Freedom” essay of 1966. It is reasonable to suppose he may have changed his mind. But that is not so. Congressman Ron Paul handed Greenspan a copy of his essay and asked if he would like to add a disclaimer. Greenspan replied with uncharacteristic candor: “No. I reread this article recently—and I wouldn’t change a sing
le word.”9
7 “To Burst or Not to Burst,” Economist, September 7, 2002.
8 Alan Greenspan, speech to the Economic Club of New York, New York, December 19, 2002.
9William Bonner and Addison Wiggen, Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (Hoboken, N.J.: Wiley, 2003), p. 159.
Terrorizing the American People— Great Depression II
On June 25, 2003, the FOMC cut the funds rate to 1.00 percent. This was as low as it would go until December 18, 2008. Three-month Treasury bills traded at 0.90 percent, the lowest yield in nearly half a century.10 It is said that Americans know very little history, but of one sequence, three-quarters of a century back, Americans come mentally equipped: the 1929 stock market crash was followed by the Great Depression. Ergo, a deflation and a depression go hand in hand.
The Fed was more interested in pumping up the housing market, but it tactfully developed its depression thesis. New theses were never hard work. Whatever the Fed said, was. It controlled the debate, talked it up, then down. Greenspan may not have made the front cover of People magazine—then again, maybe he has—but he defined what economists and Wall Street debated.
Greenspan’s emphasis on price stability is a case in point. It was by no means true that central banks had, in the past, targeted only the prices of goods and services (a glance through William McChesney Martin’s speeches is a case in point), but now, if one were to hear a Fed official, economist, or the media, this sole focus was writ in stone.
Speeches by Federal Reserve governors linked deflations with depressions. We needed inflation. This was new to the FOMC’s table of woes, but now the man who wrote the book (at least part of it) was sitting at the table: Inflation Targeting: Lessons from the International Experience (Princeton University Press, 1999).11 According to Professor Bernanke the economy needed positive price inflation to prevent deflation. Now was the time to test his thesis on a laboratory of 300 million Americans.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 31