A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Monday, September 24, 2007

My Beef with Greenspan: A Picture is Worth a Thousand Words

Don't you get the feeling that Alan Greenspan, in his last 5 years at the helm of the Federal Reserve, was the financial equivalent of Indiana Jones at the beginning of Raiders of the Lost Ark, with the boulder barreling after him being the over-inflated, debt-riddled Economy that he created. Like Jones, he managed to escape just in time (via retirement in Greenie's case). Boy do I feel badly for Bernanke, who is left to clean up his mess.

I have yet to read his book, but I find it amazing that Easy Al continues to downplay his role in inflating the housing bubble. He credits "low worldwide long-term interest rates" for that. He fails to mention that he set in motion the mechanism that created low long-term interest rates in the first place.

It goes something like this:

1. Fed drops Fed Funds Rate to 1% (practically paying banks to take its money after inflation is accounted for).

2. Foreign central banks drop their target rates to preserve the dollar's value vs. their currencies (so we can keep borrowing to buy their stuff, supporting their economies).

3. Ridiculously low interest rates spur massive increase in the global money supply (money is "created" via lending - e.g...
1. Fed "creates" $10 in Open Market Operations by lending to a bank to defend its 1% Fed Funds target (without the Fed constantly buying, the lending rate would go up as banks would require higher interest rates - at least high enough to cover inflation),

2. The bank lends $7 to someone (person B) who pays person C $7 for an item.

3. Person C deposits $7 in the bank.

4. The bank lends $4 to Person D... and so on and so forth.

Just in these four steps, the Fed's $10 turns into $21 (known as the multiplier effect).

4. U.S. spends a lot of this newly created money on imports (huge trade deficit), making foreign countries RICH!

5. RICH! foreign countries invest their surpluses (paid for by our huge debt splurge) in nice, safe T-Bills, Notes and Bonds, keeping interest rates nice and low so we can continue borrowing to buy foreign goods, making foreigners RICH!

The long and short of it: create a bunch of money, and all of that money chases the same lending opportunities. If you want to lend, you have to offer a good rate (lest the coveted borrower take someone else's monopoly money). As such, massive monetary inflation will keep rates low.

Take away Greenie's step 1., above and you don't get low long-term interest rates, a housing bubble, and most importantly this mortgage mess that Uncle Ben is trying to clean up. Uncle Ben is also trying to do this housekeeping with the politicos on the Hill trying their best to foul things up with short-sighted policy measures in order to win votes for next year's elections.

Greenspan's legacy is pretty much summed up in the following chart (click for a larger image). M3 is the broadest measure of the money supply (which the Fed conveniently stopped reporting after it completely lost control of its growth).

The Fed has aided money creation at a 9% annual rate since about 1995 - massive monetary inflation as stated above - All of that money had to go somewhere, luckily it has been in assets so far (where next?)...

Can you say... slosh - TECH BUBBLE - slosh slosh - HOUSING / CREDIT BUBBLE - slosh slosh slosh - EXPLOSIVE INFLATION? Let's hope not.

Friday, September 7, 2007

Great Housing Article from Seeking Alpha's Markham Lee

After reading an article from a fellow Seeking Alpha contributor with Case-Schiller housing appreciation data for the 1990s and for the ‘00s thru May of this year, I began to wonder how the data would look if: