Frederick J. Sheehan
Fsheehan@aucontrarian.com
Website: AuContrarian.com

April 1, 2010

Mr. Phil Angelides, Commission Chairman
Financial Crisis Inquiry Commission
1717 Pennsylvania Avenue, NW
Suite 800
Washington, DC 20006-4614

Dear Chairman Angelides:

I am writing in regard to the Financial Crisis Inquiry Commission's April 7-9, 2010, public hearing, "Subprime Lending and Securitization and Government-Sponsored Enterprises (GSEs)." Specifically, the following is written to help you examine Alan Greenspan.

Enclosed please find a copy of my book, Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession. I am also co-author of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.

In preparation for writing these books, I read ten years of Federal Reserve Open Market Committee (FOMC) transcripts, Congressional and Senate testimony over the same period, and Chairman Greenspan's speeches, interviews and articles that he wrote back to 1959 (New York Times, Wall Street Journal, Fortune, U.S. News and World Report, Newsweek, Time and others). I have followed much of his public self-vindication since his retirement from the Federal Reserve Board.

This letter addresses three areas. First, Alan Greenspan and the Government-Sponsored Enterprises (GSEs). This includes how the GSEs changed the American economy. Second, Alan Greenspan's promotion of toxic mortgage products. Third, the Federal Reserve's influence on the topics you are addressing on April 7-9. Although the role of the Federal Reserve is not, per se, the subject of the April 7-9 hearing, the Fed prints the nation's money and, for the most part, has the ability to limit the amount of credit in the economy.

1 - Alan Greenspan and the Government-Sponsored Enterprises

Alan Greenspan deserves recognition for his attempts to harness Fannie Mae and Freddie Mac. His first warning about the GSEs explosive growth was on February 24, 2004, before the U.S. Senate Committee on Banking, Housing, and Urban Affairs. He also urged reform at a conference sponsored by the Federal Reserve Bank of Atlanta on May 19, 2005. I quote and discuss the importance and timing of these warnings on pages 266-270 of my book Panderer to Power.

I think Alan Greenspan should explain to you why he waited until 2004 before issuing his first warning. If he is asked this question directly, Greenspan will state you are incorrect. He may cite a previous occasion or occasions when he issued such advice. If so, the speech or testimony should be read. This advice applies to any topic.

Chapter 22 of Panderer to Power lays out the reason I would ask why he waited until 2004. Without GSE expansion, the home mortgage market could not have grown to dominate the U.S. economy. (Northern Trust estimated that, between 2001 and 2006, 40% of new jobs were related to housing.) Fannie and Freddie were vacuum cleaners for the nation's mortgage finance growth. In 1995, home mortgage debt increased by $153 billion; in 2000, by $380 billion; in 2005, by $1.1 trillion.

In 1990, the value of Fannie Mae's and Freddie Mac's combined mortgage portfolio was $132 billion. In April 2003 - a single month - Fannie Mae (alone) bought $139 billion of mortgages. The mutation of Fannie and Freddie played a large role in the mutation of the U.S. economy.

Chapter 22, "The Mortgage Machine," integrates the parties who contributed to the housing wreckage: the non-bank mortgage companies, the commercial banks (writing and selling mortgages) the investment banks (securitizing mortgages and funding the growth of the non-bank mortgage companies), the GSEs (packaging mortgage securities and funding subprime lenders, banks and non-banks), the Office of Federal Housing Enterprise Oversight (which mishandled its role as GSE supervisor), members of Congress (who prevented OFHEO from performing its function), the Securities and Exchange Commission (which removed the 12:1 leverage limit on brokerage houses and allowed Lehman Brothers - among others - to expand their mortgage and mortgage-security holdings to a leverage ratio of over 30:1), technology (derivatives, accounting, and the ability to process loan requests in 12 seconds) and the negligence of all of the government agencies with authority over financial institutions (widespread fraud was front page news in the Wall Street Journal in 2001.) This is only a partial list of the parties discussed in Chapter 22.

In Panderer to Power, my exploration of the housing bubble veers towards the earlier years, 2001-2003. I did this to show that someone in a position of authority who picked up the morning newspaper had to know the Mortgage Machine should be reined in. Aside from fraud, the terms of loans and the incapacity of home buyers to pay their mortgages was a common newspaper topic by 2002. (I quote some of these in my book.)

I chose this emphasis after hearing Alan Greenspan state on 60 Minutes (October 3, 2007): "While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late. I really didn't get it until very late in 2005 and 2006."

You might expect this sort of answer on April 7. It is not credible.

The absurdities in the housing market were already a source of laughter at FOMC meetings in 2002. On November 2, 2002, Atlanta Federal Reserve President Jack Guynn told the FOMC: "The south Florida housing market would have to be characterized as red hot. One director reported that when a moderately priced development on the west coast of Florida opened, demand was so great that sales had to be limited to three homes per customer. That's a semi-true story. [Laughter]"

2 - Alan Greenspan Used his Position to Sell Toxic Mortgage Products

More important than his knowledge was how Greenspan used his testimony and speeches to sell the mortgage bubble. I will restrict my discussion to two of his sales talks.

On February 23, 2004, Greenspan spoke to the National Association of Homebuilders. He claimed the "traditional fixed-rate mortgage may be an expensive method of financing a home" and "[m]any homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages over the past decade."

Greenspan will deny this speech influenced the mortgage market. It did. He was still a demigod to a large part of America. The title of an article in the February 24th Wall Street Journal read: "Fed Chief Questions Loan Choices." Quoting the first sentence of the story: "In a rare evaluation of the interest rate options that households face, Federal Reserve Chairman Alan Greenspan questioned whether homeowners are well-served by popular fixed-rate long-term mortgages." Realtors quoted Greenspan in their sales materials. Adjustable-rate mortgages rose from 2% of mortgages in California in 2002 to 47% in 2004 to 61% in 2005. It is a fair though unanswerable question how much Greenspan contributed to the current fiscal problems in California.

Alan Greenspan has run away from this speech since retirement. Here is an excellent example of how he will dodge responsibility when he appears before the Financial Crisis Inquiry Commission.

An interviewer questioned Alan Greenspan about his February 23, 2004 speech at a January 2008 conference in Canada. Greenspan told the interviewer "I strongly clarified my remarks" regarding adjustable-rate mortgages in a speech on March 2, 2004 and "[s]o I plead not guilty." The transcript of the March 2, 2004, speech to the Economic Club of New York shows no mention of mortgages. He may have discussed adjustable-rate mortgages after the speech, but this certainly did not clarify his remarks to the public.

Greenspan made another attempt to extricate himself in February 2008. Greenspan told an audience in Sweden his warning (or retraction or however he planned to style it) was not in New York but in Chicago on May 6, 2004. This trail was not worth pursuing.

When he responds to your questions in like fashion, the transcript of his original remarks should be read.

Another of Greenspan's speeches worth reviewing is an address to the American Bankers Association on September 26, 2005. By this late date, it was not enough to encourage adjustable-rate mortgages. To sell mortgages, and feed the Mortgage Machine, Chairman Greenspan discussed "a long list of novel mortgage products" such as 40-year loans, option ARMs, piggyback mortgages and HELOCS used as piggyback loans. Greenspan told his listeners he was not "worr[ied] that homebuyers are especially exposed to reversals in house prices."

This was quite a conclusion since he also told the American Bankers Association: "We can have little doubt that the exceptionally low level of home mortgage interest rates has been a major driver of the recent surge of home building and home turnover and the steep climb of home prices."

It seems likely that the nation's leading banking regulator made these speeches before the National Association of Homebuilders and the American Bankers Association for a reason. Builders and bankers received Greenspan's implicit encouragement to continue to build and to lend.

3 - The Federal Reserve is Cause, Not Effect, for Abuses in Subprime Lending

There would have been no lending of any sort without the Federal Reserve. The Fed prints the money that enters the economy. It has a monopoly. Counterfeiters know that.

Credit springs from money. The commercial banking system produces credit, by and large. The Federal Reserve sets reserve requirements on commercial bank credit growth. If the Fed sets the bank reserve ratio at 10:1, a bank cannot lend more than $10 for every $1 on deposit. That effectively limits the growth of credit.

The Federal Reserve has the authority to increase or decrease bank reserve requirements at any time. During Alan Greenspan's chairmanship, the Fed reduced bank reserve requirements several ways; it never increased them. The result of the Greenspan Fed's money and credit expansion: commercial banks, having run out of proper projects to fund, lent to investment banks, hedge funds, private-equity funds, subprime mortgage lenders, and commercial property speculators. (An investment bank may have lent to a non-bank mortgage company, but it first had to borrow from the commercial banking system.)

The Federal Reserve, under Alan Greenspan, both printed every dollar that entered the economy and had sole authority to set bank reserve requirements. If the Fed had reduced reserve requirements, this would have restricted the lending that proved so destructive.

I would anticipate a rebuttal from Alan Greenspan. He spent his Federal Reserve chairmanship distracting committees by turning money and credit into a quagmire of confusion. There is, of course, much more than I have written above for a full understanding of money and credit, but Alan Greenspan will not attempt to enlighten the commission. The paper he recently presented at the Brookings Institute was a grab bag of unrelated hypotheses that never mentioned the relationship between the Federal Reserve, money and credit. The role and influence of the Federal Reserve can be explained in plain English.

He may attempt to respond to questions of money and credit with another argument, which could be phrased as follows: "We live in a global economy with a global financial system. The Federal Reserve does not have as much control as you claim." This is a specious argument. In reality the dollar is still the world's reserve currency. As the world's reserve currency, it is only the United States that can print money in any quantity it so desires.

Greenspan has attempted to dodge his responsibility as Fed chairman by talking about housing bubbles in twenty different countries. No, there was a housing bubble in the United States that we exported by printing money that was then shipped overseas to pay for goods. When these dollars were converted into local currencies, the excess credit led to the twenty housing bubbles.

I hope my letter is of service. Please let me know if I can offer instruction or advice, either for the current or later hearings.

Sincerely,