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Greenspan's Whopper

"You are wasting your life and your talents writing about Alan Greenspan every day," said an old friend.

For years, we have been working on Greenspan's obituary. As far as we know, the man is still in excellent health. But we do not want to be caught off guard. Maybe we could even rush out a quickie biography, explaining to the masses the meaning of Mr. Greenspan's life and work.

Perhaps our friend is right. But then again, we weren't doing anything special before we started keeping up with the Fed chairman. Besides, we see something in Alan Greenspan's career...his comportment...his betrayal of his old ideas...his pact with the Devil in Washington...and his attempt to hold off nature's revenge at least until he leaves the Fed...that is both entertaining and educational. It smacks of Greek tragedy without the boring monologues or bloody intrigues. Even the language of it is Greek to most people. Though the Fed chairman speaks English, of course, his words often need translation and historical annotation. Rarely does the maestro make a statement that is comprehensible to the ordinary mortal. So much the better, we guess. If the average fellow really knew what he was talking about, he would be alarmed. And we have no illusions. Whoever attempts to explain it to him will get no thanks; he might as well tell his teenage daughter what is in her hotdog.

We persevere anyway, more in mischief than in earnest.

The background: The U.S. economy faced a major recession in 2001 and had a minor one. The necessary slump he held off by a dramatic resort to central planning. The "invisible hand" is fine for lumber and poultry prices. But at the short end of the market in debt, Alan Greenspan's paw presses down, like a butcher's thumb on the meat scale. The Fed quickly cut rates to head off the recession. Indeed, never before had rates been cut so much, so fast. George W. Bush, meanwhile, boosted spending. The resultant shock of renewed, ersatz demand not only postponed the recession; it misled consumers, investors and businessmen to make even more egregious errors. Investors bought stock with low earnings yields. Consumers went further into debt. Government liabilities rose. The trade deficit grew larger. Even on the other side of the globe, foreign businessmen geared up to meet the phony new demand; China enjoyed a capital spending boom as excessive as any the world has ever seen.

What the Greenspan Fed had accomplished was to put off a natural, cyclical correction and transmogrify an entire economy into a monstrous ECONOMIC bubble. A bubble in stock prices may do little real economic damage. Eventually, the bubble pops and the phony money people thought they had disappears like a puff of marijuana smoke. There are winners and losers. But in the end, the economy is about where it began - unharmed and unhelped. The households are still there...and still spending money as they did before...and the companies still in business. Only those that leveraged themselves too highly in the bubble years are in any trouble - and they probably deserve to go out of business.

Even a property bubble may come and go with little effect on the overall economy. House prices have been running up in France, for example, at nearly the same rates as in America. But in France there is very little mortgage refinancing...or "taking out" of equity. The European Central Bank was repeatedly urged to lower rates in line with those in America. It refused to budge. Without falling rates, there was no "refi boom." Nor were European banks offering "home equity lines of credit." Property could run up...and run down...and the only people who cared would be the actual buyers or sellers, who either cursed themselves or felt like geniuses, depending on their luck.

But in Greenspan's bubble economy something remarkably awful happened. Householders were lured to "take out" the equity in their homes. They believed that the bubble in real estate priced created "wealth" that they could spend. Many did not hesitate. Mortgage debt ballooned in the early years of the 21st century - from about $6 trillion in 1999 to nearly $9 trillion at the end of 2004. Three trillion dollars may not seem like much to you, dear reader. But it increased the average household's debt by $30,000. Americans still lived in more or less the same houses. But they owed far more on them.

We had given up all hope of ever getting an honest word out of the Fed chairman on this subject when, in early February, in the year of our Lord 2005, the maestro slipped up. His speech was entitled "Current Account." Jet lagged, his defenses down, the poor man seems to have committed truth.

"The growth of home mortgage debt has been the major contributor to the decline in the personal saving rate in the United States from almost 6 percent in 1993 to its current level of 1 percent," he admitted. Thus, he did bring the up the subject. Then, he began a confession: The rapid growth in home mortgage debt over the past five years has been "driven largely by equity extraction," said the man most responsible for it. By this time, listeners were beginning to put Mr. Greenspan at the scene of the crime. And pretty soon, even the dullest economist in the room was adding 2 and 2. Mr. Greenspan lowered lending rates far below where a free market in credit would have put them. With little to be gained by putting money in savings accounts...and a lot to be gained by borrowing...households did what you would expect; they ceased saving and began borrowing. What did they borrow against? The rising value of their homes - "extracting equity," to use Mr. Greenspan's own jargon. The Fed chairman had misled them into believing that house prices increases were the same as new, disposable wealth.

But the world's most famous and most revered economist didn't stop there. He must have had the audience on the edge of its chairs. He confessed not only to having done the thing...but also to having his wits about him when he did it. This was no accident. No negligence. This was intentional.

"Approximately half of equity extraction shows up in additional household expenditures, reducing savings commensurately and thereby presumably contributing to the current account deficit.... The fall in U.S. interest rates since the early 1980s has supported home price increases," continues America's answer to Adam Smith.

People take money out of their homes. With this source of spending power available to them, they see no reason to save. Instead, they spend - often on foreign-made goods. With no savings available domestically, America must look overseas for credit.

"The obvious and most important point is that rapid growth of U.S. mortgage debt did not come out of thin air," comments Stephen Roach. "It was, of course, a direct outgrowth of the Fed's hyper-accommodation of the post-bubble era -- namely, short-term interest rates that have been negative in real terms for longer than at any point since the 1970s."

The crime of which Mr. Greenspan is guilty is fraud. Putting interest rates at an artificially low level, the Fed chairman intentionally misled Americans. Were it not for the Fed's low rates and easy lending policies, Americans wouldn't have thought themselves so rich. Their houses wouldn't have gone up so much; they wouldn't have taken out so much equity, because they wouldn't have had any equity to take out. They would have had to spend less, which would have reduced the U.S. current account deficit and diminished household indebtnedness.

"Lacking in job creation and real wage growth," explains Roach, "private sector real wage and salary disbursements have increased a mere 4% over the first 37 months of this recovery -- fully ten percentage points short of the average gains of more than 14% that occurred over the five preceding cyclical upturns. Yet consumers didn't flinch in the face of what in the past would have been a major impediment to spending. Spurred on by home equity extraction and Bush Administration tax cuts, income-short households pushed the consumption share of US GDP up to a record 71.1% in early 2003 (and still 70.7% in 4Q04) -- an unprecedented breakout from the 67% norm that had prevailed over the 1975 to 2000 period...At long last, Chairman Greenspan owns up to the central role he and his colleagues at the Federal Reserve have played in fostering these developments."

Our own Fed chairman, guardian of the nation's money...custodian of its economy...night watchman of its wealth...

How could he do such a thing? And yet he has done it. He turned a financial bubble into an economic bubble. Not only were the prices of financial assets ballooned to excess...so were the prices of houses...and so were the debts of the average household.

Where does it lead? The force of a correction is equal to the deception that preceded it. Mr. Greenspan's whopper must be followed by a whopper of a slump.


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