Smoke and Mirrors

So, it's finally happening - the bubble has burst and the economy is in a melt down. This comes as no surprise to many of us. Paul Krugman anticipated it in August of 2005.

Well, last week Mr Greenspan warned us about the very condition his smoke and mirrors economics had created and Paul Krugman explains.
Greenspan and the Bubble

What he did say, after emphasizing the recent economic importance of rising house prices, was that "this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent." And he warned that "history has not dealt kindly with the aftermath of protracted periods of low-risk premiums." I believe that translates as "Beware the bursting bubble."

Like everything else, the economic policy of the Bush administration has been driven by politics. The so called "recovery" has not created new wealth, only debt and Alan Greenspan has been a good Republican soldier first and an economist last. A recovery based only on debt is not a recovery and can't be sustained. As Krugman points out Greenspan is now warning us about the very things he was encouraging less than a year ago.

But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: "While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely."

Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by "the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages." But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage."

If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath.

In June of 2005 Eric Englund discussed the The Austrian Theory of the Trade Cycle.

The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.

Since busts are not politically acceptable credit was eased to create a new boom:

Alan Greenspan, of course, would not tolerate a recession. Accordingly, the Federal Reserve went on a money and credit creation binge and eventually brought short-term interest rates down to 1% (in 2003). The Federal Reserve, in total, cut interest rates 13 times between 2001 and 2003. With interest rates so seductively low, Americans went on a borrowing and spending spree which pulled Uncle Sam out of the recession – at least for now.

As Murray Rothbard explains, in The Austrian Theory of the Trade Cycle, America’s debt-driven "prosperity" is a mirage built upon the opiate of easy credit. Alan Greenspan’s multiple interest rate cuts, as Dr. Rothbard conveys, is nothing new in the field of central banking:

… the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit.

Well nearly three years later many more are catching on.
How Real Was the Prosperity?
We're just beginning to figure out how much of the nation's recent growth was the result of a credit-induced frenzy. Here are some guideposts

The housing markets, of course, overshot as too many buyers took out subprime mortgages they couldn't afford. The outcome will be a decline in home values, with prices in some areas already down.

But the economic writedown is likely to go far beyond housing. Household spending, consumer debt, financial sector profits: All may need a retrenchment, sudden or gradual, to get back to sustainable levels. That's bad news for investors and the global economy, which still depends heavily on U.S. consumption for growth.

There may even be a reassessment of whether recent productivity gains were fueled by excess credit. If growth in productivity slows, the economy will stagnate, real wages will weaken, corporate earnings targets will be harder to meet, and inflationary risks will increase.

Hale "Bonddad" Stewart has more:
The Illusion of the Bush Economy's Growth is Revealed
The current mess was predicted but was politically inevitable.

But they left out the politics

The editorial board of the New York Times talks about the subprime crisis and tells us how it happened and who's to blame but leaves out why it happened.
A Crisis Long Foretold

An article in The Times on Tuesday by Edmund L. Andrews leaves no doubt that the twin crises of the subprime lending mess — mass foreclosures at one end of the economic scale and a credit squeeze afflicting the financial system — are rooted in the willful failure of federal regulators to heed numerous warnings.

The Federal Reserve is especially blameworthy. Starting as early as 2000, former Fed Chairman Alan Greenspan brushed aside warnings from another Fed governor, Edward M. Gramlich, about subprime lenders who were luring borrowers into risky loans. Mr. Greenspan’s insistence, to this day, that the Fed did not have the power to rein in such lending is nonsense.

In 1994, Congress passed a law requiring the Fed to regulate all mortgage lending. The language is crystal clear: the Fed “by regulation or order, shall prohibit acts or practices in connection with A) mortgage loans that the board finds to be unfair, deceptive, or designed to evade the provisions of this section; and B) refinancing of mortgage loans that the board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.”

Yet, the Fed did nothing as junk lending proliferated — including loans that were unsustainable unless house prices rose in perpetuity, riddled with hidden fees and made to borrowers who could not repay. Mr. Greenspan has said that the law was too vague about the meaning of “unfair” and “deceptive” to warrant action.

OK as far as it goes but why did Greenspan choose to do nothing? The answer is politics - the desire to keep the myth of a good economy going to keep the Bush administration and the Republicans in power. As I discussed in Booms are always followed by busts! the so called Bush recovery was never sustainable. Now Alan Greenspan is many things but stupid is not one of them and he had to know that. But he had to keep Bush and the Republicans in power for as long as possible to get the maximize the tax cuts for the wealthy elite. The best way to do that was to keep pumping air into the housing bubble and that's just what he did.

Thanks Alan

Well I'm a little poorer tonight. Not as poorer as I could be since only about 25% of my investments are in the US but still poorer. And I have Alan Greenspan and the Bush Administration to thank. In 2004 Greenspan was still pushing the "creative" lending packages that many were already were concerned about. The reason was to keep the bubble inflated through the 2004 election. Well Big Al's chickens have come home to roost. Of course ignoring the inevitable oil shortages since Reagan was elected has not helped any and neither has George W. Bush's mortgaging the country to finance his occupation of Iraq.
Stocks Tumble on Weak Dollar and Oil Prices

Stock markets were hit today by their second sharp sell-off in less than a week, sending the Dow Jones industrial average down 360 points to a level last seen in September, before the Federal Reserve cut interest rates.

Banks and brokerage firms led the steep declines as investors remained skittish about lingering fallout from the summer’s subprime mortgage crisis. The dollar hit a new low against the euro and analysts predicted a broad fourth-quarter slowdown in businesses and consumer spending.

The Dow industrials declined 2.64 percent, to 13,300.02, its lowest finish in nearly two months. The Standard & Poor’s 500-stock index tumbled 44.65 points, or 2.94 percent, to 1,475.62. The Nasdaq composite index fell 76.42 points, or 2.7 percent, to 2,748.76.

Stocks dropped from the opening bell and never recovered, with the sell-off accelerating in the final hour of trading. General Motors weighed down the Dow after announcing the biggest quarterly loss in company history. G.M. is considered something of a bellwether for the broader business climate.

Financial stocks were off by more than 3 percent for the day. Investors remain wary that investment banks will announce more write-downs of assets related to mortgage-backed securities.

When you see the train coming you should get off of the tracks. Politics won.

First Aid for Legacies

As George W. Bush tries to salvage what will be his own misrable legacy those associated with his administration are trying to do the same by distancing themselves from him. One of those is Alan Greenspan. As Paul Krugman points out it's too little too late. He had plenty of opportunities over the last six plus years and didn't.
Sad Alan’s Lament

When President Bush first took office, it seemed unlikely that he would succeed in getting his proposed tax cuts enacted. The questionable nature of his installation in the White House seemed to leave him in a weak political position, while the Senate was evenly balanced between the parties. It was hard to see how a huge, controversial tax cut, which delivered most of its benefits to a wealthy elite, could get through Congress.

Then Alan Greenspan, the chairman of the Federal Reserve, testified before the Senate Budget Committee.

Until then Mr. Greenspan had presented himself as the voice of fiscal responsibility, warning the Clinton administration not to endanger its hard-won budget surpluses. But now Republicans held the White House, and the Greenspan who appeared before the Budget Committee was a very different man.

Suddenly, his greatest concern — the “emerging key fiscal policy need,” he told Congress — was to avert the threat that the federal government might actually pay off all its debt. To avoid this awful outcome, he advocated tax cuts. And the floodgates were opened.

As it turns out, Mr. Greenspan’s fears that the federal government would quickly pay off its debt were, shall we say, exaggerated. And Mr. Greenspan has just published a book in which he castigates the Bush administration for its fiscal irresponsibility.

Well, I’m sorry, but that criticism comes six years late and a trillion dollars short.

Mr. Greenspan now says that he didn’t mean to give the Bush tax cuts a green light, and that he was surprised at the political reaction to his remarks. There were, indeed, rumors at the time — which Mr. Greenspan now says were true — that the Fed chairman was upset about the response to his initial statement.

But the fact is that if Mr. Greenspan wasn’t intending to lend crucial support to the Bush tax cuts, he had ample opportunity to set the record straight when it could have made a difference.

His first big chance to clarify himself came a few weeks after that initial testimony, when he appeared before the Senate Committee on Banking, Housing and Urban Affairs.

Here’s what I wrote following that appearance: “Mr. Greenspan’s performance yesterday, in his first official testimony since he let the genie out of the bottle, was a profile in cowardice. Again and again he was offered the opportunity to say something that would help rein in runaway tax-cutting; each time he evaded the question, often replying by reading from his own previous testimony. He declared once again that he was speaking only for himself, thus granting himself leeway to pronounce on subjects far afield of his role as Federal Reserve chairman. But when pressed on the crucial question of whether the huge tax cuts that now seem inevitable are too large, he said it was inappropriate for him to comment on particular proposals.

“In short, Mr. Greenspan defined the rules of the game in a way that allows him to intervene as he likes in the political debate, but to retreat behind the veil of his office whenever anyone tries to hold him accountable for the results of those interventions.”

I received an irate phone call from Mr. Greenspan after that article, in which he demanded to know what he had said that was wrong. In his book, he claims that Robert Rubin, the former Treasury secretary, was stumped by that question. That’s hard to believe, because I certainly wasn’t: Mr. Greenspan’s argument for tax cuts was contorted and in places self-contradictory, not to mention based on budget projections that everyone knew, even then, were wildly overoptimistic.

Like many others he was all for George W. Bush until it became obvious to a majority that Bush policies were a disaster. He was not alone of course.

In retrospect, Mr. Greenspan’s moral collapse in 2001 was a portent. It foreshadowed the way many people in the foreign policy community would put their critical faculties on hold and support the invasion of Iraq, despite ample evidence that it was a really bad idea.

And like enthusiastic war supporters who have started describing themselves as war critics now that the Iraq venture has gone wrong, Mr. Greenspan has started portraying himself as a critic of administration fiscal irresponsibility now that President Bush has become deeply unpopular and Democrats control Congress.

Like many others who bet their legacy on George W. Bush Mr Greenspan's legacy will suffer and a mea culpa now won't save it.

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Greenspan Hearts Bill Clinton

I've made it clear that I'm not a big fan of Ayn Rand cultist Alan Greenspan. But in his memoir he does show an amazing grasp of the obvious.
Greenspan Says Bush's Economics Driven by Politics
No shit Sherlock!

Former Federal Reserve Chairman Alan Greenspan criticized President George W. Bush for pursuing an economic agenda driven by politics rather than sound policy, with little concern for future consequences.

Soon after Bush took office, Greenspan wrote in a new book, it became evident that the Treasury secretary and White House economists would play secondary roles in decisions on taxes and other issues. In addition, officials with whom he had worked in the administration of President Gerald Ford changed after Bush brought them back to Washington, he said he found.

``The Bush administration turned out to be very different from the reincarnation of the Ford administration that I had imagined. Now, the political operation was far more dominant,'' Greenspan, 81, wrote in ``The Age of Turbulence: Adventures in a New World.''

Sorry Alan but everything was driven by politics in the Bush administration - remember Terri Schiavo.

So who was Big Al's favorite president?
Greenspan Is Critical Of Bush in Memoir
Former Fed Chairman Has Praise for Clinton

While condemning Democrats, too, for rampant federal spending, he offers Bill Clinton an exemption. The former president emerges as the political hero of "The Age of Turbulence: Adventures in a New World," Greenspan's 531-page memoir, which is being published Monday.

Greenspan, who had an eight-year alliance with Clinton and Democratic Treasury secretaries in the 1990s, praises Clinton's mind and his tough anti-deficit policies, calling the former president's 1993 economic plan "an act of political courage."

[......]

During Clinton's first weeks as president, Greenspan went to the Oval Office and explained the danger of not confronting the federal deficit. Unless the deficits were cut, there could be "a financial crisis," Greenspan told the president. "The hard truth was that Reagan had borrowed from Clinton, and Clinton was having to pay it back. I was impressed that he did not seem to be trying to fudge reality to the extent politicians ordinarily do. He was forcing himself to live in the real world."

Dealing with a budget surplus in his second term, Clinton proposed devoting the extra money to "save Social Security first." Greenspan writes, "I played no role in finding the answer, but I had to admire the one Clinton and his policymakers came up with."

Greenspan interviewed Clinton for the book and clearly admires him. "President Clinton's old-fashioned attitude toward debt might have had a more lasting effect on the nation's priorities. Instead, his influence was diluted by the uproar about Monica Lewinsky." When he first heard and read details of the Clinton-Lewinsky encounters, Greenspan writes, "I was incredulous. 'There is no way these stories could be correct,' I told my friends. 'No way.' " Later, when it was verified, Greenspan says, "I wondered how the president could take such a risk. It seemed so alien to the Bill Clinton I knew, and made me feel disappointed and sad."

And about those tax cuts!

Greenspan saved his harshest analysis for the current president. Soon after Bush took office in 2001, the president set about implementing a campaign promise to cut taxes, a policy Greenspan said he believed at the time wasn't well conceived.

``Little value was placed on rigorous economic policy debate or the weighing of long-term consequences,'' he wrote.

In 2001 testimony before Congress, Greenspan was widely interpreted to have endorsed Bush's proposed tax cuts. In the book, he characterized his testimony as politically careless and said his words were misinterpreted.

Well at least he can take some responsibility.

Sowing the seeds of successive asset bubbles

I've never been one who thought that Ayn Rand disciple Alan Greenspan was a miracle worker and economic genius. A couple of my previous commentaries can be found here and here. He proved my point today:
Greenspan says didn't see subprime storm brewing

WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said he was late to see the storm gathering around U.S. mortgage lending practices and commended his successor Ben Bernanke's handling of the crisis, saying he would likely be responding in a similar fashion.

[.....]

Greenspan said that as Fed chief he knew about questionable lending practices that were leaving subprime borrowers with adjustable rate loans vulnerable to harm from rising interest rates, but did not recognize those loans would trigger broader problems until fairly recently, CBS said.

"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," Greenspan said. "I really didn't get it until very late in 2005 and 2006."

He knew about it but didn't think it would be a problem? he's either a liar, an idiot or both. I vote for liar. He knew full well what would eventually happen. As a political hack he also knew full well that the easy credit was the only thing that prevented the economy from going south before the 2004 election and threaten the reelection of George W. Bush.

Greenspan, 81, has received credit for leading the economy to its longest-ever expansion in the 1990s and many economists have praised his handling of a sequence of crises.

Indeed, some have hailed him as the greatest central banker in U.S. history.

However, others criticize Greenspan for sowing the seeds of successive asset bubbles, first in U.S. stock markets and later in housing. He has also come under fire for suggesting during his Fed tenure that adjustable rate mortgages could be a cost-saving financing option for many borrowers, just shortly before the Fed embarked on a long push to move rates higher.