Saturday, April 10, 2010

Greenspan: Overseas Savings Glut Kept Long Term Rates Low, Fed Funds Rate Was Ineffective In Controlling Housing Inflation (Financial Crisis Inquiry Commission Testimony)

Continuing from my previous post on Michael Burry vs. Greenspan vs. Peter Schiff, I thought I'd provide deep thoughts by Alan Greenspan at the Financial Crisis Inquiry Commission hearing a few days ago.

He made an interesting case that the Fed Funds rate between 2002-2005 was ineffective in controlling long term interest rates which mortgage rates are priced on ("the conundrum"). He found that a savings glut in the developing markets, or lack of investment, kept long term rates down and had no effect on home price inflation at that time. Remember he was so confused about the yield curve in 2005? The curve started to invert in March 2006 if you remember.

Treasury Yield Curve March 2006 (Courtesy of StockCharts.com)

Below I embedded Alan Greenspan answering questions from U.S House Rep. Bill Thomas below and the PDF of his testimony. Should he have forced rates significantly higher even with the inversion? Here is Greenspan's Brookings Institute paper titled "The Crisis" if interested.



"The International Roots of the Financial Crisis

It was the global proliferation of securitized U.S. subprime mortgages that was the immediate trigger of the current crisis. But its roots reach back, as best I can judge, to 1989, when the fall of the Berlin Wall exposed the economic ruin produced by the Soviet system. Central planning, in one form or another, was discredited and widely displaced by competitive markets.

China, in particular, replicated the successful economic export-oriented model of the so-called Asian Tigers, and by 2005, according to the IMF, 800 million members of the world’s labor force were engaged in export-oriented, and therefore competitive, markets, an increase of 500 million workers since 1990. Additional hundreds of millions became subject to domestic competitive forces, especially in Eastern Europe. As a consequence, between 2000 and 2007, the rate of growth in real GDP of the developing world was more than double that of the developed world.

The developing world’s consumption restrained by culture and inadequate consumer finance could not keep up with the surge of income and, as a consequence, the savings rate of the developing world soared from 24% of nominal GDP in 1999 to 34% by 2007, far outstripping its investment rate.

Whether it was a glut of excess intended saving, or a shortfall of investment intentions, the result was the same: a fall in global real long-term interest rates and their associated capitalization rates. Asset prices, particularly house prices, in nearly two dozen countries accordingly moved dramatically higher. U.S. house price gains were high by historical standards but no more than average compared to other countries.

The rate of global housing appreciation was accelerated beginning in late 2003 by the heavy securitization of American subprime and Alt-A mortgages, bonds that found willing buyers at home and abroad, many encouraged by grossly inflated credit ratings. More than a decade of virtually unrivaled global prosperity, low inflation, and low long- term interest rates reduced global risk premiums to historically unsustainably low levels. (They remained “unsustainably low” for years, however.)"

Greenspan Testimony 4/7/2010

For the most recent posts on Peter Schiff, Michael Burry and Alan Greenspan click the links.

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