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Following the September 11, 2001 attack the Greenspan led Fed voted to reduce the federal funds rate from 3.5% to 3.0%. As the Enron scandal and other corporate misdeeds of 2002 developed, the Fed dropped the federal funds rate to 1.0%. He then left rates at this level for over a year. Greenspan acknowledged that this drop in rates would have the effect of leading to a surge in home sales and refinancing.
"Besides sustaining the demand for new construction, mortgage markets have also been a powerful stabilizing force over the past two years of economic distress by facilitating the extraction of some of the equity that homeowners have built up over the years."
The only problem was that Americans extracted $3 trillion in equity from their homes and spent it on BMWs, HDTVs, exotic vacations, and whatever other selfish pursuits that appealed to them.
The national reaction to the 9/11 disaster was one of unity of purpose. We wanted to find and punish the terrorists that caused this tragedy. A call for national sacrifice would have been heeded. Instead, George Bush and Alan Greenspan encouraged Americans to teach the terrorists a lesson by spending. In June of 2001, prior to the attacks, a $1.35 trillion tax cut was enacted, including $50 billion in rebate checks. After the attacks, General Motors showed their patriotic spirit by offering 0% financing on all cars. Big ticket retailers offered easy credit and extended terms so that everyone could have a flat screen HDTV and worry about paying later. Consumers started a buying frenzy that didn’t stop until credit evaporated in 2008.
George Bush did his part to stimulate the defense industry by starting an unprovoked war that has already cost the country $750 billion, 4,500 needless deaths, and 30,000 wounded. Estimates of the total cost have risen to $3 trillion.The Bush administration estimated the cost at $50 billion before the war. The lesson is that when the government provides an estimate, multiply it by 10 to get closer to the truth. Trust in the government began to evaporate rapidly after the Iraq debacle. As Alan Greenspan denies causing the housing crisis today, his words from November 2002 come back to haunt him, “our extraordinary housing boom…financed by very large increases in mortgage debt, cannot continue indefinitely into the future.” He then proceeded to reduce interest rates to 1%, spurring the biggest bubble in history.
Never has a graph told a story more completely than Professor Shiller’s, from his book Irrational Exuberance. Between 1998 and 2006 home values virtually doubled. There is no logical explanation for this occurrence. Previous peaks were 60% lower than the peak reached in 2006. This chart is very similar to the NASDAQ 5,000 chart. After viewing this chart, any reasonable person would conclude with absolute certainty that home values would fall steeply for a long time. Too bad the reasonable people didn’t include Alan Greenspan, Bank CEOs, Mortgage companies, Rating Agencies, Homebuilders, Treasury Secretaries, Presidents, Regulators, or Congressmen. They not only didn’t see the fall coming, they spiked the punch bowl and encouraged the party to kick it up a notch. The following words from, former CEO of Citigroup, Charles Prince in July 2007 will be immortalized alongside Gordon Gekko’s “greed is good” speech:
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
He is now doing the Rumba in the Old Bank CEO “retirement” home along with James Cayne, Ken Thompson, Angelo Mozilo, Daniel Mudd, Richard Syron, Dick Fuld and Kerry Killinger. And things are now somewhat complicated.
Robert Shiller’s expert opinion regarding the 2005 Black Swan in real estate was:
“Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker.”
Much of the housing frenzy can be attributed to homeowners getting caught up in the media hype and the cascade of information about others getting rich buying and selling houses. But, Greenspan's 1% interest rates were the fuel for the frenzy. He knew exactly what these rates would do when he said the following words in 2005:
"Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission."
The final nail in the coffin of Greenspan’s legacy was his speech in February 2004. Greenspan suggested that more homeowners should consider taking out Adjustable Rate Mortgages. The Fed funds rate was at an all-time-low of 1%. A few months after his recommendation, Greenspan began raising interest rates, in a series of rate hikes that would bring the funds rate to 5.25% about two years later. Greenspan's advice came at a time when interest rates had bottomed out making it a particularly bad time to take out an ARM. The triggering factor in the current crisis was the many subprime ARMs that reset at much higher interest rates than what the borrower paid during the first few years of the mortgage. Greenspan gave the bad advice and Wall Street provided the money and derivative products which have created our worldwide meltdown.
Financial Implosion
Warren Buffett’s view of derivatives in his 2002 Annual Letter to shareholders:
“Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”.
