Will History 'Deal Kindly' With Greenspans Bubble?

The FOMC interest rate decision is out. "The Federal Reserve nudged a key interest rate up to the highest level in nearly five years on Tuesday as Alan Greenspan brought his long tenure as Fed chairman to a close." "By holding interest rates down for so long after the stock market bubble burst in the late 1990s, Greenspan pumped up a housing bubble that allowed consumers to borrow against capital gains on their homes, spending more than they earned. Indeed, strong consumer spending has kept the U.S. economy rolling along when other nations continue to languish, but at the cost of a negative personal saving rate, a growing load of household debt and a mounting deficit." "In the unending search for increased profits, FF (Freddie Mac and Fannie Mae) undertook some financial innovation. They began bundling groups of mortgages together as mortgage-backed securities (MBS) on which they guaranteed, in case of default, to pay interest and principal 'fully and in a timely fashion.' And finally, to squeeze out even more profits, FF began taking 50% of their MBS holdings and pooling them once again into derivative instruments called Real Estate Mortgage Investment Conduits, i.e.'restructured MBS' or into what are called Collateralized Mortgage Obligations for which they are paid a fee." "These instruments are highly specialized derivatives, i.e. bets on the direction of future rates of interest. FF's profits went up even more but the risks associated with these actions became excessive!! Thus, what started out as a simple home mortgage, has been transmogrified in to something one would expect to find at a Las Vegas gambling casino. Yet the housing bubble now depends on precisely these instruments as sources of funds." "Despite being delinquent on filing its annual financial statement with the SEC for almost a year, government-chartered mortgage backer Fannie Mae reported that it will not be delisted from the NYSE, at least, not yet. Fannie and Freddie are too big to fail; the repercussions on the housing market would be severe, perhaps taking down a number of financial institutions as well. That might very well create a spiral effect on the rest of the economy. Homeowners have tapped the equity in their homes to spur sales and fuel growth. If Fannie or Freddie go under, they might plunge the overall economy into a recession, or worse." "Would that lead to a massive taxpayer-financed bailout of Fannie and Freddie, like the S&L industry received in the 1980s? Perhaps not; the mortgages are not backed by the federal government, but Fannie and Freddie's congressional charters would suggest they are entitled to at least some protection. And the regulators will do all that's in their power to prevent such a collapse." "Alabama Republican Sen. Richard Shelby on Tuesday reiterated his concerns that those portfolios pose a risk, and said the investments do not help the companies fulfill their mission of supporting homeownership. 'The mission of the GSEs is important and that's why we created them,' he said. 'The risk is in the portfolio. It has nothing to do with providing money for housing.'" "Alan Greenspan, in comments made at a meeting of the Fed in Jackson Hole, Wyo., Greenspan had some choice words for investors. 'This vast increase in the market value of asset claims [read: real estate] 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..But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums."