Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (39 page)

Lindsey went on to teach a lesson that made little impression on the Federal Reserve chairman. “[F]rom my experience at Neighborhood Reinvestment
²²
and from the studies done here at the Board, it is clear that high LTV [loan-to-value] loans are a big risk for future delinquency… .[W]hen economic distress occurs,
individuals with no equity in their homes have less incentive to stay
than those who have such equity. Our experience shows these high LTV loans can be successfully and profitably made, but they require enormous amounts of handholding and follow-through with the borrower… .
Why care? I think there is a longterm social cost we are going to pay from all this
. . . . Consumption has expanded more quickly than the income of the great majority of American households”
²³
[author’s italics]. His recollection of Neighborhood Reinvestment illuminates the nonsense of mass, subprime, and HUD 3 percent down payment lending. It cannot be done.

Lindsey wasn’t through. He again admitted that he had been wrong about the endurance of the borrowing madness, then warned: “
[T]he price we are paying is the increasing fragility of the underlying financial structure of the household sector
”
²⁴
[author’s italics].

Mr. Lindsey and Mr. Coffee Lindsey was nearing the end of his Federal Reserve governorship at the September 1996 FOMC meeting:

MR. LINDSEY. [O]ur luck is about to run out in the financial markets because of what I would consider a gambler’s curse: We have won this long, let us keep the money on the table… . But the longterm costs of a bubble to the economy and society are potentially great. They include a reduction in the longterm saving rate, a seemingly random redistribution of wealth, and the diversion of scarce financial human capital into the acquisition of wealth… . I think it is far better that we [burst the stock market bubble] while the bubble still resembles surface froth and before the bubble carries the economy to stratospheric heights. Whenever we do it, it is going to be painful however… . [I]f the optimists are wrong, then indeed not only our luck but that of the markets and of the economy has run out. Thank you.
²⁵

²²
In 1978, Congress established the Neighborhood Reinvestment Corporation. The act defined Neighborhood Reinvestment’s mission as “revitalizing older urban neighborhoods by mobilizing public, private and community resources at the neighborhood level.”

²³
FOMC meeting transcript, July 2–3, 1996, p. 33.

CHAIRMAN GREENSPAN. On that note, we all can go for coffee.

Mr. Coffee escaped once again.
²⁶
Lindsey had summed up our future. His only error was timing. He did not—but who did?—predict that the stock market bubble would grow for 3½ more years. The stock market bubble forestalled a reckoning. That bubble concealed much that was wrong with a misaligned economy— specifically, the amount of borrowing required to boost the GDP.
The gambler’s curse did not strike for another 10 years. First, the stock market cured all that plagued the “real” economy. After that failed, Greenspan seeded a national housing carry trade.
“[T]he non-rich, non-old liv[ing] paycheck to paycheck”
²⁷
would live off the profits and collateral as the Dow rose from 5,000 to 11,000. This collateral, whether physical, conceptual, or psychological, “carried the economy to stratospheric heights.”
²⁸
When the stock market ceased to deliver, houses collateralized spending. In 2009, “not only our luck but that of the markets and of the economy has run out.”
²⁹

Interlude—1999: Greenspan Dissembles

Federal Reserve Chairman Alan Greenspan, before the Committee on Ways and Means, U.S. House of Representatives, January 20, 1999, “State of the Economy”:
[D]iscussions of consumer spending often continue to emphasize current income from labor and capital as the prime sources of funds, during the 1990s, capital gains, which reflect the valuation of expected
future incomes
, have taken on a more prominent role in driving our economy. The steep uptrend in asset values of recent years has had important effects on virtually all areas of our economy, but perhaps most significantly on household behavior. It can be seen most clearly in the measured personal saving rate, which has declined from almost six percent in 1992 to effectively zero today. . . . In fact, the net worth of the average household has increased by nearly 50 percent since the end of 1992… . Households have been accumulating resources for retirement or for a rainy day, despite very low measured saving rates. The resolution of this seeming dilemma illustrates the growing role of rising asset values in supporting personal consumption expenditures in recent years. It also illustrates the importance when interpreting our official statistics of taking account of how they deal with changes in asset values.

²⁵
FOMC meeting transcript, September 24, 1996, pp. 24–25.
²⁶
One could interpolate Greenspan’s statement later in the meeting, “I recognize there is a stock market bubble at this point” (p. 29), as being inspired by Lindsey, but Greenspan’s train of thought in FOMC meetings was rarely methodical.
²⁷
Lawrence Lindsey, FOMC meeting transcript, February 3–4 1996, p. 21.
²⁸
Lawrence Lindsey, FOMC meeting transcript, September 24, 1996, p. 25.

The Federal Reserve chairman spent the nineties reinterpreting— really reinventing—productivity. Now he was off to the races redefining household wealth.

2002: The Federal Impoverishment Committee

The FOMC was preoccupieal with the Stock Market through 2001. In 2002, houses drew greater interest, when members were of two minds.
³⁰
Some committee members worried that the funds rate was too low. They thought current policy was inflationary and speculative. (The Fed had cut the funds rate 11 times in 2001, from 6.5 percent to 1.75 percent.) Some worried that the economy was too weak—current policy was not stimulative. Under Greenspan, such a tussle would always favor the stimulators. In the end, the former group was routed: the funds rate would be cut from 1.75 percent to 1.25 percent in November.

³⁰
FOMC Transcripts are released five years after the meetings. This book addresses transcripts through December 2002. The 2003 transcripts were recently released.

Even on the day the FOMC cut the funds rate, Anthony Santomero, president of the Fed’s Philadelphia branch, warned about increased borrowing and leveraging: “Real estate lending has continued to rise, and some banks indicate that the pace of refinancings has accelerated.”
³¹
At the next meeting, a Federal Reserve staffer noted: “[T]his productivity growth really reflects higher productivity in the mortgage banking business. . . . that’s real productivity.”
³²
The economy was operating upside down. It was the speed of financing—of which Lindsey had warned in the previous decade—that operated at a post-human rate and caused a confederacy of mischief.

The case for a higher funds rate was frequently voiced by FOMC members, especially early in the year. They argued that zero or negative real interest rates—when borrowing rates are below the rate of inflation—encourage senseless borrowing. Greenspan recognized their concern. At the March 2002 meeting, he thought “one could argue in retrospect that we may have moved too fast on the downside.”
³³
In other words, the fed funds cut from 6.5 percent to 1.75 percent during 2001 was too much, too fast. Nevertheless, Greenspan had a greater concern: “[I]f the mortgage rate goes up, we will get some restraining effects on personal consumption expenditures because a goodly part of PCE [the personal consumption rate] has been financed by equity extraction from the appreciation in housing values.”
³⁴

Greenspan’s reasoning follows: if the Fed were to reintroduce a positive real rate of interest—when borrowing rates are above the inflation rate—consumers might not borrow as much against the equity they had accrued on their houses. He had long believed that consumers needed to spend their equity extraction to buoy the economy.

This had colored Greenspan’s view at the mid-1990s FOMC meetings and his 1999 Ways and Means testimony. To a central planner, the urgency was greater by 2002, since very little else was expanding. At the November 6 meeting, Edward Gramlich’s opinion catalogued the FOMC’s struggle to identify the source of recovery: “What is going to drive the economy? In the late 1990s it was investment; more recently it has been consumption and housing. What’s next? I can’t find much.”
³⁵
Other FOMC members were also at a loss. That was the meeting at which the committee cut the funds rate from 1.75 percent to 1.25 percent. Mortgage finance carried the economy for the next four years.

³¹
FOMC meeting transcript, November 6, 2002, p. 43.
³²
FOMC meeting transcript, December 10, 2002, p. 16.
³³
FOMC meeting transcript, March 19, 2002, p. 88.
³⁴
Ibid., p. 89.

Greenspan’s speeches and testimony extolled America’s rising “wealth.” This was a charade. House prices were the major portion of household wealth. (This is a number released on the quarterly Federal Reserve flowof-funds statement.) As house prices rose, dwellers could borrow more against this imaginary wealth. This home-equity extraction kept the GDP growing. This rising tide was an illusion, since what it did not change was the debt owed.

Greenspan was living for the moment: “I believe that equity extractions from homes will continue to be a source of positive growth in personal consumption expenditures.”
³⁶
Greenspan then extolled some Fed model (Greenspan ignored them, blamed them, cited them, or cited and then dismissed models as opportunities to salvage a hypothesis as his reputation arose) that calculated 20 percent of personal consumption came from consumers cashing out their “wealth.” Rising house prices were essential to America’s continuous shopping spree.

Through the summer and fall meetings, some members of the FOMC worried about low interest rates. This was often expressed as a concern about house prices. Federal Reserve Governor Edward Gramlich described his growing fears. At the August 13 meeting, he was “uncomfortable that the refinancing of housing should be the source of so much of the support for our recovery.”
³⁷
Greenspan was having none of that: “You sound like a true conservative.”
³⁸

House-flipping stories grew more bizarre. They left the FOMC in gales of laughter. Al Broaddus, president of the Federal Reserve Bank of Richmond, in September: “ ‘I spoke to the CEO of one of the larger North Carolina furniture companies, and his theory is that younger families are stretching so hard to pay the elevated prices for new homes that once they move in they have to sleep on the floor!’ [Laughter]”
³⁹
Jack Guynn, president of the Atlanta branch, in November: “ ‘The south Florida housing market would have to be characterized as red hot. One director reported that when a moderately priced development on the west coast of Florida opened, demand was so great that sales had to be limited to three homes per customer. That’s a semi-true story.’ [Laughter]”
⁴⁰

³⁵
FOMC meeting transcript, November 6, 2002, pp. 67–69.
³⁶
FOMC meeting transcript, June 25–26, 2002, p. 120.
³⁷
FOMC meeting transcript, August 13, 2002, p. 82.

The chairman accentuated the positive. In September, he reported record spending: “We know, for example, that the level of existing home turnover is quite brisk and that the average extraction of equity per sale of an existing home is well over $50,000. A substantial part of the equity extraction related to home sales, which is running at an annual rate close to $200 billion, is expended on personal consumption and home modernization, two components, of course, of the GDP.”
⁴¹

Greenspan had eliminated the negative at an earlier meeting: “There clearly is concern at this stage about a housing value bubble that is going to burst.”
⁴²
He dismissed it: “It’s the notion that there is an equivalency between equity bubbles and housing bubbles that I think is an illusion.”
⁴³
This is the first time he had addressed the recent stock market bubble (although, strictly speaking, Greenspan is making a general comment and does not admit to his personally autographed Nasdaq bubble here). He told the FOMC that housing bubbles were different. “[W]ith transaction costs as high as they are . . . and the necessity to move if the house is sold, the incentive to sell a house is nowhere near what it is to sell a stock to take advantage of a capital gain.”
⁴⁴
Granted, Americans never did sell two billion houses a day. Transaction and brokerage costs are high, but it was the next meeting he told the FOMC that the average equity extraction was $50,000.
⁴⁵
That (minus fees) was adequate compensation for many, even with the headache of moving.

³⁹
FOMC meeting transcript, September 24, 2002, p. 48.
⁴⁰
FOMC meeting transcript, November 6, 2002, p. 56.
⁴¹
FOMC meeting transcript, September 24, 2002, p. 78.
⁴²
FOMC meeting transcript, August 13, 2002, p. 74.
⁴³
Ibid.

Greenspan was starting to warm up to another theme at the August meeting: that the
decline
of interest rates plays an important role in trading, extracting, and spending: “That decline [in the 10-year Treasury yield] . . . has had a major impact on thirty-year fixed mortgage rates… . [W]e are seeing very significant churning in the mortgage markets… . What we are observing at this point is a very high rate of house turnover. Existing home sales are very high.”
⁴⁶

Churning was important. Not only was this true psychologically (the momentum and day-trading swagger), but greater volume contributed funds to the economy. A faster rate of house trading, multiplied by profits from house sales, prompted greater cashout consumer spending. Also, construction workers, Realtors, mortgage companies, title insurers, and new strip-mall employees (in the new towns that blotted the landscape) had more money to spend.