Greenspan Shrugged

Sunday, May 28, 2006

In February of 2004, then Federal Reserve Chairman Alan Greenspan stunned the financial community when he inexplicably began extolling the virtues of adjustable-rate mortgages. Many financial advisors and economists sounded the alarm bell. Said Axel Merk of Merk Fund:

In a speech at the Credit Union National Association, Greenspan today said that homeowners "might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade." He continued: "American consumers might benefit if lenders provided greater mortgage-product alternatives to the traditional fixed-rate mortgage."

Short-term or variable rate mortgages are the better deal in an environment with sinking interest rates, such as what we had in the past decade. However, as the Bank of England has warned, many consumers are not aware of the risks posed of short-term debt exposure in a rising interest rate environment.

There are already numerous variable and short-term instruments available for the sophisticated (or naive) homeowners. Greenspan's speech is an encouragement to use these short-term instruments. As the Wall Street Journal comments, "It is almost unheard of for an official of the central bank to offer advice on interest rates, over which it has enormous influence."

We would go much further than this: unless Greenspan clarifies his comments, he must resign...

Chicago Sun-Times collumnist Terry Savage warned:

Greenspan has a track record of forecasting mistakes. For instance, in 1990 he said, "I see no recession on the horizon." That was just before a very tough recession. Also of note, in the early 1970's, Greenspan went on record as saying there was no reason for gold to trade over $32 an ounce. Gold subsequently soared over $800 an ounce.

Every forecaster makes mistakes. But now Greenspan is advising homeowners to play the interest-rate market by taking on adjustable-rate mortgages. He also stated that he's not worried about American household balance sheets, in spite of record bankruptcies, because rising real estate prices bolster consumer finances. That's the logic that produced the stock market bubble.

What if Mr. Greenspan is wrong again? What if interest rates rise? Home values will fall. And the burden of adjustable-rate mortgages will be huge.

Economist and New York Times columnist Paul Krugman expressed concern:

A number of analysts have accused Mr. Greenspan of fostering a debt bubble in recent years, just as they accuse him of feeding the stock bubble during the 1990's. Just two months ago, Mr. Greenspan went out of his way to emphasize the financial benefits of adjustable-rate, as opposed to fixed-rate, mortgages. Let's hope that not too many families regarded that as useful advice.

Well it appears that too many families did. Now, not even two and a half years later, foreclosures are sky-rocketing. From MSNBC:

“It's been just like a roller coaster,” Bridget [Edwards] says. “Our payments have been just up and down.”

Up and down, from $1,300 a month to more than $2,000.

The reason?

“We have an adjustable-rate mortgage,” she explains. “I really didn't know it would change like this.”

Today, foreclosure looms over their $129,000 home. That’s a problem facing a growing number of Americans, who are finding themselves one crisis away from financial ruin. RealtyTrac, an industry organization that maintains a nationwide database of foreclosures, says mortgage defaults between January and March of this year numbered 323,102 compared with 188,122 during the same period last year — an increase of 72 percent. [emphasis added]

Indianapolis leads the nation, with one out of every 69 homes in foreclosure. Atlanta follows closely at 1 in 70 homes. Then Dallas — where the Edwardses live — at 1 in 99. Memphis is fourth at 1 in 101. Denver rounds out the top five at 1 in 105.

Arianna Huffington once suggested that Randian, free-market fundamentalists like Greenspan sleep with copies of "Atlas Shrugged" under their pillows. I wonder how he sleeps at all.


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