Greenspan's mess risks US recession

[FRED]

Greenspan `Mess' Risks U.S. Recession, Stiglitz Says
Nov. 16 (Reed V. Landberg and Paul George - Bloomberg)

Joseph Stiglitz, a Nobel-prize winning economist, said the U.S. economy risks tumbling into recession because of the ``mess'' left by former Federal Reserve Chairman Alan Greenspan.

``I'm very pessimistic,'' Stiglitz said in an interview in London today. ``Alan Greenspan really made a mess of all this. He pushed out too much liquidity at the wrong time. He supported the tax cut in 2001, which is the beginning of these problems. He encouraged people to take out variable-rate mortgages.''

AntiSpin: How exactly did this "mess" get here? We commented here on the reserve requirements, peso crisis, and other kindling for the stock bubble from 1995 and the all-out emergency reflation from the Greenspan Fed after the bubble collapsed. As I’ve said before, the Greenspan Fed held rates too low too long and was too slow and too predictable in normalizing them. This is not mere 20-20 hindsight. Economic statistics from 2002-2005 showed the credit bubble inflation to anyone who cared to look:

• October 2002 - Stock market bottoms. Unemployment rate is 5.7% Fed funds is at 1.75%. Housing bubble lifts off.
• July 2003 - US Stock prices up 26.5% in nine months. Commodity prices up 9.5% in nine months. Unemployment rate is 6.2%. Fed funds are cut to 1%.
• April 2004 - Stock prices up an additional 16.5% in nine months. Commodity prices up 29.7% in nine months. Unemployment rate is 5.5% Nominal GDP is up 6.5% year over year. Fed funds are still at 1%.
• July 2004 - Nominal GDP is up 7.2% year over year. FOMC finally hikes Fed funds 25 bp, embarking on a program of "removal of accommodation … at a pace that is likely to be measured". As it establishes a predictable pattern of 25 bp hikes, it tells the markets that even though it is raising rates, it is also giving them visibility in the sense of putting an effective ceiling on the forward trajectory of Fed funds, inviting a speculative bonanza of credit expansion. In other words, even as it is tightening in an absolute sense, it continues to ease by reducing a key element of credit market risk.
• July 2005 - Stock prices up an additional 10.1% year over year. Commodity prices up an additional 16.0%. The economy is said to be booming. Housing and energy prices have been galloping upward, doubling to tripling in a scant three to four years. The Fed continues its baby step program with a 25 bp Fed funds hike to 3.25%, touting low "core inflation", citing statistics that do not include energy, food, or houses. Money supply has been soaring at double-digit annual rates. This is just over a year after Greenspan himself made a speech to the Credit Union National Association extolling the benefits of adjustable rate mortgages. And for at least as long there have already been voices in the financial media warning of a credit bubble such as Doug Noland of Prudent Bear, and of housing bubble, notably Eric Janszen here at iTulip.
• October 2005 - US house prices are soaring to new all time highs. Oil is $70 a barrel. Double digit money supply growth continues. Not just oil, but virtually every physical commodity, including industrial metals, and foods, is experiencing breathaking price increases. Greenspan still insists inflation is moderate.

It is during this later time period, from April 2004 to October 2005, that the credit crisis that is getting so much attention now started. Not in August of 2007. By early 2004, it was already clear that any danger of deflation had passed, the economy was gaining strength, GDP was growing solidly, unemployment falling smartly. Commodity prices were accelerating. Stock prices were accelerating. House prices were accelerating. Money supply was accelerating. Option ARMs, no-doc loans, and the now infamous subprime mortgages were being issued. Yet the Greenspan Fed resolutely maintained it 1% "emergency" Fed funds rate. Worse yet, when it did finally wake up at the switch, it substituted rate ease with risk ease by advertising limits to future policy moves under the guise of "transparency"; a mere euphemism for predictability.

Greenspan has recently attempted to defend this abysmal record by citing the global nature of the housing and credit bubble. Like the misbehaving sixth-grader, it was okay because "everybody was doing it". Not to mention that central banks all over the world were taking their cues from the US Fed, driven at least in part by the fear of damaging their export industries by having their currencies appreciate too fast in relation to the US dollar. The maetro can hardly escape responsibility for the sonic disaster he leads.

The objective of delving into how we got in this mess is to learn from it. That the root cause of such crises takes a back seat to the immediate imperatives of how to make things better is one of the main reasons they occur in the first place. If the current crisis is "solved" by the same kind of thinking that created it, we cannot claim to have solved it at all.

Today's iTulip News by Shadow Fed Chairman, iTulip Select Member Finster.

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[GRG55]

Re: More Stiglitz - the revulsion to Wall St. gathers momentum...

Greenspan `Mess' Risks U.S. Recession, Stiglitz Says
Nov. 16 (Reed V. Landberg and Paul George - Bloomberg)

Joseph Stiglitz, a Nobel-prize winning economist, said the U.S. economy risks tumbling into recession because of the ``mess'' left by former Federal Reserve Chairman Alan Greenspan.

``I'm very pessimistic,'' Stiglitz said in an interview in London today. ``Alan Greenspan really made a mess of all this. He pushed out too much liquidity at the wrong time. He supported the tax cut in 2001, which is the beginning of these problems. He encouraged people to take out variable-rate mortgages.''

Some rather pointed commentary, including the role of Treasury in promoting Wall St. (emphasis mine).


Financial Hypocrisy

by Joseph E. Stiglitz

Joseph E. Stiglitz, a Nobel laureate in economics, is Professor of Economics at Columbia University and was Chairman of the Council of Economic Advisers to President Clinton and Chief Economist and Senior Vice President at the World
Monday, November 19th 2007

This article was received from Project Syndicate, an international not-for-profit association of newspapers dedicated to hosting a global debate on the key issues shaping our world.

This year marks the tenth anniversary of the East Asia crisis, which began in Thailand on July 2, 1997, and spread to Indonesia in October and to Korea in December. Eventually, it became a global financial crisis, embroiling Russia and Latin American countries, such as Brazil, and unleashing forces that played out over the ensuing years: Argentina in 2001 may be counted as among its victims.

There were many other innocent victims, including countries that had not even engaged in the international capital flows that were at the root of the crisis. Indeed, Laos was among the worst-affected countries.
Though every crisis eventually ends, no one knew at the time how broad, deep, and long the ensuing recessions and depressions would be. It was the worst global crisis since the Great Depression.

As the World Bank's chief economist and senior vice president, I was in the middle of the conflagration and the debates about its causes and the appropriate policy responses. This summer and fall, I revisited many of the affected countries, including Malaysia, Laos, Thailand, and Indonesia. It is heartwarming to see their recovery. These countries are now growing at 5% or 6% or more - not quite as fast as in the days of the East Asia miracle, but far more rapidly than many thought possible in the aftermath of the crisis.

Many countries changed their policies, but in directions markedly different from the reforms that the IMF had urged. The poor were among those who bore the biggest burden of the crisis, as wages plummeted and unemployment soared. As countries emerged, many placed a new emphasis on "harmony," in an effort to redress the growing divide between rich and poor, urban and rural.

They gave greater weight to investments in people, launching innovative initiatives to bring health care and access to finance to more of their citizens, and creating social funds to help develop local communities.
Looking back at the crisis a decade later, we can see more clearly how wrong the diagnosis, prescription, and prognosis of the IMF and United States Treasury were. The fundamental problem was premature capital market liberalization. It is therefore ironic to see the US Treasury Secretary once again pushing for capital market liberalization in India - one of the two major developing countries (along with China) to emerge unscathed from the 1997 crisis.

It is no accident that these countries that had not fully liberalized their capital markets have done so well. Subsequent research by the IMF has confirmed what every serious study had shown: capital market liberalization brings instability, but not necessarily growth. (India and China have, by the same token, been the fastest-growing economies.)

Of course, Wall Street (whose interests the US Treasury represents) profits from capital market liberalization: they make money as capital flows in, as it flows out, and in the restructuring that occurs in the resulting havoc. In South Korea, the IMF urged the sale of the country's banks to American investors, even though Koreans had managed their own economy impressively for four decades, with higher growth, more stability, and without the systemic scandals that have marked US financial markets with such frequency.

In some cases, US firms bought the banks, held on to them until Korea recovered, and then resold them, reaping billions in capital gains. In its rush to have westerners buy the banks, the IMF forgot one detail: to ensure that South Korea could recapture at least a fraction of those gains through taxation. Whether US investors had greater expertise in banking in emerging markets may be debatable; that they had greater expertise in tax avoidance is not.

The contrast between the IMF/US Treasury advice to East Asia and what has happened in the current sub-prime debacle is glaring. East Asian countries were told to raise their interest rates, in some cases to 25%, 40%, or higher, causing a rash of defaults. In the current crisis, the US Federal Reserve and the European Central Bank cut interest rates.

Similarly, the countries caught up in the East Asia crisis were lectured on the need for greater transparency and better regulation.

But lack of transparency played a central role in this past summer's credit crunch; toxic mortgages were sliced and diced, spread around the world, packaged with better products, and hidden away as collateral, so no one could be sure who was holding what.

And there is now a chorus of caution about new regulations, which supposedly might hamper financial markets (including their exploitation of uninformed borrowers, which lay at the root of the problem.) Finally, despite all the warnings about moral hazard, Western banks have been partly bailed out of their bad investments.

Following the 1997 crisis, there was a consensus that fundamental reform of the global financial architecture was needed.

But, while the current system may lead to unnecessary instability, and impose huge costs on developing countries, it serves some interests well. It is not surprising, then, that ten years later, there has been no fundamental reform. Nor, therefore, is it surprising that the world is once again facing a period of global financial instability, with uncertain outcomes for the world's economies.