Greenspan defends Fed ’cheap money’ policies

Bloomberg

The U.S. Federal Reserve’s "easy money" policies during the first part of this decade did not cause the housing bubble, former Chairman Alan Greenspan wrote in the Wall Street Journal. A surge in growth in China and other emerging markets led to an excess of savings that pushed global long-term interest rates down between early 2000 and 2005, Greenspan wrote in an article. That caused mortgage rates and the benchmark Fed-funds rate to diverge after moving "in lockstep" from 1971 to 2002, he said.

The article is part of the former Fed chief’s defense against charges in books such as "Greenspan’s Bubbles" by William A. Fleckenstein that his policy of keeping rates too low for too long inflated the housing bubble.

The collapse in the U.S. subprime-mortgage market led to about $1.2 trillion in writedowns and the bankruptcy of Lehman Brothers Holdings.

"Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have prevented the housing bubble," Greenspan said.



Controversial move

The Fed cut its target rate for overnight lending between banks to 1 percent in June 2003 from 6.5 percent in December 2000, and left it unchanged for the next year. Between June 2004 and June 2006, it raised the rate in quarter-point moves to 5.25 percent. Foreign demand for U.S. Treasuries helped keep long-term debt yields from rising as the Fed started to raise rates in 2004, leading Greenspan in 2005 to call the anomaly a "conundrum." Foreign ownership of U.S. government debt doubled between 2000 and 2005 to $2.03 trillion, Treasury data show.

Many developing economies adopted policies favoring export-led market competition in the early 1990s, Greenspan said.

"The result was a surge in growth in China and a large number of other emerging-market economies that led to an excess of global intended savings relative to intended capital investment," he said. That "propelled global long-term interest rates progressively lower."



Blaming ’global forces’

It matters "a great deal" to understand what caused the bubble in the real-estate market, he said.

"If it is monetary policy that is at fault, then that can be corrected in the future, at least in principle," Greenspan wrote. "If however, we are dealing with global forces beyond the control of domestic monetary policy makers, as I strongly suspect is the case, then we are facing a broader issue."

Greenspan, who served 18 years as Fed chief, took office just before the 1987 stock-market crash. He led the central bank during two eight-month-long recessions, the Asian financial crisis, the 2001 terrorist attacks and the bursting of the Internet bubble.

Policy makers should avoid "heavy regulation" in trying to navigate out of this financial crisis, Greenspan said.The solutions are "higher capital requirements and a wider prosecution of fraud, not increased micromanagement by government entities," he said. Governments need to "ensure responsible risk management on the part of financial institutions while encouraging them to continue taking the risks necessary and inherent in any successful market economy."