Greenspan on The Crisis

By: Doug Noland | Fri, Mar 19, 2010
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For the week, the S&P500 gained 0.9% (up 4.0% y-t-d), and the Dow rose 1.1% (up 3.0%). The Banks increased another 1.3% (up 19.7%), while the Broker/Dealers slipped 0.6% (down 2.7%). The Morgan Stanley Cyclicals added 0.6% (up 6.3%), and the Transports gained 1.1% (up 6.7%). The Morgan Stanley Consumer index rose 0.9% (up 4.5%), and the Utilities jumped 1.6% (down 3.6%). The S&P 400 Mid-Caps increased 0.2% (up 8.0%), while the small cap Russell 2000 declined 0.4% (up 7.8%). The Nasdaq100 increased 0.4% (up 3.9%), and the Morgan Stanley High Tech index gained 0.7% (up 3.2%). The Semiconductors were little changed (down 1.2%). The InteractiveWeek Internet index was unchanged (up 5.1%). The Biotechs slipped 0.5%, yet 2010 gains were at 29.6%. Although bullion was up $5.0, the HUI gold index was unchanged for the week (down 3.1%).

One-month Treasury bill rates ended the week at 13 bps, and three-month bills closed at 15 bps. Two-year government yields rose 4 bps to 0.995%. Five-year T-note yields increased 5 bps to 2.46%. Ten-year yields declined one basis point to 3.69%. Long bond yields fell 5 bps to 4.58%. Benchmark Fannie MBS yields increased 2 bps to 4.37%. The spread between 10-year Treasury and benchmark MBS yields widened 3 bps to 68 bps. Agency 10-yr debt spreads widened 2 bps to 37 bps. The implied yield on December 2010 eurodollar futures declined one basis point to 0.895%. The 10-year dollar swap spread declined 0.5 to 4.25, while the 30-year swap spread increased 0.5 to negative 13.5. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 2 to 86 bps, and an index of junk spreads declined 9 to 511 bps.

It was a decent week of debt issuance. Investment grade issuers included Goldman Sachs $2.75bn, International Lease Finance $2.0bn, Rockies Express Pipeline $1.7bn, Hartford Financial $1.1bn, Axis Specialty Finance $500 million, First Niagara $300 million.

Junk flows reported inflows of $597bn (Lipper). Junk issuers included US Steel $600 million, Narragansett Electric $550 million, Ball Corp $500 million, Developers Diversified $300 million, Sitel $300 million, Coleman Cable $275 million, Bioscrip $225 million, and Da-Lite Screen $105 million.

Convert issues included Knight Capital $325 million.

International dollar debt sales remain robust. Issuers included Shell $4.25bn, Commonwealth Bank of Australia $3.5bn, European Investment Bank $3.0bn, Bombardier $1.5bn, Credit Suisse $1.5bn, Digicel Group $775 million, Banco Brades $750 million, BES Investimento Brazil $500 million, QVC $1.0bn, 500 million, million.

U.K. 10-year gilt yields dropped 14 bps to 3.95%, and German bund yields fell 6 bps to 3.11%. Bond yields in Greece jumped 12 bps to 6.34%. The German DAX equities index added 0.6% (up 0.4% y-t-d). Japanese 10-year "JGB" yields increased 2 bps to 1.36%. The Nikkei 225 rose 0.7% (up 2.6%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index slipped 0.7% (up 0.4%), while the Mexico's Bolsa rose 1.3% (up 2.8%). Russia's RTS equities index jumped 1.9% (up 6.9%). India's Sensex equities index rose 2.4% (up 0.6%). China's Shanghai Exchange gained 1.8% (down 6.4%). Brazil's benchmark dollar bond yields rose 4 bps to 4.85%, and Mexico's benchmark bond yields rose 4 bps to 4.78%.

Freddie Mac 30-year fixed mortgage rates added one basis point to 4.96% (down 2bps y-o-y). Fifteen-year fixed rates gained one basis point to 4.33% (down 28bps y-o-y). One-year ARMs dropped 10 bps to 4.12% (down 79bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down one basis point to 5.81% (down 108bps y-o-y).

Federal Reserve Credit surged $30.0bn last week to $2.292 TN. Fed Credit was up $251bn, or 12.3%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/17) jumped $14.9bn to a record $2.997 TN. "Custody holdings" expanded $406bn, or 15.7%, over the past year.

M2 (narrow) "money" supply declined $13.3bn to $8.513 TN (week of 3/8). Narrow "money" has increased $1.0bn y-t-d. Over the past year, M2 expanded 1.5%. For the week, Currency added $1.0bn, while Demand & Checkable Deposits fell $13.5bn. Savings Deposits rose $15.6bn, while Small Denominated Deposits declined $5.5bn. Retail Money Funds sank $10.8bn.

Total Money Market Fund assets (from Invest Co Inst) sank $73.6bn to $3.170 TN. In the first 11 weeks of the year, money fund assets have dropped $277bn, with a one-year drop of $847bn, or 21.9%.

Total Commercial Paper outstanding fell $22.5bn last week to $1.122 TN. CP has declined $47.7bn, or 19.3% annualized year-to-date, and was down $354bn over the past year (24%).

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.185 TN y-o-y, or 17.9%, to $7.818 TN.

Global Credit Market Watch:

March 17 - Bloomberg (Jonathan Stearns and James G. Neuger): "Greek Prime Minister George Papandreou kept alive the possibility of requesting International Monetary Fund aid as German Chancellor Angela Merkel cautioned against 'hasty' decisions on European Union assistance for the country. As long as 'Greece is still borrowing at an unreasonably high interest rate, over 6%,' the country will keep 'all options open' while preferring an EU solution, Papandreou said..."

March 18 - Bloomberg (John Glover): "Company borrowing costs have fallen to the lowest levels since the credit crisis started to roil markets in 2007, as investors seek alternatives to sovereign securities tainted by governments' deteriorating finances. The extra yield investors demand to hold corporate debt rather than U.S. Treasuries tumbled to 156 bps... less than a third of the gap a year ago... Companies responded to the drop in borrowing costs by pushing issuance to a record. Corporate bond sales worldwide climbed to an all-time high of $3.2 trillion in 2009 and totalled at least $612 billion so far this year..."

March 19 - Bloomberg (Bradley Keoun): "Citigroup Inc., the bank 27% owned by the U.S. government, will ramp up purchases of mortgages underwritten by other firms and keep more loans on its balance sheet after reversing a plan to scale back home lending. Citigroup has decided mortgages are a 'core' product alongside consumer-banking staples savings accounts and credit cards, Sanjiv Das, who heads the... lender's U.S. mortgage business, said... 'In order to be full-service consumer bank we had to be able to offer mortgages to our customers' Das said. 'Then, we said, let's now start to rebuild this business.'"

March 18 - Bloomberg (Tal Barak Harif and Ye Xie): "Japanese housewives and retirees are buying record amounts of Brazilian real-denominated bonds in international markets... Japanese mutual funds' holdings of Brazilian bonds surged to a record 1.34 trillion yen ($14.8bn) in February from 431 billion yen a year earlier, according to the Investment Trusts Association."

March 17 - Bloomberg (Michael Patterson): "The combination of record mutual fund inflows and the fastest economic growth are failing to lift shares in the largest developing nations with valuations at the highest level versus advanced countries since at least 1995. Emerging-market stock funds lured $86.6 billion in the year through January, the most in 14 years of data, according... EPFR Global."

Global Government Finance Bubble Watch:

March 19 - Dow Jones (Luca Di Leo and Jeff Bater): "The U.S. Federal Reserve's balance sheet expanded... in the latest week as the central bank's huge holdings of mortgage-backed securities continued to grow. ...the Fed said its asset holdings in the week ended March 17 grew to $2.311 trillion from $2.286 trillion a week earlier. Holdings of mortgage-backed securities rose to $1.066 trillion from $1.029 trillion a week earlier."

March 16 - Bloomberg (Craig Torres and Scott Lanman): "Federal Reserve officials repeated their pledge to keep the main interest rate near zero for an 'extended period' and confirmed that emergency measures to prop up the housing market will end as planned this month. While the economy has 'continued to strengthen,' policy makers noted that 'housing starts have been flat at depressed levels' and 'employers remain reluctant to add to payrolls.'"

March 19 - Bloomberg (Bryan Keogh): "Financial company bonds are beating industrial debt by the most this year after lagging behind in February... Bond sales...by JPMorgan, the second-largest U.S. bank by assets, and... Credit Suisse drove global financial debt issuance this month to at least $121 billion, surpassing February's total by 22%..."

March 19 - Bloomberg (Nariman Gizitdinov): "The Development Bank of Kazakhstan, a state-owned bank that promotes industry, may cancel plans to sell $500 million of bonds to international investors this year after it received a $5 billion line of credit from China."

Currency Watch:

The dollar index was 1.2% higher this week to 80.758 (up 3.7% y-t-d). For the week on the upside, the New Zealand dollar increased 0.8%, the South African rand 0.8%, and the Canadian dollar 0.2% For the week on the downside, the Brazilian real declined 2.1%, the Swedish krona 1.8%, the Euro 1.7%, the Danish krone 1.7%, the Norwegian krone 1.5%, the British pound 1.3%, the Mexican peso 0.4%, and the Swiss franc 0.3%.

Commodities Watch:

The CRB index slipped 0.2% (down 3.8% y-t-d). The Goldman Sachs Commodities Index (GSCI) declined 0.4% (down 0.6% y-t-d). Gold rose 0.5% to $1,107 (up 0.9% y-t-d). Silver was little changed at $17.032 (up 1.1% y-t-d). April Crude declined 56 cents to $80.68 (up 1.7% y-t-d). April Gasoline was unchanged (up 10% y-t-d), while April Natural Gas sank 5.3% (down 25% y-t-d). May Copper slipped 0.2% (up 0.8% y-t-d). May Wheat declined 0.3% (down 11% y-t-d), while May Corn gained 2.8% (down 10% y-t-d).

China Bubble Watch:

March 17 - Bloomberg (Sophie Leung): "The World Bank indicated that China... should raise interest rates to help contain the risk of a property bubble and allow a stronger yuan to help damp inflation expectations. The nation's 'massive monetary stimulus' risks triggering large asset-price increases, a housing bubble, and bad debts from the financing of local-government projects, the... World Bank said... The group raised its economic growth forecast for this year to 9.5% from 9% in January."

March 17 - Bloomberg (Bei Hu): "China is in the midst of 'the greatest bubble in history,' said James Rickards, former general counsel of hedge fund Long-Term Capital Management LP. The Chinese central bank's balance sheet resembles that of a hedge fund buying dollars and short-selling the yuan, said Rickards, now the senior managing director for... Omnis Inc. 'As I see it, it is the greatest bubble in history with the most massive misallocation of wealth,' Rickards said..."

March 17 - Bloomberg (Jeremy van Loon): "China replaced the U.S. as the biggest investor in renewable energy for the first time in five years as the Asian nation raced to meet rising demand for power and reduce carbon emissions. China invested $34.5 billion in wind turbines, solar panels and other low-carbon energy technologies in 2009... The U.S. spent about half as much last year..."

Japan Watch:

March 18 - Bloomberg (Mayumi Otsuma and Aki Ito): "The Bank of Japan's decision to double the size of a liquidity program for banks may prove more effective in placating the government than stemming deflation. The bank yesterday increased its three-month lending facility for banks to 20 trillion yen ($221bn), a 'monetary easing' that may help reduce borrowing costs and bolster corporate sentiment, Governor Masaaki Shirakawa said..."

India Watch:

March 20 - Bloomberg (Cherian Thomas and Anil Varma): "India's central bank will probably raise interest rates again next month as the first increase in two years is only the initial step in the battle against inflation, BNP Paribas SA and Standard Chartered Plc said. The Reserve Bank of India yesterday increased the benchmark reverse repurchase rate to 3.5% from a record-low 3.25%... saying containing inflation has become 'imperative.' Governor Duvvuri Subbarao's move comes after Australia and Malaysia increased rates this month, while Norway and Israel did so at the end of last year..."

March 17 - Bloomberg (Rakteem Katakey): "India, with $254 billion of foreign-exchange reserves, may create a sovereign wealth fund to help state companies compete for overseas energy assets with China, a government official said. The oil ministry has formally asked the finance ministry to set up a fund using a part of the reserves..."

Latin America Bubble Watch:

March 17 - Bloomberg (Iuri Dantas): "Brazil's economy added a record number of jobs for the month of February as Latin America's biggest economy expands at the fastest pace in two years. The Labor Ministry said... registered 209,425 jobs in February... Brazil will generate more than 2 million jobs this year..."

Bubble Economy Watch:

March 18 - Bloomberg (John Lauerman): "Harvard College, the undergraduate division of Harvard University, raised the cost of tuition, room, board and other fees 3.8% to $50,724 for the 2010- 2011 academic year."

Central Bank Watch:

March 17 - Bloomberg (Craig Torres and Joshua Zumbrun): "Federal Reserve Chairman Ben S. Bernanke said the central bank shouldn't be relegated to the role of regulating only the largest financial firms, as proposed by a draft bill in the Senate. 'We are quite concerned by proposals to make the Fed a regulator only of the biggest banks,' Bernanke told the House Financial Services Committee... 'It makes us essentially the too-big-to-fail regulator. We don't want that responsibility.'"

Central Bank Watch:

March 13 - Wall Street Journal (Sudeep Reddy and Jon Hilsenrath): "Janet Yellen's expected nomination as Federal Reserve vice chairman would bring a strong advocate of low interest rates into the central bank's leadership just as the Fed weighs how to unwind its extraordinary intervention in the economy. For two other vacancies on the Fed's board, the White House says it is considering Sarah Raskin, Maryland's commissioner of financial regulation, and Massachusetts Institute of Technology economist Peter Diamond, an expert on Social Security, pensions and taxation... Fed Chairman Ben Bernanke, seeking to pick the appropriate time to tighten policy, is likely to get a set of new governors who support keeping interest rates low to help the economy recover. The likely nominees are expected to be a key counterweight to the Fed's most 'hawkish' policy makers..."

Real Estate Watch:

March 13 - Wall Street Journal (James R. Hagerty): "The number of U.S. households benefiting from lower mortgage payments under a government rescue program rose 6% last month to one million..."

Muni Watch:

March 17 - Bloomberg (Michael McDonald and Jerry Hart): "Florida temporarily suspended sales of Build America Bonds on concern that the Internal Revenue Service may block federal interest-cost subsidies, said Ben Watkins, who oversees the state's debt sales. The... state... halted issuance after a recent conference call in which the IRS said it may offset the 35% subsidy payments if an issuer owes the federal government for other programs, such as Medicaid, Watkins said..."

March 18 - Bloomberg (Michael B. Marois and Catarina Saraiva): "California, the largest U.S. issuer of municipal debt, is pursuing its next sale of Build America Bonds, even as Florida suspended its offerings on concern that the Internal Revenue Service may block interest-cost subsidies. 'We plan to go full speed ahead with our BABs,' Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said..."

Speculation Watch:

March 13 - Financial Times (Francesco Guerrera, Henny Sender and Patrick Jenkins): "The fallout from the report into the collapse of Lehman Brothers shook Wall Street and London on Friday as US officials grilled banks about off balance-sheet trades and questions were raised over the City's role in the company's attempts to cover up its problems. The 2,200-page report by Anton Valukas, appointed by a US court to probe the reasons for Lehman's failure in September 2008, paints a damning picture of the bank's top management..."

 

Greenspan on The Crisis

"The house price bubble, the most prominent global bubble in generations, was engendered by lower interest rates, but it was long term mortgage rates that galvanized prices, not the overnight rates of central banks, as has become the seeming conventional wisdom." Alan Greenspan, March 19, 2010

The net annual increase in U.S. Total Mortgage Debt (TMD) averaged $265bn during the decade of the nineties. Implementing its post-tech Bubble reflation, the Fed continued to aggressively slash interest rates late into 2002. This was despite a rapid acceleration in mortgage debt growth. TMD expanded a record $901bn in 2002, a heady 12.1% pace. The Fed cut rates from 1.25% to 1% one final time for that cycle in June of 2003. Not surprisingly, already hot mortgage finance turned white-hot. TMD expanded a record $1.004 TN in 2003 (12.0%), boosting six-year growth to 83% (almost four-times the annual rate from the nineties!). It should have been clear to the Fed by 2003 that it was dealing with a major financial Bubble. It was apparently at the time focused on deflationary risks.

TMD growth accelerated further during 2004, increasing $1.263 TN (13.5%). Fed funds were finally adjusted 25 bps higher at mid-year, yet ended 2004 at only 2.25%. TMD growth surged further into uncharted territory, increasing $1.439 TN in 2005. By mid-year, rates had been raised to 3.25% before ending the year at 4.25%. Home prices around much of the country were inflating at double-digit rates. Baby-step rate increases continued throughout 2006. By year-end, fed funds were at 5.25%, with 2006 TMD growth of another $1.40 TN. By the end of 2007, TMD had doubled in only six years and was up 185% over 10 years.

The growth trajectory of our Current Account Deficits followed that of mortgage debt. The deficit jumped to $215bn in 1998 (from $141bn); then to $302bn in 1999 and to $417bn in 2000. Atypically of a recessionary backdrop, the Current Account Deficit remained at an enormous $400bn in 2001. Specifically, consumption had been boosted by the huge Fed-induced growth in mortgage debt, home price inflation, and equity extraction. The deficit then jumped to $459bn in 2002, $522bn in 2003, $631bn in 2004, $749bn in 2005, and a record $804bn in 2006 - closely paralleling ballooning mortgage debt growth.

Alan Greenspan presented a paper today at a Brookings Institution conference titled "The Crisis." His paper is 45 pages, and I haven't yet had a chance to dive fully into it. But what I've read thus far is deserving of some Friday afternoon comments.

Mr. Greenspan: "In short, geopolitical events ultimately led to a fall in long-term mortgage interest rates that in turn led, with a lag, to the unsustainable boom in house prices globally."

The historical fact of the matter is that the Greenspan Fed mistakenly accommodated both the Bubble in U.S. mortgage Credit and the resulting unprecedented Current Account Deficits. Somehow, Mr. Greenspan, Dr. Bernanke and others will still argue that the massive outflow of dollar liquidity to the world - that was largely monetized by foreign central banks - was not the primary catalyst for the destabilizing decline in global market yields. And perhaps they would argue that Federal Reserve policy - including rapid rate cuts and telegraphed baby-step increases and talk of "helicopter money" and "unconventional measures" - didn't entice speculative leveraging throughout the market for GSE and "private-label" MBS. And I doubt Greenspan will concede that his position as the leading proponent for derivatives, hedge funds and contemporary Wall Street finance, more generally, was a major factor promoting their fateful runaway expansion. And, clearly, Greenspan and Bernanke refuse to acknowledge that they looked the other way as the GSEs ran completely out of control.

It's just hard for me these days to stomach the same flawed dogma that the financial crisis was caused by some nefarious "global saving glut." It was caused by a Credit Bubble whose epicenter was in Washington and New York. The crisis was all about the consequences from a historic government-induced mispricing and inflation of Credit. At its core, the crisis manifested from a massive inflation of financial obligations by the Credit system commanding the world's reserve currency. There is plenty of blame to go around, but the ongoing saga will surely be viewed as a case of monumental central banking mismanagement.

Mr. Greenspan: "We had been lulled into a sense of complacency by the only modestly negative economic aftermaths of the stock market crash of 1987 and the dot-com boom. Given history, we believed that any declines in home prices would be gradual. Destabilizing debt problems were not perceived to arise under those conditions."

I don't buy it. After the 1987 stock market crash, the 1994 bond market crisis, the 1995 Mexican meltdown, the 1996/97 Asian crisis, the 1998 Russian collapse and LTCM debacle, Brazil, the Y2K scare, Argentina, the technology stock collapse, the corporate debt crisis, and the 9/11 disaster - how on earth could there have been a shred of complacency anywhere in the Federal Reserve system? Clearly, major changes in the nature of contemporary finance had increased risk-taking and systemic fragilities. I believe the opposite of complacency was likely at work. Fragile underpinnings and Bubble dynamics throughout mortgage finance had the Fed hamstrung to baby-step timidity - and it was this submissive approach to financial regulation that really fed the U.S. and global Credit Bubble.

I do agree with Mr. Greenspan when he writes that pricking Bubbles does not come without economic pain. But the key to monetary management - certainly not recognized by Greenspan - is to ensure that Bubble risk doesn't inflate to the point where policymakers are afraid to employ restraint and discipline the instigators of excess. There must be rules of the road that work to restrain excessive risk-taking rather than promote it.

It appears Mr. Greenspan has, again, missed his opportunity to come clean and admit that the Greenspan/Bernanke doctrine of ignoring Bubbles and focusing instead on "mopping up" strategies was fundamentally flawed and a historic disaster in monetary management. Don't evoke complacency. The issue was flawed central banking doctrine and a dogmatic hands-off approach to monetary (mis)management.

Mr. Greenspan: "The primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades..."

It is not clear to me how increased capital standards coupled with liquidity and collateral requirements is going to restrain global central bank balance sheets and contain fiscal deficits. I don't see how these measures will counteract the deep distortions in the market pricing and allocation of finance today throughout the global financial system. This "primary objective" will have no meaningful impact on the unfolding government finance Bubble or upon structural economic imbalances. A focus on private-sector Credit is fighting the last war.

Mr. Greenspan: "Unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible. Assuaging their aftermath seems the best we can hope for."

This is the best we can hope for? As we have witnessed for (at least) the past 18 months now, there is not a more powerful apostle for central planning than the hardship and confusion associated with the bursting of a major Credit Bubble. Cannot Mr. Greenspan today at least question the danger to free markets occasioned by central banks' manipulation of market interest rates and their repeated market interventions?

I wish we could implement a gold standard. Global Credit systems and economies are in dire need of a mechanism that would work to promote at least a semblance of stability. Regrettably, at this stage of massive global debt and synchronized global inflationism, a gold-based monetary regime is implausible. As such, I am a proponent of sound central banking - the kind that doesn't exist today. It's our last resort. And it's in this vein that I am so frustrated with Mr. Greenspan. He just refuses to address the dangerous flaws of contemporary central banking.

So we learn so little from the past and set course for another historic Bubble - The Global Government Finance Bubble. Flawed central banking doctrine leads to mistake after bigger mistake. The consequences of previous government market interventions ensure only more intrusive interference. And Alan Greenspan, the seeming free-market ideologue, works to ensure he goes down in history as the father of modern inflationism.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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