Did Greenspan "Blow" It?

Did Greenspan “Blow” It?

The Economic Meltdown

and

The Prospects for Recovery in Kansas City and Beyond

Stephanie Kelton

Associate Professor of Economics

University of Missouri-Kansas City

February 2009

1Stephanie Kelton, Associate Professor, UMKC

Where Are We Today?Nationally

Massive solvency problems in banking system

Most severe contraction since the Great Depression

U.S. economy is shedding 600,000-700,000 jobs per month (5 million since recession began)

8.9% unemployment rate

Consumer confidence at an all-time low

2 million home foreclosures


Protests & Riots From Iceland to China

Stephanie Kelton, Associate Professor, UMKC 3

“By far the deepest global recession since the Great

Depression” (IMF, 4/22/09)

5 Distinct Regions

Below Nat’l Average◦ Great Plains◦ Northeast

Above Nat’l Average◦ South◦ Great Lake States◦ West Coast

KC Metro vs. Rest of Nation

Unemployment Rate, February 2009


Over 520,000 in Services

171,659 in Government

146,000 in Retail

All other sectors have less than 10%

Employment in the KC Economy


Children’s Mercy Hospital – 3,602

KCK Public Schools – 3,500

AT&T – 3,435

North KC School District – 3,200

U. of Kansas Hospital – 3,020

Black & Veatch – 3,012

Truman Medical Center – 3,063

General Motors – 2,900

UMKC – 2,885

Applebee’s International – 2,744

Blue Valley School Dist. – 2,717

Lee’s Summit School Dist. – 2,642

Honeywell – 2,604

Selected Major Employers

Federal Government – 25,004

Sprint Nextel Corp. – 16,403

HCA Midwest Health – 7,320

Mc Donald’s USA – 7,111

State of Missouri – 6,078

Ford Motor Co. – 5,453

DST Systems – 5,200

St. Luke’s Health Sys. – 4,808

Hallmark Cards – 4,500

City of Kansas City, MO – 4,400

KCMO School Dist. – 4,399

Cerner Corp. – 4,309

State of Kansas – 4,115

Olathe School District – 3,980

Johnson County, KS Govt – 3,774


Used to measure the strength of each industry, relative to the national average

Score > 1 indicates higher than average concentration of that type of employment and likely exporter


Economic Outlook in the KC Metro Area

8,900 jobs lost between Nov. ‘07 and Nov. ’08◦ 4,900 on the Missouri side◦ 4,000 on the Kansas side◦ Most losses in construction, mfg and trade, transportation and utilities◦ Modest gains in educ and h/care

8.4% unemployment rate (highest since ‘90)

Sprint-Nextel to eliminate 8,000 jobs (2,000 in the KC area)

Forecast to lose 20,100 jobs in ‘09 (2% of all jobs)

Regional Foreclosures were up 35% in ’08

13,609 properties in some stage of foreclosure (1.56% of all property in metro)

New housing permits at lowest point since tracking began in ‘85◦ Only 136 new permits issued metro-wide in Dec. ‘08◦ Average in Dec. since 2000 over 730

Better Off, Not Well Off


◦Did Greenspan’s policies cause the housing bubble and ensuing meltdown in financial markets?

◦Did Greenspan mishandle the situation once the bubble emerged?



Beating Up on ‘Easy Al’ Easy money following

the 2001 recession◦ John Taylor

Fleckenstein and Canterbery

◦ Baker, Palley, and Liu◦ Poole and Parry◦ Ron Paul

Lax Regulatory Stance◦ Harry Reid,

Christopher Dodd◦ Edward Gramlich

(2000)


Fed Reserve Chairman, Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8,

2005


Correct to keep rates low in post-bubble economy

Risk Premiums, not interest rates, were too low◦ Berlin Wall, Soviet Union, China on property

rights, export-led growth in Asian Tigers, free trade agreements

◦ Developing world growth rates◦ Shift in share of world GDP◦ Increase in global savings◦ Decline in risk premiums◦ Fueled housing demand worldwide

Greenspan on Low Interest Rates


Housing Boom was Global


Greenspan On Regulation and Subprime Lending

On Subprime Lending:

The “retraction”

Favorable remarks were aimed at those who would move or refinance

Low rates had little impact on use of ARMs

Gramlich’s letter

On Regulation:

“There is no way to prevent how innovative markets will develop. All

you can do is set a general strategy. [Deregulated

markets are] highly competitive, innovative,

and dynamic—but periodically visited by

wrenching crises. [Regulated markets are] more stable, but slower

growing.”

(Greenspan, 2008)14Stephanie Kelton, Associate Professor, UMKC


He has said:

◦ It is impossible to spot a bubble until after it bursts

◦ It is dangerous to ignore an emerging bubble

◦ It is dangerous to address a bubble

◦ The best strategy is to focus on the post-bubble economy


Is It Really Impossible to Identify an Emerging Bubble?

Early warning signs:

◦ Buying driven by anticipation of rising prices ◦ Home sales increase sharply◦ Numbers of resort buyers, trade-up buyers and first-time

buyers all increase◦ Houses purchased as “investments” ◦ High percentage of exotic loans◦ Residential construction activity booms◦ Expected rates of return based on recent experience not

historical norms◦ Transactions costs not a deterrent ◦ Market was extremely liquid


“There are people making real estate investments

for residential and other purposes in the

expectation that prices can only go up and go up

at accelerating rates. Those expectations

ultimately become destabilizing to the economic

system”

(Jordan, February, 1999)


He argued that:

◦ It was difficult to speculate in housing

◦ Housing markets are local

◦ National housing bubbles are nearly impossible

Greenspan Disagreed


Greenspan Says There’s “a little froth” (May, 2005)


Froth was “a euphemism for a bubble . . . all the froth bubbles add up to an aggregate bubble” (2007)

So why didn’t he target it?

He targeted the stock market bubble in 1987◦ DOW lost 508 points (22.5%) but rebounded by early 1988

He targeted the stock market again in the mid-1990s◦ First with rate hikes (1994) then with “irrational exuberance” (1996)◦ Goal was to create uncertainty (certainty→euphoria)◦ “when things get too good, human beings behave awfully”

Beginning in June 1999, the Fed raised the ffr 175bp◦ This was probably done in order to let some air out of the stock market

Greenspan Recants


Why Not This Time?


We Tried! Greenspan now

claims that the Fed did act against the emerging housing bubble

But long-term interest rates were falling as the Fed raised short-term rates


“It is household consumption or household demand more generally

that clearly is the source of strength holding this economy together . . . I

suspect that without that support, we would be observing much lower

levels of economic activity” (Greenspan, August, 2001).

The Importance of Consumer Debt


Don’t Rain on MY Parade

When he resigned on Jan. 31, 2006, he was widely hailed the most successful central banker of all time

Perhaps he was more concerned with his legacy than with the stability of the system


The Importance of Ownership

“I was aware that the loosening of mortgage

credit terms for subprime borrowers increased

financial risk . . . But I believed then, as now, that the benefits of broadened home ownership are worth

the risk. Protection of property rights, so critical

to a market economy, requires a critical mass of owners to sustain political

support”

(Greenspan, 2007)


An Unwavering Faith in Free Markets

Greenspan is a self-described libertarian

He counted among his formative influences the novelist Ayn Rand, who portrayed collective power as an evil force set against the enlightened self-interest of individuals

He was deeply committed to the belief that those participating in financial markets would act responsibly

He tethered the health of our nation’s economy to this faith


Greenspan’s Mea Culpa

Greenspan has conceded that the meltdown revealed a flaw in a lifetime of economic

thinking:

“Those of us who have looked to the self-interest of lending institutions to

protect shareholder equity (myself especially) are in

a state of shocked disbelief.”


Complacent

and

Complicit

Not The Root Cause


An Epidemic of Accounting Fraud

Modern compensation systems did not “align” interests◦ Current system not only allows but

encourages fraud

◦ Made possible by decades of deregulation

Profit margins on prime loans are extremely low

Requires CEO to maximize growth through “adverse selection”◦ Unregulated nonprime sector◦ Liar’s loans, NINJAs, etc.

Synthetic Derivatives that were impossible to value properly

Aided by the rating agencies that gave AAA ratings to CDOs without sampling loan files

In a sampling of files, Fitch found:

66% Occupancy fraud 51% Property value or condition issues —

Materially different from original appraisal

48% First Time Homebuyer 44% Questionable stated income or

employment 22% Hawk Alert — Fraud alert noted on

credit report 18% Credit Report — Questionable

ownership of accounts (name or social security numbers do not match)

16% Credit Report — Based on “authorized” user accounts

16% Straw buyer/Flip scheme indicated based on evidence in servicing file

16% Identity theft indicated 10% Signature fraud indicated

(Fitch Ratings, Special Report, Nov. 2007)29Stephanie Kelton, Associate Professor, UMKC


Ignored By Those at the Very Top

“The potential impact of mortgage fraud on financial

institutions and the stock market is clear. If fraudulent

practices become systemic within the mortgage

industry and mortgage fraud is allowed to become

unrestrained, it will ultimately place financial

institutions at risk and have adverse effects on the

stock market.”

-Chris Swecker, former FBI Assistant Director, Criminal Investigative

Division, Introductory Statement: House Financial Services

Subcommittee on Housing and Community Opportunity, 7 October

2004

So Where We Are Today?Globally

◦ Worst economic downturn since WWII◦ Protests, riots, suicides, civil unrest◦ Protectionism◦ Anti-Semitism

Nationally

◦ Will probably take 5 years to recover◦ Fiscal stimulus is too small ◦ Bailouts have done little (if anything) to

shore up confidence◦ Monetary Policy has nowhere to go◦ States are slashing spending to deal with

budgets gaps of about $120 billion

Regionally and Locally

◦ Helped by large share of jobs in federal government, health care and education

◦ Large employers in some industries will cut 25% of labor force

◦ Serious concerns about state funding in KS and MO


A New Wave of Border Wars?

Regional Decline

Will set off intense competition and beggar-thy-neighbor policies

Time-honored tradition: pay-to-play

◦ MO: $170M on historic preservation tax credits (more than total for 19 CCs)

◦ IA: $302M in ‘07 and ‘08◦ MN: proposing $50M in new tax

credits and reduction in business tax rate over next 6 yrs

◦ OH: Lt. Gov. looking to use tax breaks to create/save jobs

◦ KS: $1.3B over last 5 yrs and some legislators pushing for more


Long-term perspective 10-year transportation plan? Saudi-Arabia of wind? Area development?

◦ Casinos, water park, aquarium, etc.◦ JoCo Education Research Triangle Authority ◦ NBAF◦ $200M “Green Impact Zone” in KCMO


Better to Compete on Basis of Comparative Advantage