ALAN GREENSPAN’S HAIL MARY….Brad DeLong suggests that we might be headed toward recession because oil prices are spiking and the Fed has been raising interest rates. By itself, though, that’s not enough:
Most likely the Federal Reserve’s continued raises in interest rates will not send the economy into recession. But there is that chance, and the chance is raised from a low-probability possibility to a serious worry by the third factor: that home-as-ATM problem. The unprecedented use of home loans to squeeze cash out of equity has allowed middle-class consumers to spend well beyond their means. Someday this spending spree has to come to an end. If it comes to an end suddenly, at a time when the Federal Reserve has raised interest rates a little too much, then we have our recession.
Fed chairman Ben Bernanke, of course, is inheriting a problem that was deliberately aggravated by his famous predecessor, Alan Greenspan. Two years ago, with the housing bubble well underway but showing signs of slowing down ? and possibly taking the economy with it in an election year ? Greenspan did something very odd: he threw fuel on the home refinancing fire. Ben Wallace-Wells told the tale in “There Goes the Neighborhood,” our April 2004 cover story:
[In February,] Greenspan recommended that the home-owning public take a good hard look at switching from fixed-rate mortgages, under whose terms payments stay the same no matter what interest rates do, to adjustable rate mortgages (ARMs), where payments fluctuate along with interest rates–which, right now, makes close to zero sense. Interest rates are lower than they’ve been in 30 years, and, with all economists predicting a general economic upturn, and Bush’s budget deficit and the weak dollar sucking up capital, little doubt exists that interest rates must rise, in which case, switching from a fixed-rate to adjustable-rate mortgage would be pretty costly for any family na?ve enough to take Greenspan at his word. The episode did not pass completely without critical notice. It was “the strangest bit of advice ever to be proffered by an American central banker,” Jim Grant, publisher of Grant’s Interest Rate Observer, told the San Francisco Chronicle.
….Greenspan’s rather ham-handed effort to get [homeowners] to go for ARMs, is a sign not of the chairman’s own eccentricity or advanced age, but, instead, of the economy’s current unsteadiness. Greenspan knows, perhaps better than anyone, that this economy is perched nervously on top of a wobbly, Dr. Seuss-like tower. Our recovery is propped up by consumer spending, which is in turn propped up by mortgage refinancing, and if that refinancing dries up before more props can be put in, the whole edifice could fall. “Since long-term interest rates cannot fall low enough to facilitate another wave of fixed-rate refinancings, he is trying to encourage homeowners to refinance one last time: fixed to ARM,” Peter Schiff, president of Euro Pacific Capital in Los Angeles told the San Francisco Chronicle.
Greenspan recommended one last wave of refinancings, hoping against hope that things would turn out OK. If they didn’t, of course, we’d not only get a recession, but millions of people who took his advice would end up broke because they couldn’t afford the payments on their homes ? payments that Greenspan of all people knew perfectly well were dead certain to rise.
It was bad advice, and Greenspan knew it. And now it’s coming home to roost.