This week we got to watch as the markets went wild with the realization they were over leveraged on bad debt, until Bernanke rode in with a huge bailout, answering a question (and settling some bets) on whether he was an inflation fighter, or an inflationist (he’s an inflationist, and he has now proved it.) This Monday, we’ll get to see if the markets are reassured enough, and over the next few weeks we’ll get to see whether or not more failures occur anyway (sure, you can give banks money, but do they really want to buy out fundamentally lousy debt instruments at anything near face? Not unless Bernanke and his counterparts have been really twisting arms. Maybe not even then.)
But I don’t want to talk about last week, I want to talk about this last decade, which Stirling Newberry calls the Decade of Stupid. I’m hearing a lot of revisionism from people who should know better, such as Der Spiegel, that Greenspan wasn’t to blame and if he was, well, he had no choice.
The only really appropriate answer to that is, alas, unprintable. So let’s take a march down memory lane. We all remember the Internet bubble of the late 90′s. It should have ended in 98, but Greenspan was caught between a bubble and hard place and he made the fateful decision to put his foot to the pedal and flood the world with money. In 2000 the bubble finally burst, and the rich took a huge loss.
That simply couldn’t be allowed, so a few things happened. First Greenspan dropped interest rates to generational low rates. One can argue that this was the right thing to do, so I won’t get on his case too hard. But he kept them there for a year, then raised them much too slowly. The result was a real-estate bubble, one a number of us were talking about as early as 2002. Those mortgages were taken, cut up and turned into securities (CDOs, or collateralized debt obligations) and those were sold as investment vehicles. In the meantime, as the bubble progressed, it started using loan types not seen in large numbers since the depression – nothing down, liar’s loans (where you state your income), variable loans where the payments jumped after a few years but the first few years were very low, and so on. Underwriting standards were essentially abandoned and anyone was allowed to have a mortgage, whether they could afford it or not. Despite all the nattering about “sub-prime” the weakness in underwriting extended well into Alt-A (the sort of good class) and into Prime loans (supposedly solid loans). Because it was a bubble, and because in a bubble people have to pretend it’s not a bubble and will never end the default rate was massively underestimated as well. (Aside: anyone remember Dow 36,000? The authors still get to go on TV and act as “experts – but all they were was shills cashing in on the 90′s stock bubble by telling people it would never end.)
Even as Greenspan started raising rates slowly, money remained essentially free for the wealthy. For most of this period Japan kept its interest rate at 0% or close and if you were in a position to borrow at near prime in Japan, then take that money and use it elsewhere, you were able to massively benefit from arbitrage. Combined with leverage (a fancy word for taking the 10 million you borrowed from Japan and getting a 100 million dollar loan on it so you could gamble, er trade) and a rising market, even fools could and did make very good returns – 20% was the minimum I would have accepted, were I rich, during many of these years, and in many years returns were much higher for those in on the game. (Notice, by the way, how the world became divided into two groups – those with enough money to buy into the best funds; and peons like most people reading this, who were stuck with single digit returns).
But the bailout of the rich required more than this. It also included fiscal, that is to say – tax – policy. Bush’s first major domestic priority, as we all remember, was to drop tax rates on the rich through the floor, so they could recover from the beating they took when the market collapsed.
Nor did Treasury fail to get in on all of this. When Bush dropped tax rates through the floor, combined with a recession, it caused huge government deficits to blossom almost overnight. At this point interest rates in the US were at generational lows. What would you do if you were Treasury Secretary in such a situation? Well, I don’t know about you, but what I’d do is sell nothing but 30 year Treasuries so I could finance the deficit at the lowest possible rates for the longest time – lock in those generational lows. In fact I’d be rolling over as much debt as possible into long term bonds. That’s not what Treasury did – what it did was eliminate the 30 year bond entirely, making 20 year bonds the longest duration – and sold as many short term duration bonds as possible – at a much higher cost to the government for borrowing.
Since the new long term Treasuries were the 20 and 10 year bonds what this meant was that people who had wanted 30 years were pretty much forced to buy the shorter “long” treasuries. Since those Treasuries compete with mortgage backed securities, that flooded the market with more securities. More supply, nothing else really changed = lower prices. Lower mortgage rates. The Treasury was juicing the mortgage market by eliminating 30 year Treasuries. And by selling lots of lower duration treasuries it was also juicing consumer loans and so forth.
Both the hedge fund and housing bubbles then were a creation of coordinated activity by the US government with the help of other nations (primarily the oilarchies and China, which is beyond the scope of this article). Other decisions (for example, allowing banks to ignore reserve requirements by buying “default insurance” thus expanding leverage massively) all did the same thing. Greenspan pushed the both the bubble – telling people that variable rate mortgages were a good buy at the exact best point to get a fixed rate mortgage and testifying before Congress about how tax cuts for the rich were great (and his prestige greatly helped get those cuts through.) So.. at the base of the economy – the housing bubble. At the peaks, free capital for trading and arbitrage games, and for slicing and dicing all the paper produced by the housing bubble and selling it to the world.
The beauty of the housing and securities bubbles, from the point of view of central bankers and rich people, is that they were designed not to cause widespread general inflation. Asset prices in the bond market should have limited impact on people’s lives. Houses are the main asset most ordinary people have, but they are very illiquid, and while there was a fair bit of borrowing against value (the infamous home equity loans, in which home owners forgot that an asset you haven’t sold doesn’t have a real price you can count on).
Of course, it didn’t quite work out – that nasty Iraq war and the price of oil, and all. That has crept into real world inflation (as opposed to the pablum that the BLS feeds us, with core inflation (the inflation you pay if you don’t eat, heat your house, or drive) and which doesn’t measure housing inflation (it uses rent equivalent, which hasn’t kept up). Food inflation has recently spiked up for staples due in large part to the ethanol bill (a 19.5% increase in the price of eggs for example) but they have been rising at a steady clip for years now. Mechanized agriculture is very oil dependent and oil price increases do move down the chain very directly to food prices. More to the point, you have to eat. That’s why food prices are rising while consumer electronic prices aren’t – you can live without a surround sound system (some claims to the contrary), but stop eating, and the food withdrawal symptoms kick in pretty quick as I can attest from personal experience. Whenever you “have to” buy something, that means the supplier has pricing power – he won’t eat his costs in most circumstances.
So the bubble went on, and started bursting about this time last year. Because CDOs and their cousins are listed at book values it took some time for the increasing defaults and bankruptcies to cascade through and start causing failures in heavily leveraged hedge funds and other investment vehicles. When they did, the panic hit, and you either were getting cents on the dollar, or you just couldn’t sell the things at all.
And this is where Bernanke stepped in with loads of cash and a 50 basis point cut. Inflation had already been above target (even by the debased BLS stats) for some time. People actually paying mortgages had been in pain for about a year, and the housing bubble had clearly been deflating for some time. But, as Stirling points out it wasn’t until rich people; until heavily leveraged investment vehicles with no regulation, who have fought against regulation, were in trouble, that Bernanke stepped in. You can’t let rich people face the consequences of their actions, after all – but poor people are being allowed to go sink, despite plans from Edwards and Clinton for some sort of bailout (a billion won’t cut it, but it’s a start.)
The Housing Bubble and the highly leveraged hedge funds were both created by deliberate government policy – not just US policy, mind, but policy choices made in the golden triangle (Asia/America/The Middle Eastern Oilarchies). They were specifically created by deliberate actions by Treasury, the Fed, and Bush’s tax cuts. The rich had to be rescued from their losses when the Internet bubble collapsed. Now the attempt is being made to rescue them from their losses in highly leveraged, unregulated hedge funds which bet heavily on another bubble.
And Bernanke has shown his colors. He won’t cut rates to save normal people (if he was going to bail out ordinary mortgage holders he should have acted this time last year) – but he will bail out the rich. And if it’s a choice between inflation and keeping the rich rich, well, he’s made his choice. He’s no Volcker.
So when people tell you this all couldn’t have been foreseen; when they tell you rescuing the rich is the same as rescuing you; when they tell you Greenspan doesn’t bear the blame for this or that the President has nothing to do with the economy, laugh at them, because unlike them you don’t live in the eternal present and can remember what happened, oh, in the last ten years….
Note: Made a couple minor edits:
1) to clarify that if enough people had taken into account that it was a bubble in assigning risk then it wouldn’t have been a bubble
2) a brief note that while this required concerted government action it also required the ok and assistance of both China/Japan and the Oilarchies (much of which I don’t go into in the article, but one should be aware it’s a gap. Japan gave the free capital; China fought inflation with cheap consumer goods and bought up tons of securities and kept the dollar from collapsing; the oilarchies kept recycling a lot of thier profits into dollar denominated securities.)