It is hard to believe, but during Arizona Republican Senator John McCain’s failed presidential bid in 2000, the Senator stated that he would retain then Federal Reserve Chairman Alan Greenspan if elected. Senator McCain went one step further stating that should something happen to Mr. Greenspan, he would prop him up like in the movie “Weekend at Bernie’s”. He was only half joking. The economy of the United States was firing on all cylinders and a lot of the credit, at the time, went to the Chairman. He was beloved by both political parties and was known simply as “the maestro” for his seemingly fantastical manipulation of the economy through an unstoppable expansion.
Fast forward a dozen or so years and Time magazine lists the former Chairman as the number three person (out of twenty-five) to blame for the financial crisis. Political and financial journalist Matt Taibbi called Greenspan a "classic con man" who, through political savvy, "flattered and bullshitted his way up the Matterhorn of American power and ... jacked himself off to the attention of Wall Street for 20 consecutive years." Ouch!
How did this same man go from hero to goat so quickly? Appointed by President Ronald Reagan as the successor to Paul Volcker in 1987, Mr. Greenspan pumped liquidity into the market immediately following the 1987 stock market crash. Although blamed by President George H. W. Bush for not winning a second term, Mr. Greenspan was retained by President Clinton.
Throughout the go-go nineties, Mr. Greenspan presided over the Federal Reserve as the United States equities markets exploded. Speaking out of both sides of his mouth, he famously stated that investors were “irrationally exuberant” about stocks in 1996, but proceeded to slash interest rates in 1998 during the Asian Financial Crisis. During this period of temporary market insanity, it was not uncommon for “dot-coms” to have an Initial Public Offering without having earnings or even a timeframe for when the company would be profitable. The few tech stocks that did have earnings were trading at absurd multiples, and the Fed quite literally through gasoline on the fire. The party came to an end in May of 2000, but the Fed did not start raising rates until after the tech bubble had burst.
The tragic and senseless 9/11 attacks prompted the Fed to reverse course and lower interest rates to stimulate the economy. By 2002, the Fed rate was down to 1%. The extraordinary and unprecedented low interest rate directly contributed to the housing bubble and devastating recession that followed it.
It is said that hindsight is 20/20, but in a speech delivered in February of 2004, Mr. Greenspan advocated the use of Adjustable Rate Mortgages. Ironically, the Fed then began to raise rates from 1% to 5.25%. Any homeowner that had listened to “the maestro” would have seen their monthly mortgage payments steeply increase. These rate increases led to the subprime mortgage crisis, the collapse of Lehman Brothers, and nearly ended Wall Street. Four years after the bailouts, the United States is still in a state of an economic hangover having partied too hard through the dot-com years and the following housing bubble.
Now that several years have passed, it is possible to take a more critical look at the role of Mr. Greenspan had throughout the economic expansion. It is entirely possible that there were multiple factors that led to the expansion; breakthroughs in technology, baby boomers spending throughout their peak earning years, a peace dividend brought by the end of the Cold War, and more. None of these factors had anything to do with the Federal Reserve or their policies. If anything, the Federal Reserve directly contributed to not one, but two bubbles in the space of ten years. When times were good, no one questioned the Fed. When times went bad, it was too late.
I share this story about the US Federal Reserve and the former chairman because I believe that there are lessons to be learned that are directly applicable to the current housing market in Australia. I have no doubt that the members of the RBA (Reserve Bank of Australia) are well educated, hard working, love their country, and have good intentions. Australia has benefited from a mining boom and exports to China which has improved the lives of millions of Australians. However, there is a certain faith in the RBA, a belief that they know how to avoid the financial meltdown. The RBA, it is believed, will prevent the economic collapses that affected my homeland and the bulk of Europe.
If anything, the RBA has benefited from factors outside of their control all the while directly contributing to the housing bubble that has seen the average house appreciate 127% between 1996-2010 while the average income has increased only 47%. While every meaningful metric for property valuation from price-to-rent, the median multiple (median home price divided by median income), and mortgage debt to GDP ratios point to housing bubble. The housing bubble might have ended much earlier if it were not for the decision to keep the party going in the form of a First Time Home Owners Grants (FHOG) in 2008 (I plan to write a bit on this later).
Instead of faithfully trusting the RBA, it would be a better service to Australia to look to the economists who successfully called the housing bubble in the United States. The best and brightest at the Federal Reserve either could not or did not see it as the bubble formed right in front of them. Even if I am wrong, the indicators merit further and serious investigation.
Fast forward a dozen or so years and Time magazine lists the former Chairman as the number three person (out of twenty-five) to blame for the financial crisis. Political and financial journalist Matt Taibbi called Greenspan a "classic con man" who, through political savvy, "flattered and bullshitted his way up the Matterhorn of American power and ... jacked himself off to the attention of Wall Street for 20 consecutive years." Ouch!
How did this same man go from hero to goat so quickly? Appointed by President Ronald Reagan as the successor to Paul Volcker in 1987, Mr. Greenspan pumped liquidity into the market immediately following the 1987 stock market crash. Although blamed by President George H. W. Bush for not winning a second term, Mr. Greenspan was retained by President Clinton.
Throughout the go-go nineties, Mr. Greenspan presided over the Federal Reserve as the United States equities markets exploded. Speaking out of both sides of his mouth, he famously stated that investors were “irrationally exuberant” about stocks in 1996, but proceeded to slash interest rates in 1998 during the Asian Financial Crisis. During this period of temporary market insanity, it was not uncommon for “dot-coms” to have an Initial Public Offering without having earnings or even a timeframe for when the company would be profitable. The few tech stocks that did have earnings were trading at absurd multiples, and the Fed quite literally through gasoline on the fire. The party came to an end in May of 2000, but the Fed did not start raising rates until after the tech bubble had burst.
The tragic and senseless 9/11 attacks prompted the Fed to reverse course and lower interest rates to stimulate the economy. By 2002, the Fed rate was down to 1%. The extraordinary and unprecedented low interest rate directly contributed to the housing bubble and devastating recession that followed it.
It is said that hindsight is 20/20, but in a speech delivered in February of 2004, Mr. Greenspan advocated the use of Adjustable Rate Mortgages. Ironically, the Fed then began to raise rates from 1% to 5.25%. Any homeowner that had listened to “the maestro” would have seen their monthly mortgage payments steeply increase. These rate increases led to the subprime mortgage crisis, the collapse of Lehman Brothers, and nearly ended Wall Street. Four years after the bailouts, the United States is still in a state of an economic hangover having partied too hard through the dot-com years and the following housing bubble.
Now that several years have passed, it is possible to take a more critical look at the role of Mr. Greenspan had throughout the economic expansion. It is entirely possible that there were multiple factors that led to the expansion; breakthroughs in technology, baby boomers spending throughout their peak earning years, a peace dividend brought by the end of the Cold War, and more. None of these factors had anything to do with the Federal Reserve or their policies. If anything, the Federal Reserve directly contributed to not one, but two bubbles in the space of ten years. When times were good, no one questioned the Fed. When times went bad, it was too late.
I share this story about the US Federal Reserve and the former chairman because I believe that there are lessons to be learned that are directly applicable to the current housing market in Australia. I have no doubt that the members of the RBA (Reserve Bank of Australia) are well educated, hard working, love their country, and have good intentions. Australia has benefited from a mining boom and exports to China which has improved the lives of millions of Australians. However, there is a certain faith in the RBA, a belief that they know how to avoid the financial meltdown. The RBA, it is believed, will prevent the economic collapses that affected my homeland and the bulk of Europe.
If anything, the RBA has benefited from factors outside of their control all the while directly contributing to the housing bubble that has seen the average house appreciate 127% between 1996-2010 while the average income has increased only 47%. While every meaningful metric for property valuation from price-to-rent, the median multiple (median home price divided by median income), and mortgage debt to GDP ratios point to housing bubble. The housing bubble might have ended much earlier if it were not for the decision to keep the party going in the form of a First Time Home Owners Grants (FHOG) in 2008 (I plan to write a bit on this later).
Instead of faithfully trusting the RBA, it would be a better service to Australia to look to the economists who successfully called the housing bubble in the United States. The best and brightest at the Federal Reserve either could not or did not see it as the bubble formed right in front of them. Even if I am wrong, the indicators merit further and serious investigation.
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