Alan Greespan’s recent column in the Wall Street Journal (The Roots of the Mortgage Crisis) is a must read. He tries to put together a coherent explanation of the current mortgage crisis. As I have long suspected, central banks in all major economies are increasingly flying blind as the size of the global economy grows and the financial interactions between countries increases in complexity.
I’d like to parse Mr. Greenspan’s explanation here somewhat. He says the current crisis started a few years after the collapse of communism (1989-1991). Most nations shed their old socialist/communist past and started on the road of prosperity. The Asians employed a successful strategy of export-led growth (taking advantage of their cheap labor costs).
Of course in due time cheap products began to flood the Western market. Eventually this started to spark fears of deflation (around late 2002-2003) in the United States. Also as poor Asians started becoming rich they started saving money not spending (what a concept eh?).
So, with a glut of cash sitting in bank vaults, the global economy was suddenly flush with cash. Add in the fact that the rich countries didn’t increase business investment during this time (and employ the sitting cash) and we start to see why the money bubble kept growing.
In the final analysis Mr. Greenpsan ties all these factors together and explains how asset prices (stocks, homes etc.) rose dramatically over the past few years. He expresses bewilderment on why mortgage rates (both fixed and adjustable rates) kept falling despite a Fed tightening in 2004-2005. The Fed knew this fall in long term rates was not sustainable but was powerless to anything about it. In Mr. Greenspans words:
I had expected, as a bonus, a consequent increase in long-term interest rates, which might have helped to dampen the then mounting U.S. housing price surge. It did not happen.
I suggest you read the original article and tell me what you think. I think it’s a great example of how inter-connected the world has become and how no single authority on any continent can even fathom to control it. The future is truly fascinating.