by John M. Curtis
(310) 204-8700

Copyright August 27, 2005
All Rights Reserved.

eeting in picturesque Jackson Hole, Wyoming, U.S. Central Bankers met to (a) deal with a possible “housing bubble” and (b) venerate Federal Reserve Chairman Alan Greenspan, whose 18 year-term ends in Jan. ‘06. While no one doubts Greenspan's brilliance at turning clever one-liners, his stewardship of the U.S. economy remains controversial, especially his management of the “new economy” he touted for several years before the market crash of March 2000. Greenspan likes to point out that the Fed doesn't target specific “asset markets,” yet Wall Street knows that monetary policy, namely, setting short-term interest rates, either makes or breaks the stock and housing markets. Before the 2000 crash, Greenspan raised rates relentlessly for two consecutive years, dealing with what he called “irrational exuberance,” characterizing inflated stock market prices.

      From Jan. 1996 to March 2000, core inflation averaged 2% on an annual basis, well within the Fed's range to maintain consistent monetary policy. After saying the markets showed “irrational exuberance” Dec. 6, 1996, Greenspan waited until 1998 to start raising rates. He raised the Federal Funds rate eight times from 4.75% to 6.50%, eventually causing the market crash in March 2000. From Jan. 1996 through March 2000, the Dow Jones Industrial Average nearly doubled, rising from 6,000 to 11,723. Greenspan clearly targeted the stock market in 1998, culminating in the 2000 meltdown. Now he's concerned about a real estate bubble, in part caused by the 2000 market crash, where investors turned from stocks to real estate. When Sept. 11 threatened recession, Greenspan aggressively took the Federal Funds Rate down to 1.0%, dropping mortgage interest rates to historic lows.

      Keeping the Federal Funds rate too low caused an exodus from U.S. treasuries—especially from foreign investors—where low yields couldn't keep pace with currency devaluations. Greenspan had no choice but to methodically hike rates, not to fight inflation but to keep U.S. treasuries competitive with foreign banks. Since June 2004, Greenspan has raised rates 10 times to 3.5%. At the time the market crashed in March 2000, the Federal Funds rate was 6.5%. and fixed mortgage interest rates averaged 8.5%. Today's 30 years fixed rates are around 6-6.5%, contributing to rocketing home prices. “There's no question that the Fed should have much earlier raised interest rates, not to kill the housing sector but to keep it sustainable,” said Edward Leamer, director of UCLA's Anderson Forecast, long predicting today's housing bubble. Leamer blames Greenspan for failing to act sooner.

      Raising short-term rates invariably filters into the housing market. It's a matter of time before increased treasury yields translate into higher mortgage rates. “History had not dealt kindly” with speculators ignoring market risks, Greenspan told Central Bankers in a pre-retirement speech. Today's abnormally low interest rates and easy borrowing standards have fueled runaway inflation in real estate markets. When Greenspan warned in 1996 about “irrational exuberance,” he was a primary cheerleader boosting the “new economy” or dot-com industry. Back then, he talked about “new efficiencies,” allowing technology to sustain stock market growth. Many respected economists and journalists predicted the Nasdaq would overtake the Dow Jones Industrial Average. Greenspan helped write a different story, allowing the Fed's monetary policy to eventually sink the stock market.

      At the height of the tech bubble in March 2000, the Nasdaq—the trading home of many tech stocks—peaked at nearly 5,000. By 2002, the Nasdaq lost 85% of its value, dropping to under 800. While the Nasdaq clawed its way back to over 2,100 and remains 60% off its peak, tech stocks haven't regained past glory. No one expects the housing market to follow the Nasdaq should a correction take place. Real estate performs more like Blue-chips, whose value collapsed 40% at the worst of the 2000 meltdown. It took five years before Greenspan's remarks about “irrational exuberance” finally sunk-in to the stock market. Whether that's the case with his current warnings about a real estate bubble is anyone's guess. There's no parallel other than inflated prices between today's housing market and yesterday's dot-com bubble. There's no “new economy” when it comes to homes, observed Leamer.

      Taking out the wrecking ball, there's still more potential damage left in Greenspan's arsenal. He's still capable of raising rates at least 50-basis points before he retires. As long as long-term rates remain low, it's unlikely real estate values will plummet in the foreseeable future. There's a big difference between the dot-com hype of the late ‘90s and today's so called “real estate bubble.” Back then, Greenspan touted tech stocks before he pulled the rug out from underneath the Nasdaq. Housing markets rise and fall with supply-and-demand. Whoever inherits Greenspan's job, he'll have a difficult time keeping consumers spending, while, at the same time, hiking rates. With oil prices spiraling out-of-control, raising rates too far could be inflationary, adding to the costs of goods and services, causing scarcity and eventually pushing the economy into an unwanted recession.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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