© 2008 Ira Artman

[*click* for Prior] STERLING SLIVERS – No Place Like Homes [*click* for Special Opening Theme] 

This is the second of a three-part collection that explores the current housing/financial market conundrum using the title of a 1958 romantic "witch-hunt" comedy – Bell, Book, and Candle.

1. The first (No Pace Like Homes’ – available here), briefly reviewed the record for the prior 20 years and suggested that what is surprising is NOT the current meltdown, but the prior run-up. This should have been a signal – or bell – that our "prosperity" was a mirage.

2. THIS post will identify what I believe is the most critical document – or book – authored by the most influential practicing monetarist of the 20th century, and briefly compare its focus with one of the instruments available to the Fed prior to the mid-1980’s.

3. The next and third post will suggest that simple and transparent solutions – a candle – will be needed if we are to crawl out of our current predicament.

Alan Greenspan  became the 13th Chairman of the Board of Governors of the Federal Reserve on 11 Aug 1987.  Chairman Greenspan served for 6,748 days, stepping down on 31 Jan 2006.  This made Greenspan the second-longest serving Chairman; William McChesney Martin, Jr. (2 Apr 1951 – 31 Jan 1970) served 6,879 days.

When Greenspan became Chairman in ‘87, one well-used “avenue” of monetary control had just faded from the scene.  When he left the office, 18 1/2 years later, he took unusual care to describe – in great detail – an alternative “avenue” that had successfully moderated the course of the post 9/11 contraction. Below is the brief story of both “avenues.”

On 13 Mar 1986, 17 months before Greenspan became Chairman, the last remaining elements of "Regulation Q" were abolished.  Since that time, it has largely been forgotten.  The elimination of Reg Q put an end to the use of a critical  avenue or "tool" that the Fed had previously relied upon to control economic expansion.

During the 20 years prior to the abolition of Reg Q, ceilings for S&L deposit rates slightly exceeded those for commercial banks, and this favored the expansion of mortgage lending.  As market rates for money market instruments soared in the late 1970’s to mid 1980’s (see chart, below), it became difficult for both thrifts and banks to compete.  Lending declined – and the economy slowed – as depositors withdrew their funds from banks and reinvested their cash in either treasuries or money market securities. 

 
Source: R.A. Gilbert, Federal Reserve Bank of St. Louis – Requiem for Regulation Q: What It Did And Why It Passed Away, Chart 3 (page 8 of 16), Feb 1986.

During his 18 1/2 years as Chairman, I believe (but am not certain) that Alan Greenspan did not author any research working papers (as distinct from speeches or Congressional testimony) until Sep 2005. 

In  Sep 2005, Greenspan co-authored a paper providing a detailed description of the ways in which consumers extract equity from their homes.  Five months before he left office, he released "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences,"  Federal Reserve Working Paper # 2005-41, with James E. Kennedy of the Fed.

As Greenspan & Kennedy note in their abstract of the 83 page paper, it focused upon home equity extraction:

…[W]e have developed a system that reconciles the change in regular home mortgage debt with mortgage flows…   In the process, we derive the sources of equity extraction from homes financed by mortgages.  [emphasis added]

Chairman Greenspan relied upon the borrowers’ extraction of home equity, along with the consumption that it supported, to limit the severity of the post 9/11/2001 recession.   The 2005 Greenspan & Kennedy Working Paper, along with a 2007 G&K paper that examined home equity extraction in even greater detail, were – in my view -  published to ensure that future economists would understand the power of, and benefit from, the authors’ experience with this new method of monetary control.

In the 21st century world of monetary policy that Greenspan would shortly be leaving, consumption increased – and the economy expanded – as borrowers withdrew accumulated equity from their houses and redeployed the proceeds.

[Note: Compare this “transmission channel” with that under Reg Q, above: Lending declined – and the economy slowed -  as depositors withdrew their funds from banks and reinvested their cash in either treasuries or money market securities.

Under Reg Q, channel worked through consumers’ – as depositors -  assets (savings/money market accounts).  As described by G&K in WP 2005-41, channel worked through consumers’ – as borrowers’ -  liabilities (mortgage or home equity line/loan).  Very different.]

If you were looking for a way to control the economy, there truly was no place like homes.

Speaking to the American Bankers Association at the end of Sep 2005, Chairman Greenspan included a brief summary of  the paper’s findings and its impact upon macro policy.  I will quote extensively but selectively from it below, with emphasis added.

CHAIRMAN GREENSPAN:

… I plan …  to focus on one of the key factors driving the US economy in recent years: the sharp rise in housing valuations and the associated buildup in mortgage debt…

This enormous increase in housing values and mortgage debt has been spurred by the decline in mortgage interest rates … [T]he … associated run-up in housing values has left households with a substantial pool of available home equity... 

Home mortgage debt is thus the final source of funding of some consumer outlays originally financed by [banks’] extensions of credit card and other consumer debt …[W]e can have little doubt that the exceptionally low level of home mortgage interest rates has been a major driver of the recent surge of homebuilding and home turnover and the steep [home price] climb…

The apparent froth in housing … may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other, more-exotic forms of … mortgages… bear close scrutiny. To … the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is adding to the pressures in the marketplace.

Chairman Ben Bernanke is now working to moderate the impact of the current housing decline upon financial markets and the real economy.  As he does, we can only hope and pray the he is as creative and successful with his toolbox as Chairman Greenspan was with his.

[*click* for Special Closing Theme]
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I used to work with numbers for a living, but now I’m trying to home in on my next job or ‘idea’.   Till next time – Ira Artman 

REFERENCES

 
R.A. Gilbert, Federal Reserve Bank of St. Louis – Requiem for Regulation Q: What It Did And Why It Passed Away, Feb 1986.

 
A. Greenspan and J. Kennedy, Federal Reserve Working Paper 2005-41 – Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences, Sep 2005. 

The Fixx, Reach The Beach – One Thing Leads To Another, Rhapsody/MCA, 1983.
R. Lopez and J. Marx, Avenue Q, The Musical – For Now, Rhapsody/RCA Victor, 2003.