Housing slump tarnishes a Fed leader's legacy

By the time Alan Greenspan left the Federal Reserve in 2006 after 18 years as chairman, he was almost sainted by many in the financial community.

No longer. The subprime mortgage crisis has pummeled his reputation.

"It's hurting him," says David Wyss, chief economist of Standard & Poor's, a financial information service in New York. "He didn't solve all the problems of the world. He didn't walk on water. But he swam pretty well."

Of course, the hindsight of critics can often be better than their foresight.

On the monetary policy side, for instance, some critics don't recall the mental atmosphere in 2001 when Mr. Greenspan's Fed cut a key interest rate to about 1 percent and kept it there until 2004. Many economists then were worried about the possibility of a depression or a 10-year economic stagnation like that which had hit Japan.

Maybe the Fed should have raised that rate sooner, suggests Mr. Wyss, possibly diminishing the size of the recently burst housing price bubble. But that action might also have led to "a deeper and longer recession," he adds.

Regardless, the criticism of Greenspan is now shifting away from monetary policy to what's seen as the central banker's weakness on the regulatory side.

"Greenspan's a libertarian," says Charles McMillion, head of MBG Information Services in Washington. "He's opposed to regulation by background ... and got away with it for the most part during his tenure. I was always just astonished at his lack of interest in the regulatory role of his job."

Other economists make similar jabs.

"There was a horrible failing of regulation in the last six years or so," says Dean Baker, codirector of the Center for Economic and Policy Research in Washington. He says Greenspan should have used the Fed's powerful regulatory and supervisory functions in the financial area to deflate such bubbles as soaring stock market prices in the 1990s and the housing bubble.

The Fed's financial regulators and others did meet in August 2005 to look at slipping credit standards in the mortgage industry, recalls Harald Malmgren, a Washington economic consultant. But neither Greenspan, nor his academic-inclined successor, Ben Bernanke, made any regulatory moves to stem the rampant greed in the mortgage market.

That is, until last Tuesday when the Fed proposed changes in the Truth in Lending regulations "to protect consumers from unfair or deceptive home mortgage lending and advertising practices."

"There is no excuse for them taking so long," says Mr. Malmgren.

The new rules "would have been helpful if put into place two years ago," says Nigel Gault, an economist with Global Insight, in Waltham, Mass.

By now, the housing market is in grim shape. New home starts in November in the United States were down 48.2 percent from their peak in January 2006. That housing weakness, combined with the reluctance of banks to lend, has led to widespread fears of a recession. Mr. Gault, for example, expects barely any economic growth in the current quarter and the first half of next year.

So what can be done to prevent the economy from getting worse?

Malmgren sees a need to restore the Fed's "moral leadership" in the financial world.

What's happened, he explains, is that commercial, investment, and mortgage banks repackaged the mortgages they sold into collections of debt obligations. But the quality of some mortgages behind these financial instruments was poor – subprime. These "collateralized debt obligations" (CDOs) and other fancy financial investments were sold to a host of institutions in this country and abroad that were seeking a somewhat higher return. These include hedge funds, churches, public and private pension funds, charitable foundations, and other banks.

Then the housing bubble started to collapse. Foreclosures rose. Banks, which had attempted to shuffle off the investment risks of the CDOs to others, found they weren't really immune. Last summer, financial liquidity froze in the West as banks were afraid to buy debt obligations from each other.

"There is no trust," says Malmgren.

Facing the crisis, central banks are now trying to move to the rescue. The European Central Bank last week swamped European money markets with $501.7 billion in two-week loans to help banks deal with their portfolios of American subprime mortgage investments. The Fed last Monday auctioned off $20 billion in 28-day credits to help bolster the nation's financial system. Ninety-three unnamed institutions made bids.

Over the long run, Malmgren sees a need for the many financial regulatory agencies in the US, including the Fed, to get together to restore credibility to the mortgage market and the debt repackaging market.

Meantime, Greenspan attempted to defend his reputation this month, writing an opinion piece in The Wall Street Journal and appearing on "This Week" on ABC, during which he advocated giving cash to homeowners facing foreclosure.