12 May 2009

Geithner Blames Central Bankers, But Greenspan Only Teeny Weeny Bit

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John Cochrane sends this WSJ article relaying portions of a Charlie Rose interview with Treasury Secretary Timothy Geithner (who was head of the NY Fed from late 2003 – January 2009) talking about the causes of the worldwide financial crisis:

The revelation [of central bank responsibility] came from Timothy Geithner last Wednesday with PBS’s Charlie Rose, who asked the Treasury Secretary: “Looking back, what are the mistakes and what should you have done more of? Where were your instincts right, but you didn’t go far enough?”

Mr. Geithner: “We need a little more time to get full perspective.”

Mr. Rose: “Right.”

Mr. Geithner: “But I would say there were three types of broad errors of policy and policy both here and around the world. One was that monetary policy around the world was too loose too long. And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”

Mr. Rose: “It was too easy.”

Mr. Geithner: “It was too easy, yes. In some ways less so here in the United States, but it was true globally. Real interest rates were very low for a long period of time.”

Mr. Rose: “Now, that’s an observation. The mistake was that monetary policy was not by the Fed, was not . . .”

Mr. Geithner: “Globally is what matters.”

Mr. Rose: “By central bankers around the world.”

Mr. Geithner: “Remember as the Fed started — the Fed started tightening earlier, but our long rates in the United States started to come down — even were coming down even as the Fed was tightening over that period of time, and partly because monetary policy around the world was too loose, and that kind of overwhelmed the efforts of the Fed to initially tighten. Now, but you know, we all bear a responsibility for that. I’m not trying to put it on the world.

Seriously, can we please get some cool overlords for once, some guys with a little panache? Darth Vader didn’t go around saying, “You’d better tell me where the rebel base is, or else I won’t be able to prevent a giant laser from blowing up your home planet.” Or how about when bank robbers lock-down the scene and say, “Who’s in charge here?” and then shoot the first guy who says he is? (The correct answer is, “You’re in charge. You have the gun.”)

But no, we’ve got Greenspan and now Geithner whining and saying, “Don’t look at us! All we could control was the supply of US dollars. Why would you think that had anything to do with the global economy?”

Besides the surface absurdity of their view, let’s dig a little deeper. In his WSJ “Don’t Look at Me!” op ed, Greenspan said he tried raising short rates to stem the housing boom, but those pesky long-term mortgage rates didn’t rise in response to his prudent decision. As I pointed out, that’s because the long rates didn’t fall off a cliff when Greenspan yanked short rates way down a few years earlier. (So it’s not surprising that long rates didn’t move up when Greenspan slowly pulled short rates back up.) Here’s the chart:

So to repeat, Greenspan’s defense was that he tried raising the federal funds rate from June 2004 onward, and yet mortgage rates stubbornly refused to rise. When you see the broad history of the two series in the chart above, you can see why. (And the answer is NOT, “Those pesky Asians decided to counteract Greenspan’s caution.”)

Now back to Geithner: What the heck is he talking about? Mortgage rates didn’t fall once Greenspan began jacking the fed funds rate back up. The chart above makes it crystal clear that they were slightly higher after the Fed had brought the fed funds rate back up to 5.25%.

Does Geithner have in mind some other long term rate? Let’s try 10-year Treasurys, and contrast them with the overnight fed funds rate. (Remember the Fed directly targets the federal funds rate. If you need a primer, check out this article.)

Well you tell me, folks. In the chart above, when the Fed started pulling up the red line, does the blue line mysteriously fall? Well, you could maybe argue that that’s true for about a 4-month period right after Greenspan started raising the fed funds rate (in June 2004). (UPDATE below.) But in the broader picture, the blue line bounces around a lot; it moved up and down even when the fed funds rate was flat from June 2003 – June 2004. Clearly over the whole period of Fed tightening (from June 2004 – June 2006), the 10-year Treasury yield rose.

So the same thing holds for the fed funds/10-year Treasury spread as holds for the fed funds/30-year mortgage rate spread: The long-run historical correlation of these two series breaks down when Greenspan yanks the fed funds rate absurdly low, and then things return to normal once he allows the short rate to rise back up:

Someone please convince me that our current Treasury Secretary was referring to that 4-month period when the fed funds rate rose and the 10-year rate fell. I would hate to think that someone in charge of the IRS would actually lie about the causes of a global financial meltdown. If you can’t trust the Treasury Secretary, whom can you trust?

UPDATE: OK in fairness to Geithner, you could clock the 10-year yield in June 2004, and then say that it did not exceed that level again until about 18 months later, despite the Fed raising short rates throughout the period. So maybe that’s what he meant. But still, if you pull back and look at a longer history, you’ll see that the break in correlation between the two occurred earlier, when Greenspan slashed rates, not when he later allowed them to rise.

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