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Generational Dynamics Web Log for 20-Oct-04
Fed Chairman Greenspan uses circular reasoning to defend economy

Web Log - October, 2004

Fed Chairman Greenspan uses circular reasoning to defend economy

In an extremely bizarre statement to a bankers' association on Tuesday, Federal Reserve Chairman Alan Greenspan said that yes, household debt (especially credit card debt) is at historically high levels compared to disposable income, and yes, housing prices have experienced "an exceptional run-up."

But hey, folks, it doesn't matter. It's OK. It's fine. Here's why:

The reason that high household debt doesn't matter is because even though it's high compared to disposable income, it's not high compared to household assets, and that's because housing prices have been skyrocketing.

The reason that high housing prices are not a housing bubble is because the high prices are due to mortgage refinancings rather than speculative trading, and "the surge in cash-out mortgage refinancings likely improved rather than worsened the financial condition of the average homeowner. Some of the equity extracted through mortgage refinancing was used to pay down more-expensive, non-tax-deductible consumer debt or to make purchases that would otherwise have been financed by more-expensive and less tax-favored credit."

In other words, high household debt is OK because of high home prices; and high home prices are OK because they provide people with cash to pay household debt -- although not enough cash to reduce household debt below historic levels. It's a remarkably bizarre form of circular reasoning.

Greenspan did concede that there are "concerns":

"To be sure, some households are stretched to their limits. The persistently elevated bankruptcy rate remains a concern, as it indicates pockets of distress in the household sector. But the vast majority appear able to calibrate their borrowing and spending to minimize financial difficulties. Thus, short of a significant fall in overall household income or in home prices, debt servicing is unlikely to become destabilizing."

In other words, high household debt and high housing prices are both OK as long as they both remain high, and neither one of them falls.

But that's what a bubble is.

In a stock market bubble, like the 1920s bubble or the 1990s bubble, you could say that stock A isn't overpriced, because stock B is also overpriced; and stock B isn't overpriced, because stock A is also overpriced. And both stocks are OK as long as neither one of them falls.

And that's what Greenspan is saying now. High household debt is OK because of home prices are high, and high home prices are OK, because of household debt is high.

You know, dear reader, if you're like me then you used to listen carefully to everything that Alan Greenspan said because he was highly credible, presumably without any partisan political motivations to affect his pronouncements. At least, that's what I used to think until a few months ago.

But in recent months, I've been harshly criticizing statements by a Greenspan colleague, Fed Governer Ben Bernanke, for saying, in effect, that it's Fed jawboning rather than fundamentals that have the greatest effect on the stock market.

A couple of weeks ago, I criticized Fed Governor Ben Bernanke for saying that he believes that stock and bond prices are determined almost exclusively by Fed policy and Fed verbal statements. The Fed is ignoring fundamentals, such as astronomically high public debt, astronomically high stock valuations, and falling inflation rates.

Last month, I harshly criticized Bernanke for saying, in effect, that Fed jawboning, even misleading statements, are the major drivers for the economy rather than fundamentals.

Now, when Bernanke says things like this over and over, we have to get the message: That Greenspan's statement may or may not reflect the Fed view of the state of the economy. Bernanke has clearly and unambiguously said that Greenspan's statements are designed to influence the economy, not to credibly describe the state of the economy.

This is a big difference. Bernanke has been quite unequivocal that, within limits, the Fed is permitted to issue misleading statements to the public in order to influence the public. This is not what we normally mean by "partisan political" statements, but there's not much difference.

So, based on Bernanke's repeated statement, we must conclude that Greenspan's speech yesterday may well have been purposely misleading.

So when we're talking about historically high household debt and surging real estate prices, we're left to our own devices to determine whether the situation is serious or not.

So, we can only go back to fundamentals.

If you want to find out whether you're in a stock market bubble, you can't compare one stock price to another; you have to compare stock prices to historical stock prices using standard historical measures -- price/earnings ratios. And price/earnings ratios show that stock prices today are overpriced by 100%.

Similarly, you have to compare housing prices today to historical housing prices, and you find that real estate is in an overpriced bubble all over the world, and that housing prices are beginning to cool down after a year of record increases. With household debut, you find that public debt is at historic highs.

I'm well aware that many readers of this web site don't fully agree with all the economic concerns I've raised. But whether you do or not, you should be aware that there is something very weird going on over at the Fed.

As the weeks go by, and we read more bizarre statements by Bernanke, Greenspan and other Fed governors, we should all be getting a lot more concerned about what's happening. (20-Oct-04) Permanent Link
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Generational Dynamics Web Log for 20-Oct-04 Fed Chairman Greenspan uses circular reasoning to defend economy

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Generational Dynamics Web Log for 20-Oct-04
Fed Chairman Greenspan uses circular reasoning to defend economy