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Greenspan then reiterated the point for all the slow learners as follows: "To the degree that households are driven by fears of payment shocks but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive way of financing a home."
He also invited the mortgage industry to get with the program: "American consumers might benefit if lenders provided greater mortgage-product alternatives to the traditional fixed-rate mortgage."
Anyone who took that advice from the man who was in charge of setting interest rates at the Fed cannot be happy. In the ensuing two years, the federal funds rate more than doubled in a series of 11 rate increases.
A legacy of misery
Likewise, the financial innovation Greenspan was advocating led directly to the mortgage-related troubles that were the proximate cause for the recent discount-rate cut. Of course, as the mortgage-for-anyone-with-a-pulse party was in full bloom, Greenspan was busy cheerleading. In a speech April 8, 2005, Greenspan extolled the virtues of sublending:- Talk back: Do homeowners deserve a bailout?
"With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . As we reflect in the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial-services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers."
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Naturally, it was not until after the debacle unfolded that Greenspan warned banks about imprudent lending standards.
Unfortunately, while the equity bubble left little debt in its wake -- excluding the telecom sector -- we now have millions of homeowners with too much debt and an unknown number of financial institutions that are holding the debt. This predicament is not dissimilar to the one Japan faced in the 1990s, which ultimately saw equity and real-estate prices decline 80% over a decade.
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