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April 27, 2005

Roach To Fed: J'Accuse!

I was going to ignore Stephen Roach's latest tee-off on the Fed, until I noticed that Kash at Angry Bear added a qualified amen to Roach's general thesis.  I might have let it pass even then, but my quick survey of the blogosphere (via Technorati.com) uncovered not a single critical assessment of the piece.  I guess, then, it's left to me.

Roach begins:

In all my years in this business, never before have I seen a central bank attempt to spin the debate as America's Federal Reserve has over the past six or seven years...

... senior Federal Reserve policy makers have taken the lead role as proselytizers of a new macro spin that condones the saving, debt, property bubble, and current-account excesses of the Asset Economy.

Really?  Perhaps Mr. Roach missed the speeches and comments documented here, here, here, here, here, and here.

Of course, Mr. Roach offers plenty of examples of Fed officials making wild, wacky, throw-caution-to-the-wind statements like this one from Mr. Greenspan:

Although I scarcely wish to downplay the threats to the U.S. economy from increased debt leverage of any type, ratios of household debt to income appear to imply somewhat more stress than is likely to be the case.  For at least a half century, household debt has been rising faster than income, as ever-higher levels of discretionary income have increased the proportion of income spent on assets partially financed with debt.

The pace has been especially brisk in the past two years as existing home turnover and home price increase, the key determinants of home mortgage debt growth, have been particularly elevated.  Most analysts, even those who do not foresee a mounting bubble, anticipate a slowdown in both home sales and the rate of price increase...

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 summary, although some broader macroeconomic measures of household debt quality do not paint as favorable a picture as do the data on loan delinquencies at commercial banks and thrifts, household finances appears to be in reasonably good shape.  There are, however, pockets of severe stress within the household sector that remain a concern and we need to be mindful of the difficulties these households face.

In addition, a significant decline in consumer incomes or house prices could quickly alter the outlook; nonetheless, both scenarios appear unlikely in the quarters immediately ahead.  If lenders, including community bankers, continue their prudent lending practices, household financial conditions should be all the more likely to weather future challenges.

Or this blinders-on diatribe by Governor Don Kohn:

Some observers worry that recent Federal Reserve policy, by keeping short-term rates at very low levels for an extended period, has encouraged investors to "reach for yield"--that is, to shift their portfolios toward riskier and longer-term securities, which generally have higher yields, to keep realized returns from falling.  They also worry about the effects of a related behavior in which financial intermediaries borrow at low short-term rates to lend at higher long-term rates--the so-called "carry trade"--and about the effects of low interest rates on the prices of houses.  To a considerable extent, these processes are part of the efficient functioning of markets... The issue is whether this process has gone too far--that is, whether investors are failing to take adequate account of the risks of those alternative investments.  Forming such a judgment requires a view on the level of asset prices that would be "appropriate" given economic fundamentals.  Unfortunately, economists are not very good at this, but neither is anyone else, including Wall Street analysts...

Warnings about a possible "bubble" in house prices have been sounded for a number of years now.  About a year ago, I examined this issue in some detail and concluded that, while one could never be very confident about such a judgment, house prices were not obviously too high and the housing stock was not clearly too large.  Since then, however, prices have climbed further, and by more than the rise in rents--a proxy for the return on houses.  Consequently, the odds have risen that these prices could be out of line with fundamentals.  We still cannot be very confident about whether a significant misalignment exists, however...

In the absence of any substantial distortions in asset prices and debt levels, households and businesses, on average, have not likely been engaging in misguided decisions that they, or the central bank, will come to regret.  Nevertheless, as emphasized above, policymakers face a tremendous amount of uncertainty regarding this judgment... Because they cannot  rule out the chance that some asset prices might correct more than anticipated, policymakers must consider how the economy might withstand such a correction...

I am not disputing the argument that current policy has contributed to higher asset prices, more household indebtedness, and strong activity in interest-sensitive sectors such as housing.  But I am questioning the apparently firm conclusion of some that these developments represent distortions or imbalances that are likely to correct in an abrupt and harmful manner.  At the very minimum, one cannot reach this conclusion with a great deal of confidence... Nonetheless, I cannot rule out the possibility that destabilizing imbalances are building.

I would attempt to pull appropriate passages from the recent speeches by Greenspan, by Kohn, and by Governor Roger Ferguson that Roach proclaims "a veritable broadside against the time-honored notion of the current-account adjustment," but I don't have the first clue what he is talking about.  Ferguson's speech for example -- a quick summary is here -- is essentially a textbook breakdown of various sources of current account deficits.  His crime appears to be that he agrees with Ben Bernanke's (admittedly provocative, but far from heretical) suggestion that restoring fiscal balance in the U.S. may not be enough to substantially reverse our current account deficit.

Is this what counts as "macro spin that condones the saving, debt, property bubble, and current-account excesses of the Asset Economy"?  Are we to believe that any expression of confidence that the landing will be soft, no matter how qualified, is an act of corruption? 

I'm just getting started.  More in part II.

April 27, 2005 in Federal Reserve and Monetary Policy | Permalink


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I'm looking forward to part II. I thought Kohn's speech was very good (as were some of the others that you linked).

But I do have a problem with some of Chairman Greenspan's comments over the last few years. When Mr. Greenspan starts a speech with "I want to emphasize that I speak for myself", I always cringe. Oh well, I guess he is entitled to his personal opinion, but most people don't realize Mr. Greenspan has a terrible record of economic predictions (away from monetary policy).

Posted by: CalculatedRisk | April 27, 2005 at 09:59 PM

I have been a long time reader of Roach. His points over the years have in some ways always been viewed by the market as wrong. But, when you look at the equities market return since the 1998 low and subtract out dollar depreciation....well, maybe he is right. Alot of what his recent Fed bashing is about what has occurred since LTCM. The negative effects of easy money have not been felt by the economy as of yet. only the good times. Homeownership in the US is running north of 65%. This is getting to be "full employment" of the housing sector. The cash out refi game has only made new risks. He stresses lack of wage gains consistently. This is true. Wages cannot grow 2% while housing cost rise by 10%. The math doesnt work. The "Asset Economy" as he calls it is real. The recent tuff talk by the Fed is to save face. The damage has been done. If the foreign CBs feel the Fed is not in control they will simply raise rates themselves. Lets hope everything Roach says does not become true. I told you so would not be good.

Posted by: be | April 27, 2005 at 10:54 PM


I can appreciate your frustration. But do you really want to defend Greenspan's remarks on switching to variable interest rate loans? Come on, I heard him. It was a Kodak moment of which I observed, "He didn't really mean that, did he? Good grief!"

Once Greenspan suggested that consumers should consider switching to variable interest rate mortgages, that was the last straw for me. Simply, Greenspan crossed the line. He was no longer trying to help consumers reduce their debt load. He was promoting a vehicle that would extract more consumer spending in support of the general economy. But he was putting the American households at risk with such advice. Those who acted on his recommendation are headed for big trouble.

While I am of the judgment that Greenspan bounced back and forth on a few key subjects during some of his Congressional testimony, I will focus on Stephen Roach's point about consumer spending driven by accommodation.

My first round of remarks will be posted under your fourth post, Roach To Fed: J'Accuse! (The End).

Your four posts could create one of the best discussions among the econ blogs.

Good luck. And keep that sword where I can see it.

Yeah, I have mine in my hand.

Posted by: Movie Guy | April 28, 2005 at 02:07 AM

I think the fed did a pretty good job of getting us out of recession. We suffered a huge market shock and there was a brief and shallow recession and I think aggressively cutting interest rates was a big part of the solution. Of course, doing this wasn't risk free. But at the time, if given two options a) shallow recession with property bubble and larger current account deficit or b) deep, long recession with possible risk of depression, but no more bubbles and less imports, most people would choose a. Even though b would likely be better in the long term.

The fed has become a political organization. Ideally, this would not be the case, but because there are many more investors managing their own portfolios than in the past, there are a lot more people (more voters) tuned to what the fed does. The past two presidential elections have been very close and bad comments from the fed can hurt the economy enough to swing an election.

Having said that, I tend to agree with Roach on his diatribes about our unsustainable world economy. Since Bush doesn't need to worry about re-election, maybe now would be a good time, politically, for the fed to drop the hammer and jack up rates. The risk here is if short term rates go up and long term rates remain stuck in the 4's.

Posted by: Charlie | April 28, 2005 at 09:31 AM

MG -

Do I want to defend Mr. Greenspan's decision to offer specific investment advice? Nope -- no comment on that one.

Charlie -- In some sense, of course, the Fed is by nature a political institution, in the sense that is a creation of Congress and is ultimately accountable to the people through Congress. But I suspect you mean "political institution" in the sense of partisan. I can only tell you my own personal perspective, and that is that the Fed in my experience is about as nonpartisan as a public institution can possibly be. That doesn't mean there aren't mistakes -- and my posts were not intended to make any such claim. What I'm arguing is that I beleive what mistakes have been mad have been honest ones.

Posted by: Dave Altig | April 29, 2005 at 08:30 AM


Posted by: recorded | July 01, 2005 at 12:58 AM

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