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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.
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.
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.
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