The Federal Reserve releases transcripts of the Federal Open Market Committee (FOMC) meetings with a five-year lag (as required by law, the Fed would like to burn them). Transcripts for 2004 meetings were released on April 30, 2010. The Dow Jones Industrial Average fell 998 points on May 6, 2010. The 2004 transcripts help explain why the Dow could have disappeared last week.
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FOMC transcripts in 2004 confirm the Fed was afraid of markets. Its concerns about the economy were only a derivative function of how market volatility could disrupt consumer spending. (Over 100% of economic growth after the post-2001 recession had been consumer spending.) The Fed understood rising asset prices boosted consumer spending. As I discuss below, the FOMC was not simply fixing short-term interest rates. It was now interfering with long-term interest rates, the stock market, and the housing market. This distorted the entire structure of prices through the economy and we know how it ended – no better than the Politburo’s central planning
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The FOMC seemed most concerned that higher rates might interfere with the carry trade. In the sad tale of The Financialization of the United States, the carry trade deserves a chapter. It received one in [Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession.] Chapter 10: “Restoring the Economy: Greenspan Underwrites the Carry Trade, 1990-1994,” discusses the unique recovery from the 1990-1991 recession. Never before had the U.S. economy resurrected itself through finance rather than industry. To accomplish this amazing feat, finance flooded the banking system and hedge funds.
Federal Reserve Governor Donald Kohn stated the FOMC’s mission at the March, 2004 meeting: “Policy accommodation – and the expectation that it will persist – is distorting asset prices. Most of the distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices….”
It is worth pausing here. Kohn told his confreres that Federal Reserve policy was to distort asset prices. He also said this was deliberate and desirable. In other words, distorted asset prices were not an unfortunate consequence of such-and-such Fed policy. The Fed’s goal was to distort asset prices.
Kohn went on: “It’s hard to escape the suspicion that at least around the margin some prices and price relationships have gone beyond an economically justified response to easy policy. House prices fall into this category [note: the Fed was deliberately overpricing houses], as do risk spreads in some markets and perhaps even the level of long-term rates themselves, which many in the market perceive as particularly depressed by the carry trade….” Summarizing, Kohn believed the Fed had deliberately set a policy that raised house and long-term bond prices beyond a “justifiable response” to the 1.00% fed funds rate. (One justifiable response to free money is a price of infinity, but Kohn was not of that persuasion.) Second, Kohn thought the carry trade was reducing yields on long-term Treasury bonds. (As follows: when a trader borrows $1 billion at 1% and buys $1 billion of 10-year Treasury bonds that yield 4%, prices of the 10-year bond go up as the yield goes down.)
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Speculative risk and leverage in the banking system would not normally be welcomed by the nation’s leading bank regulator (Greenspan), but neither was it desirable to slow down the mortgage carry trade. Such developments as Interest-Only and Negative-Amortization mortgages may have remained a niche market if not for speculators who were asking for more assets to buy with the money they had borrowed. (Dino Kos at the June 29-30, 2004 FOMC meeting: “Banks and hedge funds are still holding on to large positions in mortgage-backed securities.”) By 2004, Wall Street was funding and even buying subprime mortgage lenders to accelerate the flow of mortgage securities they sold, such as CDOs. In 2004, Lehman Brothers was the 11th largest subprime lender in the U.S. and the top issuer of subprime mortgage securities.
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Consumer spending exceeded consumer income. This had to continue. Greenspan described the importance of rising asset prices in fooling the consumer at the November FOMC meeting: “We have a very significant problem with private saving. The household saving rate has come down dramatically and now is close to zero….The idea of having a negative savings rate is not out of line with the way the world works. Remember…the average household looks at the market value …of its equity holdings…. We can have a negative saving rate with a significant part of the population believing that they are saving at a fairly pronounced rate.”
This strategy of fixing asset prices at an artificially high rate to fool the American people into spending money they did not have was diabolical. It was even more so, given what Greenspan told the public. Before Congress on July 15, 2003, he claimed: “The prospects for a resumption of strong economic growth have been enhanced by steps taken in the private sector over the past couple of years to restructure and strengthen balance sheets….Nowhere has this process of balance sheet adjustment been more evident than in the household sector.” The man will say anything.
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