When experts are asked who is most the blame for the global financial crisis, one name invariably tops the list. Not the former bosses of collapsed investment banks Lehman Brothers or Bear Stearns, nor the head of AIG, nor former president George W. Bush. Instead, the lion’s share of blame for the 2008 meltdown is attributed to long-time Federal Reserve boss Alan Greenspan.
Once thought of as an economic genius (he was the centre of the infamous Committee to Save the World), Greenspan was appointed Federal Reserve boss in 1987 and, soon after, began the practice of aggressively using monetary policy to smooth economic cycles. After the 1987 crash, Greenspan added liquidity to the market, giving rise to the notion of a “Greenspan Put”.
After the Nasdaq crash of 2000 and September 11, the Greenspan Fed aggressively reduced interest rates from 6.5% to only 1% in 2004. Legendary Yale economist Robert Shiller noted that:
“… once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker.”
Of course, the rest is history. The US housing market crashed, taking with it half of Wall Street and some of Main Street (General Motors required a US taxpayer bailout) and trillions of dollars were lost.
You’d think that central bankers around the world would be wise to the risk of excessive liquidity causing a gross misallocation of capital.
Step up, Reserve Bank of Australia head, Glenn Stevens.
Australia came out of the GFC in a far better position than most. A conveniently timed mining boom assisted our terms of trade, while a taxpayer guarantee allowed Australian banks to continue to prop up the property market. Australia was also in the fortunate position of having an interest rate cushion, with the official interest rate falling from 7% to 3% in 2009, rising to 4.75% in November 2011 as the mining boom was in full swing.
Since then, despite the Australian economy being one of the best performers globally, Glenn Stevens and his band of merry men (and women) at the RBA have drastically lowered rates. Not content with emergency rates of less than 3%, Stevens reduced the interest rate to an all-time low in 2015 of 2%. Now, the dunderheaded RBA has gone and reduced two more times, yesterday to 1.5%. It’s like Greenspan all over again, although the Stevens Put will potentially be even more damaging.
The rationale for the RBA’s moves appear to be a combination of ensuring the property bubble remains inflated (the crash can happen on someone else’s watch, thank you very much), and keeping the Australian dollar low (a misguided and, in any event, futile ambition). There’s also a belief among economists (the same group of people who all failed to foresee the GFC) that Australia’s inflation rate is too low. There’s no real justification for having an inflation target of 2%, it’s a fiction created by governments and their lackey central bankers to keep real incomes down and reduce the value of debts, but it has somehow become lore.
The RBA remains a revered organisation in Australia (much like the Fed until 2007). Criticism of Stevens is almost non-existent from the business press. Stevens, who is guiding Australia to an almighty property crash, even received an Order of Australia earlier this year.
But the honours hide the inconvenient truth that there will be plenty of victims from the RBAs dovish monetary position.
Savers have already been punished. Worked for 50 years to save a retirement nest egg? Fixed income returns are below zero in real terms. This has pushed self-funded retirees into riskier asset classes and slashed their income levels. (The cash rate is effectively the risk free rate, so the ‘value’ of assets increases as the cash rate drops.)
Trying to buy a first home? Courtesy of the RBA and retail banks, house prices are at record levels (compared with disposable income) while household debt to GDP is significantly higher in Australia (above 100%) than it was in the US prior to the GFC (around 75%). This isn’t a surprise, when you make the cost of debt cheaper, people respond to those price signals. Instead of saving (and those savings used for productive investments), money is funneled into unproductive established housing or speculative assets.
Bizarrely, in lowering rates, the RBA claimed that the housing boom is over, which would be news to first home buyers, or to anyone who analyses rental yields or clearance rates (which in Sydney topped 80% last week). It appears that the RBA has lost complete sense of reality, dropping emergency low rates to an even lower level, despite there being no emergency. (Special credit must also be paid to dunderheaded Treasurer, Scott Morrison, who not only interfered in what should be an independent decision, but he also got it completely wrong.)
There are a few winners from the RBA’s insanity. The moderately wealthy who own multiple investment properties benefit as inflated values continue for a while yet. The super-rich, who are able to make more money during periods of inflation also win. Wage earners, savers and those who don’t own speculative assets are the losers in this transfer of wealth.
It was Alan Greenspan who ironically warned that irrational exuberance can “unduly [escalate] asset values, which then become subject to unexpected and prolonged contractions”. It appears Glenn Stevens hasn’t learned from Greenspan’s mistakes.
*Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed and was the 2015 CEO Magazine, Young CEO of the Year