On Friday, the Federal Reserve released the transcripts of its 2005 Open Market Committee meetings -- the gatherings in which the Fed's Board of Governors takes the pulse of the economy and then decides upon the appropriate interest rate policy. Calculated Risk looks at the transcript of the June meeting, and engages in a wry cut-and-paste.
(Atlanta Fed president Jack Guynn is discussing his negative views on the housing boom:)
My supervision and regulation staff thinks this is an accident waiting to happen in our area. And while the local market excesses probably do not represent systemic national risk, the shakeouts could have serious regional consequences. My bank supervision staff points out that housing-related credit risks to our bank lenders are not so much from defaults on permanent mortgage financing that we talked about yesterday, but rather from lending for land acquisition, development, and construction. The ugly picture we have seen before -- and that they think we may very likely see again before long -- goes something like this: the drying up of sales of new units; the painful decision of developers to go ahead and complete the construction of additional units to make them saleable, further depressing the market; and speculators who had hoped to see big capital gains walking away or defaulting on their contracts, giving their properties back to the lender. Perhaps it's because of where I sit, but I am less comforted than some of my colleagues about the housing situation ...
CHAIRMAN GREENSPAN. Let's take a break for coffee.
Most economically damaging coffee break of all time? Perhaps, but skimming through the report, I was also taken by a long summary of the subprime mortgage market, delivered by Fed Gov. Mark Olson.
... I, too, looked at the mortgage market in anticipation of the theme of our discussions yesterday. But I also had a concern about the extent to which the mortgage market might be creating froth in the market ... mortgage terms are indeed becoming more flexible and less restrictive, creating certain defined risk exposures ...
There is a lack of consensus as to how the relaxation of credit standards will impact safety and soundness. To date, loan delinquencies have remained modest, both within and outside of the banking industry. However, the undiminished appetite, particularly for the nonconforming mortgage product, has allowed for the flexibility to continue. And there is no slowing in sight, despite all the warnings that we have heard and indications in some markets that there has been a leveling, and even a decline, in some property values ...
... As for the secondary market, why is that market so avaricious? I'd cite a number of reasons. There are many new investors, including the hedge funds, with minimal experience in dealing with market uncertainties. There are many new products; 50 percent of the mortgage-backed products are either alt-A or nonprime. That's the flow, as we discussed yesterday. There is evidence of a lack of secondary market discretion, including the ability to price for risk; the risk premium simply does not reflect the risk embedded in that product ... It's not clear at this point if the MBS market will be an efficient distributor and disseminator of risk or if those in that market will be the last to recognize the risk that's embedded in what they're doing and know how to price it.
The warning signs were written in blazing Day-Glo orange on the Fed temple walls. Greenspan ignored them, and the U.S. economy hurtled directly into the worst economic disaster since the Great Depression.