Greenspan states the obvious - Central Banks reduce holdings on US Treasuries

Greenspan Says Demand for U.S. Debt May Be at `Limit' (Update1)
By Kevin Carmichael and Simon Kennedy

Oct. 21 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the dollar's depreciation may reflect growing unwillingness among foreigners to buy U.S. debt.

``Obviously there is a limit to the extent that obligations to foreigners can reach,'' Greenspan said in a speech in Washington today. The dollar's decline to its lowest since 1997 may be ``an indication America is approaching this limit.''

Greenspan's warning came after the U.S. Treasury reported last week that international investors sold a record amount of U.S. financial assets in August. Total holdings of equities, notes and bonds fell a net $69.3 billion after an increase of $19.2 billion in July.

The dollar has declined about 8 percent against the euro this year and 4 percent against the yen.

The former Fed chief, who published a 531-page memoir last month, spoke for about 35 minutes before taking questions for another half hour on the sidelines of the meetings this weekend of the International Monetary Fund and World Bank. The lecture was hosted by the Per Jacobsson Foundation.

Greenspan also said that the August surge in the cost of credit after a jump in U.S. mortgage defaults was an ``accident waiting to happen,'' given that investors were pricing risk too low.

``Something had to give,'' he said. ``Had the crisis not been trigged by subprime mortgages it would have erupted in another sector or market.''

SuperSiv Fund

Greenspan, 81, was critical last week of a plan by some of the U.S.'s biggest banks to help revive the asset-backed commercial paper market, which seized up because of investor concern that too much of the paper was backed by securities containing subprime loans.

Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. announced a plan last week to raise money for a so-called SuperSiv that would buy assets from distressed structured investment vehicles.

Investor uncertainty about the value of complex assets held by the vehicles has damped willingness to lend to the funds in the commercial paper market, stoking concern they'll have to dump holdings at fire-sale prices.

U.S. Treasury Secretary Henry Paulson, the former head of Goldman Sachs Group Inc., helped broker the agreement.

In an interview with Emerging Markets magazine published on Oct. 19, Greenspan was quoted as saying that he was unsure ``the benefits'' of the plan ``exceed the risks.''

`Best Assets'

Paulson assembled a group of reporters later that day to discuss the SIV rescue, emphasizing that the initiative was led by banks, that he had consulted the Fed and other regulators as the deal was put together, and that he was confident the initiative would work.

``The concept is not to buy bad assets or assets that have credit problems,'' Paulson said after hosting a meeting of Group of Seven finance ministers and central bank governors.

Investors will buy ``assets that aren't credit-impaired and don't have credit issues -- the very best assets,'' Paulson said. ``That will accelerate the return of liquidity to parts of this market.''

Today, Greenspan questioned whether there was any longer a market for such ``peculiar'' assets.

While he praised ``innovation'' in securitized markets as ``positive,'' he noted that demand for sales of debt backed by subprime mortgages has dried up.

`Peculiar Financial Structures'

``These peculiar financial structures that have become very prominent in the past four or five years are about to disappear from the scene,'' Greenspan said, citing ``various variations'' of collateralized debt obligations and ``special'' investment vehicles as examples.

``They have been tried and they have failed,'' Greenspan said. ``The failure is the basic way that investors have been misled as to what the value of these products is.''

The former Fed chief said central banks also increasingly appeared to have ``lost control'' of market interest rates beyond three to five years of maturity.

Much of the speech was dedicated to explaining why he doesn't view the U.S. current-account deficit with ``undue concern.''

The current-account gap, a measure of trade that includes investment flows, is now about 5.5 percent of U.S. gross domestic product, compared with 6.75 percent in 2005.

A reduction in ``home bias'' by international investors has channeled more money to the U.S., helping the country to finance its current-account deficit, Greenspan said.

He said he may become more concerned about the trade gap if ``the pernicious drift toward'' U.S. government budget deficits ``isn't arrested and compounded by protectionist reversal of globalization.''

Such a reversal would deal a ``major blow to world economic prosperity,'' he said.

Retrospection - Fed's decision to keep rates at 5.25%

Fed Gives Weak Nod to Growth and Credit Risks: Caroline Baum
By Caroline Baum

Aug. 8 (Bloomberg) -- Fed to market: You made your bed, you lie in it.

That was the essence of the Federal Reserve's message yesterday when it left its benchmark lending rate unchanged at 5.25 percent and said inflation remains the ``predominant policy concern.''

Ever since the stock market started to get wobbly in late July, with losses in the Dow Jones Industrial Average exceeding 200 points some days, interest-rate futures markets got it in their head that Fed Chairman Ben Bernanke was going to bail them out.

The message yesterday was: Not so fast. Policy makers gave the weakest possible nod to the volatility in the markets and ``tighter credit conditions for some households and businesses'' without tipping their hand, or their risk assessment, away from inflation.

In the Fed's view, the ``downside risks to growth have increased somewhat'' as the housing correction continues. Inflation in goods-and-services prices is still more troubling than deflation in asset prices (specifically housing). The decline in nationwide home prices has been mild to date, but it is certain to accelerate as the bloated supply of unsold homes comes face to face with reduced demand, with credit-tightening shutting some borrowers out of the market.

The first reaction to the Fed's statement at 2:15 p.m. New York time was to sell. The prices of stocks, bonds, gold and interest-rate futures all went down initially as the Fed failed to corroborate the view that the economic environment was deteriorating rapidly.

Antidote
Until now, ``the Fed has been pretty good at describing the theme people were sensing,'' said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. in New York. Yesterday's statement ``is out of character with the reality as we know it.''

That doesn't mean the Fed is living in a parallel universe. Policy makers have to differentiate between a financial-market event and a macroeconomic one. For the moment, they have determined that the weakness in residential real estate, the widening of credit spreads and tighter lending standards aren't a threat to economic growth.

The ``cure'' for a period of excess credit is credit restraint: from the Fed; from mortgage lenders, who are faced with rising delinquencies and increased foreclosures on the part of subprime, and now prime, borrowers; and from investors, who are suffering losses on opaque collateralized mortgage and debt obligations that were supposed to diffuse the risk of the underlying loans.

Tainted Inheritance
Bernanke inherited the housing bubble from predecessor Alan Greenspan, who seemed to be rewriting history and offloading some of the blame in yesterday's Wall Street Journal. (Greenspan's greatest problem right now is that his soon-to-be-published memoir, ``The Age of Turbulence,'' may arrive just as the foundation is collapsing.)

He also inherited an institutional burden from his predecessor. Greenspan has been accused of creating a moral hazard, or encouraging risky behavior by putting a floor under the stock market (the ``Greenspan put'').

It may well be that the current Fed chief needs to expiate the sins of the father. Bernanke earned himself the moniker ``Helicopter Ben,'' early on -- unjustly, in my view -- when he compared the Fed's money-creation process to a chopper dropping dollars from the sky.
That's right out of the Milton Friedman teaching toolkit. When was the last time anyone accused the University of Chicago economist and Nobel laureate of fanning inflation?

Base Case
For what it's worth, the Fed's provision of credit, or high- powered money, has slowed to a crawl. The monetary base, which includes currency and bank reserves, grew 2.1 percent in July from the same month a year earlier, according to the St. Louis Fed's database. That's less than the inflation rate. As recently as last year, base money was still growing in excess of 5 percent annually.

There has been some suggestion -- accusation, really -- that the current Fed board is populated with academics (Bernanke along with Fed Governors Frederic Mishkin and Randall Kroszner), and that academics lack Greenspan's innate instincts about the market.
Maybe. Not all of his gut reactions were good ones, however. Greenspan lowered the federal funds rate three times in the fall of 1998 to counter the ``seizing up'' of financial markets in response to the near-collapse of hedge fund Long-Term Capital Management.

The economy didn't miss a beat. Greenspan waited until May 1999 to remove that stimulus. In the meantime, the Nasdaq Composite Index was well on its way to an 86 percent gain for the year.

Gut Check
Greenspan was slow to cut rates when capital spending was imploding in 2000, then did so with a vengeance in 2001. The overnight rate was still at 1 percent when the economy was taking off. Real gross domestic product grew at a 7.5 percent annualized rate in the third quarter of 2003, the start of a three-year trend of strong growth. Yet Greenspan took his time moving the funds rate back to a neutral level.

The Bernanke Fed, with its model-driven forecast, may turn out to be wrong in its laissez-faire attitude toward tightening credit conditions. It will come to that decision in its own way in its own time.

The inverted yield curve, with long-term rates below the Fed's policy rate, has been signaling for almost a year that the Fed is holding the funds rate too high. That disequilibrium is always resolved in favor of lower short-term rates.

I doubt this time will be different. It never is.