Institutional Blinkers

Purblind Central Bankers

The causes of the Global Financial Crisis are complex and multi-valent--as expected.  One individual who shares a good deal of the blame, however, is Alan Greenspan, former chairman of the US Federal Reserve.  Greenspan deliberately kept interest rates low in the US (and thereby in much of the world) during the critical period of 2000 to 2004.  It was during this period that house prices began to inflate rapidly.

In May 2000 the US federal funds rate (set by the Federal Reserve) was 6.5 percent.  Then the dot-com crash happened.  Internet and IT companies had been a hot item on the stock market, trading well above their intrinsic value.  Suddenly, as is often the case, the mood of the market changed:
public shares of companies in the IT sector collapsed.  Greenspan responded by cutting the federal funds rate--lowering interest rates across the entire country and indirectly throughout much of the world. 

Then 9/11 happened, and for a time it seemed as if the entire world order were teetering on its axis.  Translated in the language of the economy and markets, that meant uncertainty; and if there is one thing which markets and economies hate, it is uncertainty.  Greenspan surveyed this landscape, took in the imminence of war and the certainty of sharply spiking oil and commodity prices at at time of what looked like a general slowdown, and made what with the benefit of hindsight was a major mistake: he continued to cut interest rates. [John Lanchester, I.O.U: Why Everyone Owes Everyone and No One Can Pay (New York: Simon & Schuster, 2010), p.107f. Emphasis, ours.]

The availability of easy and cheap credit flooded into the housing market and the great real estate speculative boom began.  When it ended it almost wrecked the world economy.

There are signs that New Zealand, in its own small way, is heading down exactly the same path--and the NZ Reserve Bank, led by Dr Allan Bollard, is leading the way.  Bollard appears to be doing a Greenspan.  He has cut interest rates to historic lows because of emergencies: first the GFC, and then the Christchurch earthquake. He justified these extravagant cuts at the time by arguing they were temporary.  When the global banking system unfroze and the Christchurch earthquake emergency passed he would increase interest rates again.

Yet for two years now, Dr Bollard has kept rates at the "emergency" level.  Now, however, the justification is more nebulous and vague. He points to "worries in the global economy", "uncertainties in Europe", and anaemic economic growth at home. In other words, he is now acting remarkably like Dr Greenspan.  There is always a worry about something just around the corner to justify keeping rates artificially low.  The emergency has become the new normal. 

Meanwhile under his nose, and those of the economic commentators (most of whom work for banks which have a vested interest in keeping interest rates low) the cheap and easy credit is flowing, not into the productive sectors of the economy, but (you guessed it) into housing.  When a three bedroom house sells for just shy of a million dollars in Auckland you know something is awry.  Then there is this piece in the NZ Herald recently:

Auckland real estate agents are bringing forward auctions and selling houses without any advertising as the housing market hits a fresh boom.  Agents say the buoyant market is driving up sales and they are bringing forward auctions to capitalise on the huge appetite. . . .

Ms Jaffe also said the hot market was resulting in many houses being sold but never advertised on the open market "and it's appalling, it's very common. Sales people come up to your door and say they've got a buyer and it's a good price. But I don't do this and I don't advise people to do it."  Few people would admit to using these tactics, she said, although many Remuera houses were being sold like this.  Another property in Remuera - a four-bedroom home - had an opening bid of $1,285,000 and sold for $1,430,000 with seven bidders after the auction was brought forward.

Nothing to see here.  Move along.

The Auckland real estate market is the largest in the country by a long stretch.  Only the purblind cannot see that it has now entered a speculative phase.  By the time the Reserve Bank admits its mistake it will have to raise interest rates way beyond historical averages to deflate the bubble.  The inevitable consequences for our productive economy will likely be dire indeed.