December 12, 2007 / 8:22 AM / 12 years ago

Greenspan: subprime "accident waiting to happen"

NEW YORK (Reuters) - The U.S. subprime mortgage crisis was an “accident waiting to happen” as a period of unprecedented global growth seduced investors into underpricing risk, former Federal Reserve Chairman Alan Greenspan argued in an article published by The Wall Street Journal on Wednesday.

Former U.S. Federal Reserve chairman Alan Greenspan speaks at the Per Jacobsson Foundation Lecture on the "Balance of Payments Imbalances" at the International Financial Corporation in Washington October 21, 2007. REUTERS/Yuri Gripas

While acknowledging the low U.S. interest rates set under his leadership may have contributed to the bubble in U.S. home prices, Greenspan said he felt the roots of the subprime mortgage crisis actually lie with global economic expansion.

“The root of the current crisis, as I see it, lies back in the aftermath of the Cold War, capitalism quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Third World,” Greenspan wrote.

The growth of fairly educated low-cost workers, and exports from developing countries flattened wages in developed countries and reduced inflation expectations globally, including inflation expectations embedded in global long-term interest rates, Greenspan said.

“In retrospect, global economic forces, which have been building for decades, appear to have gained effective control of the pricing of longer debt maturities,” Greenspan wrote in the Journal. “Simple correlations between short- and long-term interest rates in the U.S. remain significant, but have been declining for over a half-century. Asset prices more generally are gradually being decoupled from short-term interest rates.”

Greenspan noted that home prices had risen sharply around the world, with the exception of Japan and Germany, and citing a study by The Economist, said the rise in U.S. home prices was “average” compared to rises in other countries.

Greenspan also wrote that he believes there was little the Federal Reserve could have done to prevent credit markets from seizing up this August.

“After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own,” Greenspan wrote.

In the article, Greenspan predicted credit markets would recover from the current crisis only when the inventories of newly built homes have been mostly liquidated, and deflation in housing prices ends.

“That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities,” Greenspan wrote.

Reporting by Emily Chasan, editing by Tony Austin

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