Correction of Greenspan exuberance period

The credit bubble in the US and the subsequent financial crisis will be the subject of many books and comments in the year to come. The role of some architects of the financial system will be discussed, and some of them will not escape unharmed from the retrospective analysis.

In the book 'Econoshock',I explain that the monetary policy of Alan Greenspanhas been one of the direct causes of the financial crisis.

In the first, he acted as a monetary Saint, and he rebalanced successfully the US macro-economic fundamentals. The chart shows that the money supply balanced with the economy after 25 years of excess growth. That would have been a glorious moment for Greenspan to leave the Fed ast the best central banker in history.

Almost at that time, he gave his famous 'exuberance speech', back in December 1996.

The speech marked a second period in Greenspan's carreer. That in which he started to experiment with the monetary variables. Money grew faster than the economy, and fueled a bubble. Greenspan famously bailed out the LTCM hedge fund, creating a huge moral hazard problem in the form of the 'Greenspan put', the belief that the Fed would always bail out troubled risk takers ...

I was looking at some charts, and discovered that some data are now approaching the 1996 levels. They are therefore readjusting to pre-bubble levels. Yesterday, the Dow Jones closed below the level reached in February 1997. The Dow at 6,500 would be roughly the point of Greenspan's Saint Nicolas 'exuberance speech'. The S&P500, a better stock market index, has reached that level already.

Another important graph is that of the housing in the US. The ratio of home prices to rent prices is a very good indicator of the balance between buying and renting a house. It is a comparison between two competing markets. In that sense, a good ratio for judging the equilibrium in the housing market.

The ratio has been historically between 1.0 and 1.2. In 1996, he was almost spot on the equilibrium level. He then ballooned for the next ten years. At the top of the housing bubble in 2006, he was at almost 1.8. It means that housing prices were overvalued by some 45% compared to rents. The correction has gone very fast however, and the ratio was at 1.2 towards the end of 2008. We can assume that he further declined in January and February, and is now well within the historic range. This does not mean however that the drop in house prices is completely over. Rent prices are starting to decline, which could put further downward pressure on the real estate market.

The bubble period has taken 10 years to build. The adjustment phase has been very painful because of its speed. Over the last three years, excesses of a decade had to be corrected. With new housing constructions now at a 500,000 beat, the inventory adjustment can also start to take place.

The housing market is adjusting quickly. But it has been the first to correct, and other economic areas have only started to follow.Consumption for instance has more room to fall. Especially as employment, another lagging economic variable, has now started to contract sharply.