Fed Watch

Fed Policy Debate In Full Swing, Climate Change Issue Re-Emerges

At the end of June in 2004, Alan Greenspan was Chairman of the Federal Reserve and was nearing the end of a long and illustrious tenure. At that months’ meeting of the FOMC, the committee raised the federal funds rate 25 bps, from 1% to 1.25%. For the next sixteen consecutive meetings, the committee would take the same measured action.

A funny thing happened, though. The 10-yr and rates on mortgages that are typically closely correlated didn’t go up as you would expect them to. This phenomenon became known as Greenspan’s Conundrum. When looking at this situation with the benefit of hindsight, there is still no clear consensus as to whether the Fed’s slow action encouraged a hunt-for-yield that propelled moral hazard or whether it was foreign MBS buyers.

Federal Reserve Chairman Ben Bernanke best articulated the latter argument. His thesis was that the conundrum was explained primarily by the desire of foreign investors to save instead of invest. His “global savings glut” thesis says that even though the Fed attempted to cool the mortgage market, it didn’t respond because of the voracious foreign demand for mortgage-backed securities. The issue is still debated to this day, and many think both sides of this debate are correct to a degree.

Let’s come back ...

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