Greenspan's "New" Denial
"This explanation really doesn't explain why the bubble started to inflate in 2001 and ended in 2006-07. Did the savings glut start in 2001 and then end in 2006? To the contrary, the external surplus of both China and oil-exporting nations fell in 2001, while they rose quickly in 2006-07. And, as explained below, given how the central bank sets interest rates, those flows will mainly affect money supply instead of interest rates.
Greenspan himself makes this argument by pointing to how long-term interest rates did not rise after the rate increases in 2004-2005. This is dishonest for more than one reason. First of all, the housing bubble started already in 2001, when he pushed through rate cuts of an unprecedented magnitude, from 6.5% to 1.75% in a mere year. Secondly, because of the increased popularity of adjustable-rate mortgages, short-term interest rates were just as important as long-term interest rates. Thirdly, movements in market interest rates always tend to precede movements in the federal-funds rate as market interest rates are really the future average federal-funds rate during the duration of the bond.
If really long-term interest rates were determined only by global liquidity, then were long-term interest rates about 1.5% in Japan and 6.5% in Australia until only recently? This is all the more telling given the fact that Japan has a very high budget deficit and a huge public debt, while Australia had a budget surplus and a very small public debt. And to further illustrate the point, after the Reserve Bank of Australia unexpectedly reversed its previous rate-hike policy and started to aggressively lower short-term interest rates, the 10-year yield has fallen some two percentage points, while the Japanese yield has stayed unchanged.
And long-term interest rates did in fact rise from 3.3% in June 2003, when the deflation scare made everyone believe interest rates would stay low for long, to 4.7% in June 2004 when the Fed had already signaled the start of a series of rate increases. That long-term interest rates didn't rise further after that merely reflected that the series of rate increases after that was factored in by the markets."