April 9, 2008
Why Greenspan does not bear most of the blame
By Martin Wolf
When a wave of destruction hits, everybody looks for somebody to blame. Alan Greenspan, former chairman of the US Federal Reserve, once lauded as the “maestro”, has, to his discomfort, become the scapegoat. But even though I dare to disagree with him on some points, much of the criticism is highly unfair. Mr Greenspan remains the most successful central banker of modern times. More important, blame distracts from the challenge, which is to understand what happened, why it happened and what we should do.
As Mr Greenspan pointed out in his response to his critics in the Financial Times on Monday, the housing bubble was not unique to the US. On the contrary, as the background chapter on housing in the International Monetary Fund’s latest World Economic Outlook shows, US experience was far from exceptional. On the contrary, the biggest apparent overvaluations occurred in Ireland, the Netherlands and the UK.
The chart shows the proportionate increase in house prices between 1997 and 2007 that cannot be explained by the fundamental drivers: affordability (the lagged ratio of house prices to disposable incomes); growth in disposable incomes per head; interest rates (short- and long-term); credit growth; changes in equity prices; and changes in working-age population. Thus, the rises reveal the extent to which a country has experienced what seems to be a bubble. The US is in the middle ranks.
The remainder of this column can be read here. Debate from our panel of economists appears below.
The daily debate and global coverage by the FT of the financial liquidity crisis is exemplary and invaluable to insider experts as much as to the wider public. In the year since the crisis began the FT’s writers have provided an invaluable education to all about the policy uncertainties and alternate technical views, such as typified by Martin Wolf’s balancing of opinion for an against Alan Greenspan’s views; not just facts or fixed opinions.
This is invaluable because balanced debate of this quality whereby economists and bankers can discuss and understand each other, is impossible in the silo mentality of financial institutions, over-technical in regulatory consultations, and too abstract in academic studies.
We are, however, over-mesmerised by the sub-primes and financial engineering. On the face of it, the data, the property bubbles cannot be explained by the standard models and charts of national aggregated data. But,the USA is an enormous country in which states are the size of European countries. The bird’s eye view does not show the excessive pressures on rising house prices in California and Florida, for example, pressures that include population migrations. The USA contains great variations despite roughly uniform fiscal and monetary conditions. What is common to all countries with property bubbles is high trade deficits and GDP growth explained by credit booms financed in large measure by packaging financial assets for net acquisition by countries running large trade surpluses and low growth domestic demand.
To supply this demand, beginning in the USA, high deficit countries annually packaged 15-30% of the growth in retail banking assets for sale, much of it exported. Thus the mismatch between loans and deposits was not just funded by wholesale banking credit, but by foreign investors. On a world scale, therefore, another classic precept of banking was overthrown, the idea of geographically matching assets and liabilities. We are financially a globalised economy and therefore solutions to the liquidity crisis are global not national matters.
The biggest question therefore will be how over the next few years the world will re-shape its pattern of trade and distribution of domestically-fuelled and trade-driven growth, how much and which countries will shift between exogenous and endogenous growth (or recession) impulses. Just as the USA either has to re-invigorate its domestic economy by bailing out the finance sector, or accept a longer period of recession, so too must China, for example, urgently consider how to boost its internal domestic economy. It might begin by doing more to enforce the 40 hour week and other social welfare policies.
Thus, all this is not, as Wolf asks, bailing out finance, but bailing out the economy - mitigating and managing the contagion risks. The USA is only 4.5% of the world’s population, but a fifth of the world’s economy and, alongside the EU, of similar size, has a responsibility as the trading and financial counterpart to the rest of the world, which makes the sums involved in bail-out, whether profitable for government or not, appear somewhat beside the point.
Wolf echoes others in suggesting that a financial sector bail-out has to involve tighter regulation. The happy fact is that comprehensive and highly appropriate regulation (Basel II) is already in train, and in process of being applied to all international banks worldwide. But, it will be several years before this heroic initiative can be counted as complete, by which time we shall no doubt be contemplating the next great leap forward in financial risk regu8lation.
Posted by: Robert McDowell, Edinburgh | April 9th, 2008 at 11:07 am | Report this commentIt is correct to say that blame distracts from understanding what happened why it happened and what we should do, but so does defending someone from blame.
Alan Greenspan in “A response to my critics”, FT’s economist forum, April 6, says that “The core of the subprime problem lies with the misjudgements of the investment community”; and the core of that misjudgement lies of course with the credit rating agencies; as most of the other financial agents were just doing their normal business which is selling something risky valued at somewhat less risky terms.
In this case what Wolf fails to recognize, sufficiently at least, is that the immediate detonator of the current crisis was not a housing bubble but a bubble in financial securities, such as those collateralized by lousily awarded mortgages to the subprime sector.
The credit rating agencies did not do the job they were supposed to do, to err is human; but the responsible for empowering the credit rating agencies to do the risk measurement for the markets and ignoring the “to err is human” part of it all, were the bank regulators, like Greenspan. And for this Greenspan should at least stand up and take his share of the blame.
Posted by: Per Kurowski | April 9th, 2008 at 3:04 pm | Report this commentEdward Hadas: You are surely right to shield Greenspan from the most extreme accusations – he was not powerful enough to be guilty of single-handedly creating the current financial stress. Still, you might be a little kind to Greenspan in his persona of “the maestro”, the global intellectual leader of central banking. His narrow approach to the regulatory responsibility of central banks allowed him to ignore the massive increase in systemic leverage.
It is hardly as if Greenspan was unaware of the risks that come with building up mountains (or perhaps slag heaps) of debt. Greenspan seems to believe that markets, not the authorities, were best placed to deal with them. I find it hard not to think that financial markets would be healthier today (although many financiers would be less rich) if Greenspan had been less antagonistic to regulatory oversight and less blindly enthusiastic about financial “innovation”, techniques which largely translate into new and improved ways to put more debt into the economy.
Edward Hadas is associate editor at Breaking Views.
Posted by: Edward Hadas | April 9th, 2008 at 3:29 pm | Report this commentAlan Rohrbach: Greenspan’s right; yet Martin Wolf significantly more so on one of his original key points.
There’s little doubt Alan Greenspan is a master central banker. He is certainly right on many points that debunk criticism directed at the Fed. There is merit to his analysis on everything from sources of the global housing bubble, to economies remaining questionable out of the 2003 deflation scare into 2004, and tightening of regulations not likely making a difference. Tony Jackson has the right perspective on that in his Monday column: (the) banks “…figure out ways around them.”
Yet, Mr Wolf is 100 per cent correct on one point Mr Greenspan still refutes: central banks should indeed “lean against the wind”. Mr Greenspan is so well-regarded he can develop perspectives on policy and practice with little question. Yet it seems a convenient shift of central bank theory in the wake of the Dot.Com Bubble bursting that Mr Greenspan noted it is not within the remit of central banks to deflate bubbles.
In fact, the practical reason central banks must be the one to lean against generally too fair a wind is included in his analysis. As he aptly noted, “Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality.” That is consistent with both he and Ben Bernanke noting previous they were aware of this, yet could do nothing specific. The nature of the beast is that securitizers are trapped in a prison of their own devise once one of their theories (solid or otherwise) is broadly accepted by both investment community and individuals. Demand from investors is driven by animal spirits until there is a shift in general sentiment.
While it is indeed a very blunt instrument, central banks have the primary tool to implement that shift: base rate changes and anticipation of future moves. In his recent extensive exposition on the matter, Mr Bernanke explicitly noted that faulty assumptions about continued asset appreciation played a major part in the housing bubble reaching the extremes which continued into the first half of 2007.* The continued availability of subprime mortgages for securitization was based on belief by home buyers that endless asset appreciation would offset onerous loan covenants. If more economic concern had been fostered in late 2006, it could have deterred some of the irrational exuberance (to borrow a phrase from the Master.) It likely seemed counterintuitive to Mr. Bernanke to raise rates in late 2006. Yet, the DJIA pushing above the January 2000 Dot.Com Bubble high should have been grounds to fear the Credit Bubble would also continue to inflate on the back of asset appreciation expectations.
Even if US stocks were not overvalued on historic price/earnings ratio analysis, central bankers’ lack of desire to cool economies to offset a distended cheap credit cycle allowed it to continue. It was their job to deflate expectations even if inflation and equity prices were not obviously overheated at the time. At the very least that might have discouraged the worst late phase excesses Mr Greenspan now cites. Citi’s ex-head Chuck Prince was accurate in his assessment that as long as the music is playing everyone will keep dancing. If central banks will not pull the punch bowl (their classic role) when the dance gets too frenetic, it diminishes their influence and leadership.
It also raises a very telling question: If central banks are not responsible for leaning against the wind to deflate bubbles, then (pray tell) to whom does that unsavory task fall? Messrs Greenspan and Bernanke seem content to have the Fed show up with liquidity balm for the third degree financial burns when bubbles flame out like the Hindenburg. Somehow that does not seem a constructive role for central banks.
Mr Greenspan’s defense of the Fed was as factually accurate as it was vigorous. However, his review of specific reasons the Fed is blameless for the scale of the housing bubble has provided critics of its failure to ‘lean against the wind’ the general considerations by which he and his successor may be hoist by their own petards.
Alan Rohrbach is president of Chicago capital markets consultants Rohr International
Posted by: Alan Rohrbach | April 9th, 2008 at 5:54 pm | Report this comment*Fostering Sustainable Homeownership, March 14, 2008, at the National Community Reinvestment Coalition Annual Meeting, Washington, D.C.
http://www.federalreserve.gov/newsevents/speech/bernanke20080314a.htm
Stephen Roach: The blame game has reached epic proportions in this wrenching financial crisis. Alan Greenspan makes the most inarguable point of all in stating his case for the defense – that it is critical to get the lessons right. I couldn’t agree more.
Unfortunately, Greenspan has been blinded by a dangerous combination of ideology and politics in his own search for those very lessons. And it was much the same during the 18½ years he spent at the helm of the Federal Reserve. At the core of his principled stand is the belief that the US body politic demands rapid, albeit non-inflationary, economic growth. As a politically-compliant central banker, he has also stated that the independence of the Federal Reserve is not set in stone – implying that there is always huge pressure to keep the growth machine humming. And as a market libertarian, he has argued that regulatory intrusion impedes the speed of economic growth. Presto – the rest is history – and an increasingly painful one at that.
This combination of ideology and politics led to bad economics and to a succession of policy blunders – the severity of which are only now becoming evident in this most wrenching of crises. Unlike Martin Wolf, I believe that Greenspan’s treatment of The Bubble is the smoking gun. The Greenspan-Bernanke mantra has long been steeped in the belief that markets know best – that central bankers should not attempt to override the verdict of millions of market participants in rendering the judgment that an asset bubble has formed. There are the costs to economic growth to consider. And why worry? After all, goes the script, the authorities always have the wherewithal to clean up any post-bubble mess. Maybe not. The mess this time is almost beyond the realm of comprehension.
Yet the problem has never really been the bubble in the narrow sense of the word. Unfortunately, this is one of the weakest links in the Greenspan defense and in Martin’s defense of the defense – namely, a fixation on whether a serious bubble was forming in America’s housing market. Never mind, his earlier arguments that housing markets are local, not national – and that it was highly unlikely that nationwide home prices could ever fall. Whoops. Never mind also his equally irrelevant point that there were lots of housing bubbles in the world at the same time – and that America’s property market excesses didn’t look so bad by comparison. Even Martin Wolf buys the peer pressure rationale – every one’s doing it – as exoneration for the Fed.
The problem with America’s housing bubble was never its comparison with Ireland. The core of the problem lies in the distortions that asset bubbles created on the real side of the US economy. Courtesy of the most rapid rates of sustained US house price appreciation in the modern post-World War II era, in conjunction with innovative financing techniques that allowed American homeowners to extract equity with ease from their humble abodes, the new age of the asset-dependent consumer was born. Net equity extraction from residential property – ironically, based on a statistical framework developed by Alan Greenspan, himself – surged from 3 per cent to nearly 9 per cent of disposable personal income in the first half of the current decade.
And so it went in the Age of Excess. Increasingly supported by the confluence of both property and credit bubbles, American consumers spent well beyond their means – as those means were delineated by domestic income generation. Personal consumption climbed to an unheard of 72 per cent of real GDP in 2007 – a record for America and, for that matter, for any leading economy in the modern history of the world. At the same time, household sector debt soared to a record 134 per cent of disposable personal income. America had the rapid growth that Greenspan felt the body politic wanted. But it was growth based increasingly on fumes.
Unfortunately, the distortions of a bubble-infected US economy didn’t stop there. With equity extraction from residential property viewed increasingly as a permanent source of income generation, consumers felt little pressure to save the old-fashioned way – out of their paychecks. As a result, the income-based personal saving rate plunged to zero for the first time since the Great Depression. Lacking in domestic saving, an increasingly asset-dependent US economy had to borrow surplus saving from abroad in order to keep growing – and run massive current account and trade deficits in order to attract the foreign capital. Greenspan and Bernanke turned this development inside out, as well – maintaining that America was simply doing the rest of the world a huge favor by absorbing its surplus saving. Serious dollar risks were always the catch to that favor, but they were typically couched as a problem for a distant day. Suddenly, that day doesn’t seem so distant. In retrospect, the dollar bubble was the external face of America’s penchant for asset-dependent growth and saving.
The Greenspan defense completely misses the trees from the forest. His place in history will not be defined by a cross-country comparison of housing bubbles. What he missed repeatedly over the years – and still misses today – are the corrosive impacts this bubble had in fostering the imbalances and excesses of an asset-dependent US economy. Unprecedented consumer leverage is only part of the problem. So, too, is the failure of an aging US population to save at precisely the phase in its life-cycle when it needs to prepare for retirement. Global imbalances are also an outgrowth of this era of excess – underscored by America’s massive external deficit and, by the way, the protectionist fires it stokes.
Alas, these fault lines were made all the deeper by the Fed’s regulatory laxity in an era of unprecedented financial innovation – a laxity that, unfortunately, was accompanied by the cheap money that only a narrow CPI inflation targeter could justify. In retrospect, this was the most dangerous tactical blunder of all – a combination that created voracious investor demand for opaque and increasingly toxic financial products.
It didn’t have to be this way. Saying no to asset bubbles – equity, property, or credit – was always an option. In contrast to Alan Greenspan, I concur with Martin Wolf and believe that could have been achieved by common sense – “leaning against the wind” when faced with the obvious asset bubbles of the past eight years. That would have allowed the Fed to use a variety of anti-bubble tools – the bully pulpit of jawboning, more disciplined regulatory oversight, and, ultimately, a tighter monetary policy than a narrow core CPI inflation targeting rule might otherwise suggest.
Yes, economic growth would probably have been slower as a result during the period when the Fed was leaning against asset bubbles. But that shortfall may well pale in comparison to the cost of the post-bubble carnage that is now unfolding. Yet trapped in ideology and politics, Alan Greenspan simply couldn’t bring himself to follow the sage advice of one of his predecessors, William McChesney Martin, and “take away the punch bowl just when the party was getting good”.
Posted by: Stephen Roach | April 10th, 2008 at 9:05 am | Report this commentAllan Meltzer: I agree with Martin Wolf. Alan Greenspan erred but he is not responsible for what followed. Martin is right that the critics shift the blame and fail to accept their responsibility. Rates remained too low too long. Deflation was unlikely in an economy with a large budget deficit and a falling exchange rate. But no one insisted that the financial community had to invest in sub-prime loans and other risky
assets. Two other problems contributed to the bad outcome.
First, the Basel Accord required banks to hold more capital if they increased risk. Like most rules written by lawyers, the incentives created by the rule were not considered. Markets respond to costly rules by finding ways to circumvent them. Risky assets moved from banks’ balance sheets all over the world. Banks seemed safer but the markets were much riskier, and no one knew where the risks were. We find out when there are failures. Not a good system. Why is there no discussion of changing it?
Second, one has to ask why MBA graduates of the world’s best business schools were willing , even eager, to buy and sell loans with no down
payment and no credit record. My answer is that their incentives are distorted by the large bonuses they receive. And their supervisors face
the same incentives. Sell the junk and earn a big bonus. Refuse and you join the unemployment line.
The compensation system should change. Tax the bonuses heavily to push compensation to more salary. Or, pay the bonuses on 5 year average
earnings. I am sure there are other ways of altering incentives.
These are not the only problems, but they are major problems.
The system must be changed. We cannot expect the current system to survive if the bankers get the rewards and the taxpayers share heavily
Posted by: Alan Meltzer | April 10th, 2008 at 9:40 am | Report this commentin the losses.
I feel the blame for the current crisis owes its origination to the FRB during Mr.Greenspan’s tenure purely on account of major central functions to achieve Price Stability in the economy and to take necessary steps to achieve the same and maintain the same. Mr. Greenspan being one of the finest analyst of the economic data and the economy working on Newton’sq principle of Inertiac help us to believe that the seeds of the crisis were sown during past few years and the currenet Chairman had too much faith on market’s resilience and technology’s prowess and did not pay any attention to irrational earnings of Investment bankers and Banks which would have come to notice in a more rational and sane envoirnment as of now.
Posted by: Abhishek Mishra | April 10th, 2008 at 10:25 am | Report this commentQuestion: Could anyone explain something? How is it that bankers (including central ones) with all the mighty computer power at their disposal can devise quantum models and yet claim that they cannot devise sensible metrics to measure material bubbles? When house prices grow by +15% pa for consecutive years whilst salary levels grow at inflation levels or remain flat the disconnects are obvious to all and sundry.
Posted by: Philip Chung | April 10th, 2008 at 10:52 am | Report this commentWith all due respect, the highly respected gentlemen here seem to speak after the earth quake has demolished the houses.
What good is it now to be wise after the facts?
Posted by: PaxIrana | April 10th, 2008 at 11:01 am | Report this commentI do find it quite amusing and a tad ironic that despite Greenspan’s best efforts to stage-manage his legacy, something whihc verged on an obsession in his last day of office, he’s ended up carrying a lot of the can for the current mess after he has already left often.
Posted by: Jonathan | April 10th, 2008 at 1:09 pm | Report this commentAndrew Smithers: Errors of judgment are often presented as evidence of moral culpability, causing serious discussion to be buried under piles of recrimination. Martin is thus right to defend Alan Greenspan, particularly as his articles suggest that he is ill-equipped to do so himself. But while personalities should be treated with charity not malice, they should usually be avoided as they distract attention from the issues.
The central issue is neither the housing bubble, nor who or what is to blame for it, but whether central bankers should ignore asset prices and is it wrong to assume that this concern is a hindsight response to recent troubles.
Stephen Wright and I set out in a paper published in World Economics in that Journal’s Jan-March 2002 Edition, the case that central bankers should be concerned with asset prices and while we doubted then “whether this view would yet receive support from the majority of economists”, it seems likely that views have changed.
A major reason for the change of attitude is the way in which the Greenspan/Bernanke view has shifted its ground. The first defence was that asset prices were irrelevant, but this has become absurd as the Fed has responded to asset price falls. The second was that assets couldn’t be valued, but this has been replaced by a conviction, even it seems in the Fed, that many forms of debt today are undervalued. The third, which was that problems could easily be tackled ex-post, has obviously been overtaken by events. The only defence left is the counsel of despair, which is that any attempt to respond to asset price excesses will simply fail.
Only the most pessimistic would hold that this is bound to be true and only the most dedicated exponents of theory over pragmatism would hold that central bankers should not even try to respond to asset prices. This leaves us with the key questions of how to value assets and how central bankers should respond if they become concerned with their level.
One problem is that it has been difficult to get rational attention on the difference between asset values and asset prices. This is partly because we are in the middle of a Kuhnian paradigm shift, in which the Efficient Market Hypothesis (“EMH”) is still assumed, though usually implicitly rather than explicitly, in much academic work. I am of course “talking my own book” when I assert that the replacement of the EMH is a key task for the economics profession.
Practice, however, cannot afford to wait for theory to catch up. Even more urgent is agreement about how to respond to concerns about asset prices. At the moment this involves, I think, two questions. The first is whether risky debt instruments have become too cheap and if so whether, as Willem Buiter argues, we need a market maker as well as lender of last resort. The second is whether there are any other short-term steps that still need to be taken to mitigate the immediate risks to the economy.
The second point gives rise to an issue which I have had a part in raising. This is whether bank capital is adequate. Judging by statements from Mervyn King to the House of Commons Treasury Committee and by Lawrence Summers’s recent article in the FT, there is a growing consensus that it is not. Banks must therefore be expecting that their capital requirements will be raised in the future. This must inhibit their current lending and thus exacerbate the normal pro-cyclical tightening of bank credit at a time when the impact of this is likely to be made even worse by a change in non-bank credit from creation to destruction.
Governments should perhaps request or require banks to stop paying dividends for the next two years, to give time for new capital regulations to be put in place. As a government request, this should enable bank managements to act sensibly, despite the usual resistance from shareholders and, by increasing their prospective capital, make them less negative to the creation of credit.
Posted by: Andrew Smithers | April 10th, 2008 at 3:22 pm | Report this commentRobert Brusca: Greenspan protests his guilt arguing that housing pressures existed elsewhere in the world and some bubbles were worse than in the US. First, this is misdirection. Second, it wrongly encourages you to look no more deeply into the US problem.
The US is a huge country with little real land scarcity. I find the comparisons with European countries, relatively less endowed with land and not suffering the decline that US house prices are now, as a spurious comparison. In the US, home ownership has spread to new historic highs. It was enabled by imprudent lending. Imprudent lending was the spur, not scarcity. Oversight of that lending was the Fed’s (failed) mission. That’s the simple case against Greenspan. It has nothing to do with housing bubbles in Ireland or London. It might have had something to do with people favoring real and hard assets after the stock markets had earlier collapsed destroying confidence in them. Now there is an angle worth pursing…
Greenspan’s protestations are a case of magician-like misdirection - i.e. classic Greenspan. When it’s all said and done Greenspan may be the world’s greatest politician- central banker, language- and fact-twister. He is the only CENTRAL BANKER I know who was able to ‘propose’ and all but pass a FISCAL stimulus passage, single handedly. He is a powerful central banker who used his power and political connections WHILE HE WAS a central banker in office… his after-the-fact mumbling, that he wasn’t as powerful as he seemed, is just more opacity from the alleged ‘Mr Transparency’. While Greenspan pushed for transparency, no one was more opaque as he admits in his book. He admits that he practiced the sort of double-talk he gave us in testimonies before the Congressional financial committees where testimony was duty. Yet he mocked us with gibberish on those occasions. When you consider his arguments you must put this man in context… Nothing is what it seems or how he portrays it. He is harder to nail down than Jell-O.
Greenspan is not wholly responsible for the US housing problems but he may have played a greater role in them than any other single person.
Greenspan had bad judgment: he urged fiscal stimulus because budget surpluses were too big - a terrible judgment call. He encouraged people to take the equity from their homes and spend it. He repeated over and over that house prices did not fall nationally. This latter point is an example of a stylized fact that had no merit - but was true - and encouraged poor decisions by others.
In the severe 1980-1982 recession period (s) US nominal house prices did not fall because inflation was so high. Shouldn’t a Fed chairman have seen that for what it was, instead of as resiliency? Real house prices had fallen in the past. With lower inflation established, weren’t declines in nominal prices possible? Yet, Greenspan admits to urging people to take equity out of their homes jeopardizing their financial standing in order to spend it to spur an economy that hardly need more boost.
Greenspan steered the economy on a wrongful course of action: Consumption in the US also augments trade deficits. But Greenspan urged all this with a low savings rate in place, a looming crises in Medicare-Medicaid costs and with Social Security in need of a fix. He did this ahead of a time that Americans are going to have to support themselves with an untested 401K income program instead of defined pension benefits which they historically relied upon. Having a paid up house with lots of equity in it would have been a boon to such people. But no, that was not the Chairman’s advice. This was the guy who was supposed to be Mr Probity. We have yet to see what his advice has wrought. Housing is just the start. Since some have put 401K money (retirement funds) into their house purchase this housing episode has also worsened retirement prospects for many directly.
Greenspan’s actions have left the people and government financially much worse off. His biggest failing was as a regulator in not following up advice that things were amiss in the mortgage market when presented with the facts by Fed Governor Ned Gramlich. His after-the-fact ‘who could have known’ excuse sounds suspiciously like Condoleezza Rice’s statement about an FBI that also failed to follow up a hot lead before 9-11 that might have changed history. How long has it been fashionable in the US to lay off the blame on nihilism? Who could know? You WOULD HAVE had you done your job properly – that is the correct answer to that seemingly rhetorical question.
Greenspan is culpable in so many ways. He thrusts himself on the scene and imposes his judgment on others; he was not collegial; he was dictatorial. No wonder he was clueless about housing.
While he ignored the Fed’s obligation to regulate he testified up and down Washington on the merit of de-regulation everywhere else – further spreading the gospel of irresponsibility.
Having no regulation is not as dangerous as making people think they have regulation that isn’t there. That was Greenspan’s main central banking sin.
Greenspan mostly wasn’t there. His ideology was there. He had great timing but poor judgment. He was there for the productivity miracle and gone for the housing collapse. While he was at the Fed the published ‘FOMC forecasts’ consistently projected growth that was too low and inflation that was too high. A nice - and unusual - matched pair of forecasts errors. When others are wrong things rarely turn out so well. Yes, Greenspan had timing; it was his main asset, not his judgment.
The policies he set in motion as Fed chairman have implications – adverse implications - beyond housing. But his fingerprints are all over that problem. I accept none of his excuse, nor find Mr Wolf’s acquiescence compelling. I suppose because Japan had earlier gone through a decade of real estate-spurred problems Greenspan can cite them as another example of how it’s not his fault.
To the contrary… when bubbles appear they appear where people like the prospects. The appearance of past stock and international housing bubbles were warnings that were ignored. Stocks and housing were vulnerable. Oversight was not ramped up, it was set aside. The Greenspan Fed reacted badly to both of those asset bubbles. For one he sat idly by. For the other he wore the short skirt and waved the pompoms. He was Ponzie to that scheme. Blameless? Hardly. And that is only the start of the mischief he has set in motion.
Robert Brusca is a former chief economist at Nikko Securities International and a former chief of the international financial markets division of the Federal Reserve Bank of NY
Posted by: Robert Brusca | April 10th, 2008 at 3:57 pm | Report this commentIn his book, The Age of Turbulance,Dr. Greenspan cites the dramatic increase in home ownership by minorities that pushed US household’s ownership up to 69% as due to increased affluence within those groups as well as “government encouragement of sub-prime mortgages programs.”
He admits to being fully aware of the loosening of mortgage credit terms, stating “But I believed then as I do now, that the benefits of broadened home ownership are worth the risk”.
There is a lot to be read between the lines here and a lot of very questionable policy.
First,what is meant specifically by government encouragement? For example,what promises and representations were made to the various communities and their leaders that may now have to be made good because of government meddling with sound practices?
Second, what is meant here by the term home owners? Can one really be said to own a home in which you have no equity? Now we are being asked to help “homeowners” to remain in “their” homes? If I own an option to buy a stock I am not an owner of the company. Although a homeowner possesses the right of ownership, without equity it is only equivalent to an option to buy. In the environment fostered by the government and particularly the Fed it was assumed that entering into the option was a no lose proposition.
Thirdly, the inflation in house prices especially pronounced in certain locations should have tipped even the mentally challenged as to what was going to happen.
Fourthly and probably near the heart of the problem is that the Fed Chief is actually a mortal and is subject to the demands of powerful politicians and big money interests. It takes a very powerful leader to stand up to the forces that demand cheap money and growth at any price,especially if the price to be paid is bourne by someone else.It takes a powerful leader to build a consensus to “lean against the wind”. It is very clear that Chairman Greenspan was not that leader.
Posted by: David Bray | April 10th, 2008 at 4:32 pm | Report this commentGreenspan protests his guilt arguing that housing pressures existed elsewhere in the world and some bubbles were worse than in the US. First, this is misdirection. Second, it wrongly encourages you to look no more deeply into the US problem.
The US is a huge country with little real land scarcity. I find the comparisons with European countries, relatively less endowed with land and not suffering the decline that US house prices are now, as a spurious comparison. In the US, home ownership has spread to new historic highs. It was enabled by imprudent lending. Imprudent lending was the spur, not scarcity. Oversight of that lending was the Fed’s (failed) mission. That’s the simple case against Greenspan. It has nothing to do with housing bubbles in Ireland or London. It might have had something to do with people favoring real and hard assets after the stock markets had earlier collapsed destroying confidence in them. Now there is an angle worth pursing…
Greenspan’s protestations are a case of magician-like misdirection- i.e. classic Greenspan. When it’s all said and done Greenspan may be the world’s greatest politician- central banker, language- and fact-twister. He is the only CENTRAL BANKER I know who was able to ‘propose’ and all but pass a FISCAL stimulus passage, single handedly. He is a powerful central banker who used his power and political connections WHILE HE WAS a central banker in office… his after-the-fact mumbling, that he wasn’t as powerful as he seemed, is just more opacity from the alleged ‘Mr Transparency’. While Greenspan pushed for transparency, no one was more opaque as he admits in his book. He admits that he practiced the sort of double-talk he gave us in testimonies before the Congressional financial committees where testimony was duty. Yet he mocked us with gibberish on those occasions. When you consider his arguments you must put this man in context… Nothing is what it seems or how he portrays it. He is harder to nail down than Jell-O.
Greenspan is not wholly responsible for the US housing problems but he may have played a greater role in them than any other single person.
Greenspan had bad judgment: he urged fiscal stimulus because budget surpluses were too big- a terrible judgment call. He encouraged people to take the equity from their homes and spend it. He repeated over and over that house prices did not fall nationally. This latter point is an example of a stylized fact that had no merit - but was true- and encouraged poor decisions by others.
In the severe 1980-1982 recession period (s) US nominal house prices did not fall because inflation was so high. Shouldn’t a Fed chairman have seen that for what it was, instead of as resiliency? Real house prices had fallen in the past. With lower inflation established, weren’t declines in nominal prices possible? Yet, Greenspan admits to urging people to take equity out of their homes jeopardizing their financial standing in order to spend it to spur an economy that hardly need more boost.
Greenspan steered the economy on a wrongful course of action: Consumption in the US also augments trade deficits. But Greenspan urged all this with a low savings rate in place, a looming crises in Medicare-Medicaid costs and with Social Security in need of a fix. He did this ahead of a time that Americans are going to have to support themselves with an untested 401K income program instead of defined pension benefits which they historically relied upon. Having a paid up house with lots of equity in it would have been a boon to such people. But no, that was not the Chairman’s advice. . This was the guy who was supposed to be Mr Probity. We have yet to see what his advice has wrought. Housing is just the start. Since some have put 401K money (retirement funds) into their house purchase this housing episode has also worsened retirement prospects for many directly.
Greenspan’s actions have left the people and government financially much worse off. His biggest failing was as a regulator in not following up advice that things were amiss in the mortgage market when presented with the facts by Fed Governor Ned Gramlich. His after-the-fact ‘who could have known’ excuse sounds suspiciously like Condoleezza Rice’s statement about an FBI that also failed to follow up a hot lead before 9-11 that might have changed history. How long has it been fashionable in the US to lay off the blame on nihilism? Who could know? You WOULD HAVE had you done your job properly – that is the correct answer to that seemingly rhetorical question.
Greenspan is culpable in so many ways. He thrusts himself on the scene and imposes his judgment on others; he was not collegial; he was dictatorial. No wonder he was clueless about housing.
While he ignored the Fed’s obligation to regulate he testified up and down Washington on the merit of de-regulation everywhere else – further spreading the gospel of irresponsibility.
Having no regulation is not as dangerous as making people think they have regulation that isn’t there. That was Greenspan’s main central banking sin.
Greenspan mostly wasn’t there. His ideology was there. He had great timing but poor judgment. He was there for the productivity miracle and gone for the housing collapse. While he was at the Fed the published ‘FOMC forecasts’ consistently projected growth that was too low and inflation that was too high. A nice - and unusual - matched pair of forecasts errors. When others are wrong things rarely turn out so well. Yes, Greenspan had timing; it was his main asset, not his judgment.
The policies he set in motion as Fed Chairman have implications – adverse implications- beyond housing. But his fingerprints are all over that problem. I accept none of his excuse, nor find Mr Wolf’s acquiescence compelling. I suppose because Japan had earlier gone through a decade of real estate-spurred problems Greenspan can cite them as another example of how it’s not his fault.
To the contrary… when bubbles appear they appear where people like the prospects. The appearance of past stock and international housing bubbles were warnings that were ignored. Stocks and housing were vulnerable. Oversight was not ramped up, it was set aside. The Greenspan Fed reacted badly to both of those asset bubbles. For one he sat idly by. For the other he wore the short skirt and waved the pompoms. He was Ponzie to that scheme. Blameless? Hardly. And that is only the start of the mischief he has set in motion.
Robert Brusca, PhD
Posted by: Robert Brusca | April 10th, 2008 at 4:46 pm | Report this commentFormer Chief Economist at Nikko Securities International
Former Fed watcher Irving Trust
Former Chief of the international financial markets division of the Federal Reserve Bank of NY
The housing bubble is essentially a land price bubble, since the value of buildings is relatively constant and depends on construction costs. The purchase of a piece of land is the purchase of the future rental income stream, which is the value of the advantages of the particular
location. From this point of view, it is in principle much like the purchase of an annuity.
if that were all there was to it, land prices would settle at a level such that the ratio between rental value and the the land price was much the same as the general interest rate, which is usually around 5%. There would be no cyclic bubbles. But rental values have a
tendency to rise, and so the expectation of future rentals is factored in to land prices. Thus yields from land tend to be lower than yields from other investments.
At the bottom of an economic cycle expectations are low. But as the economy pulls out of recession, expectations of rental income growth start to rise and land prices with them, as could be seen about ten years ago. As time goes on, speculators, seeing land prices on a fast-rising trend, pile into the market and push them up further,
thereby depressing yields well below the general interest rate.
A positive feedback loop then takes hold. Lenders, who see land as solid collateral for their loans, become increasingly willing to lend money for land purchase (usually property purchase, but it is the land element of the property that is behaving according to this description). This drives up land values still higher and depresses the yields still further.
Eventually, yield rates become so low that loans become increasingly difficult to repay out of the earnings from the land investment. Things are then on the point of bursting and the slightest disturbance will prick the bubble. In the latest instance, the initiator was the sub-prime loan crisis last year.
The land price bubble would be of little more signficance than the seventeenth century tulip price bubble or the dot-com bubble if it were not that land is one of the factors of production. A few speculators would be left nursing their losses but that would be all.
But because everyone’s home, and all productive capital, stands on plots of land, any disturbance to the land market will have deep and prolonged effects as resources are held off the market. This is why the consequences will, as with all previous land-based bubbles, continue for several years.
The system can be compared to like an electrical circuit with a positive feedback loop. Such configurations are liable to oscillation. Data going back to the start of the nineteenth century points to a periodicity of around 18 years due to this interaction between the banking system and the land market.
As with electrical systems, the way to prevent unstable oscillations is to introduce an element of negative feedback. One way to achieve this would be for governments to collect the rental value of land and use it as their principal source of revenue, instead of existing taxes on labour and capital. Speculative trading in land would then be pointless as there could be no expectations of higher rental income streams. Moreover, banks, unable to employ land as collateral for their loans, would have to devise other means of operating profitably. They might, for instance, charge directly for more of their services. Loans would have to be made primarily on an assessment of the likelihood or otherwise of their being repaid.
But as this is one tax reform that is not going to happen, it would be prudent to pencil in the date of the next crash, around 2026.
Hon Sec
Posted by: Henry Law | April 10th, 2008 at 11:39 pm | Report this commentLand Value Taxation Campaign
As usual, I find myself essentially agreeing with the position put forth by Stephen Roach, a rare economic sage. Indeed, I do believe he has been warning those who would have cared to listen about the gross distortions being introduced by the actions of the former and current heads of the FED for quite some time.
The notion that a bubble can only be perceived after its repercussions have set in is absolutely preposterous, that is, unless one is devoid of common sense. As I, myself, foresaw the financial Armageddon forming as a result of the Greenspan/Bernanke policies well more than a decade ago, I find it hard to believe that a person of Greenspan’s intellect could not have been able to glean the consequences of his actions. Is the current financial predicament entirely his fault? Clearly not, but he certainly played one of the most prominent roles in this drawn out financial and economic debacle.
If one agrees with the general idea that Greenspan’s age has not clouded his perception, his expose attests as much, then why, the question beckons, would someone act in such a seemingly irresponsible manner? Thoughts that come to mind:
The infatuation with Keynes and the monetarist doctrine and the conviction that the economy should ONLY inhale has assuredly played a crucial role in the path followed. Monetarism, it is believed, can deal with ALL scenarios, save ingrained deflation - the trauma of the Great Depression which Bernanke studied so hard, but, alas, understood so little, taught him that - particularly when a country is “blessed” with a currency that serves as the global standard, a dubious fountain of wealth, the motto being, “print money at will” to render all problems mute.
The American political system on the other hand has become increasingly awry to the extent that one single figure, the President, simply wields too much power and influence, and, as if this were not a major concern in and of itself, this figure is essentially elected through a campaign initiative which thrives on gargantuan sums of money, the origin of which, instead of being strictly restricted to the actual electorate, is sourced from multi-national corporations and the business community. Accordingly, the interests and agendas being represented are essentially those of a privileged elite, of special interests capable of making themselves heard; hence, I surmise, the Greenspan complaint of pressures being made to bear.
At this juncture, it should be most obvious to recognize just how crucial it is to uncompromisingly maintain complete and genuine central bank independence like that accorded to the Bundesbank, and now the ECB, with a strict mission to steer a country’s economy on a sustainable course, as close to cruise control as possible, within certain constraints, whilst, in particular, maintaining the purchasing power of the currency. Politicians are, or rather, should be there to set up the most favourable conditions for their playing field, referee the players’ activity and make sure society benefits as a whole and nobody is left out in the cold and rain. The FED, I trust most shall agree, has failed dismally in this endeavour, with the dollar losing more than 60% of its purchasing power over the last half century, this despite of its reserve currency status and the US economy going through gut-wrenching booms and busts. Is it any surprise that the US population has taken to spending beyond its means and to have all but stopped saving? Why save when one’s unit of currency is on the fast-track to oblivion? Oh sorry, I forgot, the Orient was doing all that saving for the Anglo-Saxon world! The Americans’ “job” was to spend that which they did not have on that which they did not really need. Of course!
Being reluctant to believe solely in the concepts of Greenspan’s ingenuity, his potentially inebriated state of self-adulation brought about by the elevation to iconic status of his persona which the world presses and the market participants impressed upon him, and the untoward pressure being made to bear on the maestro, as explanations for his oversight which to us having to confront this “mother of all crises”, as former FED head Paul Volker, who despite his 80 years clearly possesses more common sense and fore-sight than most, so aptly calls this current fiasco, I postulate Greenspan actually found himself involved in the potentially grander scheme of things.
As all shall doubtless recollect, China, the emergent super-power, has been in the process of initially, slowly, and, in recent years, more rapidly embracing capitalism, understandably a capitalism of its own interpretation. The transition from an essentially authoritarian military regime with central planning to one in which capitalist market forces increasingly determine economic and financial organisation and direction with the consequent transition of a bellic agenda to a predominantly economic one was delicate and took its time, and only a few years ago, I suspect, passed beyond the “point of no-return”, the process having integrated all the key players. So, instead of potentially facing a human apocalypse, we shall face a more “contained” financial Armageddon, provided the concepts of Austrian economics are finally properly embraced and monetarism as viewed through Lord Keynes’ prism follows the way of Marxism.
China has now probably reached a point where it can maintain more contained but sustainable growth within the global economic context, despite the downturn of the US, something that was most probably not the case during the last Asian crisis. Indeed, it shows signs of waking up to the fact that it is better to accept an appreciating Yuan with the subsequent benefit of more bridled inflation, albeit also more tempered growth, than face population upheaval pursuant to disastrous food inflation. Now, the exodus from the dollar continues in earnest, at least until Bernanke sees the light or is ousted from his position. Accordingly, we find legendary investor Jim Rogers bailing out of his country’s currency and into those of Asia.
China now faces the challenge of adopting the tough Singapore model which would turn it into a true and enviable economic super super-power or, should unbridled greed and corruption win the day, something far less envious.
Greenspan surely shall come down in history either as the man who brought China into the capitalist fold and saved humanity from untold, unimaginable grief of an heretofore unforeseen scale, and/or who managed to “fold” the US, the erstwhile super-power turned super-debtor nation of the world, bringing about the financial misery to the majority of his countrymen and leading them into the potential serfdom and strife from whence their forefathers once escaped in Europe.
The aftermath of the “mother of all crises” shall reside in the crucial recognition by the relevant players that both market and economic corrections are absolutely critical to maintain long-term economic health and to foment renewed activity, that excessive exuberance has to be recognized and avoided, that speculation in housing and property in particular are highly undesirable, for, along with available credit provided by the banking system, it is still property pricing, despite the virtual world of the internet, which conditions economic activity and therefore the ease of a recovery, that risk and responsibility has to be properly attributed, and that a fiat currency, even, or rather, particularly, when it is the global reserve currency, can only prevail in the long run if it is dealt with the appropriate respect, meaning that the concept of price purchasing stability should always be at the forefront of concerns, irrespective of political “wishes” and “concerns”.
Stefan A Brose, MD
(Investor, student of economics)
(PS May I remind the editor that it is precisely some of the “top minds” that are responsible for this current financial bloodbath.)
Posted by: Stefan A Brose | April 11th, 2008 at 2:36 am | Report this commentGreenspan’s Fed is not to blame for the current US economic situation. Exact economics on a broad scale can never be achieved. But with the assistance of Greenspan’s key players–bank and government regulators, counterparties, and investors (I add history)–backed by responsible actions by the investment community there can be progress. Capitalism, as described by the economist, Joseph Schumpeter, is a continuous evolutionary process without an end-point. Sadly, we are witnessing in the current evolutionary stage a betrayal of capitalism. This betrayal came from the investment community, not Greenspan. To say Greenspan should have attempted to “lean against the wind” presupposes a belief that he knew (or should have known) “wind” existed at all. The “wind” in this case simply is the betrayal by the investment community. It is an exercise in futility to say Greenspan should have known about the betrayal because by its very intrinsic nature betrayal more often than not is recognized altogether too late. That is to say, it is quite difficult for the victim of an assassination to both recognize and thus prevent the crime when the perpetrator is, say, a friend or close colleague. That is why it is called betrayal. On a macro-economic level, betrayal likewise cannot be prevented through the vehicle of government regulation. Corruption and fraud are forms of betrayal. Greenspan’s Fed could no more have recognized and prevented the short-term ripples in the economic infrastructure leading to our current economic wipeout brought on by the unfortunate machinations of more than a select irresponsible few within America’s investment community than Julius Caesar could have recognized and prevented his assassins on the steps of the portico at the Forum. In short, corruption and with it unbridled innovation, its unfortunate natural counterpart, create an unwieldy variable within econometric models.
I am not saying vigilance and timely action by government regulators are not necessary. They, in fact, are eternally necessary. If anything herein lies the blame. At what point should the Fed have become involved in both recognizing and preventing deviancy and unbridled innovation (again, the betrayal)? Some say early 2006. Some say early 2007. Some say early 2008. And on and on. But that is really not the point. In my humble opinion, criticizing Greenspan’s theoretical (and ideological) timetable for when he should or should not have acted based on our rational and retrospective quantification of the consequences provides no answer as to what would or would not have happened if capitalism would not have been betrayed. That is our real starting point. It has to be. That is, whatever actions Greenspan’s Fed (and all government regulators around the globe for that matter) may take when confronted with practices that embody the negation of the system free-market economies support—i.e., fraud, corruption, and deception (and resultant unbridled innovation)—they will always to some extent take shape in the form of maintenance rather than prevention. Alternatively, we risk inviting too much unwieldy governmental control and regulation. In Greenspan’s closing remarks to his critics in this forum, “We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?”
I understand much of this is theory and ideology. But to overweight Greenspan’s ideology is wise. I do. And I agree with Greenspan that it is not the Fed’s responsibility to stifle innovation, which in the form of creative destruction is the driving force not only of capitalism but of material progress in general. It is our responsibility to make sure as we—the investment community—pursue a better material existence within our current free market economy to maintain our existing organic social system within what has hitherto been based on a “common good” capitalist system, one that religiously recognizes and prevents corruption and subjects innovation to the acid test. Otherwise, as Schumpeter once said (and I’m sure Greenspan would agree), we will, as we are now witnessing, certainly achieve material gains but we will also become free to make a mess of our lives with sufficient rope to hang ourselves.
Luke A. Eckblad is a Principal with Nova Capital Partners, a leading emerging markets investment bank headquartered in New York.
Posted by: Luke A. Eckblad | April 13th, 2008 at 1:18 am | Report this commentOnchi Maiko (guest): I salute Martin Wolf for taking on the tricky task of defending free markets while acknowledging some of its real world issues. I have the following additional comments;
1) l think the FED then and now felt that if faced the small risk of a global deflationary spiral with unknown but potentially massive consequences. In such circumstance sound risk management called for decisive action. Greenspan’s actions were therefore prudent in the circumstance. The real kicker was his reticence in following through after his 1996 “irrational exuberance” comments. At that stage easier policy options were in principle available.But he does allude to the political difficulties had he moved against an emerging asset bubble at a time when the general public and mainstream economic theory did not appear to think that the events of 2000-2008 would come to pass.
3) The expectation was however that Greenspan’s’ post 2001 actions would allow government policy makers the breathing space to deal with other serious issues on the fiscal side. That the administration would continue to believe that the major strategic challenge facing the US was how to manage the transition as power shifted to Asia. That they would apply US soft power and money in an attempt to cajole Asian governments who then and now choose to manage their currencies against the dollar. Instead the US focused most of its resources and brain power on executing the war on terror, Iraq and Afghanistan. The US decision to act largely unilaterally depleted its ability to persuade (China in particular and Asia in general) other global players that economic policy suggestions coming out of Washington were for the common good. Domestically it also passed a poorly thought out tax cut that did not appear to form part of a well thought out strategy. Greenspan can however be faulted for appearing to provide short term political cover to this tax proposal in the face of dissent from some well respected economists…..
5) The issue is therefore not Greenspan but rather that monetary policy can never in itself solve problems of this magnitude.(See the FED then and now as caught between a rock and a hard place….)
6)Internationally the fact that the US pursued a low interest rate policy largely overwhelmed most small open economies attempts (where they tried…) to impose a tighter policy. In any event those who tried to stem the US tsunami would likely have seen a stronger local currency crush local exporters presenting domestic policy makers with a real dilemma. In the larger economies domestic financial liberalization & innovation reduced their ability to insulate themselves from the consequences of US policy as innovative instruments of arbitrage could enable access to US funding
6) So while not absolving domestic policy makers overall US monetary, fiscal and to some extent political actions did play a critical part in our current crisis.
Posted by: Onchi Maiko | April 14th, 2008 at 10:27 am | Report this commentSharada Selvanathan: Maybe “blame” is the wrong word to use. Or maybe Martin Wolf’s interpretation of “blame” (that financial markets are looking for a scapegoat) is not ideal. After all, the stresses observed in global financial markets have been due to the excessive risks taken by financial institutions (globally) and private investors (globally). That is not the problem of the Fed. But let’s ignore the rest of the world for the time being. I think, the Fed under Greenspan should have known better than let the US economy fall into the rut that it is in now.
Having read through Mr. Greenspan’s letter and Martin Wolf’s analysis, I think the angle of analysis simply misses the point of the whole issue. Why use a simple cross-country study on housing markets to determine how bad the US case was? After all, financial innovation in these countries could be different, lending practices and risk taking could be different…
I find it surprising that Greenspan still notes the cross-country study to support his view that the Fed (or any other government body) was right in not taking a stronger regulatory role in the US housing market. The US subprime market had grown significantly and it was well known that mortgage institutions were imprecisely providing cheap credit to individuals with little or no credit history while financial innovation allowed these institutions to package this risk, slice and dice and pass it on to a third party. Should there not have been regulation in the happenings of the mortgage market? Mr Greenspan’s response to the use of bank regulators is that they are rarely forward looking. However, I believe it would not have required forward looking thinking to figure the problem. It is simple logic to understand that lending to risky individuals (those with little capital) would ultimately lead to blood being spilt.
Mr. Greenspan asked the question of why Northern Rock fumbled. Note: the FSA admitted that it had failed in its duty in being an effective policeman.
On the topic of regulation, Mr. Greenspan’s concludes that “free competitive markets are the unrivalled way to organize economies”, i.e. that regulation could not have helped. This is like saying that citizens should be allowed to handle their desires in any way they like and that there is no need for the enforcement of law and order for the benefit of the social good of a country. Don’t get me wrong - competitive markets are good, but the level of how “free” these markets should be, needs to be reassessed. I believe appropriate supervision and regulation is required in all circumstances.
Second, there is the great debate on whether the Fed should keep an eye on asset markets? The Greenspan Fed’s mantra is that it does not “target” asset markets. Agreed, there should not be an exact level on the S&P 500 that the Fed “targets”. But given the significant indebtedness of US households and that the housing and equity markets have been used as a credit line for American consumption habits, shouldn’t the Fed be wearier of asset market movements? After all, when asset markets are in free fall the Fed is more than happy to come in to help support domestic consumption. But when asset markets are rallying and are possibly over-extended, the Fed does little to temper the gains. Either the Fed keeps rates too low for too long or it hikes at a snail’s pace.
Or has the Fed simply been burnt by its actions in 1928, when it hiked interest rates to suck out the “speculative” excesses in the financial market? Has the Fed been trying to rid itself of the ghosts of the 1930s?
Either way, I hope the current Fed will learn from the crisis in that keeping accommodative conditions for too long will simply help blow another bubble.
Sharada Selvanathan is a currency strategist at BNP Paribas
Posted by: Sharada Selvanathan | April 15th, 2008 at 10:28 am | Report this commentLuke A. Eckblad: (guest contributor) Greenspan’s Fed is not to blame for the current US economic situation for several reasons.
First, economics is not an exact (predictive) science. Rather, it is an indeterminate science. A one-size-fits-all fiscal prescription, as we have learned, does not exist. Greenspan made rational decisions based on theory, statistics, and, as a creature of his own experience (like us all), his own personal pre-scientific cognitive vision about how the world works, i.e., his ideology. To say Greenspan should have attempted to “lean against the wind” presupposes a belief that Greenspan knew not in what direction the wind blew and, if given the chance, we would have. Greenspan, in fact, was “leaning against the wind,” just not in the direction his critics with razor sharp clarity now demand.
On page 229 of The Age of Turbulence, Greenspan says:
“At the FOMC meeting in late June [2003], where we voted to reduce
interest rates still further, to 1 percent, deflation was Topic A. We
agreed on the reduction despite our consensus that the economy probably
did not need yet another rate cut. The stock market had finally begun to
revive, and our forecasts called for much stronger GDP growth in the
year’s second half. Yet we went ahead on the basis of balancing of risk.
We wanted to shut down the possibility of corrosive deflation; we were
willing to chance that by cutting rates we might foster a bubble, an
inflationary boom of some sort, which we would subsequently have to
address. I was pleased at the way we’d weighed the contending factors.
Time would tell if it was the right decision, but it was a decision done
right.”
Second, Greenspan faced rational decision-making demands against a backdrop of various irrational distractions and uncertainties: wars (Iraq), calamities (9/11), epidemics (SARS), fraud by the financial community (Enron, WorldCom, etc.), and so forth. These historic events (variables), in effect, disrupted and frustrated Greenspan’s scientific forecasting methods encapsulated within his conceptual and policy framework. For instance, how could we possibly expect Greenspan to have made rational economic decisions within his existing long-term policy framework (no matter how strong or resilient) following probably the world’s greatest irrational act ever perpetrated against capitalism–9/11? Again, economic forecasting without these variables is more art than science. How much more when faced with 9/11-style volatility? But is that to say Greenspan’s capital markets ideology when applied to his operational framework, which demanded the discipline to make hundreds of day-to-day decisions in the “real” world, and forecasting methods failed and we should thus invite additional government regulation as a consequence, inviting unwieldy governmental control and oversight? Better put, as Greenspan said in his closing remarks to his critics in this forum, “We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?”
Lastly, the modes of capitalism are always changing and will never be perfected. Capitalism, as described by the economist, Joseph Schumpeter, is a continuous evolutionary process without an end-point. The historic (and disastrous) distractions mentioned above disrupted the core of Greenspan’s capitalism in the sense of not allowing his mode of capitalism to operate freely within his rational, operational framework, which demanded the assistance of key partners–bank and government regulators, counterparties, and investors–backed by responsible actions by the financial community. I would argue nothing matters more than working with high-quality (ethical) partners in a capitalist society-especially when faced with excess volatility and inefficient markets. Hence while critics may ask at what point the Fed should have begun tightening monetary policy to push inflation below the normal target or why didn’t Greenspan “lean against the wind” or shouldn’t the US capital markets be more regulated I would suggest asking instead whether Greenspan had quality partners to assist him with improving the probability of fiscal success.
Luke A. Eckblad is a Principal with Nova Capital Partners, a leading emerging markets investment bank headquartered in New York.
Posted by: Luke A. Eckblad | April 17th, 2008 at 11:04 am | Report this commentMartin Wolf: This has been a wonderful debate. I hope that participants will forgive me if I do not respond to all the points made.
Let me make a few preliminary points.
First, when I said Alan Greenspan was the most successful central banker of modern times, I had in mind the last two decades. I agree with those who say that Paul Volcker’s achievement in wringing inflation out of the system was crucial. It also took great moral courage. While Mr Greenspan responded to many crises very adroitly, he faced no comparable challenge.
Second, I am not saying anything about Mr Greenspan’s role in politics. I understand why people are critical of his support for the tax cuts of George W. Bush. That was not the subject of this piece, however.
Third, I have already stressed two points of disagreement with Mr Greenspan – over regulation and over the correct monetary response to asset-price inflation. I do not wish to repeat those points.
What I do not accept is the view that everything that has gone wrong in recent years is the result of the Federal Reserve’s monetary policy. I believe that this ascribes more power to monetary policy and the Fed than is correct. I think this view is particularly common in the US because there seems to be a psychological need not only to find someone to blame, but to reject the possibility that events were partly beyond domestic control.
For this reason, I wish to focus on what Stephen Roach says. So let me deal here with his lengthy argument.
Our difference is over the direction of causality. Stephen and I agree that US households have become excessively debt-dependent. We agree, too, that the high level of personal consumption and correspondingly low level of savings were both unsustainable and undesirable. We agree, as well, that this outcome was in line with what the American body politic wanted. We agree, finally, that one of the by-products was a credit and property bubble whose bursting has created the devastating consequences we see today.
We disagree, however, over our interpretation of why this has happened. Stephen’s argument is as follows: after the bursting of the stock-market bubble in 2000 the Federal Reserve decided to expand domestic demand with a burst of irresponsible monetary policy; this generated a huge current account deficit; as a result, the “asset-dependent US economy had to borrow surplus saving from abroad in order to keep growing – and run massive current account and trade deficits in order to attract the foreign capita.”
I think of this as “the blame America first” view. But it is wrong. I set out at length why I think it wrong in a book, to be entitled “Fixing Global Finance”, which is to be published in the autumn. I regard the imbalances in the global balance of payments as the causal factor. Indeed, it seems to me to be clear that this must be so.
If Stephen’s view were correct, one would expect to see two phenomena: a big rise in global real interest rates and clear signs of massive overheating in the US economy. But in fact we have seen neither. Long-term real interest rates have been exceptionally low and there has been no sign of severe excess domestic demand in the US.
Why would one have expected to see these phenomena? Well if the US had simply decided to expand the money supply, the fiscal deficit, credit and so the domestic economy in a world economy that was otherwise operating at close to full capacity, there would have been increased global demand for loanable funds. While short-term interest rates might have remained low, because of the expansionary monetary policy, long-term real interest rates and the inflation-risk premium would have risen. They did not do so. On the contrary, they were very low throughout the expansionary period.
Furthermore, one would also have expected to see massive overheating in the US. The US economy is quite closed: less than a fifth of spending goes on imports. If the Federal Reserve had pursued a massively expansionary policy, which led to a current account deficit of 7 per cent of GDP, domestic demand would have had to expand by a multiple of that. There should have been excess demand for domestically produced non-tradeables, severe tightening of the labour market, soaring wages, a collapsing exchange rate and so forth. Yet the US never showed such symptoms of chronic excess domestic demand.
For these reasons, I reject the hypothesis that the driving force in this story was an autonomous decision by the Federal Reserve to drive up domestic demand. Far more convincing is a mirror-image alternative. Thus, as a result of the emerging market financial crisis of 1997-98, the Chinese decision to pursue a macroeconomic policy that would support a pegged exchange rate at an increasingly undervalued level and the rise in oil prices, massive surplus savings emerged across the globe.
For some years, the flood of money out of these countries into the US – both private and public – also drove up the US real exchange rate. With the real exchange rate set by the outside world, the US found that any policy which generated balance between demand and potential domestic supply of non-tradeables also generated a huge excess demand for tradeables. The latter showed itself in the trade deficit, which matched the capital inflow. In the standard terminology, internal “balance” (in terms of supply and demand) went along with external “imbalance” (that is, excess demand for tradeables), at the given real exchange rate.
I am not clear what else the Federal Reserve should have done. It could have followed a tighter monetary policy. I do not see how, in Stephen’s words it could have simply said no to asset price bubbles. If the Fed had targeted asset prices, as he suggests, it would have had to reduce domestic demand substantially. A permanent recession, possibly deflation, would not be a sensible policy. Even if it were a sensible policy, it could not have been followed. The people responsible for it would inevitably have been sacked.
The fact that housing bubbles occurred in many countries is important, not because I buy the “peer pressure rationale”, but because it suggests that the causes were not national, but global. If one person falls ill, he may not have looked after himself very well. If many do, it suggests that there is a disease around.
The features of that global disease were: a massive excess supply of savings from much of the world; a determination of many countries to preserve those excess savings in any way they could (particularly by sterilised foreign currency intervention); and so low global real rates of interest and an abundant availability of cheap credit (facilitated by the financial sector’s excesses) for any country with a household or corporate sector interested in borrowing. That is why house price bubbles occurred in so many countries simultaneously.
That is also why the Fed could only have halted the US bubble if it had been willing to put the economy into permanent recession. We are not talking about small increases in interest rates here. I would guess that short-term interest rates would have had to be well above 5 per cent and probably close 10 per cent to prevent any house-price bubble. That is what “saying no” to bubbles would really have meant.
Let me put the point quite simply: everybody cannot have a current account surplus; if some countries are determined to have them, others must run deficits; and, in this case, it was predominantly the US that did so, with the results we now see. In the end, the world economy has to add up. One cannot assess the macroeconomic policy of a country in isolation from those of the rest of the world. One has to assess the policies of other countries, as well.
Posted by: Martin Wolf | April 25th, 2008 at 8:02 pm | Report this commentIan Stuart (guest): As a retired IMF economist who worked on financial crises throughout the world over a 33 year period (some would argue that we caused them) I cannot help feeling that Mr Wolf is disingenuous in his defence of Mr Greenspan. One of the central tasks of a monetary authority is to ensure that there is adequate prudential supervision of financial institutions. The problem was that Mr Greenspan was ideologically opposed to supervision and regulation. I would argue that given his visceral opposition he should not have taken a job that, in the end, clearly showed the need for intervention.
Posted by: Ian Stuart | April 28th, 2008 at 5:27 pm | Report this commentIf he had required higher margin requirements the internet bubble would have been killed at its beginning, if he had spoken out for higher deposits and/or against the rating agencies that were claiming that a package of subprime loans miraculously became AAA securities the housing bubble could never have occurred.
Martin Wolf: I agree with Mr Stuart. I thought I said so. The regulatory failure is clear.
Posted by: Martin Wolf | May 1st, 2008 at 12:57 pm | Report this comment