“The Human Race Has Never Found a Way to Confront Bubbles”
Now that is an excuse. Alan Greenspan is giving us yet another rendition of his struggles, or lack thereof, with the stock and housing bubbles that grew under his watch. Just a few years ago, back when he was the greatest central banker in history, Greenspan was confidently telling audiences that he had decided that it was best for the Fed to just let bubbles run their course and then deal with consequences. His new story is that he wrestled with the stock bubble and lost. Apparently because of this failure, he never tried to tackle the housing the bubble.
Now that the collapse of the housing bubble is throwing the economy into a recession (growing economies don’t lose jobs – don’t let the happy face economists fool you), Greenspan is telling us that it is not humanly possible to deflate a financial bubble. Sorry Mr. Greenspan, but just because you failed, doesn’t make it impossible.
The Fed has many tools with which to attack a financial bubble. The simplest and most direct is simply using its enormous megaphone to call attention to the bubble. That doesn’t mean mumbling “irrational exuberance” (and then partially retracting the comment). It means putting the facts on the table in congressional testimonies and other public forums.
When the price to earnings ratios in the stock market reached levels well above 20 to 1, Alan Greenspan could have told the public that either investors have hugely more optimistic views about future profit growth than almost all public and private forecasters, or alternatively, they are now prepared to accept stock yields that are only slightly higher than the returns available on government bonds.
If Greenspan had made these points repeatedly in his public statements with the accompanying charts and tables, it would have forced every fund manager in the country to confront his argument. Greenspan’s comments could actually put them personally at risk for mindlessly investing billions of dollars. Not only would these managers risk losing their job when the market crashed, but they could personally face negligence suits in which the first question from the plaintiff would always be “what was your response to Chairman Greenspan’s analysis?”
Would this fear have pounded a little commonsense into the heads of these highly paid fund managers? We will never know because Alan Greenspan never tried this path. Since there is no obvious downside (what is wrong with the Fed giving information?), it is inexcusable that Greenspan never sought to more aggressively counter the stock bubble.
It is even more inexcusable that he never tried to counteract the housing bubble. Housing wealth is much more evenly distributed than stock wealth. For the vast majority of middle class families, their house is by far their major financial asset. Seeing the value of their house fall by a third, as will be the case for millions of homeowners, is not funny. Families who thought that they had hundreds of thousands of dollars in home equity to support their retirement will find that they have nothing. This is not reversible.
Here also, Greenspan could have tried information. He could have pointed out that house prices had diverged from a hundred year long trend, with no obvious explanation based on the fundamentals of supply and demand. Again, the weapon of choice is not mumbled asides; it is charts and tables that throw facts into the public debate. (Instead Greenspan actually claimed the opposite, that the run-up in house prices was driven by fundamentals.) He could have also pointed that many of the mortgages being issued would almost certainly go bad and that the investors holding mortgage backed securities would likely see large losses.
This may have dampened the enthusiasm for families to buy homes at bubble inflated prices and investment managers to throw money in the garbage on bonds backed by subprime mortgages. Of course, maybe information would not have been sufficient to counter the housing bubble, but we will never know because Greenspan didn’t try.
It is understandable that Greenspan would now want to say that it is not humanly possible to combat financial bubbles. None of us like to own up to our failures. But the issue is not just one of holding Greenspan accountable. The issue is about determining the responsibilities of the Fed. The damage caused by the stock bubble and the housing bubble will swamp the potential damage from modest increases in the rate of inflation, which has been the obsession of the Fed. Containing financial bubbles is a key part of the Fed’s job and it can be done by humans.
Comments (18)
"He could have pointed out that house prices had diverged from a hundred year long trend, with no obvious explanation based on the fundamentals of supply and demand"
So he could, but then he would have been forced to further explain that what had also diverged from hundred year long trends was the real cost of renting money, which he personally turned negative in a reflexive spasm of fear on account of Bin Laden's extraordinarily good return on his investment in the 9/11 attack.*
It's not like Greenspan was some passive observer of the bubble--he was the architect.
*(I believe GWB credited OBL with 3 GDP points lost, in the '04 debates--to the subsequent delight of the Wit of Waziristan, who referenced it in the same video wherein he rebutted the charge of hating freedom saying "If we hated freedom, we would have attacked Sweden..."_)
September 9, 2007 9:13 PM | Reply | Permalink
Mr. Baker, I have mostly found you a reliable source for economic information. I am really upset by this post of yours. You write: "Of course, maybe information would not have been sufficient to counter the housing bubble, but we will never know because Greenspan didn’t try." The truth of the matter (and you seem determined to ignore it) is that Greenspan ENCOURAGED the worst excessed of the bubble and certainly helped prolong and extend it by actively encouraging the riskiest ARM loans late in the bubble cycle when the least reliable credit risks were being granted miortgages. This was widely reported at the time; I am sure you are entirely familiar with it. For whatever reason Greenspan had, he invited the excesses of this bubble, made the effects worse, and gave criminally fraudulent advice to would-be homeowners. He also participated in a very active way in the electoral process back in 2000 and 2004 backing Bush in a fairly obvious manner...in particular supporting the war and the tax cuts as do-able financially without serious financial consequences.
September 9, 2007 9:16 PM | Reply | Permalink
In other words Greenspan is a total professional failure. He was great at the easy stuff but didn't even try to deal with the hard stuff.
A whole generaration, like me, lost their retirement in the Bush crash of 2000-02. In my case almost $300,000. I'm still working but I will die in poverty, as I now, for the first time in my live, live in poverty.
There will be 10's of tousands of older folks who will die a burden on the state, who whould not have been had Greenspan and Bush done their jobs
The Great American Dream as runined by Nero Greenspan, the useless shit.
September 10, 2007 12:56 AM | Reply | Permalink
I would agree that Greenspan actively promoted the housing bubble. It is difficult to explain some of his public comments any other way, such as his efforts to dismiss the views of those of us warning about a housing bubble. But, I was trying to be generous.
September 10, 2007 2:51 AM | Reply | Permalink
Bush did not enter office until 2001. The stock market bubble predated his term in office. As I recall there was no increase in margin requirements during the stock market bubble of the late 90's. Was that a failure of the Fed IMHO.
The sons of the prophet are noble and bold,
and quite unaccustomed to fear.
But the bravest by far in the ranks of the Shah
was Abdul Abulbul Amir
September 10, 2007 5:59 AM | Reply | Permalink
You must have had your entire retirement invested in high risk stocks. There is all kinds of advice against doing this in all kinds of media, you must have realized that what you were doing was unwise. Do you think anything the Greenspan could have said would have overcome your greed?
September 10, 2007 6:49 AM | Reply | Permalink
Are you arguing that after the bubbles pop the economy, or more importantly the many people that benefitted during the bubble are worse off than they were prior to the bubble?
In the absence of bubbles and their end wouldn't the economy goes through cycles of growth and recession? The latter of which do a great deal of harm to economy and particularly those on the lower rungs of the economy.
Housing was basically unaffordable for many people in the early 1980s as the combination of inflation and high interest rates priced most Baby Boomers out of the housing market. Now home ownership has shown great growth. Those on the margin, subprime borrowers, may lose their homes but most purchasers will continue to own their owns in part thanks to the bubble. Do you oppose home ownership?
Daniel A. Greenbaum
September 10, 2007 7:05 AM | Reply | Permalink
I don't have any ideological commitment to home ownership. I want people to be able to have good secure housing and I want them to be able to accumulate wealth for retirement and other purposes. Sometimes homeownership can be a way to advance these ends. Sometimes, like when people buy houses at bubble-inflated prices, it works against these goals. I care about the reaching the goals, not whether or not people own homes.
September 10, 2007 8:16 AM | Reply | Permalink
Greenspan wants it both ways. While he was in office he performed the function expected of him to protect the interests of the rentier class. He did this by keeping inflation low and ignored the other part of the Fed mandate which is to promote employment.
Now that he is out of office and there is a growing chorus of populism he is trying to cover up his previous aims by creating a bogus "act of God" defense. Since he has never been intellectually honest to begin with, this shouldn't be surprising. (Anyone who is a follower of Ayn Rand can't be intellectually honest - it's like believing in the tooth fairy.)
--- Policies not Politics
Daily Landscape
September 10, 2007 8:16 AM | Reply | Permalink
Dean,
Is it possibly worse than just "Greenspan promoted the housing bubble?" I fear that what's really happened is that our underlying economy has been so weak that the only way the Fed can stave off stagnation is by promoting bubbles. First stocks, then a little pain, then housing, then a little pain, then they'll hope for a corporate spending bubble or something like that... otherwise, the Fed has no strategy.
thosethingswesay.blogspot.com
September 10, 2007 8:59 AM | Reply | Permalink
I think you hit it here. I read earlier today that the housing market accounted for 40% of the new jobs during the Bush administration. This would be a housing market propped up by insane lending practices. Without it, we'd probably still be in the original Bush recession.
September 10, 2007 12:10 PM | Reply | Permalink
In support of Dean's point, 78% of mortgages in the core Bay Area over the last few years were 'funny': no money down, teaser rates, NINJA, etc. Without those (which were embraced by buyers because of cheerleading by the Fed) the market here would never have gotten so out of whack. Without 'funny' mortgages, the entry and mid level buyers can't afford to buy. The lower half of the market right now if very, uh, constipated.
September 10, 2007 1:36 PM | Reply | Permalink
If we begin with the simple increase from under 5 to over 9 trillion in total govt. indebtedness, against a GDP that cannot have grown more than, maybe, 30% over the same time period (The Bush Years...) and consider whether long rates in any way reflect the kind of inflationary pressure that is implicit in the major premise, it is hard to say that the economy is anything but hollowed out; a dry husk, as it were, waiting to blow away...
September 10, 2007 8:42 PM | Reply | Permalink
Kind of.
Actually the US economy has been pretty strong in a number of ways. It's been short-sighted mismanagement of the economy and Wall Street greed that's sabotaged us. It's really a shell game.
The 90's tech bubble (dotcom, telecom, etc) was a legitimate era of prosperity and technological advancement for the US economy. Companies were doing great and since wages were rising in those growth sectors, it was going right back into the service economy. That's actual "trickle down" or more accurately wealth dispersion.
Of course the bubble ruined that as it popped, causing massive economic disruption. Greenspan and Wall Street driven policy did much to inflate the tech bubble, so the presumption is incompetence. Not really.
It's worth noting that despite the loss in economic productivity in the short term, large investors actually stand to benefit enormously, and have, from bubbles. All the large investors were of course encouraging the general public to get into the market, and bail them out, right till the end.
Ultimately it's the general public that pays the price of a bubble. Large investors make enormous profits during the bubble, and generally get out of ahead of the curve. Small losses (relative to bubble gains) are invariably passed on to the public anyways. For example, auto-insurance rates soared after the bubble burst, to cover investment losses. Across the board prices inflated while wages stagnated.
Also increased unemployment is great for employers. Notice wages have stagnated while corporate earnings continue to soar.
When bubbles pop there are the wealthy who can weather the storm, and have the advantage, and those who can't and consequently lose economic power and political power as well.
The housing bubble was also deliberately inflated for the same reason. After the tech bubble, this admin wanted to post good economic numbers and play the same shell game.
Regulation on lending was relaxed, which served to help drive housing prices through the roof. The principle is simple: if some fool takes a giant loan he can't afford and buys a house he can't afford, in the process he also drives up housing prices. Then the next person has no choice but to take a slightly larger loan to pay the inflated price, or not buy a house, and rent. Damned if you do, damned if you don't.
And so it goes, up and up, with lenders and the real estate industry making ever increasing profits. The fact is irresponsible lending will always lead to price inflation, because housing is essential and individuals are forced to deal with the market whether it's rational or not.
Also, under the Bush admin Freddie and Fannie were buying bad loans from banks, completely removing risk from lenders. So of course banks will loan huge sums if the Fed will then buy that loan from them and absorb all risk. Which is also a great way to bankrupt government, cut services, and instill apathy. Which is the goal of hyper conservatives like Grover Norquist.
To make matters even worse, Greenspan was encouraging ARM right up until the last moment, knowing full well rates were about to soar, and it would lead to massive foreclosures. Which of course then allows those with capital to buy back real estate at fire-sale prices.
To sum up: under each bubble a commodity price is inflated, during which time large investors make a killing. The Fed collaborates to keep the bubble inflated for as long as possible. The admin claims good economic growth during this period for political purpose. The large investors invariably profit more, and get out sooner than the general public, and writes off and externalizes what small losses they do take, which are minuscule compared with profits throughout the bubble. The public is left holding bag, and winds up poorer and weaker economically. Which then depresses bargaining power and wages, and results in large debt and economic servitude.
It's Charlie Brown, Lucy, and the Football. Again and again.
And let's not forget Alan Greenspan and Milton Freidman were key ideological influences on Ayn Rand and greatly promoted her works. Her novels reek of Social Darwinism, loathing for the middle class, and most of all the poor. Of course her characters never blatantly rip people off. But seeing the general populace as parasites to begin with, and embracing the ideology of Pareto's Law, and so on, and it's not hard to see where traders at Enron (and all the big investors also in on the scheme) got their predatory, even cannibalistic, regard for "Grandma Millie."
It's not a conspiracy per se. It is a culture that glorifies greed and Social Darwinism, and holds the general public and especially government in utter contempt.
September 11, 2007 2:08 AM | Reply | Permalink
The error in your logic is the presumption the housing bubble created more home owners than would have otherwise been, or perhaps that people got more house than they would have otherwise. Not so.
That's not how a bubble works. The way it worked is that the same number people got the same amount of house, for a higher price, i.e. more debt.
The housing bubble didn't create any new buyers, and hence didn't create any economic growth that wouldn't otherwise have been.
The housing bubble merely inflated housing prices for buyers, and encouraged owners use houses as credit cards.
The net result is the same number of new home owners, vastly inflated prices, far more middle class debt, and far more foreclosures, which is tremendous opportunity for investors again, and depresses wages and keeps people timid.
Investors make money on bubbles coming and going. It's the middle class who lose, both ways.
September 11, 2007 2:32 AM | Reply | Permalink
Re: For example, auto-insurance rates soared after the bubble burst, to cover investment losses.
???
I don't recall this at all. My insurance rates (I have the data) were unchanged from Mar 2000 (when I moved to Akron OH) to Jan 2003 (when I moved to St Pete FL). Did this only affect new policy suscribers or people with bad driving records?
Re: Across the board prices inflated while wages stagnated.
I also do not recall any major, or even minor, inflation in the "bust" years (other than healthcare inflation), not until energy prices started to soar about three years.
Re: The housing bubble was also deliberately inflated for the same reason.
I would replace "deliberately" with "accidentallY". The expectation from both rate cuts and tax cuts was that they would jump-start business investment-- which failed to happen (businesses had just dumped a bundle into Y2K fixes and IT upgrades in general-- they were in no mood for profligacy).
Instead, people started splurging on housing. That, I think, was initially unexpected though once it materialized, and the business boom failed to materialize, then I think the head honchos started telling themselves tales about how the Housing Boom would save the economy.
Re: The housing bubble merely inflated housing prices for buyers, and encouraged owners use houses as credit cards.
No, it also encouraged the construction of housing that otherwise would not have built (and probably should not have been built). Bubbles encourage excess production like that. Something similar happened on the telecom side of the tech bubbhle: we ended up with an enormous overcapacity of cable and bandwidth, more than we are likely to use for years to come. Visit the Detroit suburbs for a housing example. The area has been losing population for years, yet new subdivsions bloomed like toadstools after a rainstorm.
September 11, 2007 10:56 AM | Reply | Permalink
"Charlie Brown, Lucy, and the Football"
That is a nice way of putting it. Ravi Batra has compared it to the ecology of wolves and caribou. (He was wrong on his timing, but possibly prescient on the underlying mechanism.) When the wolves kill too many caribou, they do not have enough to eat, and the population of wolves collapses.
You seem to be saying, however, that the wolves are too smart to get caught by that game and it is some less dominant population in the middle of the food chain that suffers.
September 11, 2007 12:00 PM | Reply | Permalink
That's part of it.
Yes, there are cycles analogous to your wolf/caribou analogy. For example the Great Depression. Definitely the scam is better managed and it's harder to catch the wolves now.
But there is actually a much larger picture, which is more like the dinosaurs and the mammals. No matter how good the dinosaurs' game of brute power, they were never going to make the leap to become a technologically advanced species. Similarly, old-world thinking of people as exploitable resources, predatory thinking, will never produce a society maximizing potential. It requires a deep bench to maximize the creation of stars. The geniuses, inventors, and the real assets of the modern world. The person to invent your next killer application, your next death ray, and your next elixir of health.
Economically this has already happened to some extent. Conservatives thought how smart they were securing oil and resources globally largely by force, instilling anti-government apathy in Americans, and selling Americans crappy consumer goods at inflated prices, probably with debt at inflated rates too. They thought it could go on forever. It was a predatory mindset.
Now we're seeing a decline in education and American competitiveness, broken down infrastructure, and inefficient service essentials like medical care which is burdening the economy. Asymmetrical warfare challenges US military hegemony. US investors are free to invest overseas, but must always fear a foreign people/government will yank the rug out from under them or render them to a second class. As in china and other economically nationalist countries.
GM can't sell crappy pickups and SUV any more, can't afford health care, and can't please American consumers with crappy technology not even made in the USA. Toyota is now #1 in America, has the best technology and the brightest outlook, and the most efficient state infrastructure to ensure their long term dominance.
The US is still a powerhouse, and has tremendous opportunity to be a long-term leader with technology including renewable energy, electronics, software, and biotech. But if we don't evolve ideologically to ensure a higher quality of life, which is also more economically efficient, and end economically predatory practices, we won't make the transition any more than GM did.
September 11, 2007 8:04 PM | Reply | Permalink