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Opinion, commentary and analysis on everything that makes the U.S. housing economy tick -- not to mention the ghosts in the machine, too. Written by HW's team of editors and reporters each business day.

Did Fed actions lead to the housing bubble? Greenspan shrugs

Greenspan sees everything leading to the bubble except his own fingerprints

February 28, 2014
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If there’s one thing we’ve learned from the release of the Federal Reserve’s September 2008 Federal Open Markets Committee minutes, it’s that the giant minds at the central bank can be as blind as the rest of us in the hoi polloi.

But with the publication of Alan Greenspan’s new book, The Map and the Territory: Risk, Human Nature, and the Future of Forecasting, we get to see that it’s not just the current crop of central bankers who can be book-smart but range-blind.

That’s according to Steven Horowitz at Reason.com, who reviews the book and finds Greenspan’s perspective wanting.

In Greenspan's new book, The Map and the Territory, the once-lionized monetary "maestro" never considers the possibility that his own actions contributed to the housing bubble and ensuing financial collapse. Instead he focuses on government subsidies for housing, including implicit guarantees for government-sponsored mortgage lenders and congressional mandates that "historically underserved" populations get in on the home ownership binge.

This analysis is accurate as far as it goes. But the housing binge would not have been possible without the cheap credit created as a result of Greenspan's low interest rates.

Greenspan blames an influx of foreign savings, combined with irrational herd behavior, for driving up housing prices and creating the risky financial instruments, such as mortgage-backed securities and their derivative products, that were at the center of the financial collapse. But he does not so much as raise the possibility that the Fed's expansionary policies had something to do with driving the inflation-adjusted federal funds rate-the rate that banks charge one another for short-term loans of reserves-below zero for almost two years.

Horowitz’s review isn’t a slam job – he rightly praises the second-longest serving Fed Chair for his acumen where he got it right, especially in his critique of Dodd-Frank, the bailouts, and the whole repugnant concept of “too big to fail.”

Ironically (or maybe not), Greenspan is at his best in this book when he is not talking about the Fed, money, or inflation. For example, he effectively criticizes the government response to the financial crisis, heaping particular scorn on the Dodd-Frank Wall Street Reform and Consumer Protection Act, which he warns will reduce capital formation and financial market efficiency. He is rightly skeptical of the bailouts, saying they have only worsened the problem of "too big to fail," the belief that a single bank has such a large influence on the financial system that it cannot be allowed to go out of business. He argues that in 2008 the failing banks "should have been put through the normal time-tested process of balance sheet restructure" associated with bankruptcy.

Horowitz saves his strongest praise for Greenspan’s take on entitlements and how badly entitlement reform is needed, and not just for the usual fiscal responsibility reasons.

When Greenspan turns to data-driven economic analysis, as in his chapter on "Productivity and the Age of Entitlements," he is as accurate as he is blunt. He argues that the increasing costs of benefits for the elderly in the form of Social Security and Medicare have come "largely at the expense of the lower income quintile households, almost wholly through suppressed wage rate gains." The resources necessary to fund entitlements have crowded out private savings, thereby reducing capital formation, leading to lower worker productivity and wages. Greenspan concludes that "short of major entitlement reform, it is difficult to find a benevolent outcome to this clash between social spending and savings in this country."

Ultimately, Horowitz concludes, Greenspan wasn’t just blind on the events leading to the economic collapse but also the very impact of the Fed’s dual mandate policy and its ongoing interference in the marketplace. It’s the final irony for a man once described as an Ayn Rand acolyte, who pretty much talked like an Austrian and minded the store more like a Keynesian.

Shining a light on the limits to human rationality is a good thing, but that light needs to be turned on political actors as well as market forces. Much of Greenspan's economic analysis is on target, but he fails to acknowledge his own role, and that of the institution he ran for so many years, in digging the very hole from which he now wants to help extract us.

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