Monday, April 07, 2008
The most fundamental flaws in nearly all contemporary economic thought are readily apparent in the first few paragraphs of former Fed Chief Alan Greenspan's rebuttal to his recent critics in today's Financial Times:
- If it doesn't show up in standard economic data, it doesn't exist
- If it can't be modeled, it is not worthy of discussion
Alan Greenspan: A response to my criticsGood Lord!
On March 17, Alan Greenspan wrote an article for the FT entitled "We will never have a perfect model of risk", in which he argued: “We will never be able to anticipate all discontinuities in financial markets.” He concluded: “It is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation [do] not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.”
The article attracted a number of critical responses in this forum. For example, Paul de Grauwe wrote: “Greenspan’s article is a smokescreen to hide his own responsibility in making the financial crisis possible.” (Read all the responses.)
The article below is Mr Greenspan’s reply to those criticisms, written exclusively for the Economists’ Forum:
I am puzzled why the remarkably similar housing bubbles that emerged in more than two dozen countries between 2001 and 2006 are not seen to have a common cause. The dramatic fall in real long term interest rates statistically explains, and is the most likely major cause of, real estate capitalization rates that declined and converged across the globe. By 2006, long term interest rates for all developed and major developing economies declined to single digits, I believe for the first time ever.
Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence of monetary policy adding to the bubble is statistically very fragile. Paul De Grauwe depends on John Taylor’s counterfactual model simulations to conclude that the low funds rate was the source of the US housing bubble. Taylor (with whom I rarely disagree) and others derive their simulations from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. This suggests important missing variables. Counterfactuals from such flawed structures cannot form the basis for policy.
All you had to do in 2004 or 2005 to be absolutely convinced that a gigantic speculative bubble in housing was entering its final stages in major metropolitan areas of the U.S. was to stop by a few mortgage broker offices or visit a few real estate agents or talk to a few of the many thousands of aspiring homeowners who were sleeping on sidewalks while waiting in line to sign on the dotted line (with very few questions asked) so they could then begin their journey to wealth.
If and/or when any curious Fed economists heard the 2005-era housing bubble joke, "All you have to do to qualify for a home loan is fog a mirror", they probably looked in the government housing starts data for corroborating evidence which, of course, they were unable to find.
Instead, they talked about "equity cushions".