Monday, March 16, 2009
The only reason that the anonymous Economist blog post He Had the Power is believed to be authored by Greg Ip (formerly of the Wall Street Journal) is because Felix Salmon says it is, and that's good enough for me.
The piece is in reference to the latest edition of former Fed Chairman Alan Greenspan's lame defense of his long tenure at the central bank and its aftermath, a WSJ op-ed that was discussed here last week under the heading Alan Greenspan still doesn't have a clue.
For someone who was once referred to as a "Fed channeler", since his access to board members was purportedly unrivaled, it is something of a damning condemnation:
In the earlier part of this decade Mr Greenspan asserted on a number of occasions that while America might have local housing bubbles, there was no national housing bubble. Yet he now asserts there was a global housing bubble. It has always puzzled me how he could go from seeing local bubbles to a global bubble without at some point diagnosing a national bubble. By failing to diagnose a national housing bubble until it was already well inflated, the Fed under Mr Greenspan escaped the obligation to do anything about it.The nature of long-term interest rates, their role in the housing bubble, and whether or not the Fed was really "powerless" to control them is then tackled, the idea of short-term rates being hiked as high as 8 to 10 percent, all but certainly inducing a recession ala Paul Volcker in the early 1980s, floated as one approach to cooling home prices a few years back.
Perhaps if the 2003-2004 era opportunity had been seized to reinstate home prices or mortgage payments (then rising at 6-8-10 percent a year) back into the the consumer price index in lieu of the nefarious "owners' equivalent rent" (which was helping to signal "deflation"), it would have been much easier to raise rates that high and we'd all be much better off right about now as a result.
Oh well, that's why they write history books and revise economic methodologies.
According to Mr. Ip, however, the much more important failing of the Fed chief, a man who was once revered as the second most powerful man in the word, was his light-touch when it came to regulation and it is here where the most fault is found.
Had Mr Greenspan and his colleagues concluded housing prices were too high and there was value in taming them, they could have used regulatory tools instead of monetary policy. They could have insisted on a margin requirement for home purchases—no one could put down less than 20% unless they obtained mortgage insurance. (At the peak of the bubble, the widespread use of second liens made 100% loan-to-value mortgages without insurance commonplace.) This would have been politically difficult since it would have deprived lots of people the opportunity to own a home, in violation of America’s credo. It would have also contradicted Mr Greenspan’s own deregulatory impulses. He resisted raising margin requirements on stocks in the 1990s in part out of a conviction that only small investors would be affected; big sophisticated players would find a way around them.These are strong words from someone who once cast a much less critical eye.
There are many other regulatory steps that could have been taken over banks (requiring them to hold capital against off-balance sheet vehicles) and mortgage originators (requiring all of them to document income and to escrow insurance and taxes, for instance) that, while not stopping the bubble, would have mitigated the consequences. It’s worth noting that many of the countries that have had housing bubbles, like Australia and Spain, have not had banking crises in part because their regulatory regimes did not permit the same degree of leverage.
Unlike the bubble/recession trade-off, this trade-off may have been acceptable even if the current crisis had never happened. It is hard to believe that society would have been significantly worse off if we’d limited the growth in home ownership to, say, 66% instead of 69%, by excluding people unable to make a substantial financial commitment.