Wikinvest Wire

Greenspan: Don't blame me for the housing bubble

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
Have a look:
Alan Greenspan: A response to my critics

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.
Good Lord!

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".

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Tim said...

Stated another way ... it is either incompetence or negligence if you are the head of the most important central bank in the world and you sit idly by while millions of Americans take out loans that they have no reasonable expectation of paying back unless home prices continue to rise.

Anonymous said...

You can't blame greenspan alone for this mess. I believe that Ben & Greenspan just attempted to devalue the dollar by cutting interest rates. What can the Fed do if lenders, borrowers and foreign financiers behave even more irresponsibly? China, India or OPEC need not peg their currencies to dollar. The problem is more structural than just Fed engineered lower interest rates. If mfg jobs go to China and service jobs go to India, what will Americans do? It probably is miniscule portion of jobs that got lost but the trend was to be broken.

Vlad Z. said...

Well lets also not overlook the role the Fed, as top bank regulator, has had in making this mess.

First the allowed banks to set minimum paymnets so low that it ensured that naive credit card borrowers would never pay them off.

They fixed that, but did so very quickly which caused people who were just getting by on the old plan to suddenly not be able to meet the new government mandated higher minimum payments.

At which point they fell behind and got socked by the absurd penalties that these credit card companies dish out, up to 32% annual interest rates for dubious claims of "late payments".

It wasn't that long ago that the only people charging people 33% a year interest were guys named Guido who came around once a week to collect the vig.

Tire manufacterers are much more heavily regulated (in terms that are important to consumers) than banks. That's absurd.

The restults are not nice; the Economist recently reported that the financial sector made 40% of ALL PROFITS in the USA for several years running!!

Wow, the conspiracy theorists were right! You give a private cartel the right to print money and regulate themselves and pretty soon they are rich and everyone is working for them.

And now, of course, we get to bail them out. Sweet deal.


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