Monday, April 07, 2008

Greenspan takes a few swipes at his critics

There is a whole chorus of critics who blame former Federal Reserve chairman Alan Greenspan for just about everything that they think is wrong with the financial system. Now, Greenspan is striking back. In an Op-Ed piece in the Financial Times entitled "The Fed is blameless on the property bubble", Greenspan tells us:

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 capitalisation rates (rent as a percentage of a property's value) that declined and converged across the globe. By 2006, long-term interest rates for all developed and main 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 Federal Reserve monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence that monetary policy added to the bubble is statistically very fragile. Paul De Grauwe, writing in the Financial Times' Economists' Forum, depends on John Taylor's counter-factual model simulations to conclude that the low funds rate was the source of the US housing bubble. Mr 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. Counter-factuals from such flawed structures cannot form the basis for policy.

He goes on to argue:

The core of the subprime problem lies with the misjudgments of the investment community. Subprime securitisation exploded because subprime mortgage-backed securities were seemingly underpriced (high-yielding) at original issuance. Subprime delinquencies and foreclosures were modest at the time, creating the illusion of great profit opportunities. Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality. Even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle.

And he takes FT columnist Martin Wolf to task:

Martin Wolf argues in the FT that central banks "can surely lean against the wind" even if they cannot eliminate bubbles. I know of no instance in which such a policy has been successful. For reasons I have outlined elsewhere (American Economic Association, January 2004), I doubt that it is possible. If it turns out to be feasible, I would become a strong supporter of "leaning against the wind".

I am sure that Greenspan's critics will doubtless remain unpersuaded and even redouble their efforts, but basically there is simply a core disagreement about what the government and Wall Street can and should do that will never be resolved between these parties. Critics believe that asset bubbles can be managed and "popped", while others disagree.

The good news is that the availability of Greenspan to engage in public discussion takes a little bit of the heat off Bernanke and crew.

-- Jack Krupansky


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