Federal Reservations

Jesse Walker | January 30, 2006

The Baltimore Sun's most libertarian columnist, Jay Hancock, reviews Alan Greenspan's career at the Fed, arguing the erstwhile Randite "became what he once would have despised: a central economic planner, a government employee who thinks he's smarter than the markets, a price-fixer."

After summarizing the potential hazards of Greenspan's decisions, Hancock defers judgment:

Economic history often takes even longer to sort out than political history, and serious questions about the Greenspan legacy and the paper-currency standard increase the need to postpone judgment....

But I do know that central economic planners tend to mess up. I know that economies are like ecological systems: Intervention that seems to generate great results at first often comes back and bites you on the behind. The unintended consequences of the Greenspan years should be interesting.

Comments

|1.30.06 @ 9:40AM|#

Has anybody come up with a good explanation for why, at a time when mortgage interest rates were among the lowest they'd ever been, Greenspan advised people to get adjustable-rate mortgages? That is the polar opposite of financial responsibility.

|1.30.06 @ 9:46AM|#

As a liberal Democrat and free-market enthusiast (what a combo!), I have plenty of reservations about Alan Greenspan, who, no doubt wisely, realized that in the "real world" of Washington, DC it's better to be a first-rate politician and a second-rate economist than a first-rate economist and a second-rate politician, but to criticize Big Al for abandoning his youthful Randianism is like criticizing Whittiker Chambers for abandoning his youthful communism. (And, yeah, that was a long sentence, but it's all true! I swear it!)

|1.30.06 @ 9:53AM|#

"With inflation chained down by globalization, much of the money Greenspan created went not into consumer prices but rather into McMansions..."

I knew it! Alan Greenspan caused sprawl!

|1.30.06 @ 10:00AM|#

Greenspan, building on Volker, proved that modern Monetary policy could control inflation.

HIs fiscal policy pronouncements, as well as his Scocial Security fix in the eighties were disastorous.

Ed|1.30.06 @ 10:05AM|#

"Economic history often takes even longer to sort out than political history, and serious questions about the Greenspan legacy and the paper-currency standard increase the need to postpone judgment..."

Ha ha ha, not in the blogosphere!

R C Dean|1.30.06 @ 10:08AM|#

What is this postponement of judgement of which you speak?

Judge now! Think later!

amazingdrx|1.30.06 @ 10:11AM|#

Rather than lobbying his colleagues to rein in the abuses of unregulated insider trading via hedge funds, specifically Long Term Capital Management (kind of an ironic name, eyyh?), he stood by, like a duuuhbya reading "My Pet Goat", while disaster repeated itself, then knee jerkedly over revved the economy with emergency interest rate lowering.. which was the real cause of the bubble.

Then when markets were spooked by the 2000 presidential appointment fiasco, he met with Bush while the court cases to count the florida votes was still ongoing. The rates were then raised in a surprise move. The market needed no more surprises at that point.

The Scalia coup was surprising enough. As a result of the fed rate increase shock,the bubble burst, at the worst possible moment. Greenie couldn't gave done much worse in troubled times.

And now insider trading through unregulated hedge funds has eroded investor confidence to such an extent, that just when investment capital is sorely needed for energy inovation to save the US economy and place as the one superpower in the world, those funds are stuck under the collective mattresses of america.

And any funds that are at risk are used as gamblin' money by hedge fund weasels on commodity futures and Chinese technology companies.

Hedge funds are not investors they are the degenerate gamblers of the investment world. Greenie, as the ultimate insider, knows this, but has never spoken out for reform.

Stormy Dragon|1.30.06 @ 10:15AM|#

>Has anybody come up with a good explanation for
>why, at a time when mortgage interest rates were
>among the lowest they'd ever been, Greenspan
>advised people to get adjustable-rate mortgages?
>That is the polar opposite of financial
>responsibility.

It's only irresponsible if you think interest rates are likely to increase in the near future. An adjustable rate mortgage is significantly cheaper, and if you think interest rates are likely to remain stable, the premium for a fixed rate mortgage is a waste of money.

Even if you think interest rates are going to increase in the long term, you're better off taking the adjustable rate now, increasing your equity as much as possible and then refinancing in a few years.

|1.30.06 @ 10:16AM|#

http://www.nytimes.com/2006/01/29/science/earth/29climate.html?_r=1

Timothy|1.30.06 @ 10:35AM|#

Stormy Dragon beat me to the punch. An ARM can be a good deal if you think rates are stable or only going to go up slowly, and sometimes it's the only option depending on loan size. I know that with 20% down I'm likely to end up with an ARM when I first buy, because I simply can't afford to finance over $100,000 and a lot of lenders don't offer fixed-rate loans smaller than that.

|1.30.06 @ 10:36AM|#

It's very advisable to ask yourself very seriously how long you will be in a house, and then select the appropriate ARM. When you enter into a 30 year fixed mortgage, you're buying a prepayment option. And you pay a fat premium for that option.

I believe that in the course of those statments Greenspan admitted that he had a 30 year mortgage :)

amazingdrx|1.30.06 @ 10:42AM|#

Do I sense a lot of libertarian mortgage brokers with extra time on their hands here? Hehehey.

Real estate bubble ready to burst?

|1.30.06 @ 10:54AM|#

"It's very advisable to ask yourself very seriously how long you will be in a house, and then select the appropriate ARM."

Which is fine and dandy, as long as house prices are stable or appreciating. However, if there is a downturn in the real estate market, and your house loses value, you get to be in a really fun place:

Your mortgage rate has jumped up and you can't afford the new monthly payment, so you decide to sell. You try to sell, but discover that you owe more on your mortgage than your house is worth - that in order to sell, you'll need to plunk down several thousand dollars cash to pay off your mortgage! Happened in the 80s in Philly, and I know people who needed $30,000 in cash to sell their house. Needless to say, most of them declared bankruptcy, which led to a little phenomenon that many have forgotten known as the S&L collapse.

Don't think houses can lose value? Yeah, everyone thought the tech boom had revolutionized the stock market, too. Busts follow booms like spring follows winter, especially when the booms are fueled by expansionary monetary policy. Spring can be delayed a little bit, but it comes along eventually every time.

|1.30.06 @ 11:01AM|#

The LTCM crisis was not an issue of insider trading, rather it was a result of over-leverage.

A good friend of mine used to work for one of the ex-LTCM partners and they tracked the performance of the thousands of positions they had open at the crash, in the end almost all of them made money.

The reason LTCM went bankrupt was they were unable to hold withstand the swings based on their capital base. They underestimated volatility.

They were no indications that insider trading was at all involved (the position where they lost the most money was in Russian debt, not US Equities)The firm was also famously secretive and did not as a rule listen to the investment advice of Wall Street bankers.

It is also a misconception that the partners were bailed out by the government. The New York Fed helped work a deal whereby private US banks helped capitalize LTCM and avoid a potential crisis, no public dollars were pledged.

|1.30.06 @ 11:22AM|#

I don't see how "getting upside-down" is a unique feature of an adjustable rate mortgage. In fact, paying less interest in the near term should help you out in a scenario like this. But if you're not saving a dime, and you need to sell your house at a loss, you're probably screwed no matter which mortgage you use. Most ARMs have a maximum float-up each year. If you are so close to your limits that one or two years' increase knocks you out, I would argue that you were overextended.

And no, I'm not a mortgage broker. But yes, I predict there will be a lot more "disemployment" happening in the mortgage industry over the next few years.

|1.30.06 @ 11:27AM|#

sulla,

Most people borrow right up to, or close to, their limit. If you are at your limit when the ARM is at 5.0%, what happens when it floats to 8%? And, what happens if your property loses value AND your rate floats up?

|1.30.06 @ 11:38AM|#

"And, what happens if your property loses value AND your rate floats up?"

And, just to point out a not-so-hidden feature of this phenomenon - don't the two actually go hand in hand to an extent? You know, supply v. demand? If rates go up, people can borrow less money at a given monthly payment. Therefore, they have less money to use to bid up the price of a house. Eventually, the prices in the housing market will reflect this decrease in demand.

So, is it just coinky dink that the housing bubble was first started during a period of low interest rates, and now appears to be cooling, after several increases in rates, or do you think the circumstances are somehow related?

amazingdrx|1.30.06 @ 11:41AM|#

The emergency fed lowering was used to calm the crisis of confidence created by LTCM.

I said unregulated as well as insider trading. Leveraging 100 billion to trade with based on 5 billion in borrowed funds.

Insider trading is exactly how hedge funds work.

A person with fudiciary responsibility and inside knowledge of future trades, say a mutual fund manager, that is not allowed to trade on that knowledge because of his responsibility to fund investors; places money with a hedge fund that plays off of large mutual fund trades.

Then an "anonymous" tip to the hedge fund manager transmits the insider knowledge of the mutual fund manager.

(Im)plausible deniability is maintained, investors are robbed, and the hedge fund and individual account of the mutual fund manager and friends are benefitted illegally, but untraceably.

Meanwhile the big insider trading cleanup,the Martha Stewart trial gets the headlines. It's a joke.

But investors are not laughing, they are taking their savings out of play. Until the markets are actually reformed, or another bubble frenzy occurs. Since reform will not happen under corporatist governance, more likely that another bubble/burst cycle investor ripp off will result.

An economy based on a pyramid scheme? Yep, Ponzi's spirit is alive and well on wall street.

|1.30.06 @ 11:43AM|#

I realize that many of Greenspan's critics are goldbugs. They aren't fond of his up and down policies, which overshoot in both directions. I suspect they are overshooting right now too actually.

But you don't need to be either a fiat money tinkerer of a goldbug, it is not an either/or choice. Whatever happened to Milton Friedman's idea of increasing the money supply by 3% year in, year out? Is it dead because no one really knows how what constitutes money supply?

A steady money supply policy instead of crystal ball gazing, combined with a Fed that only intervenes to prevent a circular banking panic, would seem to be the way to go. We'd know what the money supply would be, we'd have genuine 0% inflation over time, give or take 1%, and we'd have a banking system where people would know for a fact they could get their money out if push came to shove, with Fed loans to otherwise sound banks during a panic.

|1.30.06 @ 11:49AM|#

The answer to your question joe, is that you are fucked. But we could just as easily talk about what if you get a 30 year fixed and you have to take a job making less money.

My point is that we are a mobile population, and yet lenders make a tidy bundle selling 30 year fixed mortgages to people who in all honestly will probably have moved for a new job in 7 or 10 years.

By all means, if you can guarantee that you'll never move, get a fixed-rate mortgage.

|1.30.06 @ 11:59AM|#

The anti-Ron Bailey,

Are humans capable of adapting to a seven meter rise in sea level over a thousand years?

|1.30.06 @ 12:10PM|#

sulla,

Come now. That interest rates are going to rise over their 2003-2004 low is a certainty. Every single person considering opening one needs to take that into account.

Losing one's job or taking a major pay cut, on the other hand, is muc less likely to happen. Heck, even in our mobile society, selling before your mortgage is up is less likely than rising interest rates.

(Full disclosure: I took an ARM (fixed for two years at 3.99%, and that ain't no typo, bee-atch!) in 2003, because I knew for certain that I was selling in 2004. So they are good for some situations.)

|1.30.06 @ 12:16PM|#

"A person with fudiciary responsibility..."

Kill da wabbit, kill da wabbit...

|1.30.06 @ 12:24PM|#

That interest rates are going to rise over their 2003-2004 low is a certainty. Every single person considering opening one needs to take that into account. Losing one's job or taking a major pay cut, on the other hand, is muc less likely to happen.

Losing one's job or taking a paycut may be unlikely if you work for the government, but considering how common stories of mass layoffs are these days, I don't think it's smart for people in general to overextend themselves on the theory "Since I make good money today, I will make good money now and forevermore, amen."

amazingdrx|1.30.06 @ 12:41PM|#

Whoops..fiduciary

"the howwow...the howwow!" (Fudd as Colonel Kurtz)

|1.30.06 @ 12:43PM|#

IIRC, housing prices do not always go down if the bubble bursts. They just stop going up for a bit. (aside from 80's japan, and maybe a few other rarities) So the impact of this bubble won't be a drastic to those who hold assets in real estate as, say the dot-com bubble.

|1.30.06 @ 1:01PM|#

happyjuggler0...

As I understand it the quantity theory of money (what Milton Friedman espoused) failed to work for two reasons.

As you correctly pointed out the definition of the money supply in our country is very fluid, and difficult to measure. With the profusion of financial isntruments (checking accounts, money market savings accounts accounts, home equity loans, etc...), actually meauring the stock of money is very complex and there is no consensus on the best measure.

Second, the equation that Friemdan used to develop the quanity theory of money depends crucially on the assumption that monetary velocity (the number of times per unit time that money is circulated in the economy, is stable).

In the period that Friedman studied most closely(1865-1945 I believe) this was a very reasonable assumption, unfortunately this has broken down in recent years.

Given this difficulties, a strict implementation of Friedman's idea is currently very difficult.

|1.30.06 @ 1:10PM|#

Jennifer, great point. (Sulla and Tim too). But people miss exactly how crazy the ARM advice was. Greenspan wasn't just saying that homeowners are irrational for buying interest rate insurance (via the fixed rate premium). He was saying that professional money managers were crazy for not bidding that premium down by betting (more) heavily that long term rates would not increase in the short term. To him, there is a market failure, with the borrowing public and Wall Street all missing out on the obvious truth.

kgsam|1.30.06 @ 1:10PM|#

The Anti Ron Bailey,
Yeah yeah, it's in all the papers.
We all know that NASA supports the Anthropogenic Global Warming Catastrophe model, so I suspect this guy just wants some media attention for the theory.

|1.30.06 @ 1:16PM|#

A lot of the rationale for having an ARM was getting a lower rate to have a lower payment if you weren't going to be in the house that long. When rates were so low 4-5 years ago, ARM's had a hard time competing because they could only go so low. But the market adjusted with interest-only loans which really lowered monthly payments. Seems like Greenspan was a few steps behind what the market was doing.

|1.30.06 @ 1:27PM|#

Step One: Recommend an increase in the payroll tax to save Social Security.

Step Two: Endorse budget-busting tax cuts, in order to create a deficit.

Step Three: Use the existence of the deficit to justify cutting the Social Security benefits that people had been paying for via the taxes in Step One.

James Bond villian stuff, is what.

Jadagul|1.30.06 @ 1:54PM|#

HappyJuggler0: I tend to agree with you.

Lannychiu: I think you can come up with a pretty good measure, but I have to run out and don't really have time to comment here (but see my comments to the linked post). As for velocity, I'm not sure you need the assumption that velocity is stable, or the equations. If you'd like to argue otherwise (or link to a paper/site that does so), please do, and I'll check.

|1.30.06 @ 2:10PM|#

"Step One: Recommend an increase in the payroll tax to save Social Security."

Step One: Increase the income tax to save Social Security? Cut benefits to save Social Security? Don't save Social Security?

"Step Two: Endorse budget-busting tax cuts, in order to create a deficit."

Step Two: Make sure that you spend every dollar you take in. Argue vehemently against the lockbox as an evil measure that starves Americans. Make sure you don't think about lost growth at all. Raise taxes some more if you can get away with it.

"Step Three: Use the existence of the deficit to justify cutting the Social Security benefits that people had been paying for via the taxes in Step One."

Step Three: Tell everyone that Social Security isn't broken at all, and that Medicare can be saved even with an even tastier Donkey flavored prescription drug attachment, and all you have to do is 'repeal tax cuts for the rich'. Because, you know, that is true. Or something.

James Bond villian stuff, is what.

Indeed.

|1.30.06 @ 2:22PM|#

I guess the difference is that nobody has actually tried to implement your steps, Jason.

Whereas mine are an accurate description of what Greenspan has done with his career.

And I suppose I could point our, for about the thousandth time, the dishonesty in your depiction of the Democratic alternative to Bush's Prescription Drug Benefit - you know, the one that would cost less? - but you haven't had the honesty to acknowledge it yet, so why bother?

|1.30.06 @ 4:00PM|#

Jadagul

last time I checked there were something like 10 measures of money out there (M1, M2, M3, etc...), increasing in generality. While different folks have different favorite measures (M1, M2, M3 are particularly popular), their is no single uniform definition of money.

The most general monetary equation, comes from Irving Fisher and is

M * V = P * Y

Where Y = Income (GDP)
M = Money Supply
P = Price Level
V = Monetary Velocity

http://www.econlib.org/library/Enc/bios/Fisher.html

Essentially the money side of the economy, must equal the output side. Which must be true since all transactions are paid for with money.

If you manipulate the equation and assume that V and Y are constant, then any increase in the money supply flows strictly into the Price Level...inflation.

Thus Milton Friedman's famous dictum,

"Inflation is always and everywhere a monetary phenomena".

and led to his proposal of the quantity theory of money.

His proposal was that we grow the money supply at some fixed rate (say 5%) which would allow for the economy to grow at say 2-3$ with 2-3% inflation annually. Sort of reasonable numbers.

If, however, velocity changes, then we cannot know what level to grow the money supply to maintain a constant level of inflation.

|1.30.06 @ 7:30PM|#

Alan Greenspan = the Dr. Robert Stadler of economics.

Kevin

|1.30.06 @ 9:49PM|#

Ironchef,
You mean oddities like the early 90s? My dad bought his house in 1989 and after the "oddity" in the early 90s it took until 1998/9 for the house to return to its nominal value. Granted, the house is now worth over 200% it's purchased value (in nominal dollars, I'm too lazy to convert it to real dollars). All this happened in my (short) lifetime and people don't remember it.

Jadagul|1.30.06 @ 10:28PM|#

Lannychiu: I contend that Friedman was right in a way he didn't realize. I'm not actually terribly interested in price inflation; I think it's more a symptom of the underlying problem than the thing we actually ought to be fixing. I think we should aim at, say, a 1% a year increase in the money supply (since exactly zero ain't happening); then price variations reflect things actually happening in the economy.

For instance, if velocity drops, that means that people aren't demanding as many goods at the old price. You'd think this ought to lead to some sort of price adjustment (unless businesses find it overall more efficient to smooth prices out, which they generally do-hence long-term contracts and futures hedges). But using monetary policy to try to eliminate those shifts so no one could possibly use them for decisions seems shortsighted and foolish.

Ron Hardin|1.31.06 @ 1:02AM|#

Maintaining the value of the dollar itself is not intervention in the markets, nor is it market planning.

It's a simple exercise in data gathering and control theory.

Money is a ticket in line to say what the economy does next. If there are too many tickets outstanding, people bid against each other for more than the economy can do, and you get inflation.

If there are too few tickets, the economy goes partly idle (you'd get deflation except people don't accept wage cuts, preferring unemployment).

So the Fed just absorbs or creates new tickets to keep inflation at its target. The better the Fed is at it, the closer to zero it can put its target, against the danger of a deflation trap that results from undershooting zero, causing it to lose control of the money supply (nobody buys today if it will be cheaper tomorrow).

The market in the meantime may partly speculate on how well the Fed is likely to do its job, but that's not the same as the Fed intervening in the market.

(The key to the Fed's success is applying control with a slowly-changing interest rate targets, and using predictors of future inflation that are orthogonal to interest rates, so they no longer blind themselves by changing the money supply. The point of interest rate targets is not the interest rate, but that it measures a degree of lean on the the economy's desire for money, allowing the economy to talk back as the Fed absorbs or creates money.)