Economics

Greenspan and the Housing Bubble: Has He Successfully Absolved the Fed?

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Judge Richard Posner, whose policy interests extend to economics, jousts with former Federal Reserve chieftain Alan Greenspan about Federal Reserve interest rate policy and its responsibility for the housing bubble and burst. Greenspan is saying that mortgage interest rates were more in thrall to dollars flowing in from China than from the short-term "federal funds" interest rate directly targeted by the Fed in the past decade; Posner thinks not. From his analysis at the Atlantic's web site:

The federal funds rate, being the rate at which banks borrow reserves (cash) from each other, has a strong influence on long-term interest rates. The lower the cost at which a bank acquires capital to lend, the lower will be the rates at which it lends, whether long term or short term, because competition will compress the spread between the bank's cost (its interest expense) and its revenue (such as interest on the loans it makes). At the beginning of 2000, when the federal funds rate was 5.45 percent, the interest rate for the standard 30-year fixed-monthly-payment mortgage rate was 8.21 percent. By the end of 2003, the federal funds rate was below 1 percent (and was negative in real terms, because there was inflation), and the mortgage interest rate had fallen to 5.88 percent. The Fed then gradually raised the federal funds rate, to 5.26 percent in July 2007, and the mortgage interest rate rose also, to 6.7 percent, a smaller but still significant increase; and the bubble burst. Furthermore, given the popularity of adjustable-rate mortgages–which Greenspan encouraged–short-term interest rates had a direct effect on the cost of mortgages during this period. Greenspan's analysis implies that the Federal Reserve lost control of long-term interest rates because of foreign capital and therefore could not have lanced the housing bubble even if it had wanted to, which is hard to square with the fact that the bubble did burst when the mortgage interest rate rose….

A Reason magazine roundtable of economists and market experts, including the late Milton Friedman, asked the unmusical question, Was Greenspan a Bubble Blower?, back in 2006.

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  1. It’s hard to take an absolution seriously when it’s coming from the guy getting absolved.

  2. Greenspan already admitted that when his aide told him the percentage of new loans that were subprime, he told his aide that his data must be bad…

    What? It just snuck up behind him, come on!

    That having been said, I’m not sure he could have done a whole lot better given the other data available at the time. I mean the problem with central planning isn’t just the competency of the people making the decisions, it’s that no one’s really competent to do that job. It’s not as if market rates were going the other way and he was going against them.

    I still say the problem was the politicians though. We may not be able to stop misinvestment from blowing bubbles up big, but we didn’t have to put the rest of the economy on the hook for the bill and then do everything we could to discourage the unwinding of those bad investments.

    So, once we’re done with Greenspan, let’s talk about the what idiots Bush the Lesser and Obama have been. …them and the well intentioned fools who cheered them on.

  3. The Chinese were absorbing our inflated money for decades. Blaming them for sending it back is a lame excuse.

    Greenspan and his fellow Fed governors are the culprits. They inflated the money like crazy.

    -jcr

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  5. DON’T FUCK ME WITH ALAN GREENSPAN!

  6. Greenspan gets a lot of flak for not breaking the housing bubble, but I don’t see that as his job. The job of the Fed (assuming you think there should be a Fed–that is a debate for another day) is to keep prices of ordinary goods and services stable: i.e. to keep inflation down and prevent deflation (which it has done very well despite oil shocks and the recession).

    I don’t think that the government should be in the business of saying “The price of housing/internet stocks/ect. is too high. We need to bring it down.” They’ll be right once in awhile, but most of the time the free market can price things better than governments. The housing crisis was caused by people buying houses they couldn’t afford, and banks dumb enough to let them. There wasn’t much Greenspan could have done about this. As far as I’m concerned, he’s still “The Maestro”.

  7. Greenspan gets a lot of flak for not breaking the housing bubble,

    No, he gets flack for inflating the money like crazy by holding the interest rate below the rate of inflation for many years. The housing bubble is just the latest symptom of the disease.

    -jcr

  8. YELLOW PERIL!!

  9. Hindsight’s 20/20.

    Given the information available at the time, there was as much reason to think he was doing the right thing as there was to think he was doing it wrong.

    What Greenspan did was the wrong move. But making the wrong move wasn’t about Greenspan specifically, it’s the nature of the beast.

    We’re libertarians. We know about the Austrians. We know about bubbles and misinvestment. I appreciate that Greenspan made the wrong move; I just hope others appreciate that it wasn’t about who the Fed Chair was or which economic indicators he should have emphasized.

    …it doesn’t matter who the central planners are. It doesn’t matter if they’re properly motivated or how smart they are. The job of a central planner can be done poorly at times, but it cannot be done well all the time. No matter who it is.

  10. At the beginning of 2000, when the federal funds rate was 5.45 percent, the interest rate for the standard 30-year fixed-monthly-payment mortgage rate was 8.21 percent. By the end of 2003, the federal funds rate was below 1 percent (and was negative in real terms, because there was inflation), and the mortgage interest rate had fallen to 5.88 percent. The Fed then gradually raised the federal funds rate, to 5.26 percent in July 2007, and the mortgage interest rate rose also, to 6.7 percent, a smaller but still significant increase;

    It’s also hard to blame foreign money when the spread increased. In 2000, the spread between fed funds was 2.76%, in 2003 it was 4.88% and in 2007 it was 1.44%. If cheap foreign money was pumping up the bubble, the prime spread would have shrunk, not gone up up over 200 bp. Not to mention, Greenspan was pimping ARMS at the exact opposite time when people should get ARMS, when prime rates were at historically low levels. Nice try Alan, but you screwed the pooch here.

  11. The job of the Fed is to keep prices of ordinary goods and services stable …..

    I don’t think that the government should be in the business of saying “The price of housing/internet stocks/ect. is too high

    Huh? You can’t really think both of these at the same time, can you?

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