Arnold Kling  

Greenspan, Bernanke, and Bubbles

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The Camden Bobos Proposal... What Next?...

Brad DeLong says I am wrong about his views of Greenspan.


I now think he was wrong not to move aggressively to curb the housing bubble of the 2000s. But I think all in all he did a very good job as a central banker over 18 years:

Let me remind Brad that when the Bush tax cuts were debated, Greenspan testified that they were necessary because with so much government surplus in the offing, the Fed would eventually run out of securities to buy to create money.

This was nonsense on many levels. It indicates the level to which a Fed Chairman must stoop in order to get along politically. Bernanke has also stooped, I believe, to get along with Paulson and, more recently, with the Democratic Congress (when Bernanke endorsed a stimulus proposal).

Megan McArdle questions whether Fed policy could have popped the housing bubble. I think that the housing bubble could have been popped easily by putting curbs on loans with low down payments. That could have been done in several ways. First, forbid Freddie and Fannie from doing anything to support low-down-payment mortgages. (Alternatively, rigidly require Freddie and Fannie to hold sufficient capital against the loans. That would have made them uneconomical to buy.) Second, adjust bank capital requirements to get rid of the loophole that allowed these high-risk loans to get low risk ratings when securitized. Third, just issue a warning against the practice.

Bernanke was a member of the Fed starting in 2002, and he could have advocated any of these policies. In my view, he shares with Greenspan any blame for not trying to pop the bubble.

I personally did not see the bubble until later than necessary to stop it. However, I was unaware of the lending practices taking place. I would have opposed the lending practices regardless.

In any case, one can argue that if the housing bubble had been popped, the excess risk-seeking funds would have gone elsewhere, creating a different bubble. I still think that the policy of encouraging high leverage in housing, a policy which continues to this day, was wrong.


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COMMENTS (5 to date)
Larry writes:

Fan/Fred helped drive homeowner leverage through the roof by buying the resulting paper. Everyone is screaming at Lehman for its excess leverage of 30:1. Well, any homeowner that puts 3% down is operating at leverage of 33:1. And they didn't stop there...

dWj writes:

The recent housing bubble and the stock market bubble of the late nineties both, in the worst of their excesses, involved a lot of leverage, and in both cases (but especially the more recent one) that leverage exacerbated the problems with the aftermath. At risk of giving aid and comfort to those who think debt in general is evil or that macroeconomic fine-tuning by government agencies is frequently a good idea, I think maintenance margins (particularly on more volatile stocks) should maybe have been raised ten years ago, and I think homeowners should have been asked to have some equity, especially in the fastest rising markets where it was least desired by the private actors.

It's also worth noting that bubbles attract fraud, and seem to lower the guard of private agents who should be monitoring it. Shareholders see their stocks go up, and ignore pilfering by executives (who also have an easier time hiding it when refinancing is easy), and lenders see collateral values rising and don't see the need to be diligent about the data they accept from borrowers. I don't think increased vigilance on the part of regulators during the bubble would do much to rein it in, but it would do something to ease the pop, and might reduce the political temptation toward overreaction later.

El Presidente writes:

Arnold,

Let me remind Brad that when the Bush tax cuts were debated, Greenspan testified that they were necessary because with so much government surplus in the offing, the Fed would eventually run out of securities to buy to create money.

While that may have been boogie-man nonsense, I believe he supported only the first round of cuts. He was publicly indifferent or opposed to subsequent rounds, as was Paul O'Neill. And, if memory serves, he remained a deficit hawk in favor of pay-go. He stated that tax-cuts payed for by deficits were not responsible policy. He bent a little, but we've been beating him with a plastic bat hoping candy will fall out. You've gotta be fair to the man and his record.

I think that the housing bubble could have been popped easily by putting curbs on loans with low down payments.

This would have helped, but much of the tomfoolery was in the appraisal and origination businesses. When a buyer receives a house AND cash, something has gone wrong. Because they were able to inflate the appraised values and rebate some of the paper-equity to both the seller and buyer, your suggestion would require only that they find a way to make a showing of deposits for the escrow rather than that they actually save their own money. They could borrow the money from others (friends, family, Cosa Nostra, etc.) for a short period then repay it plus whatever interest was necessary using the cash-out following the transaction. If commission incentives continued to be a percentage of the value of the transaction and the rate negotiated, then the broker/loan officer would both have an incentive to ensure that the buyer borrowed as much as they could bear at as high a rate as they would agree to. The seller also would like a high price. Thus, we get an asset bubble because the buyer and seller both agree on a higher price than the house itself would warrant, and subsequent appraisals are based upon comps of recent sales. If the loan originators were held liable for non-performing loans, they'd have a counteracting disincentive for this behavior. Securitization opened the door for this.

Second, adjust bank capital requirements to get rid of the loophole that allowed these high-risk loans to get low risk ratings when securitized.

Now we're talking.

Bill Woolsey writes:

The way the Federal Reserve stops asset bubbles is my restricting money grown. In other words, by causing a recession.

Now, if the Federal reserves' regulatory powers includes the power to set down payments on home mortgages (they do reglate some banks) or to regulate Fanny Mae or Freddie Mac, then, perhaps these other methods could have been used.

cato writes:

i think you are right, and also hint that the bubble might have gone elsewhere.

i have a suspicion that the housing market started to tank so masses of capital (paper capital) started to move into the oil market creating the bubble there.

when it comes down to it, loose monetary policy creates a lot of capital that needs to go somewhere, and if the amount of paper out there exceeds the amount of real investment opportunities, you almost have to have bubbles. (this is very austrian and would love to see some data to back or deny the theory this time around)

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