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Can We Take Away Alan Greenspan's Pension?

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Saturday, 29 January 2011 08:42

Joe Nocera gets most of the story right in his discussion of the Financial Crisis Inquiry's Commission's (FCIC) report today. There was gross negligence, greed, and outright fraud, but none of this would have lead to catastrophic consequences if we didn't have a housing bubble. (For that matter, having a housing bubble driven economy virtually guaranteed catastrophic consequences, even without the financial abuses. Spain, which had a well-regulated banking system and no financial crisis, keeps reminding us of this fact, with its 20.6 percent unemployment. The commission was off on the wrong foot from the outset in looking at the "financial crisis." The real crisis is an economic crisis caused by the collapse of an asset bubble which had been the engine of growth in the economy.)

Nocera blames the mass delusion that house prices could rise endlessly with no foundation in the fundamentals of the housing market. This is absolutely right, but there is a key point missing. We have regulators, most importantly central bankers like Alan Greenspan and Ben Bernanke, who are not supposed to succumb to mass delusions. They are supposed to make their assessments of the economy based on a measured analysis not the hysterical rantings of the deluded masses.

Using simple economic analysis and the arithmetic we all learned in 3rd grade it was possible to recognize the housing bubble as early as 2002. It was also possible to know that the bursting of the bubble would be bad news for the economy and that the news would get worse as the bubble grew larger.

The Fed had enormous power with which to shoot at the bubble. First, Greenspan and Bernanke could have used the resources of the Fed to document the evidence for the existence of the bubble and highlight the consequences of its bursting. Note that this is not about mumbling "irrational exuberance." The idea is to have the Fed's research staff put out paper after paper showing that house prices were hugely out of line with their historic levels with no plausible explanation in the fundamentals. This research could have been highlighted in Congressional testimony and other public appearances by Greenspan and other top Fed officials.

The second step involves the Fed's regulatory power. The deterioration of lending standards and outright fraud in issuing mortgages that is documented in the FCIC report was knowable to regulators at the time. (I knew about it because people from around the country were telling me about abuses by their friends/relatives in the mortgage industry. And, I have no regulatory authority.) The Fed could have used its regulatory authority to crack down on the banks that were issuing fraudulent mortgages and to prod the SEC to go after the investment banks that were securitizing them.

Finally, if steps one and two did not work, the Fed could have raised interest rates. Greenspan has always been dismissive of the idea that higher interest rates could have popped the bubble, noting that long-term rates stayed low in 2005 and 2006 even as short-term rates rose by several percentage points. This is again a silly cop out.

Suppose that Greenspan started a round of rate increases with the explicit target of popping the housing bubble. For example, suppose he announced the first half point rise in the federal funds rate and said that he would continue to raise interest rates until the real value of the Case-Shiller 20 City index fell below its 2000 level. This likely would have gotten the attention of financial markets and had some impact on house prices.

Instead Alan Greenspan, with Ben Bernanke at his side, did nothing. In fact, at several points he seemed to foster the bubble by dismissing the concerns of those who raised questions about the run-up in house prices.

There is a real problem of incentives here. Greenspan and Bernanke would have gotten serious heat from the financial industry if they had done the right thing and shot at the bubble. After all Angelo Mozillo, Robert Rubin, and many other rich and powerful types were getting very rich. On the other hand, they seem to have suffered zero consequence from doing nothing, even when their failure to act had absolutely disastrous consequences.

The lesson here for future central bankers is to keep the financial industry happy and everything will be fine. If that is the case, then we should expect more irresponsible behavior from the industry and possibly more bubbles. The problem is that the cops are on their payroll.

It is not too late -- we could still fire Bernanke and take away Alan Greenspan's pension. Unfortunately, the financial industry is not about to let that happen nor is the business media likely to even let these options be discussed in polite circles.

Comments (7)Add Comment
What Did They Know, When Did They Know It - and Who Cares?
written by izzatzo, January 29, 2011 9:22
There is a real problem of incentives here. Greenspan and Bernanke would have gotten serious heat from the financial industry if they had done the right thing and shot at the bubble. After all Angelo Mozillo, Robert Rubin, and many other rich and powerful types were getting very rich. On the other hand, they seem to have suffered zero consequence from doing nothing, even when their failure to act had absolutely disastrous consequences.


Exactly, straight out of public choice theory. Government officials ultimately act in their own self interest, never in the public interest.

The only time they don't is when they're in the spotlight, which never happens exactly when their self interest is highest - when everyone benefits from an asset bubble and there's nothing but downside for challenging it.

Flail them all you like for not doing their job, but continue to be buried by the opposition who says they - themselves are the problem - as unpersuadable instruments of government with unavoidable conflicts of interest.

Do the right thing? Stop living in the short run because it's deadly in the long run? Acknowledge overwhelming, crippling market failure and use government to counteract it? Hire, pay and reward or punish government officials according to performance?

Are you daft Whose Your Nanny? Any economist knows that government is always the problem.

Fire departments cause fires by creating moral hazard incentives to be careless with matches in the first place, and Greenspan, Bernanke, Rubin and Mozilo are always willing to step up and supply the matches to socialists who refuse to privatize everything.

Stupid liberals.
The FCIC report
written by Peter K., January 29, 2011 11:08
I believe the FCIC report does blame the Fed, Bernanke, Greenspan and Geithner among others even if Nocera didn't emphasize it.
...
written by Fed Up, January 29, 2011 3:12
"Using simple economic analysis and the arithmetic we all learned in 3rd grade it was possible to recognize the housing bubble as early as 2002."

Try and tell that to the neoclassical economists like nick rowe. See what kind of "stuff" they come up with to try and show that budgets and microeconomics does not apply to the macroeconomy.
...
written by liberal, January 29, 2011 3:25
Fed Up wrote,
Try and tell that to the neoclassical economists like nick rowe.


Do you have some examples? That's a query, not a challenge. (I've read a little bit of NR's blog and don't recall what I think of it.)
...
written by skeptonomist, January 29, 2011 7:29
Economists should try to wean themselves from the bizarre dogma that incentives in a free market can accomplish anything. Incentives which require rational thinking are frequently overwhelmed by herd instinct. In the crash of 1929 and subsequent depression most of those who were at the heart of the problem were wiped out and the politicians who were in charge lost power for decades. This time, of course, they were bailed out, but there is no reason at all to think they would not have done the same thing as in the years before 1929 whether or not they anticipated a bailout.

New Dealers recognized that the structure of markets had to be changed with strict regulations and automatic limits; they did not entrust the economy to Maestros wielding monetary magic.
...
written by PeonInChief, January 30, 2011 12:50
What's interesting in the intersection of Wall Street and Main Street is that the financiers really believed that the Main Streeters would somehow, someway, continue to pay their mortgages no matter what. (In other words: we can do whatever silly, stupid, fraudulent stuff we want because the masses will somehow keep their houses.) What they didn't realize was that the loans were so bad that people couldn't pay them, or decided that the houses weren't going to be worth what they paid for them for 30 years.

The problem with blaming the housing bubble, though, is that it lets the fraudsters off the hook. It was a mass delusion--can't do anything about that.
...
written by Fed Up, January 31, 2011 9:02
liberal, here is a good start.

http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/12/hair-of-the-dog.html

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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