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Home Publications Blogs Beat the Press Robert Samuelson, Alan Greenspan and the Bubble Economy

Robert Samuelson, Alan Greenspan and the Bubble Economy

Sunday, 27 October 2013 20:12

There are two major schools in economics, those who know accounting identities and those who don't. Alan Greenspan and Robert Samuelson are both members of the latter group, as Samuelson proudly proclaims in his column.

Samuelson wants to give the blame for the economy's collapse on the complacency that followed a quarter century of relatively stable growth with low inflation. He tells readers:

"But there was an unrecognized downside: With a less-risky economy, people — homeowners, bankers, investment managers — concluded they could do things once considered more risky. Consumers could borrow more because economic stability enhanced their ability to repay. “Subprime” home mortgages granted to weaker borrowers became safer because housing prices would constantly rise. Banks and investment banks could assume more debt because financial markets were calmer. Hence, the Greenspan Paradox: The belief in less risk created more risk."

Of course this is not quite right. Those of us who believe in accounting identities did recognize the downside. We saw a huge trade deficit which was draining hundreds of billions of demand from the U.S. economy. The demand drain from the trade deficit (which was the direct result of the mismanagement of the East Asian financial crisis by Greenspan, Summers and Rubin) was being offset by the demand created by the housing bubble.

The bubble was easy to recognize for anyone looking at the economy with open eyes. House prices had sharply diverged from a 100-year long trend in which they had just tracked the overall rate of inflation. It was clear this run-up had no basis in the fundamentals of the market. Income growth was weak and population growth had slowed. Furthermore, rents were still just keeping pace with inflation. And, the extraordinary levels of construction had created record vacancy rates as early as 2003.

There seemed little doubt that prices would collapse and bring an end to the building and consumption boom that were driving the economy at the time. The only question was when. The proliferation of fraudulent mortgages allowed the bubble to grow much larger and more dangerous over the years 2002-2007. Apparently Greenspan missed this tidal wave of bad mortgages because he wasn't paying attention to the housing market. Or at least that's what he wants us to believe now.

Anyhow, there are no mysteries in this story for people who understood accounting identities, except perhaps that people still take Alan Greenspan's views on the economy seriously.

By the way, since Samuelson does a little bit of "what they said then and what they say now" in reference to Greenspan, I'll give my two cents. Here's what I wrote on the eve of the Federal
Reserve Board's Greenspan retrospective in the summer of 2005:

"GREENSPANFEST 2005: BE GLAD YOU WEREN'T INVITED: The Federal Reserve Board is having its annual retreat at Jackson Hole, Wyoming and the agenda this year is devoted to a retrospective of Greenspan's 18-year tenure as Fed chairman. The world has not seen a greater display of obsequiousness since the death of Leonid Brezhnev....

1) Mr. Greenspan ignored the stock bubble.... The tens of millions of people who saw much of their retirement savings disappear in the crash are just out of luck, as are the pension funds that are now insolvent because their managers somehow didn't see the bubble.

The proper remedy for the bubble was actually very simple -- talk. If Greenspan used his Congressional testimony and other public speaking opportunities to lay out the case for the bubble, there is little doubt that it would have deflated long before it reached such outlandish proportions.... A fund manager that ignored Greenspan, and kept most of a portfolio in a bubble market, would undoubtedly be sued for negligence by their clients and probably have to pay every penny they owned in damages....

2) Mr. Greenspan promoted the housing bubble... Greenspan's tool for getting out of the recession created by the collapse of the stock bubble was to promote a bubble in the housing market. He did this most blatantly back in the summer of 2002.... When the housing bubble bursts, we will see the loss of $5 trillion in housing bubble wealth.... The economic fallout will also be enormous....

5) Finally, he did not tell the truth when he endorsed President Bush's tax cut in 2001....

Okay, I close with my own praise of Alan Greenspan. In 1995 and 1996 he lowered interest rates and kept them low. This allowed the unemployment rate to fall below the 6.0 percent level.... The decision to allow the unemployment rate to fall to levels that most economists thought would trigger inflation gave millions of people jobs.... The tight labor market of the late nineties allowed for the first sustained growth in real wages for most of the country's workers since the early seventies. We will benefit from this decision for years to come... the country benefited hugely because [of] Alan Greenspan.."

It is pathetic that we still have so many commentators making excuses for themselves and their friends. The bubble was easy to see for those with their eyes open. Unfortunately many people with prominent platforms continue to use them to try to imply that it was all so complicated and that we can't expect mere mortals -- no matter how brilliant they might be -- to have seen the wreckage beforehand. 

Comments (10)Add Comment
written by watermelonpunch, October 27, 2013 9:25
August 30, 2005
Dean Baker Is Not an Alan Greenspan-Worshipper

If only that could've been said about more economists years back.
written by James, October 28, 2013 12:03
We read your comments closely - so noticed you called the so called "who could have known" crowd and the elists "pathetic."

These titans among us are bunch of truly hypocrites and don't have any compassion for helping the poor or working class.

There have been more uproar about the failure of a gov't website compared to other colossal failures for those folks.

Yet, the House investigated the Fast and Furious and talking about an investigation on the failure of the website.

Any mistakes by business will be taken care by the market - really? Do you see 60 minutes doing a piece on Chase paying $13 billion in fines?

But they are more than willing to do a piece on the potential overpayment of some disability benefits.

What a pathetic reality for the elite world.
written by octo, October 28, 2013 7:18
"I am not yet convinced there is a housing bubble." - Tyler Cowen, April 18, 2005
Too quick with the praise.
written by dick c, October 28, 2013 7:32
"Okay, I close with my own praise of Alan Greenspan. In 1995 and 1996 he lowered interest rates and kept them low." I expect he was just preparing the ground for the next decade's bumper crop of mortgages.
Less Risk Creates More Risk? Not for Economic Predators It Doesn't
written by Last Mover, October 28, 2013 8:04
The belief in less risk created more risk.

Conservatives rant about moral hazard a lot, the notion that a third party, usually government or private insurer, bears the risk and cost of the first two buyer-seller parties overselling and overconsuming beyond economic cost.

Greenspan said financial innovation spread risk so more could own homes. Samuelson says systemic risk that blew up the economy was caused by home buyers lulled into an artificial low period of risk caused by ... the prior period of great moderation when higher risk was apparently absent ... but really was there all along according to Samuelson.

Uh huh. You see, when pathlogical liars set about explaining the current Great Recession, the first ones they exempt from causality is themselves and the economic predators whom they supported all along and still do.

Economic predators don't take risk. They take risk-free profit as privatized gains extracted with anti-competitive market power and impose any losses on everyone else, even including massive unemployment at the macro level.

That's moral hazard big time, and it didn't suddenly raise its ugly economic head after an era of great moderation with mild business cycles and inflation that "placated" Americans into thinking low risk was normal risk which ultimately evolved into the highest risk of all - fatal systemic risk.

In fact, that so called low risk period is when economic predators began to siphon off earned productivity gains by labor into their unearned coffers of predation.

If Robert Samuelson was a medical doctor and one was feeling as healthy as ever in really good spirits, and went to him for a check-up, the diagnosis would be:

You're overdoing it. You need to slow down or you're going to die an early death. You've been misled by all the past indicators that say you're healthy.

Here is a schedule for you to follow that includes enormous amounts of moral hazard purchases of overpriced, useless, wasteful and even harmful health care that will make you worse off and make me better off as you move to a lifestyle path with realistic higher risk.
written by skeptonomist, October 28, 2013 9:01
One reason there was complacency was that economists, including but not limited to Greenspan and Bernanke, attributed the stability of the preceding period to fine-tuning through monetary policy and other actions by the Fed. Greenspan was The Maestro who could control markets with a single word or two, perhaps not even needing his magic monetary tools. This attitude echos the statement by Benjamin Strong in 1928 that the Fed could prevent crashes by "flooding the street" with money and that just the existence of the Fed's power would prevent panic. Why restrain finance with regulations when the Fed has such powers?

Is our economists learning that the Fed doesn't control the economy of the world with just a word or two at the critical time? Is there anything that would convince the current dominant generation of economists that monetary policy and its Maestros are not the solution to everything?
written by sherparick, October 28, 2013 9:12
I believe Greenspan and much of the American elite regret the rise in real wages in 1990s. I believe they see the current high unemployment and falling real wages as "features," not bugs. It means that the relative prosperity of the elite is increasing astronomically and with the power they exercise in an increasingly oligarchic and feudal society.
written by skeptonomist, October 28, 2013 9:25
After 1995 it began to be obvious that the stock market was in a huge bubble. Even Greenspan recognized this and made his famous "irrational exuberance" remark in 1996. This remark did not cause the market to deflate harmlessly or even crash. Shouldn't Greenspan also have raised interest rates drastically, on the basis of the market bubble if not NAIRU? Dean says no, on the grounds that it would probably have been bad for the labor market. This is another example of why authorities do not find it easy to quash market bubbles - they are usually tied up with otherwise favorable economic conditions.
Greenspan didn't have to raise interest rates to slow the stock market bubble
written by John Wright, October 28, 2013 1:56
Greenspan had another tool at his disposal to slow the stock market bubble, the margin requirement. He could have raised it from 50% margin to perhaps 80%-90% and pulled some speculative money out of the stock market.

I remember reading that this was suggested to the Fed in the late 90's.

Greenspan never pushed for this non-interest rate change, illustrating skeptonomist's point that "authorities do not find it easy to quash market bubbles".

What is the upside to the authorities to a potentially messy bubble popping?

That is what Greenspan captured with his "clean up after the never foreseen bubble pop policy". The financial authorities enjoy the good times when the bubble is inflating and make magazine covers for the heroic rescue attempts after the bubble pop.

Will it ever be any different?
written by urban legend, October 28, 2013 3:30
Is it conceivable that Greenspan had no input into the 2003 - 2005 decisions of the Office of the Comptroller of the Currency to use a doubtful interpretation of Federal preemption doctrine to prevent state attorneys general in a number of states from attacking fraudulent lending practices in local markets by the national banks? Wouldn't a national spate of such lawsuits have started deflating the bubble before its worst phases were reached -- maybe even more than another "irrational exuberance" speech by Greenspan? A speech is nothing but publicity, and it didn't do much in 1996. Legal actions would not only have brought publicity, but also would have made continuing by defendants to engage in the fraudulent bubble-building practices more difficult -- and made derivatives created from those mortgages less desirable to buyers and less profitable to sellers?

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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.