Greenspan's Defends His Grand Experiment With History

An extremely important debate is being carried out in the WSJ.  First, Anna Schwartz (co-author of Milton Friedman's most important book) criticized Bernanke for fighting the wrong war (link to WSJ editorial in this post).  Then John Taylor criticized Greenspan for having caused the credit bubble (link to WSj editorial in that post).  Now Greenspan offers his defense as a direct rebuttal to John Taylor: the problem was not holding short term rates too low for too long, but the unusually low long term rates due to the savings glut of mercantilist economies like China.  These low long term rates then fed a worldwide housing bubble.  Greenspan acknowledges the critical importance of this issue on policy:

"How much does it matter whether the bubble was caused by inappropriate monetary policy, over which policy makers have control, or broader global forces over which their control is limited? A great deal.

"If it is monetary policy that is at fault, then that can be corrected in the future, at least in principle. If, however, we are dealing with global forces beyond the control of domestic monetary policy makers, as I strongly suspect is the case, then we are facing a broader issue."

Greenspan then shoots his cannon across the bow of the Obama administration and the mantra of 'deregulation' having caused the bubble:  "[T]he appropriate policy response is not to bridle financial intermediation with heavy regulation. ... The solutions for the financial-market failures revealed by the crisis are higher capital requirements and a wider prosecution of fraud -- not increased micromanagement by government entities."

We cannot rewind history, but we can conduct a thought experiment to test Greenspan's argument: absent his reflation of US credit, plus his coterminous relaxing of requirements (such as bank reserve levels), would the exponential growth of credit have exploded in 2004-8?  Specifically to Greenspan's defense, since he focuses on the housing bubble, would housing have exploded? 

Methinks Greenspan protests too much.  Before the Greenspan reflation, global housing was rising but not exponentially.  Fannie & Freddie had already been pushing subprime mortgages and relaxed lending requirements, but the bubble had not emerged.  Globalization and the savings glut had begun in the early '90s, and may have contributed to the dot-com bubble; but even that one was sparked by Greenspan pumping liquidity in 1997 after the Asian Flu, in 1998 after the failure of Long Term Capital Management, and in 1999 to avoid the spurious Y2K problem.  Does he really want to argue that the well-recognized Greenspan Put (to bail out investors of their excesses) did not enbolden an environment of "euphoria" and excessive risk-taking? 

As a coda to his argument, the policy solutions he proposes, of higher capital requirements for banks and prosecution of fraud, are entirely consistent with Taylor's contention that excessive easing caused the bubble.  If Greenspan really thought the mercantilist Asian economies caused the problem, he should propose counters to that.  But he welcomes globalization and believes it caused prosperity in the US.  Hence his defense contains its own rebuttal. 

Comments

[Sanjai]

Ah I wasn't really aware that it was shown on Channel 4 and not the BBC, shows I don't know much about your telivesion across the pond. My host crashed and I lost a couple comments from the past few days where another poster brought up the same concerns you have about distortion and context but the sources he provided (from the scientists themselves) were a little inconclusive. Actually I don't think the program tried dodging the fact that it has warmed in the past 30 years (I'm guessing that's what killed the hysteria around Global Cooling ). The biggest thing I took away from it is that there is insufficient evidence to link human carbon emissions to that rise in temperature. The most logical theory to me is that warming and cooling cycles on Earth are caused by increased and decreased periods of solar activity in the Sun.

[Sohnal]

Now I've lived to hear everything. Mr. Bubbles adtmis too big to fail has been a disaster. What next, a mea culpa on structured finance? A "sorry" from the Free Market crowd for deregulation? Let's not stop at too big to fail when these corps are also too big to prosecute. Any corporation in a public utility business like banking should have to agree that they will not be too lawyered up to be prosecuted. Instead of Corporate Integrity Agreements CIAs) we need Corporate Regulation Agreements for Prosecution (CRAPs).

[Malu]

You're preaching to the choir with this one. The long term trend over deacdes is global warming. During that long term there will be lots of hot and cold fluctuations both above and below that global warming trend. When I hear the argument that you did I want to give the person a stupid slap. One comedian might say, Here's your sign. Some clearly don't understand. The others are either in denial or willing to risk it all for a bit more of what they consider the good life with the minor result of global warming. We're losing the ice at the poles. No cold snap will help that. How to turn that attitude around? I have no idea.

[Ace]

I think that its's interesting you bring up this point. B/c America has been so denepdent on the government to provide for retirement and social security. But if we could just find a way to make it all for ourselves and set our lives up to our fullest possibilities we wouldn't worry about depending on any one or any program. It's still every man for themselves.