Pointing a finger

James Kwak of Baseline Scenario blames Allen "The Maestro" Greenspan.

Fourth, and most importantly, unlike every other blameworthy candidate I can think of, he could actually have done something about the bubble. If he had taken asset price inflation seriously, the answer would have been obvious: raise interest rates much earlier than he actually did. He wouldn't even have had to ask if there was a bubble or not. The way the Fed usually works, they look at the CPI -- if it is too high, they raise rates. They don't stop and think about whether there are fundamental reasons why inflation should be high; they just raise rates. If they had taken the same approach with asset prices, they would have raised rates earlier, which would have deflated the bubble.

Instead, he suggested at the time that people were fools not to take out ARMs.

Obviously, Greenspan committed no crime and he wasn't a crook. But Mr. Mitchell's reputation is sacrosanct and it deserves to get dirty.

And you know that notion just crossed my mind

Dedicated to Allan Greenspan

Greenspan's world view in flames

Atlas collapsed, is more like it.

Ideation

I guess what we need is a good ol' fashioned dose of socialism.

As the credit crisis has slowly expanded and worsened, there has been a flurry of activity in Washington to reduce the damage from it. There are bailouts and tax breaks, and even checks to parents of school-age children.

But there is remarkably little action aimed at getting the credit system functioning again.

In part, that is because there is a scarcity of ideas. Paul Volcker, the former Federal Reserve chairman whose legacy has not crumbled since he left office, was right this week when he said the financial engineers had created “a demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole.”

But it is far from clear what should replace it, or if it can somehow be mended.

To be sure, we had a system that worked for generations, based on commercial banks constrained by regulation. But that system is not coming back, as Mr. Volcker noted in his extraordinary speech to the Economic Club of New York this week.

“Any return to heavily regulated, bank-dominated, nationally insulated markets is pure nostalgia, not possible in this world of sophisticated financial techniques made possible by the wonders of electronic technology,” he said.

In any case, the banks are not all that healthy anyway, thanks to their losses from the strange securities created under the new system.

For the time being, the solutions being pushed would not seem unreasonable to an old-fashioned socialist. Most new mortgages are now guaranteed by the government or by government-sponsored enterprises, whose ability to lend is being expanded.

The Bear Stearns precedent seems to assure that investment banks have joined commercial banks in the Fed’s safety net, and the Fed has now taken control over what Mr. Volcker calls “mortgage-backed securities of questionable pedigree.

Floyd Norris concludes with a swift parting shot to "The Oracle."

There is a real risk that the ad hoc efforts now being made to deal with this crisis will create other problems. Mr. Volcker, who knows how inflation can get out of hand, said the current situation reminds him of the early 1970’s, when inflation began to accelerate. The Fed’s moves to slash short-term interest rates and bail out Wall Street, however necessary they may be, could easily raise inflation and cause more damage to the weak dollar.

It is striking to realize that while Mr. Volcker has been gone from the Fed for two decades, he is, at 80, two years younger than his successor, Alan Greenspan. Had Mr. Volcker somehow kept the job, he almost certainly would have been more skeptical about the new financial architecture — and less popular on Wall Street — than Mr. Greenspan was when times were good. But the bad times we are now entering might not have become nearly so large a threat.

Norris does say finger-pointing is inappropriate as no one could foresee the severity of the crisis. Maybe so, but as his final paragraph indicates, Greenspan and his then-deputy, Bernanke, could have tried to cool things down when it was clear the housing market had hit the red zone.

Bubblehead

Greenspan says "Not my fault," and Dean Baker is having none of it.

If Greenspan had explicitly warned of the bubble, explaining carefully with charts and graphs how the run-up in house prices was inconsistent with longstanding trends in house prices, and could not be explained by the fundamentals in the housing market, it is likely that it would have taken the air out of the bubble years ago. He also could have warned explicitly of the sort of financial meltdown that we are now seeing, which would lead to hundreds of billions of dollars of debt write-downs by banks and other financial institutions.

Such explicit warnings from the nation's central banker likely would have persuaded major actors in financial markets to act differently. This is the course of action that was advocated by some of us who recognized the housing bubble at the time.

It is difficult to see any negative consequences that could have resulted from Greenspan providing accurate analysis to the public and financial markets. It is unfortunate that the pages of the WSJ and most of the rest of the business media were not open to this view years ago. It is remarkable that these views are still excluded from the debate.

Economics smack-down

Alan Greenspan is on The Daily Show tonight.

It is a new paradigm.

Failure is an orphan

Today's Krugmaniad (Time$elect).

Sad Alan’s Lament

By PAUL KRUGMAN

When President Bush first took office, it seemed unlikely that he would succeed in getting his proposed tax cuts enacted. The questionable nature of his installation in the White House seemed to leave him in a weak political position, while the Senate was evenly balanced between the parties. It was hard to see how a huge, controversial tax cut, which delivered most of its benefits to a wealthy elite, could get through Congress.

Then Alan Greenspan, the chairman of the Federal Reserve, testified before the Senate Budget Committee.

Until then Mr. Greenspan had presented himself as the voice of fiscal responsibility, warning the Clinton administration not to endanger its hard-won budget surpluses. But now Republicans held the White House, and the Greenspan who appeared before the Budget Committee was a very different man.

Suddenly, his greatest concern — the “emerging key fiscal policy need,” he told Congress — was to avert the threat that the federal government might actually pay off all its debt. To avoid this awful outcome, he advocated tax cuts. And the floodgates were opened.

As it turns out, Mr. Greenspan’s fears that the federal government would quickly pay off its debt were, shall we say, exaggerated. And Mr. Greenspan has just published a book in which he castigates the Bush administration for its fiscal irresponsibility.

Well, I’m sorry, but that criticism comes six years late and a trillion dollars short.

Mr. Greenspan now says that he didn’t mean to give the Bush tax cuts a green light, and that he was surprised at the political reaction to his remarks. There were, indeed, rumors at the time — which Mr. Greenspan now says were true — that the Fed chairman was upset about the response to his initial statement.

But the fact is that if Mr. Greenspan wasn’t intending to lend crucial support to the Bush tax cuts, he had ample opportunity to set the record straight when it could have made a difference.

His first big chance to clarify himself came a few weeks after that initial testimony, when he appeared before the Senate Committee on Banking, Housing and Urban Affairs.

Here’s what I wrote following that appearance: “Mr. Greenspan’s performance yesterday, in his first official testimony since he let the genie out of the bottle, was a profile in cowardice. Again and again he was offered the opportunity to say something that would help rein in runaway tax-cutting; each time he evaded the question, often replying by reading from his own previous testimony. He declared once again that he was speaking only for himself, thus granting himself leeway to pronounce on subjects far afield of his role as Federal Reserve chairman. But when pressed on the crucial question of whether the huge tax cuts that now seem inevitable are too large, he said it was inappropriate for him to comment on particular proposals.

“In short, Mr. Greenspan defined the rules of the game in a way that allows him to intervene as he likes in the political debate, but to retreat behind the veil of his office whenever anyone tries to hold him accountable for the results of those interventions.”

I received an irate phone call from Mr. Greenspan after that article, in which he demanded to know what he had said that was wrong. In his book, he claims that Robert Rubin, the former Treasury secretary, was stumped by that question. That’s hard to believe, because I certainly wasn’t: Mr. Greenspan’s argument for tax cuts was contorted and in places self-contradictory, not to mention based on budget projections that everyone knew, even then, were wildly overoptimistic.

If anyone had doubts about Mr. Greenspan’s determination not to inconvenience the Bush administration, those doubts were resolved two years later, when the administration proposed another round of tax cuts, even though the budget was now deep in deficit. And guess what? The former high priest of fiscal responsibility did not object.

And in 2004 he expressed support for making the Bush tax cuts permanent — remember, these are the tax cuts he now says he didn’t endorse — and argued that the budget should be balanced with cuts in entitlement spending, including Social Security benefits, instead. Of course, back in 2001 he specifically assured Congress that cutting taxes would not threaten Social Security.

In retrospect, Mr. Greenspan’s moral collapse in 2001 was a portent. It foreshadowed the way many people in the foreign policy community would put their critical faculties on hold and support the invasion of Iraq, despite ample evidence that it was a really bad idea.

And like enthusiastic war supporters who have started describing themselves as war critics now that the Iraq venture has gone wrong, Mr. Greenspan has started portraying himself as a critic of administration fiscal irresponsibility now that President Bush has become deeply unpopular and Democrats control Congress.

© 2007 The New York Times Company

Greenspun

Alan Greenspan is a cowardly old man. Rather than let his opinions be known when he actually had an influence over policy, instead he waited to speak out -- like so many who abetted the Bush/Cheney administration over the past six years -- until he had a book deal.

Though Mr. Greenspan does not admit he made a mistake, he shows remorse about how Republicans jumped on his endorsement of the 2001 tax cuts to push through unconditional cuts without any safeguards against surprises. He recounts how Mr. Rubin and Senator Kent Conrad, Democrat of North Dakota, begged him to hold off on an endorsement because of how it would be perceived.

“It turned out that Conrad and Rubin were right,” he acknowledges glumly. He says Republican leaders in Congress made a grievous error in spending whatever it took to ensure a permanent Republican majority.

Mr. Greenspan has critics as well, and they are likely to weigh in as soon as the book is published. Though he publicly disagreed with Mr. Bush’s supply-side approach to tax cuts, urging Congress to offset the cost with savings elsewhere, he refrained from public criticism that could have shifted the debate. His willingness to criticize now, 18 months after leaving office, may open him to the accusation of failing to speak out when it could have affected policy.

Today, Mr. Greenspan is indignant and chagrined about his role in the Bush tax cuts. “I’d have given the same testimony if Al Gore had been president,” he writes, complaining that his words had been distorted by supporters and opponents of the cuts.

Mr. Greenspan, of course, had been the ultimate Washington insider for years, and knew full well that politicians cited his words selectively to suit their agendas. He was also legendary for ducking delicate issues by, as he once said, “mumbling with great incoherence.”

Of course, any fool -- and Greenspan's not a fool -- knew that had he supported tax cuts during a hypothetical Gore administration, the policy outcome would have been vastly different. Bush campaigned in 2000 promising tax cuts with no real call for spending cuts. Greenspan knew that Bush/Cheney wanted tax cuts and had no concern about deficit spending. That was obvious to everyone at the time.

Steve Forbes, Bubble Boy

Today's Krugmaniad (Time$elect)

The Sum of Some Fears

By PAUL KRUGMAN

Yesterday’s scary ride in the markets wasn’t a full-fledged panic. The interest rate on 10-year U.S. government bonds — a much better indicator than stock prices of what investors think will happen to the economy — fell sharply, but even so, it ended the day higher than its level as recently as mid-May, and well above its levels earlier in the year. This tells us that investors still consider a recession, which would cause the Fed to cut interest rates, fairly unlikely.

So it wasn’t the sum of all fears. But it was the sum of some fears — three, in particular.

The first is fear of bad credit. Back in March, after another market plunge, I spun a fantasy about how a global financial meltdown could take place: people would suddenly remember that bad stuff sometimes happens, risk premiums — the extra return people demand for holding bonds that aren’t government guaranteed — would soar, and credit would dry up.

Well, some of that happened yesterday. “The risk premium on corporate bonds soared the most in five years,” reported Bloomberg News. “And debt sales faltered as investors shunned all but the safest debt.” Mark Zandi of Moody’s Economy.com said that if another major hedge fund stumbles, “That could elicit a crisis of confidence and a global shock.”

I saw that one coming. But what’s really striking is how much of the current angst in the market is over two things that I thought had been obvious for a long time: the magnitude of the housing slump and the persistence of high oil prices.

I’ve written a lot about housing over the past couple of years, so let me just repeat the basics. Back in 2002 and 2003, low interest rates made buying a house look like a very good deal. As people piled into housing, however, prices rose — and people began assuming that they would keep on rising. So the boom fed on itself: borrowers began taking out loans they couldn’t really afford and lenders began relaxing their standards.

Eventually the bubble had to burst, and when it did it left us with prices way out of line with reality and a huge overhang of unsold properties. This in turn has caused a plunge in housing construction and a lot of mortgage defaults. And the experience of past boom-and-bust cycles in housing tells us that it should be several years at least before things return to normal.

I’ve written less about oil prices, so let me emphasize two points about the oil situation. First, we’re now in our third year of very high oil prices by historical standards — prices as high, even when adjusted for inflation, as those that prevailed in the early 1980s, after the Islamic revolution in Iran. Second, unlike the energy crises of the past, this price surge has happened even though there hasn’t been any major disruption in world oil supply.

It’s pretty clear what’s happening: economic development is colliding with geology.

The “peak oil” theorists may or may not be right in asserting that world oil production is already as high as it will ever go — anyone who really knows what’s going in Saudi Arabia’s fields, please drop me a line — but finding new oil is getting a lot harder. Meanwhile, emerging economies, especially in Asia, are burning ever more oil as they get richer. With demand soaring and supply growth sluggish at best, high prices are what you get.

So why did people seem so shocked by a few more bad housing and oil numbers? What I guess I didn’t realize was how deep the denial still runs.

Over the last couple of years a peculiar conviction emerged among some analysts — mainly, for some reason, among those with right-wing political leanings — that the housing bubble was a myth and that the real bubble was in oil prices.

Each new peak in oil prices was met with declarations that it was all speculation — like the 2005 prediction by Steve Forbes that oil was in a “huge bubble” and that its price would be down to $35 or $40 a barrel within a year. And on the other side, as recently as this January, National Review’s Buzzcharts column declared that we were having a “pop-free” housing slowdown.

I didn’t think many people believed this stuff, but the market’s sudden freakout over housing and oil suggests that I was wrong.

Anyway, now reality is settling in. And there’s one more thing worth mentioning: the economic expansion that began in 2001, while it has been great for corporate profits, has yet to produce any significant gains for ordinary working Americans. And now it looks as if it never will.

© 2007 The New York Times Company

On a related note, Floyd Norris (also behind the firewall) reminds us of the Oracle at Delphi's role in all of this.

In Mr. Poole’s [William Poole, the president of the Federal Reserve Bank of St. Louis] view, it was obvious from 2002 to 2004 that short-term interest rates were all but certain to rise, thus driving up the cost of ARMs. But the bankers did not point that out to their customers.

“Apparently driven by the prospects of high fee income,” said Mr. Poole in a speech a week ago, “mortgage originators persuaded many relatively unsophisticated borrowers to take out these mortgages; then, investors willingly purchased them when they were securitized. Many of these mortgages are now in default, some of the lenders are bankrupt, and the mortgage-backed securities are trading at deep discounts to face value.”

In 2004, however, the Fed sent a different signal. Mr. Greenspan, speaking to Credit Union executives on Feb. 23, said “recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable rate mortgages rather than fixed rate mortgages during the past decade.”

He conceded that they might suffer if rates rose, but that was not the point he emphasized. Instead, he used option pricing theory to conclude that homeowners were paying a very steep price when they took out fixed rate mortgages.

“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed rate mortgage,” said the Fed chairman.

Rarely has an industry done a better job of following a regulator’s suggestion. The bankers came up with mortgages that took 40 years to pay off, rather than the customary 30-year amortization period. If that was not enough, they offered loans with negative amortization, so that every month a borrower owed more than he had the month before. People could get mortgages without anyone’s checking to see if they had lied about their income.

Mr. Greenspan may have come to regret his 2004 remarks. In the fall of 2005, he told a group of mortgage bankers that the “apparent froth in housing markets may have spilled over into mortgage markets.” He voiced concern over “more exotic forms of adjustable rate mortgages,” but said nothing to indicate banks should stop offering them.

Had Mr. Poole been willing to talk to me, I would have asked if he thought the Fed bore any responsibility.

[...]

Actually, there were forecasts of disaster. But Mr. Poole was not among the Cassandras.

In March of last year, a few months before home prices peaked, he said a housing bubble might be brewing, but that Fed research indicated home prices were not unreasonable.

“So, if you have an academic interest in house prices, I recommend that you wait a few years,” he said. “If you have a direct financial interest, I can’t help much — you’re on your own!”

That exclamation point was in the text released by the Fed.

Good times. Good times.