Every parent has heard the words ‘I didn’t do it!’ Virtually all of us have said it at some point in our lives. But a statement that is understandable from a frosting-smeared tyke is unbecoming to a former Federal Reserve Chairman. If Alan Greenspan cares about his legacy, he should just pipe down and lie low.
Public opinion is a fickle thing. One year you are the maestro, ever increasing the wealth of U.S. households through your skillful management of the nation’s economy. A few years later you are the chump who sat on his hands as the greatest financial bubble in 80 years grew relentlessly, until its bursting touched off a financial crisis for homeowners and multinational financial institutions alike.
One heard little criticism of the Fed while the housing bubble was expanding. Few noted how fast the money supply was growing compared to the overall economy. Few, with the noteworthy exception of then-Fed governor Edward Gramlich, urged greater regulation of the mortgage industry.
But as the severity of the bubble’s collapse becomes more evident week by week, the Fed and Greenspan are under greater scrutiny.
Some critics note the rate of money growth for a decade starting in 1995. Over that period, the money supply grew nearly twice as fast as output.
That is a classic prescription for inflation. Little showed up at the consumer level, but now critics argue that the excess liquidity instead boosted asset prices, especially for housing, but also for corporate stocks.
Others are combing through Gramlich’s old speeches and writings, noting his prescient warnings of dangerous practices in mortgage lending. Unfortunately, Gramlich died of leukemia in September, after stepping down from the Fed’s Board of Governors in 2005, so he cannot make his case personally.
Greenspan vigorously defended himself and the Fed in a much-noted op-ed piece in the Financial Times on Monday. Entitled “The Fed is blameless on the property bubble,” the rebuttal contains several points:
- The United States was not alone in experiencing giddy growth in house prices. Many other countries had increases, including some that were even more pronounced, such as the United Kingdom and Spain. If the U.S. bubble resulted from faulty monetary policy, why did similar froth emerge elsewhere?
- Bankers always know more than bank regulators about lending dangers and have greater incentives to scrutinize prospective loans. Yet neither loan officers nor regulatory agencies foresaw a jarring collapse. Hence it must have been unforeseeable.
- The fault really lies with financial firms that misjudged the risks of new mortgage-related financial securities. In their thirst for these instruments, they incited mortgage originators to make riskier and riskier loans.
- Yes, he (Greenspan) does believe that markets usually function better than any alternatives and that regulation often is ineffective or even perverse in its effects. But this is not some sort of ideological straitjacket. It is, instead, the correct view of the world. Personal ideology had no role in his leadership.
Greenspan’s points contain some merit. Like an airplane crash or bridge collapse, investigation of financial crises usually reveals a chain of interlinked causes that led to catastrophe. No single factor is responsible for the whole debacle.
Yes, housing prices have advanced faster in other countries. Yes, regulating financial institutions is more difficult than people think. Yes, mistakes by investment banks and mortgage companies were harmful.
Milton Friedman blamed the Fed for causing the Great Depression. Few historians agree with Friedman’s single-cause explanation. But no one maintains the Fed did a wonderful job between 1919 and 1938. The debate is about how much blame it should bear compared to other contributing factors.
History is likely to reach a similar verdict on current events. Alan Greenspan and the Fed did not single-handedly cause our ongoing financial sector problems and the recession that is ensuing. But the Fed did make serious errors both in allowing the money supply to grow and in its hands-off approach to financial regulation.
When Fidel Castro was tried for attempting to overthrow Cuban dictator Fulgencio Batista in 1953, he cried, “History will absolve me.” Greenspan could cry the same thing. But he should just assume a low profile. The more he brings attention to his record, the worse the criticism will be.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.