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STOCK MARKET KEYNESIANISM
From the start of 1995, US equity prices exploded upwards, with the S&P500 index rising 62 per cent by the end of 1996. By the end of 1994, the stock market had already experienced a remarkable twelve year ascent, during which equities had surged by 200 per cent, despite the plunge of 1987 and the mini-crash of 1989. But that spectacular climb in asset values had been more or less justified, and indeed driven, by a corresponding rise in corporate profits, the same revival of the rate of return that had brought the US economy by this juncture to the brink of a new take off. There can be no doubt that the long bull run of the stock market predisposed investors to continue to buy shares. But what actually drove equities to take flight was, almost certainly, a sudden sharp fall in the cost of borrowing, both short and long term. To help insure stability in the wake of the Mexican Peso and Southern American Tequila crises, the Fed abruptly discontinued its campaign to raise short term interest rates of the previous year and reduced the cost of short term borrowing, from 6.05 per cent in April 1995 to 5.2 per cent in January 1996, not to increase it again until 1999 (except for a lone quarter point increase in 1999). Meanwhile, to implement the Reverse Plaza Accord and bring down the yen, Japan cut its discount rate and, along with other governments in East Asia aiming to keep down their own currencies, unleashed a huge wave of purchases of dollar denominated assets, especially treasury bonds. The reduction in the cost of borrowing in Japan had the effect of pumping up the global supply of credit, as international financiers fabricated a very profitable carry trade, borrowing yen at low rates of interest, converting them into dollars, and using the proceeds to invest around the world, not least in the US stock market. The buying up of US government debt by the East Asians appears to have been the main factor in bringing about a stunning twenty-three per cent decline in the long term cost of borrowing over the course of 1995. As is usually the case with asset price run-ups, it was the sudden major easing of credit that catalyzed the new rise of the stock market. But, by now, with the dollar ascending, the material foundations of the long term profitability recovery and associated rise in equity prices were crumbling. The stock market was climbing skyward without a ladder.
This is where Alan Greenspan and the Fed enter the picture.At the 24 September 1996 meeting of the Federal Open Market Committee, the body that sets short term interest rates for the US economy, Federal Reserve Governor Lawrence Lindsey expressed his worry that runaway increases in share prices were far exceeding the potential growth of corporate profits, and that a distorting bubble, which could not but make for a vast misallocation of capital and eventually a destructive bust, was in the offing. Fed Chair Greenspan did not for a moment deny Lindsay’s observation. “I recognize that there is a stock market bubble problem at this point, and I agree with Governor Lindsey that this is a problem that we should keep an eye on.” Greenspan acknowledged, moreover, that the Fed had ample means at its disposal to deflate the bubble, if it so chose. “We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it. My concern is that I am not sure what else it will do.”7 In fact, as 7 FOMC Minutes, 24 September 1996, pp.23-25, 30-31 Fed Reserve web site; William A. Fleckenstein, Greenspan’s Bubbles. The Age of Ignorance at the Federal Reserve, New York, 2008, p.135. Greenspan made crystal clear at this meeting and subsequently, he had no interest in combating the bubble by any method whatsoever. The economy did seem to be gathering steam, but he was not sure that the expansion had fully taken hold, and he was reluctant to consider raising interest rates, let alone risk directly undermining the equity markets by raising margin requirements, unless and until he was certain it had.8
At the next FOMC meeting, on 13 November 1996, Governor Lindsey, supported by several others, re-stated his concern about over-valued share prices, as well as the threat of inflation, and recommended a significant interest rate increase. But Greenspan preferred standing pat and, as always, he won the day.9 A few weeks later, on December 1996, Greenspan did give his famous warning about “irrational exuberance” in the equity markets. Yet not only did share values continue to rocket into the heavens, but the Fed did absolutely nothing about it. Greenspan not only failed to raise interest rates in the normal way as the economic expansion extended itself, increasing the Federal Funds rate on just one solitary occasion in the years 1995-1999, and that by just onequarter of a percentage point. He also brought down the cost of borrowing at every point at which the stock market experienced the slightest tremor of fear, a fact not lost on equity investors, who soon came to take for granted the infamous “Greenspan put.”
Still, there was a method to Greenspan’s madness. The Fed chair well understood the downward pressure on the economy that was resulting from the rise of the dollar, the disappearance of the Federal deficit, and the declining capacity of the rest of the world to power its own expansion, let alone pull the US economy forward. With traditional Keynesianism off the agenda, he had to find an alternative way to insure that the growth of demand would be sustained. Although Greenspan did not explicitly refer to this, he was well aware that, during the previous decade, the Japanese had implemented a novel form of economic stimulus. In 1985-1986, following the Plaza Accord, Japan had faced a situation rather similar to that of the US in 1995-1996. A fast rising yen had put a sudden end to Japan’s manufacturing-centered, export-led expansion of the previous half decade, was placing harsh downward pressure on prices and profits, and was driving the economy into recession. To counter the incipient cyclical downturn, the Bank of Japan radically reduced interest rates, and saw to it that banks and brokerages channeled the resulting flood of easy credit to stock and land markets. The historic run-ups of equity and land prices that ensued during the second half of the decade provided the increase in paper wealth that was required to enable both corporations and households to step up their borrowing, raise investment and consumption, and keep the economy expanding. The great Japanese boom—and accompanying bubbles--of the second half of the 1980s was the outcome.
Greenspan followed the Japanese example. By nursing instead of limiting the ascent of equity prices, he created the conditions under which firms and households could borrow easily, invest in the stock market, and push up share values. As companies’ stock market valuations rose, their net worth increased and they were enabled to raise money with consummate ease--either by borrowing against the increased collateral represented by their enhanced capital market valuations or by selling their overvalued equities--and, on that basis, to step up investment. As wealthy households’ net worth inflated, they could reduce saving, borrow more, and increase consumption. Instead of supporting growth by increasing its own borrowing and deficit spending--as with traditional Keynesianism--the government would thus stimulate expansion by enabling corporations and rich households to increase their borrowing and deficit spending by making them wealthier (at least on paper) by encouraging speculation in equities—what might be called “asset price Keynesianism”.
The “wealth effect” of rising asset prices would, in this way, underwrite a boom for which the underlying fundamentals were lacking -- notably, the prospect of sufficient rate of return on investment. Greenspan’s stimulus program was a dream come true for corporations and the wealthy, as well as for banks and other financiers, who could hardly fail to profit on lending, by way of the Fed’s unspoken commitment to moderate short term interest rates and to reduce them whenever this was necessary to prevent equity prices from plunging. Its implementation is incomprehensible apart from an accelerating shift to the right in the polity as a whole and ushered in what has been rightly termed the New Gilded Age. Nevertheless, it invited not only the blowing up, but also the bursting, of momentous asset price bubbles.Much as in Japan, the Fed’s buttressing of the stock market called forth a share price ascent of historic proportions, and one witnessed still another re-enactment of the classic drama of asset price run-ups familiar throughout history. The basic enabling condition was, as usual, low-cost access to credit, both long term—initially bequeathed by the Japanese and East Asians by way of their massive purchases of US treasury bonds in connection with the reverse Plaza Accord -- and short term — provided, and seemingly assured, by the Fed. With credit made so cheap, and profit-making on lending rendered so easy, banks and non-bank financial institutions could not resist opening the floodgates and advancing funds without limit. Stepped up borrowing made possible jumped up investment in stocks, which drove up share values, thus households’ wealth and firms’ market capitalization. The resulting decrease in the ratio of debt to equity for stock market investors, as well as for corporations, made those investors and corporations more credit worthy, at least in appearance. Financiers could therefore justify to themselves, as they have always tended to do in such situations, further increases in lending for further purchases of financial assets, as well as for plant and equipment, paving the way for more speculation, higher asset prices, and of course still more lending -- a self-perpetuating upward spiral.
October 21, 2009 at 1:17 pm
What a superb program!
That said, however, I nevertheless wish that it would have delved a little more into the underlying dogmas and pseudoscience that underpin the philosophies of Rand, Greenspan, Rubin, Summers, Bernanke and Geithner.
“A consistent pessimism in regard to man’s rational capacity for justice invariably leads to absolutistic political theories,” Reinhold Niebuhr cautions us in “The children of light and the children of darkness”; “for they prompt the conviction that only preponderant power can coerce the various vitalities of a community into working harmony.”
And there can be little doubt as to how Niebuhr would have judged Rand, Greenspan, Rubin, Summers, Bernanke and Geithner: “the moral cynics, who know no law beyond their will and interest, with a scriptural designation of ‘children of this world’ or ‘children of darkness’. “
“This is no mere arbitrary device,” Niebuhr goes on to explain; “for evil is always the assertion of some self-interest without regard to the whole, whether the whole be conceived as the immediate community, or the total community of mankind, or the total order of the world.”
Martin Luther King was to pick up on and greatly elaborate upon the “children of darkness,” their pessimism concerning man’s moral and rational resources to achieve fairness and justice:
Plato, centuries ago said that the human personality is like a charioteer with two headstrong horses, each wanting to go in different directions, so that within our own individual lives we see this conflict and certainly when we come to the collective life of man, we see a strange badness. But in spite of this there is something in human nature that can respond to goodness. So that man is neither innately good nor is he innately bad; he has potentialities for both. So in this sense, Carlyle was right when he said that, “there are depths in man which go down to the lowest hell, and heights which reach the highest heaven, for are not both heaven and hell made out of him, ever-lasting miracle and mystery that he is?” Man has the capacity to be good, man has the capacity to be evil.
And so the nonviolent resister never lets this idea go, that there is something within human nature that can respond to goodness. So that a Jesus of Nazareth or a Mohandas Gandhi, can appeal to human beings and appeal to that element of goodness within them, and a Hitler can appeal to the element of evil within him.
–Martin Luther King, “Love, law and civil disobedience”
What we saw beginning about sixty years ago was the rollout of a full court press by the children of darkness. It pervaded every aspect of our thinking lives—art, science, religion, economics and politics. And the New Atheist Ayn Rand was undoubtedly the high priestess of the paladins of selfishness and greed.
But she has many disciples, including the Four Horsemen—the new New Atheists Richard Dawkins, Dan Dennett, Christopher Hitchens and Sam Harris. Probably nowhere are the pseudoscientific half-truths they peddle more amply revealed than in this lecture by Richard Dawkins (beginning at minute 40:00):
For a long time, certainly during all of Rand’s lifetime, the New Atheists, without a doubt due to their deep-pocked patrons and sponsors, ran roughshod over the academic community. Anyone foolish enough to assert “man’s capacity to do good” was exiled into academic oblivion. However, with more recent findings by neuroscientists, the “red in tooth and claw” portrayal of man proselytized by the New Scientists has become empirically indefensible.
So what can be seen in Dawkins’ presentation is his acknowledgment that man does indeed have the capacity to do good, but with the qualification that this is a “mistake” or “misfire.” Man ought to follow his instincts for greed and selfishness, Dawkins advises us, because these benevolent impulses no longer function to enhance survival.
On the religious front, the perversion and corruption is just as egregious. We find the mirror image of Dawkins, Dennett, Harris and Hitchens in such well-known Christian evangelical figures as Pat Robertson, Jerry Falwell, James Dobson, Jim Bakker, Tim LaHaye, James Robinson and a host of other millionaire preachers. Other denominations notable for smiling kindly upon greed and selfishness are the Mormons and the Missouri Synod Lutherans. Kevin Phillips, Andrew J. Bacevich and Greg Grandin, between the three of them do a superb job of researching the current state of right-wing religion in America and its celebration of greed and selfishness.
In the arts, we see the “greed is good” message not only overtly verbalized by the artist, but also conveyed in the iconic sharks and gold-plated bulls of the billionaire-artist Damien Hirst.
And I suppose this audience needs no schooling on how, as Amitai Etzioni so thoroughly documented in The Moral Dimension, “neoclassicists have labored long and hard to show that practically all behavior is driven by pleasure and self-interest.” “The neoclassical paradigm does not merely ignore the moral dimension but actively opposes its inclusion,” he writes.
And politics? What can we say about politics?
Francois Haas in “German science and black racism—roots of the Nazi Holocaust” posits a rather interesting theory. Traditional political theory, Haas explains, holds that “science under dictatorship becomes subordinated to the guiding philosophy of the dictatorship.” Haas, however, says: “I am proposing the inverse, that Politics under Science becomes subordinated to the guiding philosophy of that Science.”
So as the little piece of ground that the New Atheists stand upon is eroded away, as the tyranny they inflicted upon the academe is swept away, does that not give hope that the evil politics they inspired will also be swept away?
Friday, October 16, 2009
The new FRONTLINE documentary The Warning, scheduled to debut next Tuesday, is not likely to provide any assistance in the "reputation rebuilding" effort by former Fed Chairman Alan Greenspan whose comments yesterday regarding "too big to fail" might be seen in a whole new light given new revelations from the late-1990s about regulation of derivatives.
Pictured above with former Treasury Secretary and Goldman Sachs alum Robert Rubin, this duo constituted two-thirds of the "Committee to Save the World" (along with top Obama administration economic adviser Larry Summers), a call that, in retrospect, may have been a bit premature.
Brooksley Born:"We didn't truly know the dangers of the market, because it was a dark market," says Brooksley Born, the head of an obscure federal regulatory agency -- the Commodity Futures Trading Commission (CFTC) -- who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country's key economic powerbrokers to take actions that could have helped avert the crisis. "They were totally opposed to it," Born says. "That puzzled me. What was it that was in this market that had to be hidden?"This should be good, particularly in light of the fact that there has been virtually no progress on any financial market reforms, despite continuing calls from the likes of Paul Volcker.
In The Warning, airing Tuesday, Oct. 20, 2009, at 9 P.M. ET on PBS (check local listings), veteran FRONTLINE producer Michael Kirk (Inside the Meltdown, Breaking the Bank) unearths the hidden history of the nation's worst financial crisis since the Great Depression. At the center of it all he finds Brooksley Born, who speaks for the first time on television about her failed campaign to regulate the secretive, multitrillion-dollar derivatives market whose crash helped trigger the financial collapse in the fall of 2008.
"I didn't know Brooksley Born," says former SEC Chairman Arthur Levitt, a member of President Clinton's powerful Working Group on Financial Markets. "I was told that she was irascible, difficult, stubborn, unreasonable." Levitt explains how the other principals of the Working Group -- former Fed Chairman Alan
Greenspanand former Treasury Secretary Robert Rubin -- convinced him that Born's attempt to regulate the risky derivatives market could lead to financial turmoil, a conclusion he now believes was "clearly a mistake."
Born's battle behind closed doors was epic, Kirk finds. The members of the President's Working Group vehemently opposed regulation -- especially when proposed by a Washington outsider like Born.
"I walk into Brooksley's office one day; the blood has drained from her face," says Michael Greenberger, a former top official at the CFTC who worked closely with Born. "She's hanging up the telephone; she says to me: 'That was [former Assistant Treasury Secretary] Larry Summers. He says, "You're going to cause the worst financial crisis since the end of World War II."... [He says he has] 13 bankers in his office who informed him of this. Stop, right away. No more.'"
Greenspan, Rubin and Summers ultimately prevailed on Congress to stop Born and limit future regulation of derivatives. "Born faced a formidable struggle pushing for regulation at a time when the stock market was booming," Kirk says. "Alan Greenspan was the maestro, and both parties in Washington were united in a belief that the markets would take care of themselves."
Now, with many of the same men who shut down Born in key positions in the Obama administration, The Warning reveals the complicated politics that led to this crisis and what it may say about current attempts to prevent the next one.
"It'll happen again if we don't take the appropriate steps," Born warns. "There will be significant financial downturns and disasters attributed to this regulatory gap over and over until we learn from experience."
A book titled Affluenza (by John De Graaf, David Wann, and Thomas H. Naylor) sums it up: “The dogged pursuit for more” accounts for Americans’ “overload, debt, anxiety, and waste.” If Americans are out of money, it must be because they are over-consuming—buying junk they don’t really need.
September 13, 2009 | Mish's Global Economic Trend Analysis
We know why the bubble occurred. Call its Greenspanism. Central banks rescued assets each time there was a hiccup, but let booms run unchecked. They pulled "real" rates ever lower, creating addiction to monetary stimulus. Larger doses were required with each cycle, until we hit zero, and it is still not enough. Debt burdens rose to records across the OECD.
Greenspan’s Dark Legacy Unmasked
October 1, 2007
After retiring as the Federal Reserve’s second longest ever serving chairman, Alan Greenspan is now cashing in big late in life at age 81. He chaired the Fed’s Board of Governors from the time he was appointed in August, 1987 to when he stepped down January 31, 2006 amidst a hail of ill-deserved praise for his stewardship during good and perilous times. USA Today noted “the onetime jazz band musician went out on a high note.” The Wall Street Journal said “his economic legacy (rests on results) and seems secure.” The Washington Post cited his “nearly mythical status.”
Stanford Washington Research Group chief strategist Greg Valliere called him a “giant,” and Bob Woodward called him “Maestro” in his cloying hagiography (now priced $1.99 used on Alibris and $2.19 on Amazon) that was published in 2000 as the Greenspan-built house of cards was collapsing. The book was an adoring tribute to a man he called a symbol of American economic preeminence, who the Financial Times also praised as “An Activist Unafraid to Depart From the Rule” - by taking from the public and giving to the rich.
Others joined the chorus, too, lauding his steady, disciplined hand on the monetary steering wheel, his success keeping inflation and unemployment low, and his having represented the embodiment of prosperity in compiling a record of achievement his successor will be hard-pressed to match.
In 2004, William Greider in The Nation magazine had a different view. He’s the author of “Secrets of the Temple” on “how the Federal Reserve runs the country.” He wrote Greenspan “ranks among the most duplicitous figures to serve in modern American government (who used) his exalted status as economic wizard (to) regularly corrupt the political dialogue by sowing outrageously false impressions among gullible members of Congress and adoring financial reporters.”
They were front and center in the New York Times for the man who “steer(ed) the economy through multiple calamities and ultimately….one of the longest economic booms in history….(He earned his bona fides) weather(ing) the Black Monday stock crash of 1987 (and in 18 and a half years in office) achieved more celebrity than most rock stars” and may now approach them in earnings.
The new book of his memoirs “The Age of Turbulence” is just out for which his reported advance exceeded $8.5 million (second only to Bill Clinton’s $10 for his memoirs) plus additional royalties if sales exceed 1.9 million copies. They may given the amount of high-impact publicity it and he are getting nonstop. And that’s not all. He’s in great demand on the lecture circuit at six figure fees, has his own consulting firm, Greenspan Associates LLC, and his lawyer, Robert Barnett says “virtually every major investment-banking firm” in the world wants to hire him for his rainmaking connections.
They have value, not his market advice, best avoided for the man who engineered the largest ever stock market bubble and bust in history through incompetence, timidity, dereliction of duty, and subservience to the capital interests he represented at the expense of the greater good and a sustained sound economy he didn’t worry about nor did Wall Street.
For firms on the Street and big banks, he could do no wrong and was above reproach for letting them cash in big and then get plenty of advance warning when to exit. Most ordinary investors weren’t so fortunate. They’re not insiders and were caught flat-footed by advice from market pundit fraudsters and the most influential one of all in the Fed Chairman. Just weeks before the market peak in January, 2000, he claimed “the American economy was experiencing a once-in-a-century acceleration of innovation, which propelled forward productivity, output, corporate profits and stock prices at a pace not seen in generations, if ever.”
It was hype and nonsense and on a par with famed economist and professor Irving Fisher’s remarks just before the 1929 stock market crash and Great Depression when he claimed economic fundamentals in the country were strong, stocks undervalued, and an unending period of prosperity lay ahead. It took a world war a decade later, not market magic, for them to arrive, but before it did Fisher kept insisting in the early 1930s recovery was just around the corner. It’s the same way Wall Street touts operate today on gullible investors who even after they’ve been had are easy prey again for the next con.
And they’re really in trouble when it comes from the “Maestro,” who at the height of the stock market bubble said: “Lofty equity prices have reduced the cost of capital. The result has been a veritable explosion of spending on high-tech equipment…And I see nothing to suggest that these opportunities will peter out anytime soon….Indeed many argue that the pace of innovation will continue to quicken….to exploit the still largely untapped potential for e-commerce, especially the business-to-business arena.”
One week later, the Nasdaq peaked at 5048 and crashed to a low of 1114 on October 9, 2002. It lost 78% of its value, the S&P 500 stock index dropped 49%, and retail investors lost out while Greenspan was busy engineering another bubble with a tsunami of easy money for Wall Street and big investors. It’s now unwinding as he gets a big payday for his memoirs and a chance to rewrite history. He aims to raise himself to sainthood and at the same time distance himself from the very costly policies he implemented on top of trillions he helped scam in the greatest modern era wealth transfer from the public to the rich. More on that below.
Greenspan’s Background and Tenure as Federal Reserve Chairman
Alan Greenspan grew up in New York, got his B.A. and M.A. in economics from New York University and later was awarded a Ph.D. in economics from Columbia without completing a dissertation the degree usually requires. In a highly unusual move, Columbia made an exception in his case.
Early on, he became enamored with free market ideologue Ayn Rand, wrote for her newsletters and authored three essays for her book “Capitalism: The Unknown Ideal.” It expressed her views on capitalism’s “moral aspects” and her attempt (with Greenspan’s help) to rescue it from its “alleged champions who are responsible for the fact that capitalism is being destroyed without a hearing (or) trial, without any public knowledge of its principles, its nature, its history, or its moral meaning.”
That was in 1966 when Rand, a staunch libertarian as is Greenspan, believed fundamentalist capitalism was being battered by a flood of altruism in the wake of New Deal and Great Society programs she (and Greenspan) abhorred. She defended big business, made excuses for its wars, and denounced the student rebellion at the time and the evils of altruism. Greenspan concurred, maintained a 20 year association with Rand (who died in 1982), and never looked back.
From 1948 until his 1987 Federal Reserve appointment, he served as Richard Nixon’s domestic policy coordinator in his 1968 nomination campaign and later as Gerald Ford’s Council of Economic Advisers Chairman. He also headed the economic consulting firm, Townsend-Greenspan & Company, from 1955 - 1987. Its forecasting record was so poor it was about to be liquidated when he left to join the Fed. A former competitor, Pierre Renfret, noted: “When Greenspan closed down his economic consulting business to (become Fed Chairman) he did so because he had no clients left and the business was going under (and we found) out he had none (of his employees left).” That made him Reagan’s perfect Fed Chairman choice, and Renfret added it was Greenspan’s failure in private business that got him into government service in the first place.
He wouldn’t disappoint as Wall Street’s man from the start. He bailed it out in 1987 after the disastrous October black Monday. It was the same way he did in it later in 1998 following Long Term Capital Management’s collapse and again after the dot-com bubble burst. It was by his favorite monetary medicine guaranteed to work when taken as directed - floods of easy money followed by still more until the patient is healed, unmindful that the cure may be worse than the disease. No matter, it’s a new Chairman’s problem with Greenspan claiming no culpability for his 18 and a half year tenure of misdeeds, subservience to capital, and contempt for the public interest.
His new book claims the opposite. It’s a breathtaking example of historical revisionism that’s become standard practice for the man Sydney Morning News’ Political and International Editor Peter Hartcher calls “Bubble Man” in his new book by that title. In it, he quotes Bob Woodward saying Greenspan “believed he had done all he could” to contain over-exuberance when, in fact, he let it get out of control. He now claims:
– he didn’t support George Bush’s regressive tax cuts for the rich (that helped create huge budget deficits). In fact, he did, and in 2001 wholeheartedly endorsed this centerpiece of the administration’s economic policy in his testimony before the Senate Budget Committee. At the time, he cited the economic slowdown saying: “Should current economic weakness spread….having a tax cut….may….do noticeable good.”
– he’s “saddened (in his book) that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil.” In his typical obfuscating way to confuse and have things both ways, he tried clarifying his position in a September interview claiming: “I was not saying that that’s the administration’s motive. I’m just saying that if somebody asked me, are we fortunate in taking out Saddam? I would say it was essential.” He failed to say he supported the Bush administration agenda across the board, including the Afghanistan and Iraq wars, with reasons given at the time he’s now distancing himself from.
– no responsibility for the 2000 stock market bubble. He falsely claimed he never saw it coming while providing generous amounts of liquidity to fuel it. After citing the market’s “irrational exuberance” in a December, 1996 speech, he failed to curb it and could have by raising interest rates, margin requirements, and jawboning investors to cool an overheated market to restore stability for long-term economic growth. Instead, he did nothing. He failed to take away the punch bowl, created a bubble, and allowed it to burst causing investors (mostly retail ones) to lose trillions.
– no responsibility for the housing and bond bubbles he created by cutting interest rates aggressively to 1% and flooding the markets with liquidity. As things got out of hand, timely responsible action could have avoided the summer, 2007 credit crisis. Again, he allowed a bad situation to get worse to keep the party going and allow lenders to profit hugely. In the unprecedented run-up in house prices to an $8 trillion wealth bubble, he derided critics claiming anything was wrong. He even encouraged homebuyers to take out adjustable rate mortgages, approved of very risky no down payment purchases, created the subprime mess as a consequence, and isn’t around to address buyers faced with $1.2 trillion in mortgage resets later this year and next that will cause many thousands of painful foreclosures.
Affected homeowners won’t likely be cheered by his speech-making bunkum that bubble level asset prices proved his monetary policies worked by getting investors to demand lower risk premiums. They also won’t be calmed by his arrogant claim that it’s “simply not realistic” to expect the Fed to identify and deflate asset bubbles when it’s real role is to champion flexible and unregulated markets leaving everyone unprotected on our own.
– no responsibility for allowing outstanding US debt to more than triple to around $40 trillion on his watch that one analyst calls his “most conspicuous achievement.” Those having to pay it off won’t thank him.
Greenspan’s Role in the Greatest Modern Era Wealth Transfer from the Public to the Rich
Greenspan was a one-man wrecking crew years before he became Fed Chairman, and his earlier role likely sealed the job for him as a man the power elite could trust. He earned his stripes and then some for his role in charge of the National Commission on Social Security Reform (called the Greenspan Commission). He was appointed by Ronald Reagan to chair it in 1981 to study and recommend actions to deal with “the short-term financing crisis that Social Security faced….(with claims the) Old-Age and Survivors Insurance Trust Fund would run out of money….as early as August, 1983.”
There was just one problem. It was a hoax, but who’d know as the dominant media stayed silent. They let the Commission do its work that would end up transfering trillions of public dollars to the rich. It represents one of the greatest ever heists in plain sight, still ongoing and greater than ever, with no one crying foul to stop it. The Commission issued its report in January, 1983, and Congress used it as the basis for the 1983 Social Security Amendments to “resolve short-term financing problem(s) and (make) many other significant changes in Social Security law” with the public none the wiser it was a scam harming them.
The Commission recommended:
– Social Security remain government funded and not become a voluntary program (that would have killed it);
– $150 - 200 billion in either additional income or decreased outgo be provided the Old Age, Survivors, and Disability Insurance (OASDI) Trust Funds in calendar years 1983 - 89;
– the actuarial imbalance for the 75 year Trust Funds valuation period of an average 1.80% of taxable payroll be resolved;
– a “consensus package” to fix the problem by raising payroll taxes on incomes but exempting the rich beyond a maximum level taxed. Also a gradual increase in the retirement age and various other possible short and longer range options for consideration. The result today is low income earners pay more in payroll than income tax. For bottom level earners, the burden is especially onerous. They pay no income tax but aren’t exempt from 6.2% of their wages going for Social Security and Medicare.
– coverage under OASDI be extended on a mandatory, basis as of January 1, 1984, to all newly hired civilian employees of the federal government and all employees of nonprofit organizations;
– state and local governments that elected coverage for their employees under the OASDI-HI program not be allowed to terminate it in the future;
– the method of computing benefits be revised to exclude benefits that can accrue to individuals from non-covered OASDI employment and only be for the period when they became eligible - to eliminate “windfall” benefits;
– 50% of OASDI benefits should henceforth be taxable as ordinary income for individuals earning $20,000 or more and married couples $25,000 or more;
– in addition, other recommendations concerning cost of living adjustments, the law pertaining to surviving spouses who remarry after age 60, divorced spouses, disabled widows and widowers, and for scheduled payroll tax increases to move up to earlier years up to 1990 after which no further change be made with the wage base rising and is now at a level of $97,500 in 2007 at a tax rate of 6.2% matched by employers;
– self-employed persons beginning in 1984 pay the combined employer-employee rates now at 12.4% with half considered a business expense;
– in addition, a number of other changes recommended that in total would penalize the public to benefit the most well-off that was the whole idea of the scheme in the first place.
The public was told the Commission recommendations of 1983 were supposed to make Social Security fiscally sound for the next 75 years. They weren’t told there was no problem to fix and the changes enacted were to transfer massive wealth from the public to the rich. It was one part of an overall Reagan administration scheme that included huge individual and corporate tax cuts that took place from 1981 to 1986. The rich benefitted most with top rates dropping from 70% in 1981 to 50% over three years and then to 28% in 1986 while the bottom rate actually rose from 11 to 15%.
It was the first time US income tax rates were ever reduced at the top and raised at the bottom simultaneously. But it was far worse than that. In only a few years, Reagan got enacted the largest ever US income tax cut (mostly for the rich) while instituting the greatest ever increase entirely against working Americans earning $30,000 or less.
Alan Greenspan engineered it for him by supporting income tax cuts and doubling the payroll tax to defray the revenue shortfall. He also recommended raiding the Social Security Trust Fund to offset the deficit, and who’d know the difference. His scheme helped make the US tax code hugely regressive as well as for the first time transform a pay-as-you-go retirement and disability benefits program into one where wage earner contributions subsidize the rich as well as support current beneficiaries.
As a consequence, the wealth gap widened, continued under Clinton but became unprecedented under George W. Bush with Greenspan at it again. He supported the administration’s wealth transfer scheme to the rich and outsized corporate subsidies with the public getting stuck with out-of-control deficits, deep social service cuts, and a new Treasury Department report just out promising more of the same.
It claims Social Security faces a $13.6 trillion shortfall “over the indefinite future,” “reforms” are needed, delaying them punishes younger workers, and the program “can be made permanently solvent only by reducing the present value of scheduled benefits and/or increasing the present value of scheduled tax increases.” Translation: cut benefits deeply, raise payroll taxes, and privatize Social Security so more public wealth goes to Wall Street and big investors.
Already the top 1% owns 40% of global assets; the top 10% 85% of them; the top 1% in the US controls one-third of the nation’s wealth; the bottom 80% just 15.3%; and the top 20% 84.7%. In contrast, the poorest 20% are in debt, owe more than they own, and it’s getting worse.
A generation of financial manipulation devastated working Americans, but it’s even worse than that. Added are the effects of globalization, automation, outsourcing, the shift from manufacturing to services, deregulation, other harmful economic factors plus weak unions just gotten far weaker in the wake of the UAW September membership sellout to General Motors. The tentative agreement reached (for members to vote on) amounted to an unconditional surrender by a corrupted leadership after a two day walkout that was likely orchestrated in advance to cause GM the least pain. If the package is approved as is likely, it will encourage other companies to offer similar deals, take it or leave it. Organized labor suffered another grievous blow, corporate giants gained, and are more empowered than ever to win out at the expense of workers’ futures.
The whole scheme was kick-started under Ronald Reagan. Between his tax cuts for the rich and the Greenspan Commission’s orchestrated Social Security heist, working Americans lost out in a generational wealth transfer shift now exceeding $1 trillion annually from 90 million working class households to for-profit corporations and the richest 1% of the population. It created an unprecedented wealth disparity that continues to grow, shames the nation and is destroying the bedrock middle class without which democracy can’t survive.
Greenspan helped orchestrate it with economist Ravi Batra calling his economics “Greenomics” in his 2005 book “Greenspan’s Fraud.” It “turns out to be Greedomics” advocating anti-trust laws, regulations and social services be ended so “nothing….interfere(s) with business greed and the pursuit of profits.”
It won’t affect the “Maestro.” He’s getting by quite nicely on his six figure retirement income that’s just a drop in the bucket supplementing the millions he’s making as payback for the trillions he helped shift to the rich and super-rich. They take care of their own, and Greenspan is one of them.Jules on October 5th, 2007
This article is very interesting I always felt he (Greenspan) was a snake, it is obvious - just look at him, but I did not know that he is one of the economic masterminds behind the “rich get richer, poor get poorer” machine. Whats horrible is that they will all get away with it - Americans have been brainwashed so completely. They just can’t seem to wrap their self-centered, cowardly minds around this International Banking Fraud and Secret Govt. Even worse is the fact that they (Americans) are the only ones who can fix this; all they have to do is REFUSE to believe their lies and REFUSE their system of money, credit, etc. Then replace it with one they want.
Obstacles: 1)Ignorance 2) Laziness 3)Cowardice Martin on October 6th, 2007
Jules, you are right, but please understand that what our laziness and cowardliness create is the very ignorance you speak of. Our largest problem is that this article, and the books mentioned will not be ready by the American public, they (we) are too busy watching Britney Spears and the like on TV.
I believe the only way for Americans to change or wake up is to force their TV’s off. TV and the laziness and brainwashing that it encourages is so addictive that Americans can’t be bothered to read or discuss items other than celebrities, we simply want to be told, and entertained; even if it means being lied to and hoodwinked and sold to the lowest bidder.
Anyhow, I can’t blame Greenspan for too much, because honestly, he represents the Federal Reserve, and that (I believe history will show) is the very institution responsible for America’s demise. Just check out this quote from Frank Vanderlip’s biography …
“I was as secretive, indeed I was as furtive as any conspirator. Discovery, we knew, simply must not happen, or else all our time and effort would have been wasted. If it were to be exposed that our particular group had got together and written a banking bill, that bill would have no chance whatever of passage by Congress…I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System.” —
The “Group” he speaks of is not the US Government and not one that is interested in the betterment of general Americans but none other than …
“The executives included Frank Vanderlip, president of the National City Bank of New York, associated with the Rockefellers; Henry Davison, senior partner of J. P Morgan Company; Charles D. Norton, president of the First National Bank of New York; and Col. Edward House, who would later become President Woodrow Wilson’s closest adviser and founder of the Council on Foreign Relations. There, Paul Warburg of Kuhn, Loeb, & Co. directed the proceedings and wrote the primary features of the Federal Reserve Act. Warburg would later write that “The matter of a uniform discount rate (interest rate) was discussed and settled at Jekyll Island.” … who wrote the bill to introduce the Federal Reserve for THEIR INTERESTS, not yours and mine, BUT THEIRS.
There is a reason the above article (the main article on this page) speaks of the great divide between classes now is directly related to the people who guaranteed that outcome for their families in 1913. This meeting was kept secret by this group for 3 years AFTER they had passed the bill via their purchased congressmen.
America was screwed and purchased on the cheap in 1913, we still have yet to recover from this slight of hand. Alan Greenspan …. he is just another pawn in the long list of Federal Reserve pawns hired to do the bidding of their masters … The great depression was orchestrated by this group and our greatest depression (soon to be seen) has been orchestrated by their ancestors and followers … Ask yourself who benefits from it, and then ask yourself when, if ever, you will see a story about it on the major news networks. Don’t ever forget that John F Kennedy was assassinated because he threatened to shut down the Federal Reserve. I believe they simply could not let that happen after 30 years of absolute financial control.
Greenspan was no mastermind, he did what they told him to do, and he did his job well. We must expose “them”.
– Federal Reserve Creative Group Information found on Wikipedia but confirmed in countless other sources.
But during the years of the housing boom, the pleas failed to move the Fed, the sole federal regulator with authority over the businesses. Under a policy quietly formalized in 1998, the Fed refused to police lenders' compliance with federal laws protecting borrowers, despite repeated urging by consumer advocates across the country and even by other government agencies.
The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates.
"In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision," former Fed Governor Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007. "It is like a city with a murder law, but no cops on the beat."
Between 2004 and 2007, bank affiliates made more than 1.1 million subprime loans, around 13 percent of the national total, federal data show. Thousands ended in foreclosure, helping to spark the crisis and leaving borrowers and investors to deal with the consequences.
Congress now is weighing whether the Fed should be fired. The Obama administration has proposed shifting consumer protection duties away from the Fed and other banking regulators and into a new watchdog agency. That proposal, a central plank in the administration's plan to overhaul financial regulation, is opposed by the industry and faces a battle on Capitol Hill.
The Federal Reserve is best known as an economic shepherd, responsible for adjusting interest rates to keep prices steady and unemployment low. But since its creation, the Fed has held a second job as a banking regulator, one of four federal agencies responsible for keeping banks healthy and protecting their customers. Congress also authorized the Fed to write consumer protection rules enforced by all the agencies.
During the boom, however, the Fed left those powers largely unused. It imposed few new constraints on mortgage lending and pulled back from enforcing rules that did exist.
The Fed's performance was undercut by several factors, according to documents and more than two dozen interviews with current and former Fed governors and employees, government officials, industry executives and consumer advocates. It was crippled by the doubts of senior officials about the value of regulation, by a tendency to discount anecdotal evidence of problems and by its affinity for the financial industry.
By George Washington of Washington’s Blog.
How well has the Federal Reserve performed for America? Mainstream pundits, of course, say that Bernanke has saved the world . . . . but they said the same thing about Greenspan. So let’s look at the actual historical record to determine how well the Fed has done.
Initially, Milton Friedman and Ben Bernanke have both said that the Federal Reserve caused (or at least failed to cure) the Great Depression through its poor monetary policy.
Many also blame the Fed for blowing an unsustainable bubble between 2001-2007 through artificially low interest rates. If this sounds too much like an Austrian economics perspective, that may be true. But remember that Hayek won the Nobel prize in 1974 partly for arguing that artificially low interest rates lead to the misallocation of capital and to bubbles, which in turn lead to busts.
Moreover, one of the Fed’s main justification has been that it can provide a “counter-cyclical” balance. In other words, during boom times it can put on the brakes (”take the punch bowl away right as the party gets started”), and during busts it can get things moving again. But as economist Jane D’Arista has shown, the Fed has failed miserably at that task:
Jane D’Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit [has a] devastating critique of the central bank. The Federal Reserve, she explains, has failed in its most essential function: to serve as the balance wheel that keeps economic cycles from going too far. It is supposed to be a moderating force in American capitalism on the upside and on the downside, the role popularly described as “leaning against the wind.” By applying its leverage on the available supply of credit, the Fed can slow down a boom that is dangerously overwrought or, likewise, stimulate the economy if it is sinking into recession. The Fed’s job, a former chairman once joked, is “to take away the punch bowl just when the party gets going.” Economists know this function as “counter-cyclical policy.”
The Fed not only lost control, D’Arista asserts, but its policy actions have unintentionally become “pro-cyclical”–encouraging financial excesses instead of countering the extremes. “The pattern that has developed over the last two decades,” she wrote in 2008, “suggests that relying on changes in interest rates as the primary tool of monetary policy can set off pro-cyclical foreign capital flows that tend to reverse the intended result of the action taken. As a result, monetary policy can no longer reliably perform its counter-cyclical function–its raison d’être–and its attempts to do so may exacerbate instability.”…
The Fed is also supposed to act as a regulator for banks and their affiliates, but failed miserably in that role as well.
Indeed, the central bankers’ central banker – BIS – has itself slammed the Fed:
In a pointed attack on the US Federal Reserve, [BIS and its chief economist William White] said central banks would not find it easy to “clean up” once property bubbles have burst…
Nor does it exonerate the watchdogs. “How could such a huge shadow banking system emerge without provoking clear statements of official concern?”
“The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low,” [White] said.
The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning…
“Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.
“To deny this through the use of gimmicks and palliatives will only make things worse in the end,” he said.
As PhD economist Steve Keen has pointed out, the Fed (along with Treasury) has also given money to the wrong people to kick-start the economy.
Remember also that Greenspan acted as one of the main supporters of derivatives (including credit default swaps) between the late 1990’s and the present (and see this).
Greenspan was also one of the main cheerleaders for subprime loans (and see this).
The above list is only partial. And it ignores:
(1) allegations that the Fed has manipulated the markets; and
(2) claims that the Federal Reserve System saddles the U.S. government and American people with trillions of dollars in unnecessary debt (that would not be incurred if the government took back the “power to coin money” granted to the government itself in the Constitution).
Even so, it shows that the Federal Reserve has performed very poorly indeed.
May 27, 2009 | Bloomberg.com
His verdict on former Fed Chairman Alan Greenspan is as astute as it is merciless. A telling moment comes when Ritholtz shows how Greenspan drew the wrong conclusion from the first crisis during his tenure, the crash of ‘87.
“What the astute student learns from the history of speculative frenzies is that the 1987 crash was a unique aberration,” Ritholtz writes. It was a rare combination of a sizzling equity market, a (dangerously) innovative product called portfolio insurance and some antiquated stock-exchange plumbing that together created a short, brutal drop in an otherwise strong economy, he says.
“Greenspan completely missed this point,” he says. “The 1987 crash was the rare exception, not the rule.”
The upshot: Greenspan would respond to crisis after crisis -- from LTCM to the popping dot-com bubble -- with the same mistaken treatment: more liquidity and lower rates. The Greenspan Put was born.
September 8, 2009 | The New Republic
In September 1998, we saw the failure of a single lightly regulated U.S. hedge fund, Long-Term Capital Management. This threatened our financial system, and the Fed cut rates preemptively--making popular the term “Greenspan put.” (A put is a contract that gives the owner the right to sell assets at a fixed price, and it is often used to lock in profits or limit losses. So, if your assets fell in value, Greenspan would effectively buy them or--literally--put a floor under their value. Stocks, for example, are underpinned by future expected company earnings; the value today of those future flows goes up when interest rates are lower--so any cut by the Fed is welcomed by stock-market investors.) In a bright shining moment, markets realized that the Fed was prepared, through interest rate cuts and loose credit, to do whatever it took to bail out financiers facing large losses. Risk-taking without fear for the consequences became the name of the game, at least for our largest financial players: They get the upside if things go well, and the Fed will limit their downside when the speculative frenzy of the day finally runs out of steam.
This environment helped feed the technology bubble--and bust. And this led to further rate cuts--championed by Bernanke, then working under Greenspan. Those 2001 rate cuts--and subsequent decisions to hold interest rates low--encouraged our housing bubble. The phrase “Bernanke put” is now catching hold, meaning an explosive burst of bailouts, liquidity provision, and supportive fiscal stimulus far larger than anything implemented under Greenspan. But Bernanke’s mega-put is just one further step along a path that was established long ago, back in 1913 when the Federal Reserve was founded.
Over the past century, we have moved away from a system where bank shareholders and senior executives paid dearly for bad management--and toward a system where fired bank bosses make off with fortunes or launch brilliant political careers. No one is on the financial hook, other than the taxpayer. Consider the case of Citigroup, a seriously troubled bank. Chuck Prince, the CEO who fell flat on his face, walked away with close to $100 million. Win Bischoff, former chairman and interim CEO of Citigroup during the debacle, has just been appointed chairman of Lloyds Banking Group in the United Kingdom--reflecting the high esteem in which he is apparently still held. And Robert Rubin, Treasury secretary under Clinton, made over $100 million as board member and chair of Citigroup. In an interview late in 2008, he brushed off any responsibility for the mismanagement of anything. And so, our recurring financial crises are not isolated random events; they emerge from a pattern of private and public sector behavior. Enabled by the Fed, our system’s tolerance for risk is out of control. This is an increasingly dangerous system. It is only a matter of time until it collapses again.
...But the capital inadequacy did not evolve by itself. It was created by the policy by the Federal Reserve. Geithner seems to have forgotten the stated official views of the Fed under Alan Greenspan who said in a 1998 testimony before Congress:We should note that were banks required by the market, or their regulator, to hold 40% capital against assets as they did after the Civil War, there would, of course, be far less moral hazard and far fewer instances of fire-sale market disruptions. At the same time, far fewer banks would be profitable, the degree of financial intermediation less, capital would be more costly, and the level of output and standards of living decidedly lower. Our current economy, with its wide financial safety net, fiat money, and highly leveraged financial institutions, has been a conscious choice of the American people since the 1930s. We do not have the choice of accepting the benefits of the current system without its costs.The risk of systemic market failure was a conscious choice of Fed monetary policy that the American people did not have much say in. Greenspan, notwithstanding his denial of responsibility in helping throughout the 1990s to unleash the equity bubble, had this to say in 2004 in hindsight after the bubble burst in 2000: "Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion."
By the "next expansion", Greenspan meant the next bubble, which manifested itself in housing. He did not heed the dire warnings in 2000. The "wide financial safety net" that Greenspan relied on had holes big enough to drive a Mack truck through. By 2008, Greenspan was forced to admit to Congress that he erred in his faith in the self-regulatory regime of banks.
The Huffington PostThe Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.
This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.
"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."
One critical way the Fed exerts control on academic economists is through its relationships with the field's gatekeepers. For instance, at the Journal of Monetary Economics, a must-publish venue for rising economists, more than half of the editorial board members are currently on the Fed payroll -- and the rest have been in the past.
The Fed failed to see the housing bubble as it happened, insisting that the rise in housing prices was normal. In 2004, after "flipping" had become a term cops and janitors were using to describe the way to get rich in real estate, then-Federal Reserve Chairman Alan Greenspan said that "a national severe price distortion [is] most unlikely." A year later, current Chairman Ben Bernanke said that the boom "largely reflect strong economic fundamentals."
The Fed also failed to sufficiently regulate major financial institutions, with Greenspan -- and the dominant economists -- believing that the banks would regulate themselves in their own self-interest.
Despite all this, Bernanke has been nominated for a second term by President Obama.
In the field of economics, the chairman remains a much-heralded figure, lauded for reaction to a crisis generated, in the first place, by the Fed itself. Congress is even considering legislation to greatly expand the powers of the Fed to systemically regulate the financial industry.
Paul Krugman, in Sunday's New York Times magazine, did his own autopsy of economics, asking "How Did Economists Get It So Wrong?" Krugman concludes that "[e]conomics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system."
So who seduced them?
The Fed did it.
Three Decades of Domination
The Fed has been dominating the profession for about three decades. "For the economics profession that came out of the [second world] war, the Federal Reserve was not a very important place as far as they were concerned, and their views on monetary policy were not framed by a working relationship with the Federal Reserve. So I would date it to maybe the mid-1970s," says University of Texas economics professor -- and Fed critic -- James Galbraith. "The generation that I grew up under, which included both Milton Friedman on the right and Jim Tobin on the left, were independent of the Fed. They sent students to the Fed and they influenced the Fed, but there wasn't a culture of consulting, and it wasn't the same vast network of professional economists working there."
But by 1993, when former Fed Chairman Greenspan provided the House banking committee with a breakdown of the number of economists on contract or employed by the Fed, he reported that 189 worked for the board itself and another 171 for the various regional banks. Adding in statisticians, support staff and "officers" -- who are generally also economists -- the total number came to 730. And then there were the contracts. Over a three-year period ending in October 1994, the Fed awarded 305 contracts to 209 professors worth a total of $3 million.
Just how dominant is the Fed today?
The Federal Reserve's Board of Governors employs 220 PhD economists and a host of researchers and support staff, according to a Fed spokeswoman. The 12 regional banks employ scores more. (HuffPost placed calls to them but was unable to get exact numbers.) The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.
That's a lot of money for a relatively small number of economists. According to the American Economic Association, a total of only 487 economists list "monetary policy, central banking, and the supply of money and credit," as either their primary or secondary specialty; 310 list "money and interest rates"; and 244 list "macroeconomic policy formation [and] aspects of public finance and general policy." The National Association of Business Economists tells HuffPost that 611 of its roughly 2,400 members are part of their "Financial Roundtable," the closest way they can approximate a focus on monetary policy and central banking.
Robert Auerbach, a former investigator with the House banking committee, spent years looking into the workings of the Fed and published much of what he found in the 2008 book, "Deception
and Abuse at the Fed". A chapter in that book, excerpted here, provided the impetus for this investigation.
Auerbach found that in 1992, roughly 968 members of the AEA designated "domestic monetary and financial theory and institutions" as their primary field, and 717 designated it as their secondary field. Combining his numbers with the current ones from the AEA and NABE, it's fair to conclude that there are something like 1,000 to 1,500 monetary economists working across the country. Add up the 220 economist jobs at the Board of Governors along with regional bank hires and contracted economists, and the Fed employs or contracts with easily 500 economists at any given time. Add in those who have previously worked for the Fed -- or who hope to one day soon -- and you've accounted for a very significant majority of the field.
Auerbach concludes that the "problems associated with the Fed's employing or contracting with large numbers of economists" arise "when these economists testify as witnesses at legislative hearings or as experts at judicial proceedings, and when they publish their research and views on Fed policies, including in Fed publications."
Gatekeepers On The Payroll
The Fed keeps many of the influential editors of prominent acade>The pharmaceutical industry has similarly worked to control key medical journals, but that involves several companies. In the field of economics, it's just the Fed.
Being on the Fed payroll isn't just about the money, either. A relationship with the Fed carries prestige; invitations to Fed conferences and offers of visiting scholarships with the bank signal a rising star or an economist who has arrived.
Affiliations with the Fed have become the oxygen of academic life for monetary economists. "It's very important, if you are tenure track and don't have tenure, to show that you are valued by the Federal Reserve," says Jane D'Arista, a Fed critic and an economist with the Political Economy Research Institute at the University of Massachusetts, Amherst.
Robert King, editor in chief of the Journal of Monetary Economics and a visiting scholar at the Richmond Federal Reserve Bank, dismisses the notion that his journal was influenced by its Fed connections. "I think that the suggestion is a silly one, based on my own experience at least," he wrote in an e-mail. (His full response is at the bottom.)
Galbraith, a Fed critic, has seen the Fed's influence on academia first hand. He and co-authors Olivier Giovannoni and Ann Russo found that in the year before a presidential election, there is a significantly tighter monetary policy coming from the Fed if a Democrat is in office and a significantly looser policy if a Republican is in office. The effects are both statistically significant, allowing for controls, and economically important.
They submitted a paper with their findings to the Review of Economics and Statistics in 2008, but the paper was rejected. "The editor assigned to it turned out to be a fellow at the Fed and that was after I requested that it not be assigned to someone affiliated with the Fed," Galbraith says.
Publishing in top journals is, like in any discipline, the key to getting tenure. Indeed, pursuing tenure ironically requires a kind of fealty to the dominant economic ideology that is the precise opposite of the purpose of tenure, which is to protect academics who present oppositional perspectives.
And while most academic disciplines and top-tier journals are controlled by some defining paradigm, in an academic field like poetry, that situation can do no harm other than to, perhaps, a forest of trees. Economics, unfortunately, collides with reality -- as it did with the Fed's incorrect reading of the housing bubble and failure to regulate financial institutions. Neither was a matter of incompetence, but both resulted from the Fed's unchallenged assumptions about the way the market worked.
Even the late Milton Friedman, whose monetary economic theories heavily influenced Greenspan, was concerned about the stifled nature of the debate. Friedman, in a 1993 letter to Auerbach that the author quotes in his book, argued that the Fed practice was harming objectivity: "I cannot disagree with you that having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results," Friedman wrote.
Greenspan told Congress in October 2008 that he was in a state of "shocked disbelief" and that the "whole intellectual edifice" had "collapsed." House Committee on Oversight and Government Reform Chairman Henry Waxman (D-Calif.) followed up: "In other words, you found that your view of the world, your ideology, was not right, it was not working."
"Absolutely, precisely," Greenspan replied. "You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."
But, if the intellectual edifice has collapsed, the intellectual infrastructure remains in place. The same economists who provided Greenspan his "very considerable evidence" are still running the journals and still analyzing the world using the same models that were incapable of seeing the credit boom and the coming collapse.
Rosner, the Wall Street analyst who foresaw the crash, says that the Fed's ideological dominance of the journals hampered his attempt to warn his colleagues about what was to come. Rosner wrote a strikingly prescient paper in 2001 arguing that relaxed lending standards and other factors would lead to a boom in housing prices over the next several years, but that the growth would be highly susceptible to an economic disruption because it was fundamentally unsound.
He expanded on those ideas over the next few years, connecting the dots and concluding that the coming housing collapse would wreak havoc on the collateralized debt obligation (CDO) and mortgage backed securities (MBS) markets, which would have a ripple effect on the rest of the economy. That, of course, is exactly what happened and it took the Fed and the economics field completely by surprise.
"What you're doing is, actually, in order to get published, having to whittle down or narrow what might otherwise be oppositional or expansionary views," says Rosner. "The only way you can actually get in a journal is by subscribing to the views of one of the journals."
When Rosner was casting his paper on CDOs and MBSs about, he knew he needed an academic economist to co-author the paper for a journal to consider it. Seven economists turned him down.
"You don't believe that markets are efficient?" he says they asked, telling him the paper was "outside the bounds" of what could be published. "I would say 'Markets are efficient when there's equal access to information, but that doesn't exist,'" he recalls.
The CDO and MBS markets froze because, as the housing market crashed, buyers didn't trust that they had reliable information about them -- precisely the case Rosner had been making.
He eventually found a co-author, Joseph Mason, an associate Professor of Finance at Drexel University LeBow College of Business, a senior fellow at the Wharton School, and a visiting scholar at the Federal Deposit Insurance Corporation. But the pair could only land their papers with the conservative Hudson Institute. In February 2007, they published a paper called "How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?" and in May posted another, "How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions."
Together, the two papers offer a better analysis of what led to the crash than the economic journals have managed to put together - and they were published by a non-PhD before the crisis.
Not As Simple As A Pay-Off
Economist Rob Johnson serves on the UN Commission of Experts on Finance and International Monetary Reform and was a top economist on the Senate banking committee under both a Democratic and Republican chairman. He says that the consulting gigs shouldn't be looked at "like it's a payoff, like money. I think it's more being one of, part of, a club -- being respected, invited to the conferences, have a hearing with the chairman, having all the prestige dimensions, as much as a paycheck."
The Fed's hiring of so many economists can be looked at in several ways, Johnson says, because the institution does, of course, need talented analysts. "You can look at it from a telescope, either direction. One, you can say well they're reaching out, they've got a big budget and what they're doing, I'd say, is canvassing as broad a range of talent," he says. "You might call that the 'healthy hypothesis.'"
The other hypothesis, he says, "is that they're essentially using taxpayer money to wrap their arms around everybody that's a critic and therefore muffle or silence the debate. And I would say that probably both dimensions are operative, in reality."
To get a mainstream take, HuffPost called monetary economists at random from the list as members of the AEA. "I think there is a pretty good number of professors of economics who want a very limited use of monetary policy and I don't think that that necessarily has a negative impact on their careers," said Ahmed Ehsan, reached at the economics department at James Madison University. "It's quite possible that if they have some new ideas, that might be attractive to the Federal Reserve."
Ehsan, reflecting on his own career and those of his students, allowed that there is, in fact, something to what the Fed critics are saying. "I don't think [the Fed has too much influence], but then my area is monetary economics and I know my own professors, who were really well known when I was at Michigan State, my adviser, he ended up at the St. Louis Fed," he recalls. "He did lots of work. He was a product of the time...so there is some evidence, but it's not an overwhelming thing."
There's definitely prestige in spending a few years at the Fed that can give a boost to an academic career, he added. "It's one of the better career moves for lots of undergraduate students. It's very competitive."
Press officers for the Federal Reserve's board of governors provided some background information for this article, but declined to make anyone available to comment on its substance.
The Fed's Intolerance For Dissent
When dissent has arisen, the Fed has dealt with it like any other institution that cherishes homogeneity.
Take the case of Alan Blinder. Though he's squarely within the mainstream and considered one of the great economic minds of his generation, he lasted a mere year and a half as vice chairman of the Fed, leaving in January 1996.
Rob Johnson, who watched the Blinder ordeal, says Blinder made the mistake of behaving as if the Fed was a place where competing ideas and assumptions were debated. "Sociologically, what was happening was the Fed staff was really afraid of Blinder. At some level, as an applied empirical economist, Alan Blinder is really brilliant," says Johnson.
In closed-door meetings, Blinder did what so few do: challenged assumptions. "The Fed staff would come out and their ritual is: Greenspan has kind of told them what to conclude and they produce studies in which they conclude this. And Blinder treated it more like an open academic debate when he first got there and he'd come out and say, 'Well, that's not true. If you change this assumption and change this assumption and use this kind of assumption you get a completely different result.' And it just created a stir inside--it was sort of like the whole pipeline of Greenspan-arriving-at-decisions was
It didn't sit well with Greenspan or his staff. "A lot of senior staff...were pissed off about Blinder -- how should we say? -- not playing by the customs that they were accustomed to," Johnson says.
And celebrity is no shield against Fed excommunication. Paul Krugman, in fact, has gotten rough treatment. "I've been blackballed from the Fed summer conference at Jackson Hole, which I used to be a regular at, ever since I criticized him," Krugman said of Greenspan in a 2007 interview with Pacifica Radio's Democracy Now! "Nobody really wants to cross him."
An invitation to the annual conference, or some other blessing from the Fed, is a signal to the economic profession that you're a certified member of the club. Even Krugman seems a bit burned by the slight. "And two years ago," he said in 2007, "the conference was devoted to a field, new economic geography, that I invented, and I wasn't invited."
Three years after the conference, Krugman won a Nobel Prize in 2008 for his work in economic geography.
One Journal, In Detail
The Huffington Post reviewed the mastheads of the American Journal of Economics, the Journal of Economic Perspectives, Journal of Economic Literature, the American Economic Journal: Applied Economics, American Economic Journal: Economic Policy, the Journal of Political Economy and the Journal of Monetary Economics.
HuffPost interns Googled around looking for resumes and otherwise searched for Fed connections for the 190 people on those mastheads. Of the 84 that were affiliated with the Federal Reserve at one point in their careers, 21 were on the Fed payroll even as they served as gatekeepers at prominent journals.
At the Journal of Monetary Economics, every single member of the editorial board is or has been affiliated with the Fed and 14 of the 26 board members are presently on the Fed payroll.
After the top editor, King, comes senior associate editor Marianne Baxter, who has written papers for the Chicago and Minneapolis banks and was a visiting scholar at the Minneapolis bank in '84, '85, at the Richmond bank in '97, and at the board itself in '87. She was an advisor to the president of the New York bank from '02-'05. Tim Geithner, now the Treasury Secretary, became president of the New York bank in '03.
The senior associate editors: Janice C Eberly was a Fed visiting-scholar at Philadelphia ('94), Minneapolis ('97) and the board ('97). Martin Eichenbaum has written several papers for the Fed and is a consultant to the Chicago and Atlanta banks. Sergio Rebelo has written for and was previously a consultant to the board. Stephen Williamson has written for the Cleveland, Minneapolis and Richmond banks, he worked in the Minneapolis bank's research department from '85-'87, he's on the editorial board of the Federal Reserve Bank of St. Louis Review, is the co-organizer of the '09 St. Louis Federal Reserve Bank annual economic policy conference and the co-organizer of the same bank's '08 conference on Money, Credit, and Policy, and has been a visiting scholar at the Richmond bank ever since '98.
And then there are the associate editors. Klaus Adam is a visiting scholar at the San Francisco bank. Yongsung Chang is a research associate at the Cleveland bank and has been working with the Fed in one position or another since '01. Mario Crucini was a visiting scholar at the Federal Reserve Bank of New York in '08 and has been a senior fellow at the Dallas bank since that year. Huberto Ennis is a senior economist at the Federal Reserve Bank of Richmond, a position he's held since '00. Jonathan Heathcote is a senior economist at the Minneapolis bank and has been a visiting scholar three times dating back to '01.
Ricardo Lagos is a visiting scholar at the New York bank, a former senior economist for the Minneapolis bank and a visiting scholar at that bank and Cleveland's. In fact, he was a visiting scholar at both the Cleveland and New York banks in '07 and '08. Edward Nelson was the assistant vice president of the St Louis bank from '03-'09.
Esteban Rossi-Hansberg was a visiting scholar at the Philadelphia bank from '05-'09 and similarly served at the Richmond, Minneapolis and New York banks.
Pierre-Daniel Sarte is a senior economist at the Richmond bank, a position he's held since '96. Frank Schorfheide has been a visiting scholar at the Philadelphia bank since '03 and at the New York bank since '07. He's done four such stints at the Atlanta bank and scholared for the board in '03. Alexander Wolman has been a senior economist at the Richmond bank since 1989.
Here is the complete response from King, the journal's editor in chief: "I think that the suggestion is a silly one, based on my own experience at least. In a 1988 article for AEI later republished in the Federal Reserve Bank of Richmond Review, Marvin Goodfriend (then at FRB Richmond and now at Carnegie Mellon) and I argued that it was very important for the Fed to separate monetary policy decisions (setting of interest rates) and banking policy decisions (loans to banks, via the discount window and otherwise). We argued further that there was little positive case for the Fed to be involved in the latter: broadbased liquidity could always be provided by the former. We also argued that moral hazard was a cost of banking intervention.
"Ben Bernanke understands this distinction well: he and other members of the FOMC have read my perspective and sometimes use exactly this distinction between monetary and banking policies. In difficult times, Bernanke and his fellow FOMC members have chosen to involve the Fed in major financial market interventions, well beyond the traditional banking area, a position that attracts plenty of criticism and support. JME and other economics major journals would certainly publish exciting articles that fell between these two distinct perspectives: no intervention and extensive intervention. An upcoming Carnegie-Rochester conference, with its proceeding published in JME, will host a debate on 'The Future of Central Banking'.
"You may use only the entire quotation above or no quotation at all."
Auerbach, shown King's e-mail, says it's just this simple: "If you're on the Fed payroll there's a conflict of interest."
Elyse Siegel, Julian Hattem, Jeff Muskus and Jenna Staul contributed to this report
One such petition occurred in 1875, in the Ukraine’s Chigrin District. An outside agitator had tried to organize resistance, to stir up trouble, with the local peasantry. After being found out and expelled, a petition asking for Czar Alexander II’s forgiveness was drafted by the locals.
"How could we, simple, backward people, not believe in the kindness of our beloved monarch, when the whole world attests to it, when we know of his love and his trust for his people, his concern for them."
If you think that such bootlicking fawning obsequiousness could never happen in the United States, freedom’s home, the land where the people rule and the rulers serve, you haven’t watched a Congressional hearing with a US Federal Reserve Board chairman recently.
It happens two or three times a year, and it’s always the same. After an exchange of pleasantries, the Fed chairman delivers his opening statement. During the Alan Greenspan era, this invariably meant about a half hour of indecipherable economic gobbledygook flowing thick like molasses; the financial markets could understand what was being said, and frequently reacted violently in response, but few average citizens could. (Hillary Clinton recently announced that, if elected, she wanted Greenspan to head a commission studying the foreclosure crisis, although, in her continuing effort to prove herself just one of the guys downing shots and beer nuts around the bar in working class Pennsylvania, she admitted that "I never understand what he's saying.")
Then the committe members are permitted to question the great oracle. Sometimes, you can tell that the solon is just reading something written by somebody on his staff who once passed an economics course. Sometimes, since the great augur was obviously in possession of wisdom in all matters of the physical domain, the questions might be related to areas totally beyond the chairman’s purview, like, "Tell me, Mr Chairman, what’s your opinion, chains or studded snow tires?" Frequently, like a local asking for the blessing of a Mafia Don for the success of a new enterprise, the questions would be totally parochial, like, "Tell me, Mr Chairman, isn’t the real problem with our economy the lack of funding for post offices in southwestern Wyoming?", asked by, of course, the representative from southwestern Wyoming.
But the main phenomenon of this process was that the questions were almost always asked with the maximum amount of awe, deference and respect, and, invariably, the questioner would not get a straight answer to his question.
An evangel for corruption, August 19, 2009 By Luc REYNAERT (Beernem, Belgium) - See all my reviews
Based principally on the DeLay-Abramoff affair with its muddy torrent of graft, Thomas Frank denounces highly emotionally but limpidly the agenda of the conservative right concerning the State and its government, as well as their ideology of selfishness and greed.
The core of US conservatism is the interests of business. These interests are mightily more important than their `free market' evangel. Mechanisms like tariff walls, public subsidies, monopolies, no-bid contracts or patent protections, will be adopted without any resistance if they enhance profits.
The conservative right sees the liberal State as a perversion, as a corruption of private interests (taxes), not as an instrument to service the population as a whole.
When they took power, they sabotaged the working of the government by appointing ferocious opponents of State agencies (EPA, FDA, SEC) at their head. They even created anti-agencies (OIRA, Council on Competitiveness).
For them, all public services should be subjected to the market system, because that is the most efficient way of ruling. In other words, those services have to be managed by private interests.
For Thomas Frank, the result of these policies was a rip-off. The institutions created for the protection of the population became institutions for the exploitation of the population (arms industry, anti-terrorism, administration of Iraq, recovery of hurricane Katrina ...).
One of the main targets of the conservatives is the Welfare State. The money flows of the welfare programs should be privately managed, thereby generating colossal commissions for a bunch of Wall Street managers, while in the meantime `defunding the left'.
For Thomas Frank, this is a sure way for turning US politics into a plutocracy and concomitantly a `bought' government.
Through lobbyism and pure propaganda for the agenda of the Right, conservatism itself became a business with monster fees for the preachers.
A US senator asked a few years ago: `Have you missed the government?'
If the government had not intervened heavily in the huge banking crisis of the last years, the whole capitalist system would have been turned into a desert, an enormous Great Depression for many years to come. The other side of the coin would have been an astonishing handover of all political, economic and financial world powers to the East (China).
This book is a must read for all those who want to understand the world we live in.
N.B. James K. Galbraith treated the same all important issues in a more theoretical way in his formidable book `The Predator State'.Exposing the Deliberate Mismanagement of a Flawed Political Philosophy,
May 4, 2009
Reading Thomas Frank's The Wrecking Crew has been like finding a key piece to a jigsaw puzzle. My other research led me to believe the things Frank writes about were going on. Frank provides the proof without having to do the first hand research.
By Larry R. Bradley "Author, Neither Liberal Nor... (Omaha, NE) - See all my reviews
In a nutshell, Frank proves the Republican/Conservative approach to governing is not to govern at all. If you are someone who believes there is essentially no difference between the two major US political parties, then this book will change your mind.
My personal preference is I want to vote for a political party whose approach is to govern by balancing the interests of all parties concerned. This approach, to me, is more likely to produce effective and efficient government. In other words, the party might have a preference for one group over another, but the party operates on the premise it will be more likely to be re-elected if it shows itself to be even handed.
Republicans/Conservatives take an entirely different approach. According to Frank's book, Republicans govern only to benefit business and their supporters, not the public as a whole. More on this thought in a moment.
Having recommended in my own book independent voters make contributions to both parties in order to see what each party says about the other, I was especially interested in Frank's description of conservative direct mail fund raising and its enabling of the physical (not intellectual) growth of what passes for conservatism. Frank describes the origins of that phenomenon and how the money is used not just for political purposes but also to feather the nests of those who conduct the operations.
Frank also does a marvelous job of describing the origins and driving philosophies of people such as Jack Abramoff, Grover Norquist and Tom Delay and the creation of the intensive lobbying efforts enabled by those flawed philosophies.
Some prime elements of that flawed philosophy include the following. Govern on behalf of business and your campaign contributors at the expense of the public at large, rather than balancing the interests of all. Hollow out and suppress the activities of regulatory agencies by putting political appointees in place who will to keep the agencies from doing their jobs. Reward your campaign contributors by outsourcing more and more government functions and awarding the contracts to your contributors. Incur excessive amounts of debt so the government will be forced to shrink and push off its welfare and education programs to churches (or at least that is the whispered plan with a wink. Whether such a plan was actually intended to be supported is debatable.)
Show me some examples, you say? How about failure to regulate financial markets to prevent either the speculation in oil prices or the sub-prime meltdown? How about passing drug legislation without negotiation requirements or credit card bills written by credit card companies? How about FEMA and "Heckuva job, Brownie"? How about Monica Goodling (a graduate of Pat Robertson's Regent University) using political litmus tests for attorneys to work for the Justice Department? How about no-bid contracts to Halliburton and using Blackwater mercenaries?
I also liked Frank's cataloging of something I've heard before. If a conservative politician fails to govern well, conservatives will blame not the flawed philosophy. Instead, conservatives will say of the politician that he/she was not a "true conservative".
Overall, I shake my head at the lack of perspective of the people expressing these philosophies. They are like people who complain about the mess the mud between the logs of the log cabin makes inside the cabin, never realizing the purpose of the mud and the damage removing the mud will create.
Thanks to The Wrecking Crew, the flaws of this philosophy have never been more evident.
The Will to Power and Its Followers in the Socially Immature"I am afraid we may have, in the near future, friendly fascism. And I do not use the term lightly. I grew up under fascism, in Franco’s Spain, and if nothing else, I recognize fascism when I see it. And we are seeing a growing fascism with a working-class base in the U.S. This is why we cannot afford to see Obama fail. But his staff and advisors are doing a remarkable job to achieve this. Ideologues such as chief-of-staff Rahm Emanuel (who, when a congressman, was the most highly funded by Wall Street) and his brother, Ezekiel Emanuel (who did indeed write that old people should have a lower priority for health care spending) are leading the country along a wrong path."
Vincente Navarro, Obama's Mistakes in Health Care Reform
Vincent Navarro writes an amazingly insightful political analysis of health care reform and the Obama Adminstration. This is as we would expect, since Navarro, is an M.D., Ph.D., and professor of Health Policy at The Johns Hopkins University and editor-in-chief of the International Journal of Health Services.
But then he goes on to end his essay with this remarkably bad prescription."Given this reality, it seems to me that the role of the left is to initiate a program of social political agitation and rebellion (I applaud the health professionals who disrupted the meetings of the Senate Finance Committee), following the tactics of the Civil Rights and anti-Vietnam War movements of the 1960s and 1970s. It is wrong to expect and hope that the Obama administration will change. Without pressure and agitation, not much will be done."
The Will to Power has a bewitching siren call. It offers simple solutions to complex problems. It provokes the cycle of problem - reaction - solution, and the eye for an eye approach that 'makes the whole world blind.'"Communism and fascism or nazism, although poles apart in their intellectual content, are similar in this, that both have emotional appeal to the type of personality that takes pleasure in being submerged in a mass movement and submitting to superior authority." James A. C. Brown
And yet, like most dark powers, it decimates and destroys who pick up the sword, and lays waste to them, their country, and their children.
This is the lesson of history, the abyss of madness into which a great leader can bring a nation once it loses its sense of proportion, that people in their passionate desire for power often forget.
Target fixation is a process by which the brain is focused so intently on an observed object that awareness of other obstacles or hazards can diminish...The term "target fixation" may have been borrowed from World War II fighter pilots, who spoke of a tendency to want to fly into targets during a strafing run…. Target fixation may also refer to a phenomenon where a skydiver may forget to pull the ripcord because he or she is so focused on the landing area.(From Wikipedia, the free encyclopedia)
... ... ...Evidence of Fed Target Fixation
A speech by Rajan “Has Financial Development Made the World Riskier?” aufficient liqu the past 18 years. I believe that the Greenspan doctrine, if I may call it that, has reflected the Chairman's analysis and deeply held belief that private interest and technological change, interacting in a stable macroeconomic environment, will advance the general welfare.
July 19, 2009 | www.ritholtz.com
This week’s Barron’s has Randall Forsyth going a bit postal on the Usual Suspects:
“With so many miscreants participating in arguably the biggest financial catastrophe in history, it’s all but impossible to point to the chief perpetrator.
In truth, there was a suspension of disbelief all down the line: by mortgage brokers who arranged loans for delusional borrowers who bought houses they both knew they couldn’t afford; bankers who collected, pooled and sliced and diced the junk mortgages into triple-A securities; ratings agencies who provided that Good Housekeeping Seal of Approval to those defective products; investors who credulously bought these mortgage-backed securities with gilt-edged ratings and junk-bond yields; sellers of credit-default swaps who never thought they’d have to pay off on the insurance they’d written. And don’t forget Fannie and Freddie, which leveraged the implicit (and later explicit) backing of Uncle Sam to use cheap credit to balloon their balance sheets. And it was all fine, of course, because house prices never went down.
No less an authority than Alan Greenspan, the former Federal Reserve chairman, saw no problem with this because, firstly, scattering all these loans to the wind meant the risk was dispersed and therefore nobody needed to worry about the all these dubious loans threatening the financial health of any one institution. Moreover, there was no need to worry about bubbles; though they inevitably burst, the damage can be contained by reinflating a new one.
In that, Greenspan had empirical evidence on his side, after having reflated successive burst bubbles over his tenure. The Fed had done just that after the 1987 stock-market crash, which led to the commercial real-estate and junk-bond booms and busts of the late ’80s. And after the dot-com bust of 2001 (which was helped importantly by Fed pumping to stave off the supposed Y2K threat), Greenspan countered by slashing rates to 1% by 2003 and leaving them at preternaturely low levels for a couple of years, which inflated the housing bubble.”
Note what Forsyth writes: Not that there are no villains, but that its hard to pick the worst of the bunch out of all the miscreants involved. Still, it seems he is nominating Greenie as the front runner.
And yet some other people continue to think there were no villains in all of this. Some folks have suggested its simply a case of defining deviancy down, but I believe the more likely explanation is that its yet another Atlas-addled brain unable to process evidence that conflicts with now hard-wired ideolology.
Call it yet another case of cognitive dissonance . . .
It’s Good to Be Goldman
Barron’s, JULY 20, 2009
The way I see this distorted situation is that when someone does come along (in banking or government) who can whip it (whip it good) they are slandered or screwed over like Brooksley E. Born (who could whip it): "As the financial crisis of 2008 gained momentum, newspapers began reporting on what might be some of its causes, including the adversarial relationship Greenspan, Rubin and Levitt had with Brooksley Born,  with Greenspan leading the opposition, and how Born's recommendations were suppressed. She is retired from Arnold & Porter and until recently had declined to comment on the unfolding crisis and her efforts to rein in the growing market for derivatives. "The market grew so enormously, with so little oversight and regulation, that it made the financial crisis much deeper and more pervasive than it otherwise would have been." The disagreement has been described as a classic Washington turf war. She now laments the influence of Wall Street lobbyists on the process and the refusal of regulators to discuss even modest reforms"
Praise be Wiki: http://en.wikipedia.org/wiki/Brooksley_Born
We are living in the wreckage of the Greenspan bubble
As recently as two years ago consumers were buying so many goods on credit that the domestic savings rate was zero. (Financing the U.S. Government’s budget deficit with foreign central bank recycling of the dollar’s balance-of-payments deficit actually produced a negative 2% savings rate.) During these Bubble Years savings by the wealthiest 10% of the population found their counterpart in the debt that the bottom 90% were running up. In effect, the wealthy were lending their surplus revenue to an increasingly indebted economy at large.
Today, homeowners no longer can re-finance their mortgages and compensate for their wage squeeze by borrowing against rising prices for their homes. Payback time has arrived – paying back bank loans, whose volume has been augmented to include accrued interest charges and penalties. New bank lending has hit a wall as banks are limiting their activity to raking in amortization and interest on existing mortgages, credit cards and personal loans.
Many families are able to remain financially afloat by running down their savings and cutting back their spending to try and avoid bankruptcy. This diversion of income to pay creditors explains why retail sales figures, auto sales and other commercial statistics are plunging vertically downward in almost a straight line, while unemployment rates soar toward the 10% level. The ability of most people to spend at past rates has hit a wall. The same income cannot be used for two purposes. It cannot be used to pay down debt and also for spending on goods and services. Something must give. So more stores and shopping malls are becoming vacant each month. And unlike homeowners, absentee property investors have little compunction about walking away from negative equity situations – owing creditors more than the property is worth.
Over two-thirds of the U.S. population are homeowners, and real estate economists estimate that about a quarter of U.S. homes are now in a state of negative equity as market prices plunges below the mortgages attached to them. This is the condition in which Citigroup and AIG found themselves last year, along with many other Wall Street institutions. But whereas the government absorbed their losses “to get the economy moving again” (or at least to help Congress’s major campaign contributors to recover), personal debtors are in no such favored position. Their designated role is to help make the banks whole by paying off the debts they have been running up in an attempt to maintain living standards that their take-home pay no longer is supporting.
. For this attempt to spoil the party, she was excoriated and isolated by an old-boys' mob that included Alan Greenspan, Robert Rubin, Lawrence Summers and Gary Gensler. Incredibly enough, Gensler, an Obama appointee, now holds Born's old job as chair of the CFTC.
More than a decade and several meltdowns later, the Obama administration's 88-page white paper is ambiguous on the subject of whether and how
The Baseline Scenario
As Ezra Klein puts it: “When evaluating a particular financial regulation proposal, ask yourself this question: Would these regulations have worked if Alan Greenspan hadn’t wanted to implement them?” That’s a good question, although it’s a bit unfair: if you posit a regulator who doesn’t believe in regulation, then virtually any regulatory scheme is bound to fail. This is why Fox and Klein argue for ironclad rules that don’t leave room for discretion. In addition, though, I think we also need to think about how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry.
The Mess That Greenspan
Former Fed chairman Alan Greenspan writes in the Financial Times that, if only stock prices would keep going higher, we might have a chance at a sustained economic recovery.The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen.PLEASE!! JUST STOP!!
Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment...
You can't blow more bubbles just by writing an occasional op-ed piece in the Financial Times, an organization that, for their own perhaps perverse reasons, still allows you to air your thoughts to a wide audience on a regular basis.
Maybe the Financial Times still hasn't gotten over the whole "transfer of global superpower status" from six or seven decades ago and sees this as an opportunity to highlight some of the reasons why, in the decades ahead, this power will be shifting again.
Back to the Maestro, as he explains his thinking on perpetually rising asset prices.
It's too bad that not too many people listen to what 'ol Greenie has to say anymore because, in his later years, he's offering more insight into why he did what he did.
I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance
sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the “green shoots” spotted in recent weeks to wither.
Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it.
As evidenced by that last paragraph above, he really believed that a bubble-based economy was the right way to go.
He goes on to talk about inflation, deflation, and political pressure on the Fed.For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3½-year lag) with annual changes in money supply per unit of capacity.While the statistical analysis referred to might be woefully underestimating the timeframe for inflation (look at what oil prices have done lately, just based on "green shoots"), the comments on political pressure are probably on the mark.
That will be Ben Bernanke's big test over the next year - to do what's in the best interest of the economy in the long-term despite there being a mid-term election approaching.
As for the demands of Congress and the White House during Greenspan's tenure, he learned his lesson well from the early-retirement of his unpopular (but now highly regarded) predecessor at the central bank, Paul Volcker:
Political pressure is a constant - if you want to be reappointed, keep the easy money coming.
6/20/2009 | CalculatedRisk
CR Note: This is a guest post by Mathew Padilla of the Mortgage Insider blog. All opinions expressed are Matt's.
A book review by Mathew Padilla for Calculated Risk.
Count the following among the most accurate titles ever written: Nasdaq’s Peak was Greenspan’s. The title introduced a 2001 essay by James Grant, author of newsletter Grant’s Interest Rate Observer, in which the author addresses former Fed Chief Alan Greenspan’s approach to the ‘90s stock bubble: “He seeded it, accommodated it, celebrated it and defended it from those who believed they saw it turn into a bubble.”
The essay is an opening salvo against Greenspan to be followed by three other works that eviscerate the Maestro, the Federal Reserve and U.S. monetary policy in Grant’s late 2008 book Mr. Market Miscalculates: The Bubble Years and Beyond, which is a compilation of his essays celebrating the 25th anniversary of his newsletter. (I confess I submitted the review to Calculated Risk this month because I just finished reading the book.)
In the Nasdaq’s Peak essay Grant deconstructs Greenspan’s March 6, 2000 speech before the Boston College Conference on the New Economy. Greenspan praised the “revolution in information technology” including how managers formulated decisions with “real-time” information and that reduced uncertainty, allowing them to better control inventories. Grant delivers one of his many wry lines:Thanks to clarity afforded by instantaneous communications, Cisco Systems had to write off only $2.25 billion in excess inventories during its third fiscal quarter, in addition to just $1.17 billion in restructuring and other special charges. … Lucent, Corning, Nortel and JDS Uniphase have been devastated by one of the greatest misallocations of investment capital outside the chronicles of the Soviet Gosplan. Who can conceive of the size of this waste had there been no e-mail?It’s the misallocation of capital that gets at the heart of Grant’s criticism of both Greenspan and the Fed. Grant saw Greenspan as the Chairman of Perpetual Intervention, juicing the money supply
- When a big hedge fund had a serious hiccup
- When computers might go bonkers over two-digit dates.
- After Nasdaq tanked. But the former chief saw no need to raise rates to stem speculative excesses. (Recall the 2001 essay is before the most pernicious bubble of all.) Greenspan practiced a lopsided monetary policy.
Compounding his folly, Greenspan was slow to react to the Nasdaq crash and start lowering rates when boom turned to bust in the second half of 2000, Grant writes, adding: “(B)ecause information technology was an absolute and unqualified good thing, it followed that it could not be held responsible for a bad thing – for instance, the bottom falling out of capital investment and, therefore, out of the GDP growth rate.”
That was Grant annoyed. Grant disgusted comes across in a September 13, 2002 essay, Monetary Regime Change, in which Grant’s prose oozes with repugnance as he picks apart Greenspan’s speech that year at the “monetary jamboree” of the Kansas City Federal Reserve Bank in Jackson Hole, Wyo. “Alan Greenspan washed his hands of responsibility for the bubble he said he could not have pricked even if he had noticed it floating above his desk on a string.” Again we are talking about the tech bubble – a warning that Greenspan was a deeply flawed policymaker. Grant goes on:Following is a speculation on the outlines of a post-Greenspan monetary system. It is supported by some of the historical works that the chairman can read in the well-deserved retirement he should have taken starting in about 1996. We say “post-Greenspan” because, we believe, the Jackson Hole Speech will raise the odds against his reappointment (his current term expires in 2004), speed the day of his departure and reduce his policy-making influence for a long as he remains in office.Grant was right about Greenspan not being reappointed, but wrong about his waning influence. In his final years, Greenspan fueled a pernicious explosion in credit, and he provided intellectual cover to politicians either ideologically opposed to regulation or too preoccupied with other matters to get to it. The essayist also was prescient but a little early with this in 2002: “Only one of the troubles with bubbles is that, after they pop, ultra-low interest rates and extraordinary rates of credit expansion lose their stimulative potency. The rate of creation of new yen by the Bank of Japan stands at 26.1% year-over-year, but this outpouring has yielded no appreciable reflationary results.” Grant was exactly right, but after a property bubble, not a stock-market bubble.
Greenspan is the lighting rod, but monetary policy is the storm. Grant writes since the late 19th century to their creators, each monetary system suited the ages. “But none lasted much longer than a generation. The system in place since 1971 is the worldwide paper-dollar system.” Grant takes this idea and runs with it in Mission Creeps, a November 7, 2003 essay that takes stock of the Federal Reserve on the eve of its 90th anniversary. “The Federal Reserve would be unrecognizable to the men who conceived it.” The law creating the Fed defined its purposes as follows, “to provide for the establishment of the Federal Reserve banks, to furnish and elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States, and for other purposes.”
The founders, including Sen. Carter Glass (D.Va.), feared bank runs and their potential to disrupt commerce. They envisioned a central bank that could keep the banking system liquid. But they lived in the era of the gold standard, and never, ever dreamed of an expanding money supply designed to boost employment. Balancing full employment and appropriate inflation came later – the Fed and Congress found uses for the original act’s “and for other purposes.” Grant’s strongest ammunition is fired at the very idea of a central bank’s power to steer an economy, and all the myriad actors in it, by comparing economics to the hard science of physics in 2003:Both use quantitative methods to build predictive models, but physics deals with matter; economics confronts human beings. And because matter doesn’t talk back or change its mind in the middle of a controlled experiment or buy high with the hope of selling even higher, economists can never match the predictive success of the scientists who wear lab coats. … Gov. Ben S. Bernanke is one of those true believers, as he reiterated last month in a lecture at the London School of Economic. “If all goes as planned,” said Bernanke, getting off on the wrong foot, “the changes in financial asset prices and returns induced by the actions of monetary policymakers lead to changes in economic behavior that the policy was trying to achieve.” If all went according to plan, the LSE would be teaching case studies in the triumphs of the Soviet economy.In yet another essay, There ought to be Deflation, in January 14, 2005, Grant builds on the idea of a monetary policy as a source of economic distortion. He quotes Friedrich von Hayek, who, while accepting the Nobel price for economics more than 20 years ago, said:The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of money stops or slows down, together with the expectation of a continuing rise in prices, draws labor and other resources into employment which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate.And that is exactly what happened when Greenspan cut rates in the 2000s. Workers flooded into subprime lenders, construction companies, Home Depots, and on and on.
Grant bemoans, in more than one essay, the death of the gold standard. In his view a fixed currency would constrain both the Fed and the federal government. It might even have prevented a war of choice in Iraq, since what cannot be funded cannot be done. But fixed currencies have their disadvantages, writes another Nobel laureate, Paul Krugman, in another book tackling our current woes, his updated The Return of Depression Economics and the Crisis of 2008. A currency that is allowed to fall benefits an economy in recession since its exports become cheaper, Krugman argues. He’s also a proponent of a flexible currency giving a central bank freedom to expand money and combat unemployment.
Curiously, Krugman has a chapter in his book dubbed Greenspan’s Bubbles, but he does not address the Greenspan conundrum: what to do about the risk a Fed chairman will over stimulate asset prices while doing nothing to stop credit abuses. Until that problem is addressed I side with Grant and Hayek – expansionary monetary policy is dangerous.
In all of Mr. Market Miscalculates, I have but one quibble with Grant’s views. He cites the “socialization of risk” as encouraging reckless corporate behavior. The problem began with FDIC insurance and culminated in Greenspan’s interventions, including the orderly dissolution of hedge fund Long Term Capital Management. Grant’s case is that banks are more willing to lend to corporate cowboys if they think government will bail them out, or the market overall.
An alternative view is that FDIC insurance has been a key element among government initiatives that maintained safety and soundness in banking for some 50 years. It wasn’t until President Reagan initiated the anti-regulation era that insured institutions went bonkers – S&Ls binged on junk bonds and commercial real estate. Even now, with all that has happened, consumers are not lining up at insured banks in an all out panic – before FDIC insurance some good banks failed on mere rumors of trouble.
And moral hazard did not fuel the excesses of the era just ended. As an example, noninsured, nonbank New Century Financial secured more than $15 billion in credit lines from bigger banks in housing’s heyday. No one thought the subprime generator was too big to fail. And as soon as it wobbled, New Century found its credit cut off, and it fell into the abyss. This is the real issue with the modern era -- capital flows quickly, at times too quickly, into and out of any venture anywhere in the world.
On the whole, there is much genius in Grant’s observations. And his book covers more than what I touched on here. He gives a modern take on value investing, illuminates Wall Street’s mortgage fantasies, and more. As for a solution to the Greenspan problem, it is not Grant’s style to offer one. He never explicitly says the country should return to the gold standard or hack some appendages off the Federal Reserve. Grant is subtler, and more general. He simply warns us: change is coming.
Mathew Padilla is co-author of Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis, a USA Today Business Book of the Year, and hosts the Mortgage Insider blog.
And this brings us to Alan Greenspan, whom I've known for over 50 years and who I regarded as one of the best young business economists. Townsend-Greenspan was his company. But the trouble is that he had been an Ayn Rander. You can take the boy out of the cult but you can't take the cult out of the boy. He actually had instruction, probably pinned on the wall: 'Nothing from this office should go forth which discredits the capitalist system. Greed is good.'
However, unlike someone like Milton, Greenspan was quite streetwise. But he was overconfident that he could handle anything that arose. I can remember when some of us -- and I remember there were a lot of us in the late 90s -- said you should do something about the stock bubble. And he kind of said, 'look, reasonable men are putting their money into these things -- who are we to second guess them?' Well, reasonable men are not reasonable when you're in the bubbles which have characterized capitalism since the beginning of time.
But now Greenspan admits he was wrong.
Because we had, instead of three standard deviations storm, a six standard deviation storm. Well, we did have something unprecedented. I think looking for scapegoats and blame can be left to the economic historian. But, at the bottom, with eight years of no regulation from the second Bush administration, from the day that the new SEC chairman -- Harvey Pitt -- said 'I'm going to run a kinder and gentler SEC,' every financial officer knew they weren't going to be penalized.
Self regulation never worked as far as macroeconomic events -- whether we're talking about post-Napoleonic War business cycles or the big south sea bubble back in Isaac Newton's time, up to today's time. The pendulum just swings back in the other direction.
October 9, 2008 | www.huffingtonpost.com
In a superb front-page article in today's New York Times, "Taking a Hard Look at a Greenspan Legacy," Peter S. Goodman treats his readers to a banquet of former Federal Reserve Chairman Alan Greenspan's oracular pronouncements in favor of deregulating derivative markets -- Yes, those unregulated, absurdly inflated "swaps" and other exotic debt instruments that are largely responsible for crippling the financial system of our civilization.
According to the article, Mr. Greenspan told a Congressional committee in the mid-1990s: "Risks in financial markets, including derivative markets, are being regulated by private parties. There is nothing involved in federal regulation per se which makes it superior to market regulation." Oh, Really? I don't know what history books Mr. Greenspan reads -- maybe he should put down Atlas Shrugged for a moment and read about the causes of the Great Depression, or even the causes of the more recent dot-com bust or the failure of WorldCom, Tyco, Adelphia, etc. Or, better yet, maybe Greenspan should return the "Enron Prize" that "Kenny Boy" Lay gave him in 2000 and read up on the causes of the Enron collapse. I guess it is too much to ask a multimillionaire economist to lower himself and pick up a book about how American society has actually worked in the past, instead of relying on his ideological wet dreams.
Greenspan knows that banking regulations, like the 1933 Glass-Steagall Act, did not come forth because the financial system was humming along, but rather, they emerged out of a financial crisis similar to the one we are experiencing right now.
Goodman's piece shows that Mr. Greenspan is an ideologue. His devotion to the free-market Ayn Rand-Milton Friedman creed is as fanatical as a Conquistador or a Maoist. Although Greenspan refused to grant an interview for the article, he is still gallivanting around the country telling his acolytes at high-paid speaking engagements: "Risk management can never achieve perfection." His assessment of the current financial meltdown is exactly like George Bush's assessment of the damage caused by Hurricane Katrina: "Oops, sorry -- I'll try to get it right next time." Well, that attitude is simply not good enough anymore -- if it ever was. We expect more from our public officials now.
Ironically, the economic crisis Greenspan helped create offers us an opportunity. It comes at the perfect time for an electoral referendum on the disastrous eight-year reign of Bush the Younger and his Republican cheerleaders, as well as a repudiation of neo-liberal, laissez-faire, right-wing ideology that has been rammed down the nation's throat for three decades. I think most Americans now realize that Greenspan's libertarian worldview is nothing more than greed posing as public policy.
And yet with all of the evidence that Wall Street could not be trusted -- the "golden parachutes" for executives who crash their companies, the insider trading and fraudulent over-valuation of stocks, the labyrinthine network of off-shore accounts and "special purpose entities" that look a lot like money laundering, and so on -- Mr. Greenspan, at a time when derivatives were infecting the international banking system like a financial AIDS virus, had this to say in 2004 : "Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient."
Those words should be Alan Greenspan's epitaph -- they should be inscribed on his tombstone when he joins Ayn Rand and Milton Friedman in the great free-market utopia in the sky.
The sociologist/economist, James O'Connor, argued long ago that an "accumulation crisis" of the magnitude we're now seeing historically always ushers in a "legitimation crisis" as millions of people slowly begin to realize that the smart white men in pin-striped suit (like Greenspan) who they trusted to run the nation's most important financial institutions have been lying to them all along, and are, in reality, nothing but a bunch of white-collar criminals free of any ethical constraints. That's what happened after the Great Depression: two crises, one economic, the other political. And just look at the behavior of the AIG executives who took a weeklong vacation partying and golfing and getting pedicures and manicures (and who knows what else) at a beachside resort lavishing on themselves $500,000 AFTER receiving the $85 billion bail out from the American taxpayers. What are we to make of people like that? And Alan Greenspan still says we can trust these guys?
No wonder the Republicans do not want us to look back on the recent history that brought us to this point. Given that Ronald Reagan, the free-market avatar who started the ball rolling, appointed Alan Greenspan to be Fed Chair, he, more than any other individual, embodies the market fundamentalist philosophy that has brought the nation to its knees.
Hank Paulson and Ben Bernanke are trying to pretend that they have the situation under control, but this thing is so huge and complex and international in scope they do not have a clue about how to begin addressing the crisis. They're not riding a "tiger," they're chasing a thousand tigers in the middle of a hurricane. They are play acting as if they are running things so the stock market is reassured. Well, today's 678 point drop in the Dow indicates that these men have no credibility, hence, proof that the "legitimacy crisis" continues.
I think it's safe to say that Alan Greenspan will go down in history, along with George W. Bush, as a reckless and radical proponent of failed laissez-faire policies, as well as one of the worst public officials in American history.
October 20, 2005
The editor of The Economist is currently on NPR. Responding to a question from a listener about Alan Greenspan's role in the Bush deficits, he deflected it by saying that Greenspan is just in charge of monetary policy, so it's really on Bush, but perhaps could have used his "bully pulpit" more. The dishonesty here, of course, is implying that Greenspan has consistently opposed Bush's fiscal policy but not loudly enough. Er, no. As the country's Randian-in-chief is let out to pasture, let his profoundly embarrassing argument in 2001 that the possibility that the national debt would be paid off too quickly was a good reason for Bush's unpaid-for upper-class tax cuts be mentioned as much as possible.
Apr 17, 2009 | NYT (Reuters)
The Federal Reserve allowed the global credit crisis to happen and must be redrawn as a tough regulator to stop big financial institutions from taking excessive risks, prominent Wall Street economist Henry Kaufman said on Friday.
The world is "now in the midst of the worst financial crisis since the Second World War," Kaufman said in a speech titled "Who is Primarily Responsible for the Credit Crisis?" he gave to a conference in New York.
"I am convinced that the misbehavior of some would have been much rarer -- and far less damaging to our economy -- if the Federal Reserve and, to a lesser extent, other supervisory authorities, had measured up to their responsibilities," Kaufman said.
Kaufman became known for correctly forecasting higher inflation and interest rates when he was chief economist with Salomon Brothers in the 1970s and 1980s. During that time, he acquired the moniker "Doctor Doom" among financial market watchers and is well known as an expert on monetary policy and how financial markets work.
"At a minimum, the Fed's sensitivity to financial excesses must be improved," Kaufman said.
SAYS GREENSPAN FAILED TO WARN ABOUT RISKS
Kaufman directly criticized former Federal Reserve Chairman Alan Greenspan for not using his position to dissuade big banks and others from taking big risks.
"Alan Greenspan spoke about irrational exuberance only as a theoretical concept, not as a warning to the market to curb excessive behavior," Kaufman said. "It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective."
Partly because the Fed did not strongly oppose the repeal in 1999 of the Depression-era Glass-Steagall Act, more large financial conglomerates that were "too big to fail" have formed, Kaufman said, citing a factor that has made the global credit crisis especially acute.
"Financial conglomerates have become more and more opaque, especially about their massive off-balance-sheet activities," he said. "The Fed failed to rein in the problem."
Banks' exposure via hedge funds and structured investment vehicles, known as SIVs, to assets that turned bad have burdened them with trillions of dollars of write-downs and losses since the credit crisis erupted in mid-2007.
The U.S. central bank is largely to blame for the banking system's ballooning exposure to such risks, Kaufman said.
"Much of the recent extreme financial behavior is rooted in faulty monetary policies," he said. "Poor policies encourage excessive risk taking."
Now the Fed should act as a regulator to strictly oversee big financial institutions and impose "constraints on their assets and profit growth," he said.
However, Kaufman praised the central bank's many emergency measures to combat the global financial crisis by supporting securities markets to get credit flowing again.
For the central bank's "resourcefulness and innovativeness in working to revive the credit market ... the Fed deserves to be commended," Kaufman said. "Even so, these actions came after the crisis had gained considerable momentum."
(Reporting by John Parry; Editing by Jan Paschal)
To outline his fears about the U.S. economy, Raghuram Rajan picked a tough crowd.
It was August 2005, at an annual gathering of high-powered economists at Jackson Hole, Wyo. -- and that year they were honoring Alan Greenspan. Mr. Greenspan, a giant of 20th-century economic policy, was about to retire as Federal Reserve chairman after presiding over a historic period of economic growth.
Mr. Rajan, a professor at the University of Chicago's Booth Graduate School of Business, chose that moment to deliver a paper called "Has Financial Development Made the World Riskier?"
His answer: Yes.
Mr. Rajan quickly came under attack as an antimarket Luddite, wistful for old days of regulation. Today, however, few are dismissing his ideas. The financial crisis has savaged the reputation of Mr. Greenspan and others now seen as having turned a blind eye toward excessive risk-taking.
He says he had planned to write about how financial developments during Mr. Greenspan's 18-year tenure made the world safer. But the more he looked, the less he believed that. In the end, with Mr. Greenspan watching from the audience, he argued that disaster might loom.
Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. Rajan argued. That encouraged financial firms to invest in complex products with potentially big payoffs, which could on occasion fail spectacularly.
He pointed to "credit-default swaps," which act as insurance against bond defaults. He said insurers and others were generating big returns selling these swaps with the appearance of taking on little risk, even though the pain could be immense if defaults actually occurred.
Mr. Rajan also argued that because banks were holding a portion of the credit securities they created on their books, if those securities ran into trouble, the banking system itself would be at risk. Banks would lose confidence in one another, he said: "The interbank market could freeze up, and one could well have a full-blown financial crisis."
Two years later, that's essentially what happened.
Many of the big names in Jackson Hole weren't ready to hear the warning. Former Treasury Secretary Lawrence Summers, famous among economists for his blistering attacks, told the audience he found "the basic, slightly lead-eyed premise of [Mr. Rajan's] paper to be misguided."
The 45-year-old Mr. Rajan is an unlikely dissident. Born in Bhopal, India, he had a childhood marked by stints in Indonesia, Sri Lanka and Belgium, as his civil-servant father rose through the ranks. In high school, he came across the work of British economist John Maynard Keynes, who became his intellectual hero.
He was "helping the world out of recession," Mr. Rajan says of Lord Keynes. "For a person growing up in a developing country, you sort of believe that there has to be a better way."
Joining the University of Chicago's business school in 1991, Mr. Rajan established himself as a rising star. He won the first Fischer Black Prize in 2003 for the person under 40 who has contributed most to the theory and practice of finance. Later that year he became the IMF's chief economist, the youngest person and first non-Westerner in that position.
The Jackson Hole contretemps followed by a few months another set of attacks on Mr. Rajan for a study he co-wrote at the IMF that concluded foreign aid didn't help developing countries grow. Mr. Rajan says the twin controversies didn't deter him. At the IMF, he pushed the research department to focus on financial-sector issues, and continued to sound alarm bells about financial-market risks.
By summer 2007, as the crisis began unfolding in earnest, Fed bank presidents Janet Yellen and Gary Stern were citing Mr. Rajan's critiques in their speeches.
With the economy heading toward the deepest recession since World War II, Mr. Rajan believes, the government needs to be more forceful in its efforts to right the still-teetering banking sector, deciding bank by bank which ones deserve capital injections and which need to die. Otherwise, banking problems will deepen, as they did in Japan in the 1990s, he says, and delay an economic recovery.
Mr. Rajan is now focused on coming up with ways to avoid a regulatory backlash akin to what happened during the Great Depression, when governments around the world threw up protectionist barriers and clamped down on financial markets.
Instead of heavy regulation, he says, the incentives of Wall Streeters need to change so that punishments for losing money are in line with rewards for earning it.
At the start of 2008, he suggested that bonuses that financial workers make during boom times should be kept in escrow accounts for a period of time. If the firm experienced big losses later, those accounts would be drained.
Facing withering criticism over the bonuses paid out in the boom, financial giant UBS and Wall Street firm Morgan Stanley have recently announced they're adopting policies along the lines of what Mr. Rajan proposed.
Mr. Rajan also urges other safeguards. Along with Chicago colleagues Anil Kashyap and Harvard economist Jeremy Stein, he's come up with a plan to create a form of financial-catastrophe insurance that firms would buy into.
When he presented the insurance idea at last year's Jackson Hole confab, the reaction was different than back in 2005. Finnish central-bank governor Erkki Liikanen, recalling the weaknesses Mr. Rajan had spotted in the system back then, said: "I don't dare criticize you. That is all."
William White’s tussle with Alan Greenspan is spilling into their retirements as world leaders meet in London to try to prevent the next financial meltdown.
White challenged the former Federal Reserve chairman’s mantra that central bankers can’t effectively slow the causes of asset bubbles when he was chief economist at the Bank for International Settlements.
As heads of state gather for tomorrow’s Group of 20 summit, several former central bankers and regulators are advising them to advance the same arguments White has made for more than a decade: raise interest rates when credit expands too fast and force banks to build up cash cushions in fat times to use in lean years.
"We started worrying about this at the same time that Alan Greenspan started worrying about irrational exuberance" in 1996, said White, a Canadian who has remained in Basel, Switzerland, since retiring from the BIS in June. "The difference was he stopped worrying about it, or at least he stopped worrying about it publicly, and we didn’t."
Chiefs of the world’s 20 biggest economies, including U.S. President Barack Obama and Chinese President Hu Jintao, will debate how the first contraction in the global economy since the Great Depression could have been avoided, and how to change systems for managing growth and regulating financial industries.
White, now 65, suddenly has company. His approach is reflected in position papers for the G-20 written by Jacques de Larosiere, former head of the International Monetary Fund and the Bank of France, and former Fed Chairman Paul Volcker.
"Concerns for financial stability are relevant not just in times of financial crisis, but also in times of rapid credit expansion and increased use of leverage that may lead to crises," a panel led by Volcker said in a January report for the coalition of former central bankers, finance ministers and academics known as the Group of Thirty.
Stability matters because today’s economic stress could quickly lead to social unrest, which is what happened in the 1930s, White said in an interview across from his old office in Basel. He described how his father was killed in 1944 fighting Adolf Hitler’s forces in France near the town of Caen in Normandy. White was born on May 17, 1943, in Kenora, Ontario, about 400 miles north of Minneapolis.
In this crisis, the U.S. government and the Fed alone have spent, lent or guaranteed US$12.8 trillion to try to prop up the banking industry and overall economy to stem the longest recession since the 1930s. The World Bank said last month that the global economy will probably shrink this year for the first time since World War II.
White’s warnings that credit risks were building up started while he was at the Bank of Canada, where he was deputy governor from 1988 to 1994. They were his constant refrain for more than 15 years, said Michael Mussa, senior fellow at the Peterson Institute in Washington and former IMF chief economist.
"I met Bill in 1991 or 1992, and we were already talking about this back then," Mussa said.
In 1994, White joined the BIS, a counterparty for the world’s central banks and a forum for top policy makers and finance officials. He became head of the monetary and economic department in 1995. The BIS also houses the Basel Committee on Banking Supervision, which sets international bank capital requirements.
White took his argument directly to Greenspan on Aug. 28, 2003, at the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming. Claudio Borio, head of research for White’s department, prepared for questions as White wrote his notes out in longhand at the Jackson Lake Lodge in Grand Teton National Park.
"Claudio said to me quite rightly, ‘We cannot miss this chance, everybody is going to be there,’" White said. Borio, still at the BIS, declined to comment.
Greenspan was unmoved by the presentation and said he pointed out that the Fed had tried and failed to stem a surge in stock prices by raising its target for the Federal Funds rate by 300 basis points in 1994. A basis point is 0.01 percentage point. He still isn’t convinced White’s monetary policy plan would work, he said.
"There has never been an instance, of which I’m aware, that leaning against the wind was successfully done," Greenspan, 83, said in a Feb. 27 telephone interview. He added that spotting a bubble is easy. What’s hard is predicting when it will pop.
‘Out of Whack’
Greenspan, who retired as Fed chairman in 2006, did broadly agree with White’s position on safety margins for banks, he said.
"It has always bothered me that our capital requirements are so low," he said. "We do not have an adequate cushion."
Mark Gertler, a New York University economics professor who has collaborated on research with Fed Chairman Ben Bernanke, Greenspan’s successor, said that the U.S. housing boom and bust weren’t caused by low interest rates in 2003 and 2004. The problem stemmed from the decline in subprime mortgage lending standards and from leaving investment banks essentially unregulated even as they held mortgages and issued short-term liabilities like commercial banks, he said.
"The first-order cause of this crisis was the regulatory system was way out of whack," Gertler said. "It’s not the case that you can get at this alone with interest-rate policy; it really requires smart regulatory policy."
White’s policy plans recently have been endorsed through words and actions. Axel Weber, president of Germany’s central bank and a European Central Bank board member, said in a Feb. 10 speech in Malaysia that monetary authorities should consider raising rates if risk increases in financial markets, even if there is no short-term inflation-fighting reason to do so.
UBS, Credit Suisse
Bank capital regulation changes like the ones White promotes were adopted in December by Switzerland. The country set up new rules for UBS AG and Credit Suisse Group AG requiring them, by 2013, to hold between 50% and 100% more capital than the minimum 8% of risk-weighted assets under Basel rules. They could dip into the shock absorber in hard times. The regulator also instituted a leverage ratio, or a maximum amount of debt each bank could hold relative to its capital.
White will have influenced the discussion at the G-20 meeting, which he’s not attending, as part of a committee headed by the ECB’s former chief economist, Otmar Issing, which made recommendations to the German government. White also presented his views at a Feb. 18 conference in Toronto aimed at forming the Canadian government’s proposals.
White watched from the Bank of Canada as shares and real- estate prices soared in Japan in the 1980s. Asset prices then crashed, growth ground almost to a halt and unemployment climbed.
"It’s not rocket science in the sense that the fundamental insight is to watch the developments, what I would call the what, the why and the when of these crises," White said. "When you’ve seen one of them and it’s made an impression on you, it’s easier for you to see the problems building up elsewhere."
That led White to pen admonitions for a series of BIS annual reports.
"Some developments over the past year revealed disturbing laxities in internal governance, of both corporations and financial institutions, as well as in oversight and market discipline," White wrote for the report published in June 2004.
No ‘New Era’
Two years later, he wrote, "The recent historical experiences of Japan, Germany and Southeast Asia all indicate that costly economic downturns are possible, even after long periods of exceptional performance."
His darkest warning came on the eve of today’s financial turmoil.
"Virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s," he wrote for the June 2007 report. "Each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived."
ECB President Jean-Claude Trichet praised the BIS as "obviously the most lucid institution in terms of its own research and publications" when asked about White after a Feb. 20 speech to the European American Press Club in Paris.
Beyond the current economic pain, White said the social costs of a severe economic crisis, in particular potential spikes in extremism, also propel him in his quest to find a way to limit boom-and-bust cycles.
"When you think about the big economic disruptions, what I always worry about is that you get into the fault lines on the political and social side of things pretty fast," White said, citing the confluence of the Great Depression and Hitler’s rise to power in Germany.
White’s critics often mistake the symptom of asset bubbles for the cause, which is a rapid increase in credit, he said. While his policy wouldn’t stop asset appreciation, it might squeeze out some of the gains that didn’t stem from improved productivity or technology, he said.
Still, he is modest about whether his financial stability elixir is made up of exactly the right ingredients.
"I’d like to believe that having been right about one thing implies a greater probability of being right about the other," White said, smiling. "But, of course, logically it’s not true. It doesn’t necessarily follow."
04.03.09 | Forbes.com
It's been quite a spectacle for those who have followed Alan Greenspan's career for decades. Gone is the financial rock star or even the statesman testifying before Congress in a measured baritone. Instead, over the past several months, Alan Greenspan has morphed into a totally new person.
The first incarnation was the shaken Greenspan who was stunned that greedy and reckless short-term behavior could overwhelm long-term, rational self-interest. That was rather amazing all by itself. But now, there's a newer Greenspan--a decidedly prickly and whiny one.
I'm talking about Greenspan's recent op-ed in The Wall Street Journal. A 1,500-word attempt to move blame for the financial crisis away from himself and onto ... China.
It was, writes Greenspan, Chinese growth that led to "an excess" of global savings. That growth kept long-term interest rates low, which fueled the housing bubble. As for himself, the lowly chairperson of the Fed, he says he was helpless. He only had control over short-term rates.
Why this recent incarnation as a self-pitying victim of historical forces? Most likely, it's because of John Taylor, a mild-mannered professor at Stanford and former colleague of Greenspan's at the Fed.
In his Getting Off Track, a nifty little book, Taylor exposes, as plain as day, the culprit behind the financial boom-bust: Greenspan. His weapon of choice is the "Taylor rule" (discovered by Taylor--but not named by him, as he modestly points out.) (The Taylor rule is a recommendation about how the Fed should set the short interest rate--suggesting the amount it should be changed given economic conditions.)
Here's Taylor's take. Short interest rates fell in 2001 in response to the dot-com bust. But--and here's the important moment--beginning in 2002, the Taylor rule indicated that Greenspan ought to have tightened. Indeed, from 2002 to 2005, rates ought to have climbed to a touch over 5% and then stayed there through 2006.
But the Fed kept to a loose monetary stance, and rates kept falling during the period 2002 through 2004. Rates didn't start back up until middle of 2004 and didn't reach 5% until 2006. You can check this out in Figure 1, below.
The result? The Greenspan Loose policy went on to fuel a boom, while the Taylor Tight would have avoided one. As Taylor says, all the Fed needed to do was follow "... the kind of policy that had worked well during the period of economic stability called the Great Moderation, which began in the early 1980s."
The connection between Greenspan Loose and the housing boom is also clear. Housing starts took a sharp spike up in 2003 and then continued to climb through 2006. If the Fed had followed Taylor Tight, however, housing starts would have peaked at a much lower level at the end of 2003, and drifted down through 2006.
What about Greenspan's argument that he only controlled short-term rates? And that short rates became decoupled from long-term rates in 2002?
Nonsense, says Taylor. Surely the existence of adjustable-rate mortgages (accounting for about one-third of mortgages starting in 2003) linked the mortgage market and short-term rates. Moreover, says Taylor, whatever minor decoupling occurred, happened because bond investors were flummoxed by the Fed's odd behavior.
Taylor also takes on Greenspan's excuse that he was helpless in the face of a global saving glut. Cutting off the feet of Greenspan's excuse, Taylor says there wasn't a glut, there was a shortage. Figures from the International Monetary Fund show global saving rates, as a share of world GDP, were low during 2002 to 2004--way lower than rates in the 1970s and 1980s. In fact, the global saving rate fell at the end of 1990s, hitting bottom about 2003.
Greenspan's monetary excess was also crucial in setting off a chain of bad government policies. As Taylor argues, Greenspan Loose was amplified by the popularity of subprime mortgages, especially adjustable-rates, which promoted risk taking. And it made for a lethal brew in a pot of policies to promote homeownership.
Greenspan pulls out many stops in his defense. He even quotes the great Milton Friedman's approving assessment of Fed policy between 1987 and 2005. Well, Friedman died in 2006 and, in 2009, his equally great colleague, Anna Schwartz, has this to say: "There never would have been a subprime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for." As for Greenspan's argument that the whole mess is China's fault, she says tartly: "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can't be blamed on global events."
As fine a last word as there could be.
Susan Lee has written several books on economics, including a college text. She is an economics commentator for NPR's "Marketplace" and writes a weekly column for Forbes.
MARCH 30, 2009
I was wrong, Alan Greenspan said in so many words. Seated before his congressional inquisitors in October 2008, with the worst financial crisis since the Great Depression cascading down Wall Street, Mr. Greenspan confessed that the philosophical principle upon which he had based his highly influential professional judgment is—flawed.
For some two decades as chairman of the Federal Reserve, Greenspan had counseled presidents and Congresses that government deregulation of financial markets and reliance upon self-regulation by self-interest was the way of both freedom and prosperity. The collapse of one insolvent bank after another has called such counsel into question.
Here are Greenspan’s own words: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.... The whole intellectual edifice [of risk-management in derivative markets]...collapsed last summer.” Asked whether his ideological bias led him to faulty judgments, he answered: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”
One pillar in the “intellectual edifice” of Mr. Greenspan’s economic philosophy is the objectivist philosophy of the late Ayn Rand, whose inner circle Greenspan joined in the 1950s. As explained in her book The Virtue of Selfishness (1964), Rand believed that the individual exists solely for her own happiness and thus that rational self-interest is the only objective basis for moral action. There are no moral constraints on the selfish pursuit of personal happiness, except force and fraud. And there is no moral duty to sacrifice individual advantage for any greater good, because there simply is no greater good than personal happiness (“egoism”).
In the view of the objectivist philosophy, the only moral economic system is laissez-faire capitalism, which gives free rein to the selfish pursuit of individual profit. Accordingly, government should be minimal, limited to national defense, property protection and criminal prosecution. In his memoir, The Age of Turbulence, Greenspan acknowledged Rand as a “stabilizing force” in his life and reconfirmed as “compelling” the “philosophy of unfettered market competition.”
Ayn Rand and the Egoist Ethic
As his comments to Congress indicate, Greenspan seemed sincerely surprised (and distressed) that financial institutions managed by self-interested individuals seeking to maximize private gain in unregulated markets would not have more prudently protected shareholder interest from excessive risk. He had assumed, implicitly, that corporate executives would seek what was best for the institution and its investors—and hence, that self-regulated self-interest would align private profit with institutional good. Given a Randian ethic of rational selfishness, however, one should be wary of such assumptions.
The egoist ideal is that, short of force or fraud, I pursue my own advantage regardless of others, because individual happiness is the ultimate good. Consider executive compensation. If I am an executive, then on egoist terms, I have limited rational interest to sacrifice personal gain for shareholder equity on account of risk assessment, as long as my compensation package guarantees me multimillions regardless of stock performance. Even if the company crashes, I escape with my “golden parachute.”
The egoist ethic amplifies this divergence between private interest and common good throughout the financial market. Consider the mortgage market. If I am a mortgage lender, then issuing risky loans that are unlikely to be repaid is a good investment for me, as long as the secondary mortgage market allows me to pass the risk of default to others—say, by selling the loans on the secondary market for bundling into mortgage-backed “securities.” Even if the borrower later goes into default, I have gained in the market as long as I am able to remove the loan from my books and reap my commission.
And if I am an investment banker, then purchasing bonds backed by risky loans is also a good investment, as long as a derivatives market allows me to “swap” the risk with a leveraged investor or an insurance company. Even if the underlying loans go into default, I have still maintained my market position, as long as my credit-default swaps pay out and I cover my losses.
In short, as long as there is an unregulated market for betting on loan defaults and as long as there are investors willing to take the bets, financial risks that promise individual profit with potential cost to the common good make rational sense. Of course, this game of risk is sustainable only as long as the bets continue paying off—which meant in this case, only as long as housing prices continued rising. With the burst of the bubble in the housing market, resuluting in a flood of mortgage defaults, bond sellers and default insurers alike were left unable to make good on their promises, leaving bond holders to absorb the losses they had gambled others would pay. Although the risk-takers have reaped their reward in a whirlwind, it is ultimately stockholders and taxpayers who have borne the real cost through losses to retirement funds and education budgets.
Greenspan’s “intellectual edifice” of self-regulation by self-interest has thus collapsed upon its own presuppositions. Having recognized the “flaw” in his thinking, Greenspan now suggests that financial institutions selling complex products (e.g., securities backed by high-risk mortgages) be required to hold a substantial portion of the bonds they issue in their own portfolio. That is, institutions should be required to expose themselves to the risk they market to others in order to constrain the excesses of self-interest.
Reasonable regulation of capital markets and executive compensation to rein in self-interest, though necessary, does not get to the heart of the matter, however. The deeper philosophical issue is that the egoist ethic underlying Greenspan’s theory is an insufficient foundation for how we envision our economic life. According to the Randian philosophy, rational selfishness is the chief virtue, its constraint the chief vice. What the financial crisis teaches us is that excessive self-interest is economically destructive. Unrestrained selfishness is thus itself a vice, undermining not only the general welfare but also self-interest.
While self-interest is the operative principle of the marketplace, and while Greenspan is correct to argue that markets have made expanding prosperity possible for many, the unrestrained self-interest that egoism values has proved corrupting of the very free market in which it was supposed to flourish. Rational selfishness without moral constraint has corroded the trust between financial institutions that is necessary to sustain the flow of credit upon which a market-capitalist economy depends. Not even the lowering by the Federal Reserve of its lending rate to practically zero has been sufficient to stimulate financial markets in the current climate of mistrust.
Buying into the market, inasmuch as it involves risk, depends on trust; but trust in the market cannot be bought. For trust depends essentially upon the trustworthiness of prospective buyers and sellers, borrowers and lenders. Without mutual trustworthiness, freedom of exchange is undercut, even if the cost of buying into the market (the interest rate, for example) is cut to zero. Virtue thus is prior to freedom; and without virtue, freedom destroys itself. The free market cannot operate by self-interest alone, therefore, but relies on ethical presuppositions.
An Alternate Vision
What is further lacking in the Randian philosophy is a robust concept of the common good. The common good is more than the competing interests of selfish individuals (the view on the right). It is also more than the composite interests of special groups (the view on the left). The common good is “the good we have in common”—the comprehensive communal conditions necessary for the virtuous pursuit of human fulfillment by all in society.
Talk of virtue ethics and the common good is the language of Christian moral philosophy. The financial crisis, then, issues a special call to the faithful. American society needs an alternative vision of economic life to the one that has reigned over the past quarter-century and has now brought so many institutions and investors to ruin.
The first task of this alternate vision—in the face of ingrained individualism and endemic egoism—is to reclaim the very fact of our common life as the basis of our obligations to one another. Times of crisis remind us of our inter-dependence and summon us to our mutual responsibilities. Without sustained focus and reflection, however, such lessons learned can be quickly lost in the public consciousness. (Recall how soon the official message after 9/11 shifted from “let’s pull together” to “everyone go shopping.”)
As a Mennonite philosopher, I have found Catholic social teaching to provide a plentiful resource of reflection on these questions, especially Leo XIII’s encyclical Rerum Novarum (1891), where we can find precisely the principle that we need to re-learn: “Civil society exists for the common good, and, therefore, is concerned with the interests of all in general, and with the individual interests in their due place and proportion” (No. 37).
From the perspective of Catholic social teaching, individual interest is inseparable from the common good. The individual’s claim on the community is bound up with the community’s claim on the individual. Such mutuality implies moral principles for the economic system: individual profit is accountable to the common good; gain for the wealthy is immoral apart from justice for the poor; economic freedom entails social responsibility (see the U.S. Catholic bishops’ pastoral letter, Economic Justice for All, 1986).
Another rich resource for reflection is John Paul II’s centenary reflection on Pope Leo’s encyclical, Centesimus Annus (1991), which includes a comment (No. 17) with a remarkable relevance for the current crisis:We see how [Rerum Novarum] points essentially to the socioeconomic consequences of an error which has even greater implications.... This error consists in an understanding of human freedom which detaches it from obedience to the truth, and consequently from the duty to respect the rights of others. The essence of freedom then becomes self-love carried to the point of contempt for God and neighbor, a self-love which leads to an unbridled affirmation of self-interest and which refuses to be limited by any demand of justice.
The “unbridled affirmation of self-interest”—among buyers and sellers, borrowers and lenders—was indeed the mantra of the Greenspan era. And the “socioeconomic consequences” of that “error” are now evident to all.
The wisdom of virtue ethics and the common good, as Catholic social teaching itself acknowledges, is not confined to the tradition of the church. It would thus behoove people of faith, when presenting an alternative vision to persons of good will in American society who are not Christian, to seek out sources of such wisdom beyond ecclesial documents.
We could reconsider such classic writers as Aristotle, Aquinas and Tocqueville. They understood civil society as the natural setting for human fulfillment, the common good as the moral horizon of individual pursuit and wise governance to be as important as individual liberty for the sustainable pursuit of living well.
We would also do well to consider contemporary writers like Robert Bellah, Stephen Carter and Amitai Etzioni. They not only remind us of the republican ideal of a common good above private interest, but also call us away from the egoist ethic of selfish individualism toward a civic ethic of shared sacrifice and social virtue.
The need now, for both people of faith and all people of good will, is a return to the ethics of virtue and the philosophy of the common good, within which human freedom and individual interest find their “due place and proportion.” The welfare of the nation depends on it.
From the archives, America's review of Ayn Rand's Atlas Shrugged.
Darrin W. Snyder Belousek is instructor of philosophy at Louisburg College in North Carolina and a member of Bridgefolk, a Catholic-Mennonite ecumenical organization.
Newsweek's Michael Hirsh says that although there are many people responsible for out current economic meltdown, we should thank one very special guy in particular:
This mess is mostly a titanic failure of regulation. And the largest share of blame goes back to one man: Alan Greenspan. People mainly fault the former Fed chief, who once enjoyed a near-saintly reputation because of his reputed "feel" for market conditions, for ushering in an era of easy credit that accelerated the mortgage mania. But the much bigger problem was Greenspan's Ayn Randian passion for regulatory minimalism. Under the Home Ownership and Equity Protection Act enacted by Congress in 1994, the Fed was given the authority to oversee mortgage loans. But Greenspan kept putting off writing any rules. As late as April 2005, when things were seriously beginning to go wrong, he was saying that subprime lending would work out for the common good—without government interference. "Lenders are now able to quite efficiently judge the risk posed by individual applicants," he declared at the time. So much for his feel. New regs didn't get put into place until this past July—long after the crash had come, under Greenspan's successor, Ben Bernanke. The new Fed chief's "Regulation Z" finally created some common-sense rules, such as forbidding loans without sufficient documentation to show if a person has the ability to repay.
Greenspan has tried to defend himself repeatedly, though as bank after bank has failed he's retreated to the shadows. But in a 2007 interview with CBS he admitted: "While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late." This, from a man who once told me, in an interview, that he most enjoyed scanning economic reports for hours in his bathtub. Now, with Tuesday's $85 billion bailout of AIG adding to the hundreds of billions the government has already put up to rescue Bear Stearns, Fannie Mae and Freddie Mac, this apostle of free-market absolutism has realized his worst nightmare. He has given us the largest government intervention into the markets since FDR. Heckuva job, Greenie.
Reimagined as a pitchfork wielding populist reformer (while he tries to figure out how many houses he owns) John McCain is out on the stump this week railing about greed and avarice. But it was only yesterday he was saying this:"Get ol' Alan Greenspan -- whether he's alive or dead. And um if he's dead, we'll put dark glasses on him and prop him up like they did at Weekend at Bernie's."(Town Hall Meeting in Concord, NH 12/17/07)
And then we have Guru number 2, Phil "you're all a bunch 'o whiners" Gramm, the man McCain extols as an economic genius:
When Senator Phil Gramm and his wife Wendy danced, it was most often to Enron's tune.
Mr. Gramm, a Texas Republican, is one of the top recipients of Enron largess in the Senate. And he is a demon for deregulation. In December 2000 Mr. Gramm was one of the ringleaders who engineered the stealthlike approval of a bill that exempted energy commodity trading from government regulation and public disclosure. It was a gift tied with a bright ribbon for Enron.
Wendy Gramm has been influential in her own right. She, too, is a demon for deregulation. She headed the presidential Task Force on Regulatory Relief in the Reagan administration. And she was chairwoman of the U.S. Commodity Futures Trading Commission from 1988 until 1993.
In her final days with the commission she helped push through a ruling that exempted many energy futures contracts from regulation, a move that had been sought by Enron. Five weeks later, after resigning from the commission, Wendy Gramm was appointed to Enron's board of directors.
According to a report by Public Citizen, a watchdog group in Washington, ''Enron paid her between $915,000 and $1.85 million in salary, attendance fees, stock options and dividends from 1993 to 2001.''
As a board member, Ms. Gramm has served on Enron's audit committee, but her eyesight wasn't any better than that of the folks at Arthur Andersen. The one thing Enron did not pay big bucks for was vigilance.
There's a lot more you can say about the Gramms and Enron, and not much of it good. But Phil and Wendy Gramm are just convenient symptoms of the problem that has contributed so mightily to the Enron debacle and other major scandals of our time, from the savings and loan disaster to the Firestone tires fiasco. That problem is the obsession with deregulation that has had such a hold on the Republican Party and corporate America.
Enron is so 2001, right? Something out of the past. Except it really isn't. It's yet another example of the GOP's deregulation fetish of the past quarter century, which seems to result every, single time in a bunch of people losing their savings and the taxpayers being on the hook for billions. Sure, the big boys have to take some heat --- why some of them are down to their last 100 million or so. But seeing as they've been swallowing a fire hose of money for the past seven years, I think they'll pull pull through. The rest of us have to stay up nights wondering what the hell the next few years are going to bring us.
And John McCain has been out there selling this crap the whole time, vacationing with Keating, being best buds with Gramm and drooling over Alan Greenspan like a Hannah Montana fanboy. If anyone expects change from this guy they are living in a total dreamworld. He's one of them.
If you like useless expensive wars, financial scandals, stock market crashes, foreclosures and economic instability as far as the eye can see, vote Republican. They've got everything you need.
By Guest Author - March 17th, 2009, 9:15AM
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.”
Alan Greenspan’s March 11 opinion piece in the Wall Street Journal (“The Fed Didn’t Cause the Housing Bubble”) sought to cast doubt on growing suspicions that the Fed shares substantial blame for the current global crisis. We find Mr. Greenspan’s denials and assertions unreasonable. Let there be no doubt; the Fed is largely responsible for the current economic crisis and, as the Chairman of the Fed leading up to the crisis, Mr. Greenspan was one of its principal architects.
Mr. Greenspan cited two generally accepted “broad and competing explanations for the origins of the crisis” that he then cast as spurious: 1) easy monetary policies, which he summarily dismissed as in-credible and 2) the “far more credible” (and later denied) notion that interest rates stayed low despite Fed rate hikes, which “spawned speculative euphoria”. Mr. Greenspan seemed to try to separate the Fed from blame by asserting the Fed “lost control” of mortgage and longer term rates because of an organically-created “excess savings pool.”
We find the construct for Mr. Greenspan’s plea lacking. As the body responsible for targeting overnight funding rates in a largely finance-based economy, the Fed is (or should be) concerned only with the interest rate or quantity level of overnight funds relative to available returns that investors may capture from borrowing those funds. The absolute levels of the Fed’s target rate or market-based interest rates do not matter.
Consider that the shadow banking system comprised of global leveraged arbitrage investors (on Wall Street and independent of Wall Street) care only about yield spreads, not about yields. A Fed funds target that rises from 1% to 5.25% over two years may not induce a diminution of credit issuance because as long as arbitrageurs may buy credit paper with higher yields than their funding costs, they will continue do so.
Against this more relevant backdrop, Mr. Greenspan’s Fed maintained an extraordinarily easy monetary policy throughout his tenure, even at times when overnight funding rates rose. This easy money policy engendered credit expansion; at first among mostly creditworthy borrowers, then among more marginal borrowers and ultimately among dubious borrowers with virtually no hope of repaying their home mortgage and consumer loans.
Nevertheless, we will respectfully address Mr. Greenspan’s arguments and then seek to substantiate our claim that the Fed is indeed largely responsible for the current crisis.
* * * * *
Regarding low interest rates, Mr. Greenspan argued that from 2002 to 2005 mortgage rates decoupled from their long history of being tightly correlated to short-term benchmark interest rates that the Fed controlled and/or heavily influenced. He noted that the leading indicator of home prices was the mortgage rate and not the fed-funds rate, which the Fed explicitly targets. Any fact-checker can see this is true, but it is an irrelevant data point taken out of context. As we have already implied, the driver of home prices from 2002 to 2005 was easy credit that ultimately influenced mortgage rates lower than pure economic fundamentals would have dictated.
Indeed, the record is clear that the Fed chose an easy money path that created supplemental demand in US
Treasury and mortgage markets. This artificially-induced demand in turn caused mortgage rates to drop to
artificially low levels (i.e., levels not explicitly tied to true home values or borrower credit risk), and to then be relatively insensitive to rising funding rates later on.
A little background is appropriate. The mechanism the Fed deploys to create credit is time-worn and well known among Wall Street bankers. Simply, the Fed provides daily amounts of credit to Wall Street primary dealers through repurchase agreements. (Fed repurchase agreements or “repos” are overnight or short-term credit facilities between the Fed and the largest Wall Street banks in which eligible collateral is swapped in return for Fed credit in the form of US dollars. The borrowers pay an implicit interest rate — or repo rate — for this credit that finances their balance sheets.)
There was (and remains) no limit to the repo lines the Fed and Wall Street may create (other than the amount of eligible assets that may be offered as collateral), meaning the Fed largely controls the amount of US dollar-based credit provided to the markets. In short, through the repo market the Fed controls/supplies funding for the largest Wall Street banks and, secondarily, the shadow banking system (the securitization process and levered buyers of those securities that borrow from Wall Street).
Through Fed repos, Wall Street was able to grow its collective balance sheet dramatically and then use it to
distribute — through the shadow banking system — credit to homeowners and consumers. Wall Street provided vendor financing to leveraged debt investors through their profitable prime brokerage units. Yet, ultimately, the credit came from the Fed. (The Fed and commercial banks “create, distribute and sometimes even extinguish” credit while Wall Street “intermediates and demands” it. Wall Street does not create it but does “market” and “redistributes” it.)
Ironically, Mr. Greenspan seems to be pointing his finger at banks and borrowers for taking the Fed’s credit. (Even more ironic is that, as the Fed Chairman, he was the chief bank regulator and could have stepped in to prevent bank, and ergo, leveraged-investor balance sheet growth by demanding and enforcing more traditionally- stringent lending standards.)
We assert that Mr. Greenspan knew perfectly well what he was doing and, as the graph below indicates, he was quite proficient in meeting his goals. Beginning in 1996, the Fed seemed to have increased the magnitude of its repo program dramatically as indicated by the expanding differential of M3 growth (green line), which includes repurchase agreements, and M2 growth (blue line), a narrower money stock measure, which does not.
Source: St. Louis Fed
We can see from the graph the degree to which the Fed financed Wall Street directly and thus, the shadow banking system, indirectly. Notable is that from 1981 to 1996, the growth rates of M2 and M3 tracked one another quite closely, implying the Fed’s manufacturing of credit would be sustainable (a dollar loaned could be paid back with an existing dollar). However, from 1996 to 2006 — during Mr. Greenspan’s chairmanship — M3 growth consistently pulled away from M2, implying increasing future hardship for debtors with obligations to repay the credit leant to them. The red line at the bottom of the graph represents the difference in growth rates of M2 and M3.
(Curiously, the Fed ceased publishing M3 in March 2006 to save on “administrative costs.” Hmm. Who could blame it? The growth of M3 relative to M2 seems to provide clear evidence of risk-enticing Fed monetary policy.)
From 1996 to 2006, M3 grew from about $4.7 trillion to about $9.6 trillion, an astounding average annual increase of 10.2%. M2, the narrower monetary aggregate that does not include repurchase agreements, rose a more modest 8.2%. This difference was a big deal. In these ten years, M3 growth compounded to a 94% increase over M2 growth. This difference reflects the aggressiveness of Fed-lending to Wall Street, ergo the capital markets, ergo the housing and derivative markets.
We assert that without this Fed-induced financing, the credit, housing and derivative bubbles would not have developed to anywhere near the magnitude they ultimately did. The nexus of these bubbles was a currency bubble initiated and exacerbated by the Greenspan Fed. It appears the Maestro sacrificed the future for the present, which is a sure way to make people on Wall Street, Main Street and in Washington happy…temporarily.
We must ask ourselves why banks and investors would keep buying homeowner and consumer debt even as
interest rates began rising in 2004. The answer is simple: as long as banks could maintain a profitable spread between the rate at which they borrowed overnight from the Fed (the repo rate) and either the rate at which they could lend directly or the rate of return implicit in the fees they generated by effectively re-structuring and distributing their repurchase agreements (and, as long as debt buyers could maintain a positive arbitrage), then the actual level of interest rates – benchmark, mortgage or consumer rates – didn’t matter. It was, as all things financial usually are, the “spread” that mattered.
Wall Street and the shadow banking system were fundamentally engaged in a grand carry trade for which the Fed provided funding. This is the business of finance, which is precisely the business that Wall Street and investors practice. After fourteen years at the helm of the Fed (in 2002) Mr. Greenspan should have known this (or, might we dare say, should not have forgotten this).
* * * * *
By 2007 the entire interest rate pricing structure had been corrupted by: a) the difference in the amounts of credit previously sold and the available funds necessary to retire that credit and, b) generally-accepted benchmarks that erroneously signaled all was well when all was anything-but-well. There seems to have been a bit of deception that made the markets seem healthy when in reality they were not.
To start, we think low inflation expectations subsequent to a time of very high monetary inflation (1996 to 2006) may have made it an inevitability that the bubble would burst. Treasury Inflation-Protected Securities (TIPS) are viewed upon by the fixed-income markets to be a practical, market-based indicator of inflation expectations. While their yields may have accurately reflected — and still reflect — the public’s general perception of low future inflation rates (at least as expressed by CPI-U), they did not in 2007 — and still do not – compensate investors for anything close to recent historical or anticipated monetary inflation rates in our view.
Without getting into too much detail, it is broadly agreed that in pure economic terms inflation is a monetary phenomenon in which changes in the stock of money (and by extension, credit) determine changes in nominal prices for goods, services and assets. Simply, the more dollars outstanding, the less purchasing power each has and the more dollars it takes to purchase an item. In other words, money creation produces nominal price increases and money destruction (a dynamic that has not occurred for any length of time since the Fed was established in 1913) would produce price declines.
This has real-world investment applications. As is evident in the graph, the substantial and consistent creation of asset-supporting credit by the Fed from 1996 to 2006 also created the future need for more dollars to service and pay down that credit. So inflation was (and is) built into the system yet few investors seemed positioned for it. Either the value of credit had to drop or the amount of money in the system had to rise to repay that credit. (This is literally the same dynamic that perpetuates a Ponzi scheme – the need to find or manufacture more money to satisfy existing claims.)
But there is a far more granular reason for the bursting of the currency/credit bubble. Too much credit in the system drove down fixed-income yields across the board (thanks to a wide arbitrage spread separating funding rates from nominal debt yields). When the Fed began allowing the fed funds rate to rise in 2004, it triggered a narrowing arbitrage spread and nominal price losses on the bond side of the arbitrage. This, in turn, triggered redemptions for bond funds like the Bear Stearns mortgage funds.
There was an air pocket underneath. Bonds and their derivatives were being priced at the margin by leveraged arbitrageurs. Smart real money buyers were waiting for positive real yields which, given the aggressive monetary inflation at that time, could only be found at nominal yield levels well in excess of those then available (hey, today’s “safe haven” Treasury buyers, are you listening?). Can Greenspan’s Fed be held accountable for this?
We think so. In 2004 the Fed began to allow a progressively higher fed funds rate to “be targeted” which created the perception of tightening monetary policy. Yet the Fed was NOT TIGHTENING AT ALL. Despite a steadily rising fed funds rate we believe the Fed stood by as market-based funding demand continued to increase substantially. In fact, short-term credit provisions from the Fed continued to grow during this time. Indeed the Fed pursued an easy money policy despite the optics of it “targeting” a higher funds rate. To us, “easy money” means more money and credit, not less.
Orthodox economic supply/demand curve analysis has no difficulty reconciling a progressively higher fed funds rate with simultaneous growth in the quantity of credit clearing in the marketplace. (Don’t demand curves shifting to the right create both higher clearing prices and clearing quantities? And, don’t supply curves shifting to the left create higher clearing prices but lower clearing quantities? We intuit a lot of the former and little to none of the latter during the period in question.)
We argue that Mr. Greenspan would have had to restrict Fed credit far more than he did if he wanted to close the arbitrage spread giving bond investors incentive to keep adding credit to their balance sheets. He should have shifted the funds rate higher and more forcefully. The move in the fed funds rate from 1% to 5.25% from 2004 to 2006 was woefully inadequate and should have been MUCH more aggressive if spurious credit demand were to be discouraged. Put slightly differently, we assert that the ENTIRE fed funds move from 1% to 5.25% was driven by increased credit DEMAND (levered credit buyers had incentive to put as much on their balance sheets at a positive spread between funding costs and bond yields). Mr. Greenspan didn’t seem to get this.
Had the Fed wanted to restrict the clearing quantity of credit, it would have had to target a fed funds rate well in excess of 5.25% and/or acted much quicker than it did. The Fed would have needed to restrict SUPPLY and thus target less growth in overall credit. This, no doubt, would have endeared him to no one (but former Chairman Volcker perhaps?).
More forceful credit restriction would have clearly retarded any growth in demand from the shadow banking
system and the credit bubble would have been stopped in its tracks well before it burst. We don’t believe that Econ-101 supply/demand curve analysis is beyond Mr. Greenspan’s reach as he seems to protest, nor was it so when he was Chairman of the Fed.
* * * * *
In a broader sense, real (inflation-adjusted) losses had already been locked-in by fixed-income investors because prevailing absolute nominal yields were lower than the higher rate of monetary inflation. And as we discussed, the Fed’s monetary inflation between 1996 and 2006 actually produced lower absolute bond yields than would have otherwise prevailed (too much money chasing bonds). Why did this “irrational investment behavior” occur?
It was not irrational-investor behavior though it was irrational investing. We think there were two inter-related issues at hand: 1) investors didn’t mind running a mismatched asset/liability book because they were compensated at shorter intervals and, 2) conventional economic wisdom, that seems to have been fostered and encouraged by policymakers, produces terribly inaccurate economic data that these mismatched investors used to justify their actions. (The two dynamics remain in place today.)
For example, the Consumer Price Index (CPI) and other price baskets generally used as “inflation” indicators had not risen to reflect gross monetary inflation produced by the Fed from 1996 to 2006. This is not proof that money growth does not equal inflation; rather it is proof that the CPI does not accurately reflect the diminution of a dollar’s purchasing power. (If an indicator like the M3 growth rate had been a generally-accepted inflation metric — not perfect but closer than highly subjective price baskets — then there would not have been buyers of credit at negative real yields.)
In this light, it would also not appear to be acceptable Fed regulatory policy to assume that Wall Street banks — competitive publicly traded institutions with quarterly incentives to produce ever-increasing revenues — would somehow not re-distribute that credit to its credit-purchasing clients (that they were vendor-financing). It is also not reasonable to assume that credit buyers — competitive institutional asset managers with daily incentives to produce competitive returns relative to benchmark indexes and their peers, not relative to the creditworthiness of the instruments they were buying or even the real returns they were producing — would somehow not buy that credit priced at yield spreads above diminutive benchmark Treasury yields and funding rates (particularly when many of those asset buyers accessed leverage through Wall Street banks.).
There is more to Mr. Greenspan’s assertions that we find troubling. As he brought up for the second time in as many years:
“As I noted on this page in December 2007, the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.”
Mr. Greenspan surely knows that there cannot be “an excess pool of savings” because, by definition, the pool of savings equals the pool of investment. (Mr. Bernanke seems guilty of this lapse too, we’re afraid.) However, there is an excess pool of “currency” in today’s world. Again, as the simple laws of supply and demand suggest, an increase in the supply of currency which is not coincident with an increased supply of assets will drive asset prices higher. A prudent central banker acting in the interests of economic stability would have absorbed that excess pool of currency (and would not now dub it as “savings”).
In an honest or “hard” money system, the “tectonic shift” Mr. Greenspan discusses would have led to CPI
deflation as the newly accessible pool of cheap Asian labor would have been deployed in the productive process. This would have implied lower consumer prices and higher interest rates. There would have been better margins helping asset prices on the one hand, and higher interest rates hurting them on the other. The net effect on productive asset prices would thus be ambiguous.
But the economy would have been sustainable and the US dollar would have remained sound. Clearly, Mr.
Greenspan allowed the various measures of the monetary aggregates to inflate and his reputation did not suffer for it during his tenure. The organic forces of price deflation provided him a shield. Why did he do this? To keep asset prices up? To keep US tax receipts up? The effect of his actions hurt dollar-based savers, fixed-wage workers and people living on a fixed-income. All would have been better off if the purchasing power of the dollar were to have been maintained or even, via the “tectonic shift”, enhanced.
And finally, Mr. Greenspan’s reminder that “prior to the crisis, the U.S. economy exhibited an impressive degree of productivity advance” is almost too much to bear. If this were true, where then were the fruits of this productivity advance? Doesn’t an increase in productivity, ceteris paribus, imply lower output prices and thus lower consumer prices? (Is this the “shabby secret” of modern central banks — they are inflation machines that counterbalance natural deflationary pricing forces brought about by private sector competition?) Mr. Greenspan’s record is crystal clear and his knack for obfuscation is not as charming now — or helpful to society — as it appeared it once was.PERMALINK
4 Responses to “The Maestro Has No Clothes”
- AJS Says:
March 17th, 2009 at 11:50 am
If, coming out of a tech bubble and mild recession, an increase from 1% to 5.25% was woefully inadequate, what size increase will be necessary to take away the punch bowl this time? I just don’t see the Fed having the cojones to do it (maybe that’s why Obama has Volcker waiting in the wings).
- tom brakke Says:
March 17th, 2009 at 2:24 pm
In him we trusted.
Two parts to the equation. Him and us.
- GB Says:
March 17th, 2009 at 3:35 pm
Maybe the economy was okay to soak up all this money.
1) Population increase Immigration and job creation
2) If people understood inflation and excepted price increases
3) Job and wages followed inflation / population increase.
4) Investment class sold real estate near peak. denial of inflation.
5) Investment clases compensation and wages were controlled rationally and re-invested into sound business activity instead of more paper investments.
Just playing devil’s advocate here. Yes it would be easier to regulate the money than all things here.
- d4winds Says:
March 18th, 2009 at 5:21 am
The Bush tax cuts in ‘03 came at a time of relatively full employment, so they had no or little real output effect but almost exclusively an inflationary one. Greenspan accomodated the fiscal stimulus by expanding M2/M3 as you have noted, keeping interest rates low and adding fuel to the inflationary fire. Rather than seeing a widespread increase in prices, however, the inflationary effects were directed to a broad-based market in which the speculative profit from price increases was largest and the opportunities least regulated (by Greenspan among others), the mortgage origination/securitization market and thus to housing. Ergo, the bubble.
Since Greespan’s low interest rates meant that private real investment was not being crowded-out, the real resources for the financing for the huge deficit spending from those tax cuts, Medicare expansion, 2 wars, and an unprecedented expansion in other defense-spending had to come from somewhere. China obliged.
Thus Greenspan and now Bernanke have it backward: There was no saving glut from China but a huge desire for dissaving in the US from the tax cuts. Effectively, Bush spawned a housing bubble, Greesnspan ratified it, and the real resources needed for this excess came from China, Japan, Germany, etc. , who became double winners at our expense: the increasing capital surplus account for the US spawned an increasing current account deficit to drive their export-oriented economies. We threw a party–guns are good, houses are better, and paying for them with taxes (Bush) or interest rates (Greenspan) or reduced private investment (both) is bad–and paid for it by posting a big sign saying “For sale America.”
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