October 28, 2013
There are two major schools in economics, those who know accounting identities and those who don’t. Alan Greenspan and Robert Samuelson are both members of the latter group, as Samuelson proudly proclaims in his column.
Samuelson wants to give the blame for the economy’s collapse on the complacency that followed a quarter century of relatively stable growth with low inflation. He tells readers:
“But there was an unrecognized downside: With a less-risky economy, people — homeowners, bankers, investment managers — concluded they could do things once considered more risky. Consumers could borrow more because economic stability enhanced their ability to repay. “Subprime” home mortgages granted to weaker borrowers became safer because housing prices would constantly rise. Banks and investment banks could assume more debt because financial markets were calmer. Hence, the Greenspan Paradox: The belief in less risk created more risk.”
Of course this is not quite right. Those of us who believe in accounting identities did recognize the downside. We saw a huge trade deficit which was draining hundreds of billions of demand from the U.S. economy. The demand drain from the trade deficit (which was the direct result of the mismanagement of the East Asian financial crisis by Greenspan, Summers and Rubin) was being offset by the demand created by the housing bubble.
The bubble was easy to recognize for anyone looking at the economy with open eyes. House prices had sharply diverged from a 100-year long trend in which they had just tracked the overall rate of inflation. It was clear this run-up had no basis in the fundamentals of the market. Income growth was weak and population growth had slowed. Furthermore, rents were still just keeping pace with inflation. And, the extraordinary levels of construction had created record vacancy rates as early as 2003.
There seemed little doubt that prices would collapse and bring an end to the building and consumption boom that were driving the economy at the time. The only question was when. The proliferation of fraudulent mortgages allowed the bubble to grow much larger and more dangerous over the years 2002-2007. Apparently Greenspan missed this tidal wave of bad mortgages because he wasn’t paying attention to the housing market. Or at least that’s what he wants us to believe now.
Anyhow, there are no mysteries in this story for people who understood accounting identities, except perhaps that people still take Alan Greenspan’s views on the economy seriously.
By the way, since Samuelson does a little bit of “what they said then and what they say now” in reference to Greenspan, I’ll give my two cents. Here’s what I wrote on the eve of the Federal
Reserve Board’s Greenspan retrospective in the summer of 2005:
“GREENSPANFEST 2005: BE GLAD YOU WEREN’T INVITED: The Federal Reserve Board is having its annual retreat at Jackson Hole, Wyoming and the agenda this year is devoted to a retrospective of Greenspan’s 18-year tenure as Fed chairman. The world has not seen a greater display of obsequiousness since the death of Leonid Brezhnev….
1) Mr. Greenspan ignored the stock bubble…. The tens of millions of people who saw much of their retirement savings disappear in the crash are just out of luck, as are the pension funds that are now insolvent because their managers somehow didn’t see the bubble.
The proper remedy for the bubble was actually very simple — talk. If Greenspan used his Congressional testimony and other public speaking opportunities to lay out the case for the bubble, there is little doubt that it would have deflated long before it reached such outlandish proportions…. A fund manager that ignored Greenspan, and kept most of a portfolio in a bubble market, would undoubtedly be sued for negligence by their clients and probably have to pay every penny they owned in damages….
2) Mr. Greenspan promoted the housing bubble… Greenspan’s tool for getting out of the recession created by the collapse of the stock bubble was to promote a bubble in the housing market. He did this most blatantly back in the summer of 2002…. When the housing bubble bursts, we will see the loss of $5 trillion in housing bubble wealth…. The economic fallout will also be enormous….
5) Finally, he did not tell the truth when he endorsed President Bush’s tax cut in 2001….
Okay, I close with my own praise of Alan Greenspan. In 1995 and 1996 he lowered interest rates and kept them low. This allowed the unemployment rate to fall below the 6.0 percent level…. The decision to allow the unemployment rate to fall to levels that most economists thought would trigger inflation gave millions of people jobs…. The tight labor market of the late nineties allowed for the first sustained growth in real wages for most of the country’s workers since the early seventies. We will benefit from this decision for years to come… the country benefited hugely because [of] Alan Greenspan..”
It is pathetic that we still have so many commentators making excuses for themselves and their friends. The bubble was easy to see for those with their eyes open. Unfortunately many people with prominent platforms continue to use them to try to imply that it was all so complicated and that we can’t expect mere mortals — no matter how brilliant they might be — to have seen the wreckage beforehand.
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