"The fed didn't cause the housing bubble"
Alan Greenspan has written a remarkablecolumn in the Wall Street Journal, entitled :
The Fed Didn't Cause the Housing Bubble - Any new regulations should help direct savings toward productive investments.
Greenspan makes the subtle difference between 'low interest rates' (fixed by his federal reserve) and low mortgage rates (set by the market). In that way, he tries to downplay his direct responsibility:
There are at least two broad and competing explanations of the origins of this crisis. The first is that the 'easy money' policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.
The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria.However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages.(my emphasisis)
Greenspan used to be a 'chart-watcher', and his argument to underscore this view is:
Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate.
Then, Greenspan takes a more complicated turn, saying that they (the Fed) were surprised to see a continuing rise in house prices, while they were tightening the Fed funds.
The Federal Reserve became acutely aware of thedisconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier -- in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.
The disconnect can be questioned (long rates are a series of implied future short term rates) and the Fed had created the impression of Greenspan put, a readiness to lower rates quickly whenever a problem would arise. Moreover, the Fed could have prevented mortgage rates from staying so low, if it had more effectively contained the excessive growth of Fannie Mae and Freddie Mac. Greenspan started to point to Fannie Mae and Freddie Mac in 2004, and could have acted more decisively to limit their balance growth.
Greenspan then tackles John taylor. Beware when Greenspan calls you his friend:
However, starting in mid-2007, history began to be rewritten, in large part by my good friend and former colleague, Stanford University Professor John Taylor, with whom I have rarely disagreed. Yet writing in these pages last month, Mr. Taylor unequivocally claimed that had the Federal Reserve from 2003-2005 kept short-term interest rates at the levels implied by his "Taylor Rule," "it would have prevented this housing boom and bust. "This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom.
Aside from the inappropriate use of short-term rates to explain the value of long-term assets, his statistical indictment of Federal Reserve policy in the period 2003-2005 fails to address the aforementioned extraordinary structural developments in the global economy.His statistical analysis carries empirical relationships of earlier decades into the most recent period where they no longer apply.
Moreover, while I believe the "Taylor Rule" is a useful first approximation to the path of monetary policy, its parameters and predictions derive from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.
Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble.
So Greenspan says that the Taylor rule is flawed, and is not a good tool for monetary policy. What tools Greenspan used to put the fed funds at such low levels for a rather long period remains unknown however. Greenspan also prefers Milton Friedman's assessment of the Fed, which by coincidance is rahter positive:
All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind."
Greenspan concludes that the bubble was not created by the fed, but by global forces, the infamous savings glut.
If it is monetary policy that is at fault, then that can be corrected in the future, at least in principle. If, however, we are dealing with global forces beyond the control of domestic monetary policy makers, as I strongly suspect is the case, then we are facing a broader issue.
Now, let us not forget that the savings glut was the other end of a credit bubble, and the crowding out of world savings by the US credit-driven consumer. The dealer and junky story, in which the US was the junky encouraged by "Easy Al".
As Alan Greenspan is coming at cruising speed in his column, he also tackles the question of de-regulation, and not surprisingly:
However, the appropriate policy response is not to bridle financial intermediation with heavy regulation.That would stifle important advances in finance that enhance standards of living.
Sure, we have all seen the important advances in finance and the enhancement of the standards of living across the western world.
So, after reading this article I have two remarks:
1. The housing bubble is just one aspect of the financial crisis. Even if the Fed does not bear full responsibility for the housing bubble (which I would question), it does carry partial responsibility for a lot of critical choices: light regulation of derivatives and hedge funds, allowing excessive leverage in investment banks, encouraging ARM's and other mortgages, creating moral hazard (i.a. LTCM), not drawing lessons from the dotcom bubble etc etc.
2. The Fed did not cause the housing bubble, it was much more the responsibility of the chairman himself, Alan Greenspan.
Could it be that Alan Greenspan is feeling any regret about the second half of his term as chairman of the US Federal Reserve ?