Greenspan and the Housing Bubble

Scott Sumner writes,

I really don’t care whether money was about right during 2005-06, or slightly too easy. Either way it wasn’t at all unusual compared to earlier periods of our history. Indeed during most of my life policy was far more expansionary during cyclical expansions than 2002-06.

John Taylor and some libertarian/Austrian economists judget Alan Greenspan as guilty for greatly exacerbating the housing bubble by keeping interest rates too low for too long. Scott Sumner exonerates Greenspan. I do, too, although for a very different reason. Sumner’s argument is that nominal GDP was not so far out of line. That is a fair point.

I would say that I find the strength of the link that Taylor finds between the Fed Funds rate and the housing market to be implausibly strong. The interest rates faced by borrowers are determined in the bond market, and the Fed’s influence there tend to be weak.

The other argument comes from the left, where it is suggested that Greenspan’s benign view of the markets blinded him to the excesses in credit creation that were fueling the bubble. In hindsight, this argument is compelling. Knowing what we know now, we can say that the Fed should have questioned the AAA ratings of securities backed by sub-prime loans, stress-tested banks on their exposure to a decline in house prices, and yelled “Danger!” about the collapse of credit standards at Freddie Mac and Fannie Mae. However, back when it mattered, in 2005 and 2006, not even the Bakers and the Shillers and the Krugmans who were talking about a housing bubble were recommending those actions.

7 thoughts on “Greenspan and the Housing Bubble

  1. As I recall, Alan Greenspan did, repeatedly, warn Congress (both houses) [Sarbanes assembled!] as to the *extreme* concentration of risks at and through Fannie and Freddie.

  2. You can always believe that “the left…suggested that — fill any name here — benign view of the markets blinded him to — fill many bad things that could happen, in hindsight.” But one of them is not promoting easier credit to support housing.

    If anything, it was the Austrians who riled against the excesive credit expansion. Their criticism would have been dead on had they focused it to the excesses of leverage and its effect on financial instability, instead of the inadequacy of the level of interest rates and its effect on inflation.

  3. The real issue is margin (or, in the case of single family residential housing finance, the lack thereof). Or in more recent parlance, “macroprudential regulation”. When NASDAQ had a bubble burst, it barely registered in GDP. That is because, no matter how big the bubble, there is at least a 50% equity cushion in it, which absorbs the drop in value first. Because housing finance, and intermediaties’ financing of housing finance, had no margin to speak of come 2007, the drop in value flowed straight through to the real economy much more directly and quickly. If every actor in the chain of housing finance had been required to maintain a 20%+ equity stake in its extensions of credit, there would never have been a crash.

  4. Yes, the Fed could have spoken about the micro problems of credit deterioration, excessive subsidies, etc., as long as it didn’t actually think that changing monetary policy was the solution.

Comments are closed.