It is bad enough that Alan Greenspan refuses to acknowledge what more and more people are realizing: his ultralow interest rates — which were in turn accomplished through injections of artificial credits into the banking system — fueled the housing boom. The Greenspan Fed was not a sufficient condition to cause the housing and stock bubbles, but it was almost certainly a necessary factor. If the Fed had let the post-9/11 recession run its course, there would have been no absurd boom (and now bust). FULL ARTICLE
Source link: http://archive.mises.org/9739/greenspans-bogus-defense/
Greenspan’s Bogus Defense
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“What a warped view of how the market economy works …”
But does Greenspan ever even think in terms of a market economy? When he was fueling booms, he was loved and called the maestro. He could do no wrong. That power and adoration will likely turn any human brain into mush. It’s as though he was on crack the whole time.
But when everything started falling apart and he was coming down from the heights, his underling was standing by the curtain telling everyone, “Nobody get’s to see the wizard”. So, don’t pay any attention to that man behind the curtain – he’s not at fault, it’s those Asians from Kansas that caused all the problems.
Greenspan was a good economist when he followed Rand, but once he became Chairman he let the praise of inflationists go to his head. He seemed to believe what the ignorant media were saying about him. Nothing like hubris to make a person do stupid things; it’s worse than alcohol.
Can anybody explain (with detail) how the other periods plotted in the graph, where the Fed rate was above the red line, is so different from the current situation. I know Robert Murphy talks about the impressive hikes and lowering but there needs to be a more elaborate explanation. I would welcome some more feedback on this whole graph.
“What a warped view of how the market economy works …”
But does Greenspan ever even think in terms of a market economy? When he was fueling booms, he was loved and called the maestro. He could do no wrong. That power and adoration will likely turn any human brain into mush. It’s as though he was on crack the whole time.
But when everything started falling apart and he was coming down from the heights, his underling was standing by the curtain telling everyone, “Nobody get’s to see the wizard”. So, don’t pay any attention to that man behind the curtain – he’s not at fault, it’s those Asians from Kansas that caused all the problems.
This is a very helpful article. Take a look at 1975-1979 (“Effective Federal Funds Rate vs. 30-Year Conventional Fixed Mortgage Rate”) where the mortgage rates stayed high even though the funds rate was reduced. There is a trough under the mortgage rates very similar to the one just experienced; and increases in the funds rate doesn’t push up mortgage rates unless the funds rate goes to a level that exceeds the mortgage rate.
cmg
Isn’t the Austrian point that the Fed cannot set the proper interest rate? That only a free market in money can reflect the time preferences of saving individuals and the demand for money for investment? Why criticize Greenspan for getting wrong what is simply impossible to get right? Focusing on the individual gives people the impression that a smarter guy could have gotten it right. Criticizing Greenspan for taking the job in the first place makes more sense to me than criticizing him for making decisions that were inevitably wrong.
Yes yes, Greenspan did it. I wonder how many more of these articles there will be. As many as it takes to expose his lies? If there were a hell, Greenspan would be consigned to a spot in it.
Can someone explain the second chart to me, with the average? I’m not sure what it is meant to show, though I get the point that Murphy is making. Just having a hard time relating the graph to it.
Brian- I think that Austrian theory would say that the Fed can certainly influence rates, if not target the correct market rate.
What you may be thinking is that Austrians believe that the Fed tampering cannot set the correct market rate – or what you deem as ‘proper’ – that is because they do not have the prescience (cannot evaluate all of the market variables even close to well enough) to set it as the market would.
Disagree with the author’s main premise that Fed’s lowering of Federal Funds and Discount rates have caused the housing bubble. Fed did what it had to do to stimulate the economy…
In fact, there is no clear evidence of low interest rates in question causing inflation. This follows from the simple facts that these rates affect only inter-bank lending and have to do with technical interworkings of bank transactions, and have no immediate wide-range impact on the majority of ultimate consumers – individuals and small or medium size businesses…
Moreover, there was no real malpractice committed by lenders in giving the exotic loan products to the subprime consumers, since the loans were well securitized by the real estate collaterals, rapidly increasing in value at the time…
Conclusion: it is not entirely clear what caused the housing problem. It’s like chicken and egg thing – “Did people lose their jobs first, and then the housing bubble burst, or was just the opposite that happened?”…
Sure this beats me…
Thank you, Bob Murphy, for filling in this piece of the puzzle. It makes what Shostak says more understandable in terms of the lag between pumping and interest rates by providing the mechanism for how this happened. It’s funny that Greenspan couldn’t figure out where all those Chinese dollars came from. Good work.
Pbergn says “no immediate wide-range impact” as if the short-range, unprincipled view of addicts, prostitutes and alcoholics should guide science and govt. If I correctly understand Murphy, Greenspan evades long-range causes for short-range correlations. Mises taught that correlations prove nothing because they may cover a cause.
Also, Hazlitt claimed that no one, even Austrians, can predict the course of an inflation. Is this still true?
pbergn,
there is an oped in WSJ today, written by Vernon L. Smith showing how the official CPI underestimated the “inflation” because of the Owner’s Equivalent Rent component ( 23% of the CPI ). I suggest that you read it. This is not a completely new revelation; Mish @ Global Economic Analysis has pointed this out many times in the past.
More over, it doesn’t matter if the CPI was “low” as long the interest rate was lower. Which was truly the case for most of the period from 2002-2004.
here is the article by Smith and Gjerstad
http://online.wsj.com/article/SB123897612802791281.html?mod=googlenews_wsj
Lucas,
Of course Austrian theory says the Fed can influence rates. But even Austrian theory cannot tell whether the rate they set is above or below the originary rate. Only free market rates, which don’t exist, can tell you (and they probably can’t because they will include other factors like risk premiums).
My point is that criticizing the actions of an individual as opposed to the institution itself clouds the issue. Yes, Greenspan got it wrong, but we couldn’t really expect anything else!
Brian Gladish wrote:
My point is that criticizing the actions of an individual as opposed to the institution itself clouds the issue. Yes, Greenspan got it wrong, but we couldn’t really expect anything else!
Man, you guys are seriously the toughest crowd on the Internet.
If Greenspan had said, “Yeah I may have screwed up, but I did the best I could given the institutional constraints,” fine. But that’s not what he said. He is denying that the Federal Reserve (under his leadership) had anything to do with the housing bubble.
So Brian, if we are going to get people to see the harm of the institution of the Fed, then we need to sound the alarm when it really screws up. Like right now.
What do we expect Greenspan to say? “I did it. The idea that the fed can protect the economy is bogus. Basically, my entire life’s work is a sham.” That would require courage and self-reflection that few have.
pbergn:
The low fed funds rate is the absolute reason for the bubble. The spread between the market interest rates and the fed funds rate creates an incentive to lend. That is how the mony supply is inflated. During the boom, real incomes did not grow at the rate of housing. People did not all of a sudden have a lot more wealth. Debt became cheaper, so people took on debt.
The fed getting the economy moving is actually the problem and will result in another bust (more severe than the prior). The Austrians understand what others don’t, credit does not create wealth.
Why do you think that so many businesses are failing right now? The market it trying to value all the bad investments. Only the gov’t is trying to keep that from happening by protecting the same organizations that made those investments. The fastest way to fix it is to have those companies liquidate those investments at their present market value.
While it is all but impossible to properly set nominal interest rates that correlate with the real rate, Greenspan could have at least taken a look at the savings rate in making his decision instead of pure Keynesian business cycle theory.
TO: HM Lee
Strongly disagree with your explanation, sir.
A simple example:
Let us say you want to borrow money to buy a car you cannot normally afford, since you do not have cash on hand to buy it at once.
You have two choices – save money and then buy, or borrow (well, or not buy a car you cannot afford at all…)
Now, let us say the Fed Fund rate is at 6%. The commercial bank will give you a new auto loan let us say at the same or slightly higher rate, let us say 7%.
You claim that a person that would not borrow money at say some nominal 7%, would more likely do so when it much lower, say 3%-4%… Bear in mind that this would not significantly affect the monthly payment, and the monthly payment is the primary concern among average borrowers…
Well, here is the big surprise for you: now the Fed Fund rate and Discount rate are at 0.25% or so rate, but guess what, there is NO WAY to get an auto loan at 2%-3%… It is still 7%-8% on average, and even higher for buyouts and used cars…
The same phenomenon is observed in personal loans and home mortgages…
My point is this:
As long as banks CAN borrow from the central bank and from each other, it is insignificant at what rate they can do that, as long as they can turn around and pass the interest to the consumer… So, if Fed Fund and Discount rates are at almost historical lowest rate of 0%, this does NOT necessarily mean that there will be more loans originated, or that the loans will have lower interest rate. Not at all, sir…
There is no direct corelation between low Fed Fund and Discount rates and the number of loans originated. That number is more dependant on the GDP growth, and consumer buying power and confidence, rather than on the aforementioned rates…
So your point is that if banks choose not to loan money, then the interest rate matters not. Um, what a stunning revelation. That still does not address the issue that the fed makes the giving of loans cheaper than it otherwise would be…Asserting there is no “direct” correlation does not change that fact. Sorry.
Bob Murphy wrote:
Man, you guys are seriously the toughest crowd on the Internet.
Thanks for the compliment, but not nearly as tough as those raving about the failure of capitalism and the explosion of greed!
I just worry that the world always sees the problems as “people making mistakes” as opposed to institutions that mask price signals and mislead the market. To paraphrase Thomas Paine in defending the life of the French king, kill the Fed, not the Fed chairman.
Its obvious to me that the problem is way beyond greenspan. Of course greenspan’s years at the fed will go down as terrible for our economy, but look at Bernanke, he’s doing the same thing. More importantly, look at a Chart of the Dollar since 1913, and particularly since 1971, both very important years in monetary history. It doesn’t matter who is the frontman for the FED, the policy is still the same. Andrew Jackson was right to kill the bank. The bottom line is, our currency has been hijacked, and the chaos that has ensued, and is only getting worse is not a “mistake” or an accident. These people know full well what they are doing, although they won’t state it in public. I personally know several investors who had dinner with Alan Greenspan and he said explicitly “don’t listen to what i say in public.” Those who understand the business cycle know that it’s probably the greatest mechanism for wealth transfer ever devised. that’s why they keep blowing and bursting bubbles. this will never change. we are on a road to feudal society. the institutions need to be shut down. we need a new system.
“The low fed funds rate is the absolute reason for the bubble. The spread between the market interest rates and the fed funds rate creates an incentive to lend. That is how the mony supply is inflated. ”
This is precisely backwards. The Fed targets the Fed Funds rate by increasing and decreasing the money supply, not the other way around. It does not control any interest rates (other than the Fed discount window rate which is rarely used) which is usually how it’s “job” is incorrectly described by the press.
There is no guarantee that the Fed Funds rate, or any other rate for that matter, will behave like the Fed wants, but the Fed Funds rate is highly correlated with immediate changes in the money supply. The changes in the money supply affect all interest rates rippling through the financial system affecting credit and loaning activity – leading to malinvestments.
In a sense Greenspan is right in that once he created the money he couldn’t really control how it was multiplied through the global financial system. But this all the more reason to resist creating too much money: Once it’s created it is very hard to predict what it will do.
The Fed is actually much worse than a mad scientist sitting atop the economy pulling strings to make it do precisely what it wants. The Fed is doctor Frankenstein and has little ability to predict what it’s monster will do once unleashed.
The very concept of Central Banking is to blame, focusing on Greenspan is fun (since at point he appeared to know better) but ultimately he sat atop a corrupt and broken system.
I took out a $30,000 at 0% APR for 15 months loan from my mastercard account with citi in Oct 2008. Not that I needed the money, but I will take money with no cost. Plenty of money available for those capable of paying back.
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