Alan Greenspan Responds to His Critics

The most fundamental flaws in nearly all contemporary economic thought are readily apparent in the first few paragraphs of former Fed Chief Alan Greenspan's rebuttal to his recent critics in today's Financial Times:

• If it doesn't show up in standard economic data, it doesn't exist
• If it can't be modeled, it is not worthy of discussion

Have a look:

Alan Greenspan: A response to my critics

On March 17, Alan Greenspan wrote an article for the FT entitled "We will never have a perfect model of risk", in which he argued: “We will never be able to anticipate all discontinuities in financial markets.” He concluded: “It is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation [do] not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.”

The article attracted a number of critical responses in this forum. For example, Paul de Grauwe wrote: “Greenspan’s article is a smokescreen to hide his own responsibility in making the financial crisis possible.” (Read all the responses.)

The article below is Mr Greenspan’s reply to those criticisms, written exclusively for the Economists’ Forum:

I am puzzled why the remarkably similar housing bubbles that emerged in more than two dozen countries between 2001 and 2006 are not seen to have a common cause. The dramatic fall in real long term interest rates statistically explains, and is the most likely major cause of, real estate capitalization rates that declined and converged across the globe. By 2006, long term interest rates for all developed and major developing economies declined to single digits, I believe for the first time ever.

Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence of monetary policy adding to the bubble is statistically very fragile. Paul De Grauwe depends on John Taylor’s counterfactual model simulations to conclude that the low funds rate was the source of the US housing bubble. Taylor (with whom I rarely disagree) and others derive their simulations from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. This suggests important missing variables. Counterfactuals from such flawed structures cannot form the basis for policy.
...

Good Lord!

All you had to do in 2004 or 2005 to be absolutely convinced that a gigantic speculative bubble in housing was entering its final stages in major metropolitan areas of the U.S. was to stop by a few mortgage broker offices or visit a few real estate agents or talk to a few of the many thousands of aspiring homeowners who were sleeping on sidewalks while waiting in line to sign on the dotted line (with very few questions asked) so they could then begin their journey to wealth.

If and/or when any curious Fed economists heard the 2005-era housing bubble joke, "All you have to do to qualify for a home loan is fog a mirror", they probably looked in the government housing starts data for corroborating evidence which, of course, they were unable to find.

Instead, they talked about "equity cushions".

Comments

[fabien_hug]

If there is a decoupling in the economy I think we have one in the data produced by our governments and the perception of the public. In a less spectacular way we face a similar situation as the one your described with inflation (Bernanke just said again that inflation is not a problem but my day to day purchasing power is REALY shrinking). This is extremely confusing and nobody seems to mind about it.
It is like if a foot is still 12 inches long in Washington but only 10 inches at Home Depot.

[keithp]

""All you had to do in 2004 or 2005 to be absolutely convinced ...was to stop by a few mortgage broker offices or visit a few real estate agents or talk to a few of the many thousands of aspiring homeowners."

Yes, that sounds like a very sophisticated model - talking to non-random highly invested parties. I can't imagine why Greenspan missed that approach - it's so repeatable, predictable, and scaleable.

[nukldrager]

Grimm and bear it. Milk was $3.49 2 weeks ago, and $4.49 last night. I have the receipts.

[nukldrager]

Talk about the pen being mightier than the sword... "Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence of monetary policy adding to the bubble is statistically very fragile."

[Malkiel]

I disagree with the theory that declining interest rates made a speculative bubble inevitable. We have ample evidence that the severity of our current credit problem was caused by fraudulent activity in the real estate market, as well as failure of institutional lenders to adhere to institutional standards. So questions of corporate governance and government regulation are tied to the genesis of this speculative bubble in a low interest-rate environment when they are separate issues. Just as Sarbanes-Oxley chokes off certain avenues of excess in corporate governance, tighter regulation of lending transactions could have choked off speculative excess in the recent housing market, and probably will in future markets. Instead of accepting the wisdom of a level playing field mediated by government regulation American capitalism will stumble from one crisis to another until most of the regulatory bases have been covered through post facto legislation designed to fight the last war...

[Matt Blackman]

Malkiel;
I couldn't disagree with you more. In every bubble in history, rules were in place and were broken in the excitement and greed that each bubble engendered. When greed is powerful enough to create mass hysteria, no rules in the world will stop it.

There were very clear anti-fraud rules already in place that both lenders and borrowers blatantly broke (Liar, Ninja loans for example) but when home prices are accelerating, both parties simply ignored those rules. So the solution is to add even more rules to increase the complexity? What is the good of that if they too will not be enforced? In Ohio, 49% of those taking out subprime mortgages never made their first payment. They obviously got caught up in the home-buying hysteria and greed in all the money they were going to make. Whatever happened to personal responsibility?

The US currently has the most strict regime of rules governing markets of all sort and they do not stop abuse when bubbles are in the process of building because those in the know find ways around them or just plain ignore the rules. Create more rules and you create more opportunities for abuse and when markets heat up in the next bubble, people simply ignore them. But you also increase the costs of doing business for all and unfortunately its the smallest companies that pay the price as the regulatory thresholds to entry to markets in the way of excessive legal costs etc. are raised. Sarbanes Oxley is one reason why companies are flocking to European equities markets for this very reason.

As you say in your post, regulator bases have been covered through post facto legislation designed to fight the last war but how do you design legislation for a problem that hasn't occurred yet?