Is Greenspan Really Innocent of Causing the Housing Boom?

David Henderson and Jeff Hummel have written a remarkably pro-Greenspan article, “Was Money Really Easy Under Greenspan?” (www.tinyurl.com/cuf3ug).  The authors overlooked several points that would undermine their portrayal of Fed chairman Alan Greenspan as an anti-inflationist and the best Fed chairman ever. (Better than Paul Volcker?) To conclude that Greenspan “oversaw relatively low and stable inflation” is surely missing the mark. Granted, the Consumer Price Index (CPI) rose “only” an average 3.1 percent a year during his tenure as Fed chairman (1987–2006), but I’d hardly call it anti-inflationary. Moreover, the CPI is a notorious price index aggregate that largely ignores price bubbles in areas such as real estate and the stock market. If you judge Greenspan by the value of the dollar—and certainly one of the missions of the Fed chairman is to defend the nation’s currency—then Greenspan witnessed a substantial overall decline in the value of the dollar against the hard European currencies and the Japanese yen. The gold price, another bellwether, declined during most of the Greenspan years—a plus—but then took off, doubling in price during Greenspan’s final years.

Messrs. Henderson and Hummel also largely ignored the frequent changes in monetary policy, from easy to tight and back again. As measured by the Fed’s discount-rate policy, he switched policies seven times in 19 years. A stable non-inflationary monetary policy is surely the sign of a good Fed helmsman.

Clearly Greenspan’s worst period was the cheap interest rate policies of 2002–04. The authors fatally underplay the role Greenspan played in cutting rates far below the natural rate, due to his unwarranted fear that the United States was facing a deflationary collapse a la Japan. As a practitioner on Wall Street, I witnessed firsthand the malinvestments that were caused by the Fed’s deliberate plan. (I find it remarkable that Messrs. Henderson and Hummel made no reference in their article to the Wicksellian “natural” rate of interest hypothesis, a fundamental factor in the Austrian theory of the business cycle.)

Mortgage rates and real estate prices were clearly affected by this Greenspan cheap money policy, and so were the pricing of REITs [real estate investment trusts], closed-end income funds, and the carry trade, which sold at huge premiums as a result of 1 percent interest rates. Investment bankers and hedge-fund traders were constantly borrowing short and investing long during this 2002–04 time period. Then when the Fed started raising rates sharply, REITs and closed-end income funds collapsed very quickly, and the economy fell apart.

In short, the authors failed to disaggregate, as the Austrians are always emphasizing.

But their biggest sin of omission was to ignore the monstrous excessive monetary growth in the BRIC countries [Brazil, Russia, India, China] and emerging markets. The monetary aggregates rose much faster in China and the emerging markets than the G8 nations. We live in a global economy, and that money had to go somewhere, and it not only went into the BRIC economies, but also they bought a large amount of securitized U.S. mortgage securities, and profited from the yield spread.

Did Greenspan’s low interest-rate policy contribute to the artificial mortgage boom? Despite his denials, it did very definitely. As the Economist states (“A Tale of Two Worlds,” May 8, 2008), “Apart from the Gulf states, few countries still peg their currencies to the dollar, but most try to limit the amount of appreciation. This means that as the Fed cuts rates there is pressure on emerging economies to do the same, to prevent capital inflows pushing up their exchange rates.” The worldwide easy money policies lead to worldwide asset bubbles, commodity inflation, and unsustainable economic growth.

Consequently: “Emerging economies were partly to blame for America’s housing and credit bubble. As China and Gulf oil exporters purchased American Treasury bonds in order to hold down their currencies, this pushed down bond yields and helped to fuel the housing boom. Low yields also encouraged investors to seek higher returns in riskier assets, such as mortgage-backed securities.”

Finally, I find it incredible that Messrs. Henderson and Hummel would defend Mr. Greenspan’s indefensible record as a bank regulator. The Fed’s charter requires the chairman to oversee bank management policies, and the reckless way that banks promoted subprime and Alt-A mortgages can be laid at the feet of a complacent Federal Reserve Board. Contrast his approach to Canada’s strict banking regulations, which categorically prohibited these shameless banking policies north of the border.

David R. Henderson and Jeffrey Rogers Hummel respond:

Mr. Skousen would “hardly call” Alan Greenspan’s average annual inflation rate of 3.1 percent “anti-inflationary.” Neither would we. Nor did we. As Mr. Skousen admits, we wrote that Greenspan “oversaw relatively low and stable inflation.” This is not perfect, as we noted in our article.

Mr. Skousen points out that the consumer price index “largely ignores price bubbles in areas such as real estate and the stock market.” True. The CPI measures the cost of living, not the value of assets. As for gold, the price on August 11, 1987, when Greenspan became Fed chairman, was $461.20 per ounce. It had risen to $568.75 by January 31, 2006, the day he left office. That’s an increase of 23.3 percent, or an annual average of only 1.2 percent, far below the average inflation rate.

Mr. Skousen insists on measuring Fed policy by the discount rate. We argued that even the federal funds rate, which commentators other than Mr. Skousen tend to use, is not a good measure and that the best measure is the growth of the monetary aggregates. Mr. Skousen does not challenge our argument; he ignores it.

As for the real estate boom, we never denied it. Nor do we deny that low interest rates contributed to that boom. Rather, we questioned the role of the Federal Reserve in bringing about those low rates, an argument that Mr. Skousen does not grapple with.

Mr. Skousen claims our “biggest sin of omission” was to ignore the “monstrous excessive monetary growth” in other countries. Well, yes. We were evaluating Greenspan’s policy, not the policy of other central banks.

Finally, Mr. Skousen faults Greenspan for not regulating banks more. Although we did write that Greenspan contributed to the “too big to fail” doctrine, our preference is still deregulation and, as we noted, ending the Federal Reserve.

Those who wish to read an extended reply to our critics can go to www.tinyurl.com/csuae8 for details.