Friday, February 22, 2008

Greenspan: Not really all that?

A few postings ago, I attacked the Fed's post-1995 performance as helping to enable the two great asset bubbles of the last two economic expansions, the stock bubble of 1996-2000 and the 2002-2007 housing bubble, now deflating and taking subpar housing borrowers with it. In both cases, recession scares (only a scare in 1994-95; a real, if mild and short, recession in 2001) misled the Fed into keeping credit too cheap for too long. Cheap credit, among other things, then fed the asset bubbles.

An interesting book-length attack on Greenspan has appeared recently, William Fleckenstein and Fred Sheehan's Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve. Their attack aims at essentially the same targets as we have here at Kavanna, points not original with either us or them. But they develop the thought at length and back it up with compelling evidence.

From just skimming the book, the attack seems somewhat overdone. Greenspan's performance from 1987 until about 1995 was quite good, including holding everyone's hands after the 1987 stock market crash and negotiating the savings and loan crisis of the early 90s. After 1994, however, Greenspan lost his fear of inflation - inflation in the conventional, everyday sense of consumer and producer prices - while becoming strikingly blind to asset inflation, as in stocks and real estate. He failed to fully grasp the growth of speculative forces in the economy and how certain governmental policies fed those forces.

We can only hope that Bernanke doesn't repeat these mistakes. Of course, he could make others: there is real risk now of conventional price inflation returning, with all those raw materials prices rising. This risk is more real than the risk of recession. But the Fed only controls a few things. Many unbalanced features of the world economy - especially Asia's tendency to oversave and underconsume and its inability to find adequate investment opportunities except here in America - result from long-standing policies and unforeseen twists in global economic evolution. The cheap loans we get here results from all those international savings being dumped on our credit markets. And far more than the Federal Reserve, those government-backed loan agencies (Freddie Mac, Fannie Mae et al.) and Congress have been pushing home buying hard for more than a decade, with scant regard for whether the borrowers could afford it.

The Fed is a collective, collegial body, with regional boards as well. Concentrating on the Fed chief is misleading and overpersonalizing. Such bodies can be subject to herdthink, but they also allow important information into decision-making that might be otherwise blocked out.

POSTSCRIPT: Fleckenstein, it seems, is a busy man. He's got a blog over at MSN Money.

Lots of economist types, especially the followers of the
laissez-faire Austrian school,* have been criticizing Greenspan for a long time on just this issue. Of course, it's the Fed itself they don't like. Just search on "greenspan fleckenstein".
* Boasting two of the greatest economists of the last century, Hayek and his mentor, Mises: more refugees from the Hapsburg Austro-Hungarian collapse and final representatives of Europe's pre-1914 belle époque.

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