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GreenspanFest '09

The Reappointment of Bernanke


The world’s central bankers met in Jackson Hole last weekend for their annual gathering. Undoubtedly one of the main topics of discussion was the reappointment of Ben Bernanke as Federal Reserve Board chairman. His reappointment would almost certainly win the support of the vast majority of attendees. This should raise serious concerns.

This is the same group that in 2005 devoted their meeting to an Alan Greenspan retrospective (seriously). The world’s leading thinkers and practitioners of monetary policy debated whether Alan Greenspan was the greatest central banker of all time.

I’m not sure how the polling on this question turned out, but four years later the world is facing the worst economic downturn since the Great Depression because of Alan Greenspan’s failed monetary policy. Greenspan either did not recognize an $8 trillion housing bubble, or did not think it was a big enough deal to demand his attention. The collapse of this bubble gave us the financial panics of 2008 and, more importantly, led to the falloff in demand that produced the downturn.

None of this should have been a surprise to people who understand monetary policy. The housing bubble should have been easy to recognize. There was a 100-year long trend in which nationwide house prices in the United States had just tracked the overall rate of inflation. At the peak of the bubble in 2006, house prices had risen by more than 70 percent after adjusting for inflation.

There were no changes in the fundamentals of the supply or demand of housing that could provide a remotely plausible explanation for this unprecedented run-up in prices. Furthermore, rents were not outpacing inflation. If the run-up in house prices was being driven by fundamentals, then there should have been at least some upward pressure on prices in the rental market.

The bubble was very evidently driving the economy by the time of Greenspanfest ’05. The residential construction sector had expanded to more than 6 percent of GDP, an increase of more than 2 percentage points (@$300 billion a year) from its normal level. The $8 trillion in housing bubble wealth was also propelling consumption. Assuming a wealth effect of 6 cents on the dollar, the bubble wealth was generating close to $500 billion a year in increased consumption.

It was inevitable that both the construction and consumption demand would disappear when the bubble burst. What did Greenspan and his acolytes think would make up this lost demand?

Even the financial crisis was entirely predictable although the exact course of events could not be known to someone who lacked access to the information held by central bankers. Housing is always a highly leveraged asset and it was no secret that it had become much more so during the bubble years.

Down payment requirements were thrown out the door, as homebuyers often purchased homes with no money down; in many cases even borrowing more than the appraised value of a bubble-inflated house price. The explosion of subprime and Alt-A loans was also not classified information. How could any economist have been surprised by the flood of defaults and the resulting stress on banks following the collapse of the bubble? This was as predictable as the sunset at the end of the day.

But the attendees of GreenspanFest ’05, most of whom are back to attend GreenspanFest ’09, apparently were surprised. Remarkably, almost none of the attendees suffered any consequences from the failure to see the largest financial bubble in the history of the world. In the United States alone, 25 million people are either unemployed or underemployed in large part because of the failure of the GreenspanFest attendees to do their job. Yet, the GreenspanFest attendees are not among those fearing unemployment. The official slogan of GreenspanFest ’09 is: “who could have known?”

Ben Bernanke has moved very effectively in the last year to prevent the collapse of the financial system. However, even in this area there have been serious issues of unnecessary secrecy and failed regulation. (Isn’t Goldman Sachs supposed to be a bank holding company now?)

But more importantly, Bernanke is waist deep in responsibility for this mess. Before becoming Fed chairman in January of 2006 he had served on the Board of Governors since 2002, and had been head of President Bush’s Council of Economic Advisors from June of 2005. After Greenspan, there was probably no one else better positioned to combat the bubble.

The attendees of GreenspanFest ’09 may not want to be so rude as to discuss their culpability for this disaster, but that should not prevent the rest of us from raising the topic. It would be an insult to the tens of millions of people who have lost their jobs, their homes, and/or their life savings to see Bernanke reappointed. Failure should have consequences, even for central bank chairmen.

DEAN BAKER is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy.

This column was originally published by The Guardian.