FacebookTwitterGoogle+RedditEmail

What Greenspan Should Have Done

In Washington policy circles, money and influence can be used to make even the most simple and obvious things complicated and confusing. This is certainly the case with the housing bubble and its aftermath. Four years into the housing bubble downturn, much of the country remains hopelessly confused about what happened, why it happened and who is to blame.

First, what happened is very straightforward. We had a huge run-up in house prices that had no basis in the fundamentals of the housing market. After 100 years in which nationwide house prices just kept even with the overall rate of inflation, house prices began to sharply outpace inflation beginning in the late 90s. By 2002, when some of us first noticed the bubble, house prices had already risen by more than 30 percentage points in excess of inflation. By the peak of the bubble in 2006, the increase in house prices was more than 70 percentage points above the rate of inflation.

This was a huge problem because this bubble was driving the economy. It drove it directly by creating a boom in residential housing construction. We were building housing at a near-record pace in the years 2002-2006. This was in spite of the fact that we had an aging population and record levels of vacancies at the start of the period.

The other way in which the bubble was driving the economy was through its effect on consumption. The bubble created more than $8 trillion in ephemeral wealth in housing. Homeowners thought this wealth was real and spent accordingly. The result was a massive consumption boom that sent the saving rate down to zero in the years from 2004-2006.

When the bubble burst, the building boom went bust. Construction fell to its lowest levels since the 50s as the country waits to gradually work off a glut of housing. Consumption fell back to more normal levels as people came to grips with the fact that they had lost tens of thousands or even hundreds of thousands of dollars of equity in their home.

The combined impact of the plunge in construction and consumption spending together with the collapse of a bubble in non-residential real estate is to lower annual demand in the economy by more than $1.2 trillion. This is the reason for the prolonged downturn. There is nothing in the economists’ bag of tricks that will allow the economy to quickly and easily replace $1.2 trillion in lost demand. That is the reason we are still 10 million jobs below full employment four years after the onset of the recession.

The “why” in this story is simple: Businesses were making money. Many people acted poorly in this story — almost everywhere the motivation was money and profit. Countrywide and Merrill Lynch were issuing and packaging fraudulent mortgages because they were making tons of money on them, not because they wanted to make moderate-income people and minorities homeowners.

Fannie Mae and Freddie Mac deserve plenty of blame in this story. Housing is all they do. They should have seen the bubble and tried to stop it. Instead they jumped on the bandwagon. But they were followers, not leaders. The worst loans were securitized by the Wall Street boys. Fannie and Freddie got into junk mortgages late in the game and they did so to regain market share as a profit-making business, not out of aconcern to extend homeownership.

The government agency devoted to extending homeownership to moderate-income people, the Federal Housing Authority, became almost irrelevant. Its market share shrank to less than 2.0 percent at the peak of the bubble (compared with around 10 percent in more normal times), as it lending standards were far stricter than those of the subprime mortgage pushers.

Finally, some quick points on what could have been done. First, the Fed has responsibility for maintaining the stability of the U.S. economy. Alan Greenspan should have recognized the bubble and done everything in his power to burst it before it grew to such dangerous levels.

Step one in this process should have been to document its existence and show the harm that its collapse would bring. This means using the Fed’s huge staff of economists to gather the overwhelming evidence of a bubble and to shoot down anyone who tried to argue otherwise. Greenspan should have used his Congressional testimony and other public appearances to call attention to the bubble.

This would have put the bubble clearly on everyone’s radar screen. And, the reality was that there were no serious counterarguments. It is difficult to believe that this action by itself would not have slowed the home buying frenzy and curbed the issuance of junk loans, or at least their repurchase for securitization.

Second, the Fed has enormous regulatory power beginning with setting guidelines for issuing mortgages. They first issued draft guidelines inDecember of 2007. It was not hard to find abusive and outright fraudulent practices in the mortgage industry, if anyone in a position of authority was looking for it.

Finally, the Fed could have used interest rate increases as a mechanism to rein in the bubble. This should have been a last resort, since higher rates would have slowed the economy at a time when it was still recovering from the collapse of the stock market bubble.

To maximize the impact of any rate increases, Greenspan could have announced that he was targeting the housing market. He could have said that he would continue to raise rates until house prices were brought back to a more normal level.

This surely would have gotten the attention of the mortgage industry and potential homebuyers. Would it have been an extraordinary action from a Fed chair? Sure, but so what. It might have prevented the economic devastation that is ruining tens of millions of lives. If this required Alan Greenspan to deviate from the standard script for Fed chairs, that would have been a very small price.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy.

This article originally appeared in Al Jazeera English.

 

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

Weekend Edition
August 17, 2018
Friday - Sunday
Daniel Wolff
The Aretha Dialogue
Nick Pemberton
Donald Trump and the Rise of Patriotism 
Joseph Natoli
First Amendment Rights and the Court of Popular Opinion
Andrew Levine
Midterms 2018: What’s There to Hope For?
Robert Hunziker
Hothouse Earth
Jeffrey St. Clair
Roaming Charges: Running Out of Fools
Ajamu Baraka
Opposing Bipartisan Warmongering is Defending Human Rights of the Poor and Working Class
Paul Street
Corporate Media: the Enemy of the People
David Macaray
Trump and the Sex Tape
CJ Hopkins
Where Have All the Nazis Gone?
Daniel Falcone
The Future of NATO: an Interview With Richard Falk
Cesar Chelala
The Historic Responsibility of the Catholic Church
Ron Jacobs
The Barbarism of US Immigration Policy
Kenneth Surin
In Shanghai
William Camacaro - Frederick B. Mills
The Military Option Against Venezuela in the “Year of the Americas”
Nancy Kurshan
The Whole World Was Watching: Chicago ’68, Revisited
Robert Fantina
Yemeni and Palestinian Children
Alexandra Isfahani-Hammond
Orcas and Other-Than-Human Grief
Shoshana Fine – Thomas Lindemann
Migrants Deaths: European Democracies and the Right to Not Protect?
Paul Edwards
Totally Irrusianal
Thomas Knapp
Murphy’s Law: Big Tech Must Serve as Censorship Subcontractors
Mark Ashwill
More Demons Unleashed After Fulbright University Vietnam Official Drops Rhetorical Bombshells
Ralph Nader
Going Fundamental Eludes Congressional Progressives
Hans-Armin Ohlmann
My Longest Day: How World War II Ended for My Family
Matthew Funke
The Nordic Countries Aren’t Socialist
Daniel Warner
Tiger Woods, Donald Trump and Crime and Punishment
Dave Lindorff
Mainstream Media Hypocrisy on Display
Jeff Cohen
Democrats Gather in Chicago: Elite Party or Party of the People?
Victor Grossman
Stand Up With New Hope in Germany?
Christopher Brauchli
A Family Affair
Jill Richardson
Profiting From Poison
Patrick Bobilin
Moving the Margins
Alison Barros
Dear White American
Celia Bottger
If Ireland Can Reject Fossil Fuels, Your Town Can Too
Ian Scott Horst
Less Voting, More Revolution
Peter Certo
Trump Snubbed McCain, Then the Media Snubbed the Rest of Us
Dan Ritzman
Drilling ANWR: One of Our Last Links to the Wild World is in Danger
Brandon Do
The World and Palestine, Palestine and the World
Chris Wright
An Updated and Improved Marxism
Daryan Rezazad
Iran and the Doomsday Machine
Patrick Bond
Africa’s Pioneering Marxist Political Economist, Samir Amin (1931-2018)
Louis Proyect
Memoir From the Underground
Binoy Kampmark
Meaningless Titles and Liveable Cities: Melbourne Loses to Vienna
Andrew Stewart
Blackkklansman: Spike Lee Delivers a Masterpiece
Elizabeth Lennard
Alan Chadwick in the Budding Grove: Story Summary for a Documentary Film
FacebookTwitterGoogle+RedditEmail