- The Washington Times - Sunday, April 20, 2008


As the economy continues to deteriorate amid falling home prices, soaring foreclosures and tightening credit, scapegoating has become a popular pastime. With the pain from the deflation of the housing bubble becoming more excruciating and more widespread, scapegoaters and housing-market “victims” — in many cases they are the same — are finding it far more convenient targeting another person or institution rather than looking in the mirror and accepting personal responsibility. Others with an ideological ax to grind or an economic theory to protect want to focus the blame for the economy’s deterioration on the actions of policymakers whose views and priorities were different from those of the scapegoaters.

The Federal Reserve and its former chairman, Alan Greenspan, have become the prime targets of this campaign. Both are being blamed for precipitating the housing bubble and looking the other way as it inflated. While there is more than enough blame to go around, our view is that the Fed and Mr. Greenspan are being unfairly deluged by a hugely disproportionate amount of responsibility for the unfolding debacle. Interestingly, much of the criticism comes from both ends of the ideological spectrum. It has been payback time for countless liberals, who have detested Mr. Greenspan’s deeply entrenched conservative views. On the right, much scapegoating has come from the supply-side editorial page of the Wall Street Journal, which spent years instructing Mr. Greenspan to butt-out of fiscal policy whenever the Fed chairman expressed concern about soaring budget deficits.

In two recent essays appearing in the Financial Times — “We will never have a perfect model of risk” (March 16) and “The Fed is blameless on the property bubble” (April 6), which appeared in a much-expanded version on the Times Web site — Mr. Greenspan himself has entered the debate about his culpability, defending his chairmanship during the housing-bubble years.

To be sure, some of the criticism of the Fed and Mr. Greenspan is reasonable and fair-minded. For example, Alice Rivlin, the Brookings scholar who served as vice chairman of the Fed (1996-99) under Mr. Greenspan, helpfully responded to March 16 essay as follows: “Greenspan is right, of course, that we will never have a perfect model of risk in a complex economy. But the culprit was not imperfect models. It was the failure to ask commonsense questions: Q: Will house prices keep going up forever? A: Not likely. Q: What will happen to the value of mortgage-backed securities when housing prices stop rising or fall? A: They will go down.” In addition, the central bank could have — and should have — been more aggressive on the regulatory front.

Many other arguments attacking Fed policy are simply wrong. Claiming that an excessively expansionary monetary policy provided the liquidity to inflate the housing bubble, most critics of the Fed blame the central bank for keeping short-term interest rates too low for too long and then raising them too slowly. The Fed reduced its targeted overnight interest rate from 6.5 percent in early 2001 to 1.75 percent by the end of the year. Eighteen months later, the overnight rate was lowered to 1 percent, where it remained for the next year, at which time it was raised in quarter-point increments every six weeks or so thereafter until it reached 5.25 percent in June 2006. The Fed convincingly argued at the time that short-term interest rates needed to remain low to thwart the emergence of a debilitating bout of deflation, which had afflicted Japan for more than a decade. Moreover, even though an eight-month recession officially ended in November 2001, the U.S. unemployment rate continued to increase until it peaked in June 2003; and nonfarm employment did not begin to rise steadily until three months later.

In his efforts to absolve the Fed of blame for the housing bubble, Mr. Greenspan is quite persuasive when he points out that housing bubbles occurred in many other nations, including those whose central banks pursued much more restrictive monetary policies than the Fed, such as Britain and Australia. In addition, central banks exert far less control over long-term interest rates, which are essentially determined in the bond market and which affect the housing market far more than short-term rates do. Indeed, it was the savings glut in developing nations that flooded the bond market with liquidity, driving down long-term inflation-adjusted mortgage rates to levels not seen in decades. These low long-term rates, combined with a dramatic, worldwide liberalization of mortgage finance (even adjustable-rate mortgages commit money for 30 years), helped to fuel the housing bubble far more than any actions by the Fed.

Absent the housing bubble, the average annual economic growth rate during the Bush-Cheney administration would have been much closer to an abysmal 1 percent. If the economy is flat during 2008, the actual average annual growth rate (2001-08) will be less than 2.1 percent.

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