It Really Is All Greenspan's Fault

Susan Lee

Ask John Taylor ...

It's been quite a spectacle for those who have followed Alan Greenspan's career for decades. Gone is the financial rock star or even the statesman testifying before Congress in a measured baritone. Instead, over the past several months, Alan Greenspan has morphed into a totally new person.

The first incarnation was the shaken Greenspan who was stunned that greedy and reckless short-term behavior could overwhelm long-term, rational self-interest. That was rather amazing all by itself. But now, there's a newer Greenspan--a decidedly prickly and whiny one.

I'm talking about Greenspan's recent op-ed in The Wall Street Journal. A 1,500-word attempt to move blame for the financial crisis away from himself and onto ... China.

It was, writes Greenspan, Chinese growth that led to "an excess" of global savings. That growth kept long-term interest rates low, which fueled the housing bubble. As for himself, the lowly chairperson of the Fed, he says he was helpless. He only had control over short-term rates.

Why this recent incarnation as a self-pitying victim of historical forces? Most likely, it's because of John Taylor, a mild-mannered professor at Stanford and former colleague of Greenspan's at the Fed.

In his Getting Off Track, a nifty little book, Taylor exposes, as plain as day, the culprit behind the financial boom-bust: Greenspan. His weapon of choice is the "Taylor rule" (discovered by Taylor--but not named by him, as he modestly points out.) (The Taylor rule is a recommendation about how the Fed should set the short interest rate--suggesting the amount it should be changed given economic conditions.)

Here's Taylor's take. Short interest rates fell in 2001 in response to the dot-com bust. But--and here's the important moment--beginning in 2002, the Taylor rule indicated that Greenspan ought to have tightened. Indeed, from 2002 to 2005, rates ought to have climbed to a touch over 5% and then stayed there through 2006.

But the Fed kept to a loose monetary stance, and rates kept falling during the period 2002 through 2004. Rates didn't start back up until middle of 2004 and didn't reach 5% until 2006. You can check this out in Figure 1, below.

The result? The Greenspan Loose policy went on to fuel a boom, while the Taylor Tight would have avoided one. As Taylor says, all the Fed needed to do was follow "... the kind of policy that had worked well during the period of economic stability called the Great Moderation, which began in the early 1980s."

The connection between Greenspan Loose and the housing boom is also clear. Housing starts took a sharp spike up in 2003 and then continued to climb through 2006. If the Fed had followed Taylor Tight, however, housing starts would have peaked at a much lower level at the end of 2003, and drifted down through 2006.

What about Greenspan's argument that he only controlled short-term rates? And that short rates became decoupled from long-term rates in 2002?

Nonsense, says Taylor. Surely the existence of adjustable-rate mortgages (accounting for about one-third of mortgages starting in 2003) linked the mortgage market and short-term rates. Moreover, says Taylor, whatever minor decoupling occurred, happened because bond investors were flummoxed by the Fed's odd behavior.

Taylor also takes on Greenspan's excuse that he was helpless in the face of a global saving glut. Cutting off the feet of Greenspan's excuse, Taylor says there wasn't a glut, there was a shortage. Figures from the International Monetary Fund show global saving rates, as a share of world GDP, were low during 2002 to 2004--way lower than rates in the 1970s and 1980s. In fact, the global saving rate fell at the end of 1990s, hitting bottom about 2003.

Greenspan's monetary excess was also crucial in setting off a chain of bad government policies. As Taylor argues, Greenspan Loose was amplified by the popularity of subprime mortgages, especially adjustable-rates, which promoted risk taking. And it made for a lethal brew in a pot of policies to promote homeownership.

Greenspan pulls out many stops in his defense. He even quotes the great Milton Friedman's approving assessment of Fed policy between 1987 and 2005. Well, Friedman died in 2006 and, in 2009, his equally great colleague, Anna Schwartz, has this to say: "There never would have been a subprime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for." As for Greenspan's argument that the whole mess is China's fault, she says tartly: "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can't be blamed on global events."

As fine a last word as there could be.

Susan Lee has written several books on economics, including a college text. She is an economics commentator for NPR's "Marketplace" and writes a weekly column for Forbes.

Geithner-Obama Economics: A Joke That's Not Funny

By Byron York

Treasury Secretary Timothy Geithner testifies on Capitol Hill in Washington, Thursday, March 12, 2009, before the Senate Budget Committee hearing on the economy. (AP Photo/Susan Walsh) When they start making jokes about you, it's hard to recover. And that's what is happening now to Treasury Secretary Timothy Geithner.

It's not just "Saturday Night Live" poking fun at him -- you saw the skit depicting a Geithner so clueless that he offered a huge reward to anyone who called his hotline, 1-800-IDEAS, with a plan to get us out of the financial crisis. Beyond the TV shows, Geithner, who was confirmed despite having to pay $48,000 in back taxes and interest, is also the target of suppressed snickers on Capitol Hill whenever the subject turns to the IRS. And now, he is widely thought to be not up to the job.

The fundamental problem, of course, is that Geithner hasn't come up with a financial rescue plan. There is nearly unanimous agreement among economists and policymakers that the single most important thing the Secretary of the Treasury should do now is develop a plan to deal with the "toxic assets" that threaten the survival of financial institutions. But Geithner, who has been acutely aware of this problem for months, doesn't have such a plan. If he had, the comedians wouldn't be talking about 1-800-IDEAS.

The situation has gotten so bad that Geithner is the subject of private buyer's remorse from some of the very politicians who supported him. A number of senators voted to confirm Geithner, even with tax problems they deemed disqualifying, because they believed the financial crisis required immediate action. Now, with little happening, their feeling is: We put aside some very troubling concerns for this?

"I'm fairly confident that if the vote on the nomination were held today, he would not be confirmed," a top Senate aide told me recently. "The thing that saved him -- even though people with lesser problems were not saved -- was that he was the only one who could do the job, and he was seen as the wunderkind who would come in and save the day."

But as troublesome as Geithner's performance has been, focusing too much on him obscures the bigger, more important problem: Barack Obama doesn't seem to know what to do next when it comes to the economy.

Signs of confusion are all around. First, the president hasn't troubled himself to hire a team to work alongside Geithner at Treasury. There are normally eighteen high-ranking Department officials who have to be confirmed by the Senate, and Obama has nominated three -- and none of them have even had hearings yet. "Geithner isn't getting any support from the White House," another clued-in GOP aide told me. "No one man can do this job. Where is everyone who is supposed to be helping?"

Second, the administration is giving off signs of uncertainty about its own analysis of the crisis. The White House knows its forecasts of growth next year -- when the administration predicts the economy will magically snap out of deep recession and resume robust growth -- are too rosy. But they know they can't rein in those forecasts, bring them more in line with the expert consensus, without blowing the president's big-spending budget out of the water. So they stick to a less and less credible forecast.

Third, the White House even seems unsure of its much-touted $787 billion stimulus package. Do you remember how often President Obama said his plan will "create or save" four million jobs? Well, a group of economists sympathetic to Capitol Hill Democrats reportedly says the number might be significantly lower -- maybe 2.5 million jobs.

In light of that, the president's pledge to "save" jobs is looking fuzzier by the day. At a Senate hearing last week, Geithner hemmed and hawed when he was asked the simple question, "What's a saved job?"

"That's a loss avoided, or a rise in unemployment avoided, by getting growth back on track," Geithner answered. But when he was asked just how we will know when a job loss was prevented from happening, Geithner could only say that we'll know when the president tells us.

Geithner's answer seemed almost sheepish, as if he knew -- and he knew the senators knew -- that the administration is making it all up as it goes along. He might just as well have asked us to call 1-800-IDEAS.