I'm not even going to try to make a claim I have the slightest lick of economic expertise in comparison with former Federal Reserve Chairman Alan Greenspan, but I disagree with his latest defense that the persistently low federal funds rate - the Fed's short-term, benchmark interest rate - had nothing to do with the historically low, long-term mortgage interest rates that are blamed for contributing to a massive, unsustainable and unchecked expansion of housing credit.
Over-saving in growing Asian countries led to an excess of capital, which, after being reinvested in the United States and other economies to finance our deficits, pushed downward on long-term interest rates, he writes.
Greenspan does not mention that when interest rates are low, and banks can borrow from the Fed at dirt cheap prices, the ability to capture even higher profit margins sends banks looking for the high-priced goods, sub-prime mortgages and the like - at the very least, to beat inflation. The ability to get easy money in the short-term has spillover effects for the short and long term.
Mortgage rates may have been decoupled from short-term interest rate fluctuations as Greenspan contends, but don't low short-term rates spur inflationary growth and perhaps make people more confident about the economy and more willing to shell out cash for a long-term, debt-financed investment such as a home? The short-term and long-term may not be directly correlated, but doesn't the former impact a consumer's willingness to take risks in the latter?
He also neglects to mention the impact of short-term interest rates on the ability for banks to multiply money supply and expand other shorter-term vehicles of credit, from car loans to credit cards. This expansion drove up consumption to levels that, as we now see, were highly overblown (just look at how much the economy has receded without such free availability of cheap credit).
Finally, he barely mentions the Fed's utter inability to regulate banks' mortgage-lending practices. The crisis was as much a regulatory policy failure as much as it was a market failure.
Nevertheless, it may be difficult to pin the crisis on any one person or institution. The moral of the story probably is that the crisis is not Greenspan's or the Fed's fault, but that persistently low interest rates helped create a credit bubble - and the housing market was the first bubble to go bust.
Posts
3 years ago
1 comment:
heh - if you have no economic expertise then what the hell am I left with...?! anyway here goes.
As I see it, the problem stems from being in rapt awe of Friedman's monetarist theory of inflation - i.e. that under given inflationary conditions, manipulation of central bank interest rates in and of itself would give price stability and hence economic equilibrium. Nice thought, but as the last twenty years have shown (and as you rightly point out) the setting of low central interest rates simply overheats the credit supply, and far from stabilising prices launches them into an unsustainable bubble - one which cannot be given the soft landing that Friedman's monetarist model predicts on a gentle raising of central lending rates.
The myopic view that manipulation of the money supply, in isolation from controls on capital and wages, is sufficient to control an economy is what gave us this crisis. That, and on a simplistic level when fed rates are low, commercial rates are low, people borrow too much that they can't afford, defaults mount, and the whole system crashes - if Greenspan can't see the wood for the trees we're doomed...!
Post a Comment