Dean Baker Is Not an Alan Greenspan-Worshipper

Dean Baker says that Alan Greenspan-worshippers (like me) are deluded:

MaxSpeak, You Listen!: GREENSPANFEST 2005: BE GLAD YOU WEREN'T INVITED: The Federal Reserve Board is having its annual retreat at Jackson Hole, Wyoming and the agenda this year is devoted to a retrospective of Greenspan's 18-year tenure as Fed chairman. The world has not seen a greater display of obsequiousness since the death of Leonid Brezhnev....

1) Mr. Greenspan ignored the stock bubble.... The tens of millions of people who saw much of their retirement savings disappear in the crash are just out of luck, as are the pension funds that are now insolvent because their managers somehow didn't see the bubble.

The proper remedy for the bubble was actually very simple -- talk. If Greenspan used his Congressional testimony and other public speaking opportunities to lay out the case for the bubble, there is little doubt that it would have deflated long before it reached such outlandish proportions.... A fund manager that ignored Greenspan, and kept most of a portfolio in a bubble market, would undoubtedly be sued for negligence by their clients and probably have to pay every penny they owned in damages....

2) Mr. Greenspan promoted the housing bubble... Greenspan's tool for getting out of the recession created by the collapse of the stock bubble was to promote a bubble in the housing market. He did this most blatantly back in the summer of 2002.... When the housing bubble bursts, we will see the loss of $5 trillion in housing bubble wealth.... The economic fallout will also be enormous....

5) Finally, he did not tell the truth when he endorsed President Bush's tax cut in 2001....

Okay, I close with my own praise of Alan Greenspan. In 1995 and 1996 he lowered interest rates and kept them low. This allowed the unemployment rate to fall below the 6.0 percent level.... The decision to allow the unemployment rate to fall to levels that most economists thought would trigger inflation gave millions of people jobs.... The tight labor market of the late nineties allowed for the first sustained growth in real wages for most of the country's workers since the early seventies. We will benefit from this decision for years to come... the country benefited hugely because [of] Alan Greenspan..

I think Dean Baker understates how big a win Greenspan's decision to go for growth in 1995-1996 was. I agree with Dean's criticism (5): Greenspan did not understand how much damage the Bush administration was going to do to America's long-term fiscal stability, and should have worked much harder to aid the deficit-hawk wing of the Bush administration.

(1) and (2) are, I think, harder questions. Dean Baker wants Alan Greenspan to have taken on the role of investment adviser to America--telling Americans when assets are overvalued. Alan Greenspan would say that that is not his role, and that he's not very good at that role: he thought that stocks were overvalued in December of 1996, and high-tech stocks now--long after the end of the dot-com bubble--are twice what they were then. I don't think that it was as simple as "talk."

I also reject the claim that Greenspan should have raised interest rates and added to unemployment in the late 1990s to cool off stocks and in the early 2000s to cool off housing. That seems to me to be a clear loser, and a bad thing.

Where I would criticize Greenspan is in his failure to use his regulatory authority to brake some of the enthusiasm for first high-tech stocks and then housing. Organizations making it easier for individuals to make risky and ill-considered bets are creating systematic risk--and should be subject to heightened scrutiny and raised capital requirements as a result. That both stabilizes the system and potentially cools off the bubble. And that wasn't done.

But my thoughts critical of Greenspan--except in fiscal policy--are unformed. I think that of the three kinds of policy--monetary, fiscal, and financial asset--that Greenspan was concerned with, monetary policy was most important. And Greenspan has done a masterly job at monetary policy.

Comments

[Ralph]

I like Dean Baker's commentaries on economics a lot especially his early efforts with Mark Weisbrot on exposing the folly of social security reform. But I have to agree with you that the Fed should not be held responsible for policing the stock market and housing bubbles. Having said that I admit to being confused and mystified about the criticism that loose monetary policy contributed to the existence and nurturing of bubbles, one after the other.

[Hektor Bim]

Greenspan deliberately and with full knowledge gave ammunition to the Bush administration to cut taxes, even though he knew it would promote deficits, because he is blinded by a low-tax ideology. That was a colossal failure of judgement, and he should be held responsible.

[theCoach]

The stats on wages since the seventies, in general, are appalling. You should be proud of your efforts to affect the one bright spot in there.
Greenspan would have to have a spotless record of rising wages to outweigh his disastorous endorsement of Bush tax policy. THe damage is not just in the fiscal mismanagement, but in the credbility of the US system. If you then factor in his admiration for Ayn Rand, I think there is nothing to conclude but that Greenspan's stay on earth has been a net negative for society.

[save_the_rustbelt]

I always marvel at the ability of economists to talk about huge issues - creating or destroying millions of jobs -- as if it were an abstract chess game.

Many posters on this and other boards talk of destroying 3 1/2 million manufacturing jobs as if it some cosmic amusement.

I know we need people to look at the macro picture, but it really takes a certain cold-blooded approach to life.

Anyone who can read a newspaper knows about the housing bubble, so why should Greenspan have to protect us?

The stock bubble was more complex, perhaps from a macro view (not an individual investor view) Greenspan should have been more vocal.

[Dean Baker]

It’s great to be on the opposite side of an argument with Brad, with Alan Greenspan in the middle. We have two bones of contention:

1) whether I adequately appreciate Greenspan’s decision to allow the unemployment rate to fall in 1995-96 and throughout the rest of the decade; and
2) whether Greenspan should have played investment advisor and warned the world about the stock and housing bubbles.

I can easily deal with #1, there is no disagreement. It was a truly great thing that Alan Greenspan went against the orthodoxy in the profession (and 2 Clinton appointees to the Fed) and allowed the unemployment rate to continue to drop to the lowest levels since the late sixties. Low unemployment benefits everyone, but especially those at the bottom, such as African Americans and Latinos. I co-authored a book on the topic with my friend Jared Bernstein (The Benefits of Full Employment, Economic Policy Institute, 2003). If my appreciation of Greenspan’s actions on this issue is not evident, then maybe I should add some adjectives or italics to my earlier comment.

On point #2, I will hold my ground. First, just to clear the battle field, Brad tells us that Alan Greenspan would say that it is not his role to play investment advisor. Actually, he would have trouble saying this with a straight face. Alan Greenspan advised homebuyers to take out adjustable rate mortgages back in the summer of 2003, when fixed rate mortgages were near a 50-year low. So Alan Greenspan has not hesitated to give investment advice when he thought it appropriate.

More concretely, the question is what advice I would have him give. I would settle for the basic information that allowed him to reach the judgment that the stock market was experiencing a bubble in 1996 (or even more in 1998-2000), or more recently that the housing market currently faces a bubble.

This information isn’t a secret. The basic point is that once price to earnings ratios climb substantially above normal levels (as they had by 1996), it is impossible for the stock market to sustain normal returns, unless profit growth proves to be far more rapid than most analysts (e.g. CBO, OMB, the Fed) project. I seem to recall a good paper on this topic (see “Asset Returns and Economic Growth,” by Baker, DeLong, and Krugman [www.j-bradford-delong.net/movable_type/BDK-BPEA.pdf] ). This means that:

1) either investors in the stock market must be willing to accept much lower than normal returns, or
2) they must anticipate far more rapid profit growth than virtually all economic analysts.

If Greenspan had used his congressional testimonies and other public speaking opportunities to make these points, he would have forced every investment fund manager in the country to address these arguments. Needless to say, they had no plausible response. In fact, given how angry many investors no doubt were when their stock portfolios plummeted (and homeowners will be), it is likely that many would have sued their fund managers/advisors had they completely ignored the wisdom emanating from Mr. Greenspan.

Had Greenspan gone this route, it would have solved a moral hazard problem – as things stand now, investment advisors and fund managers (who typically draw six and seven figure salaries) suffer no consequence from doing incredibly stupid things, as long as they are the same incredibly stupid things that other investment advisors are doing. [Proof: how many fund managers lost their jobs as a result of keeping most of their fund’s assets in a stock market with a PE ratio over 30?]

So, I think the key is not Mr. Greenspan’s investment advice, in the sense of giving “buy” or “sell” recommendations, but rather his putting facts on the table. I find it hard to believe that it would not have made a difference if Mr. Greenspan made the case for the existence of a stock or housing bubble. (The market’s response to his offhand quip about “irrational exuberance” would seem to support my argument). Certainly, I have a hard time seeing what harm it could have done to give the market information.

[Cranky Observer]

Funny how we always slip by Long-Term Capital Management, which was of course not long-term and did not involve any management. Just billions of dollars of losses to the pocketbooks of multi-billionaire which Mr. Greenspan directed be made good by - the average American taxpayer, household income $40,000/year. Seems that "moral hazard" is something that only affects the little guy; do they give vaccinations for it at Andover?

Cranky

[cb]

Dean Baker is out of his element when not writing about Social Security.

[scorpio]

all wrong. raising rates is an economy-wide decision that shd only be forced by perceived monetary inflation and GENERAL increases in prices. it's a blunderbuss that shd be used sparingly. on the other hand, the FRB has many tools to go after specific bubbles like stocks (raise margin requirements) and housing (tighten credit standards) and shd use them before the feedback effect takes place and feeds into general price rises (through the wealth-effect).

[nate]

->isn't there more to monetary policy than interest rates and talking?
->what all does monetary policy include, and what did Greenspan or monetary policy people do on things other than interest rates?

[fred c. dobbs]

Cranky: The bailout of Long Term Capital Management did not cost any taxpayer money. All it cost was the Fed's reputation.
CB: Dean has been right about the stock market bubble and right about the housing bubble.
Brad: Can you talk some more about specifically what the Fed could do about bubbles other than raising interest rates? For stocks, it could raise margin requirements. For housing, what can the Fed do specifically?

[nate]

it is not clear to me how the fed anticipated and planned for the diffusion of etrade, ameritrade and other on-line access to stock markets in the 1990s.

[wcw]

the FRB has many tools to go after specific bubbles like stocks
(raise margin requirements) and housing (tighten credit standards) and
shd use them before the feedback effect takes place

Hear, hear.

Smart and expert as Mssrs. De Long and Baker
remain, neither to my knowledge has worked on
the buy side. I do and have, and can assure
them both that jawboning is no guarantee of
investment manager behavior.

Compliance will never conclude that staying
long when the FRB Chair says "bubble" violates
fiduciary duty, ERISA or your firm's ethics.
Meanwhile, if you do not go long during a
sustained late '90s-style market, your firm
will bleed assets until you capitulate.

Raising margin requirements might have, by
nipping the worst of the daytrading dot-com
equity culture in the bud and by telegraphing
commitment to regulate the worst market excess,
actually worked.

Talking about it almost assuredly would not.

[bailey]

Dean Baker doesn't need my support, but I've found him to be a welcomed voice of reason since he first challenged the Boskin Commission's recommendations for dramatically lowering the CPI. I believed BLS' Abraham quiet assertion that the Boskin changes were political but after Greenspan boisterously argued (ahead of the hearings), few Economists spoke up. I've yet to understand the silence of Academic Economists on the absurdity of hedonics & the quantity of subjective decisions included in the CPI.
It's easy to criticize Fed Heads decades later, i.e. Arthur Burns. It's a lot harder to sibject them to critical examination in the context of their times.

[Dean Baker]

On the question of Fed talk -- Greenspan is not just a voice speaking quietly in the wilderness. That it is why it matters that it is Alan Greenspan and not Dean Baker explaining that there is a stock bubble.

If Alan Greenspan calmly and clearly lays out the case that the stock market is over-valued, then we are less likely to see irresponsible news outlets like the Washington Post, the Lehrer News Hour, and NPR giving prominence to people who write books like "Dow 36,000." We also would not constantly be hearing the views of stock analysts whose methodology appears to be projecting that in a year, the NASDAQ will be 20 percent higher than wherever it is today.

Instead, the views of people who know arithmetic would occasionally be included in news stories. This would likely take the wind out of a bubble, probably before it even got too irrational.

I'll acknowledge that I could be proved wrong on this point, but since our Fed Chair never tried the talk route, the naysayers have no evidence to support their view.

[david]

What about the Bush 1 recession? Just wondering why it isn't up there on the Greenspan review account.

[js]

Ah, economists in their ivory tower mumbling ideas and mathematics.

Economics is ultimately about human actions, and not numbers.

As a central banker he should have known, that he can create liquidity, but cannot control where it goes (unless it is planned soviet style economy where the govt decides).

Greenspans flooding of the system with liquidity has bred a system where asset flipping creates "wealth". This would have been normal if it was some marginal activity, which one could choose not to meddle in, but housing is a primary need. And this asset flipping grew to be a monster, where sitting on the sidelines meant life passing by. Ultimately, one has live. One cannot grow old waiting for normalcy. So even normal people are locked into high debts now.

And how is this going to play out? By inflating the debt away? That would mean that those who held onto sanity, and saved, instead of taking on a lifetime of debt are going to be punished. And those who speculated, will gain without any productive contribution to society.

Or maybe we should make the people pay for their actions - hang the debt around them. But there is no yardstick that can be used to separate the speculators from the rest.

This is what Greenspan's legacy is - he made gamblers out of people. He destroyed the relationship between industriousness and its legitimate rewards. Now he will either crush people who were forced into the lottery, or crush the people who refused to play. It remains to be seen what it will be. But either way, it's going to be as destructive, capricious and arbitrary as inflation.

When economics loses touch with humans, their wants and means, and becomes an end in itself, this shouldn't be surprising.

[Barry]

Brad: "I agree with Dean's criticism (5): Greenspan did not understand how much damage the Bush administration was going to do to America's long-term fiscal stability, and should have worked much harder to aid the deficit-hawk wing of the Bush administration."

There's that saying about the job of a central banker, that he takes away the punch bowl just as the party is getting going strong.

In the case of the Bush administration, it was quite clear (read Krugman's columns) that Bush & Co had seen the results of Reagon's tax cuts and deficits, and had noted that they were mostly positive to that administration. Bush I and Clinton suffered. And with a Republican Congress, there was potential for a lot of damage.

Greenspan should have swung his weight against the tax cuts immediately. Instead, he supported them, and later, when talking about deficits, didn't mention them. Combined with his Social Security fraud (Greenspan committee taxes to save a surplus, then supporting cuts due to deficits later), the case for deliberate, premeditated fraud is pretty clear.

[VJ]

While both Brad and Dean are patting Greenspan on the back because he "allowed" the unemployment rate to fall "in 1995-96 and throughout the rest of the decade", I'd like to point out that he fought to do just the opposite as late as 1997. In March of that year, he announced that with the unemployment rate having fallen below 5.5%, inflation must surely be returning, which was his excuse for raising the fed funds rate.

It wasn't until Greenspan finally realized that the declining unemployment was not inflationary (after being wrong for years) that he relented.

[Maynard]

In Greenspan's defense:

(1) He did try to talk the bubble down, starting with his "irrational exuberance" speech in December 1996, but it did no good until he matched his talk with what amounted to an explicit promise in his Congressional testimony in February 2000 to continue to raise interest rates until the bubble burst.

(2) He would have been hard pressed to raise interest rates in 1997-98 because of the turmoil in financial markets (East Asian crisis, LTCM, Brazil and Russia). I don't know when exactly calm returned to the markets, but it seems to me there wasn't too long a delay between that point and the Fed's decision to start raising rates in 1999.

On the other hand, I agree with Krugman that Greenspan's promise to American workers in 1983 that their Social Security benefits would be secure if they accepted a higher payroll tax rates, followed by his statements in 2001 to the effect that we could afford huge income tax cuts, capped by his calls for "reform" of Social Security in 2004(?) because of the government's looming fiscal crisis, was an extraordinary bait and switch. He should stick to monetary policy.

[psh]

Now it's mortgage brokers shaking the money trees by faking borrowers' incomes and assets. Then it was internet entrepreneurs and their advisors shaking the money trees by making business plans show 50% IRR. In both cases, the fastest-growing sectors were wholly dependent on the asset bubble and its associated liquidity firehose. Those jobs spawned others, of course, but Greenspan's stimulative policies don't strike me as such a no-brainer, because the incremental employment entailed distortions in asset markets. Would we be so gung-ho for employment gains if we knew the price would always be another asset boom and bust? Because that kind of job growth is a hell of a lot easier to get than growth in the tradables sector, and it will be for a long time to come.

[pat]

I find people are too willing to accept the claim that "Greenspan’s decision to allow the unemployment rate to fall in 1995-96 and throughout the rest of the decade". I would give the FOMC the credit and Greenspan at most played a contributing role in it. As VJ pointed out, even on that account, Greenspan was actually a bit late in coming to this view.

[Richard Salsman]

"Greenspan has done a masterly job at monetary policy." Is this the single case where de Long must praise George Bush? After all, that devil-president reappointed the "master." But not to fear - for it was a bad appointment after all, de Long's claims to the contrary notwithstanding. In the 18-year reign of Greenspan the "master" central planner, the US stock market has performed no better than it did in the 18 previous years - a prior period (1969-1987) that included the horrendous stagflationary 1970s. "Masterly" indeed! Greenspan, like most economists, is a bubble-head - which means he cries "bubble" whenever he can't explain (or else just disagrees with) the price of something (be it equities or houses). Beyond the word "God," I challenge one and all to find another word, besides the word "bubble," which has so often been used as a placeholder for ignorance. As for planning, did the Soviet's collapse teach us nothing? Please spare us the encomiums for Master Planners.