Blame It on the Fed
A week or two ago, the Wall Street Journal had an interview with Anna Schwartz in which she blamed the current financial situation on the artificially low interest rates created by the Federal Reserve in the early years of the new millennium:
How did we get into this mess in the first place? As in the 1920s, the current “disturbance” started with a “mania.” But manias always have a cause. “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.
“The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”
The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.
Schwartz is the co-author of one of the most respected and influential works on the causes of the Great Depression, a work whose thesis has been endorsed by now Fed Chairman Ben Bernanke (money quote: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”) Her opinion on the matter thus cannot be dismissed out of hand. And, for what it’s worth, Alan Greenspan’s recent repudiation of capitalism makes more sense on the assumption that he was trying to deflect blame from himself.
Nevertheless, “the blame it on the fed” line of argument has been largely absent from the punditocracy and the popular press. There have been plenty of attempts to prove that some government action, such as the CRA or the backing of Fannie and Freddie, was behind the housing bubble. But fed policy, if it’s mentioned at all, is generally only tacked on as an afterthought.
I don’t know whether Fed policy was responsible for creating the housing bubble (my guess is that it played a role, though whether this was decisive I can’t say). Yet the absence of this line of attack on the part of many conservatives and free marketeers in favor of less plausible scapegoats is strange. I can think of a couple of possible explanations here:
1. Conservatives are racists and hate the poor, and thus are predisposed to believe explanations that blame the crisis on the poor and/or minorities. Possible. Perhaps even likely in some cases. I don’t believe in ascribing such low motives to people, however, if their actions can plausibly be explained i some other way.
2. Blaming the Fed doesn’t get Republicans off the hook. Blaming Fed policy for the crisis means blaming Greenspan. And while Greenspan was appointed Fed chair by both Democrats and Republicans (indeed, the actions that would have gotten us into trouble occurred during a term he was appointed to by Bill Clinton), he is identified much more with the Republican party. He’s also so associated with free markets in many people’s minds that to blame him would seem to a lot of folks like a condemnation of markets, even if it was anything but (David Friedman’s remarks on politicians who claim to favor smaller government would seem applicable here).
3. It’s too complicated. “Government forced banks to lend to people with no money” is easy to understand, even if it isn’t true. Talk about “greed,” “deregulation,” etc. is likewise easy to do. Explaining how lowering interest rates could lead to overinvestment in the housing industry, by contrast, is hard to fit into a soundbite.
4. There’s no obvious solution. If you think that the problem was caused by Fannie and Freddie, then the answer is to get rid of Fannie and Freddie. If the problem was “deregulation” then the answer must be more regulation. But if the problem was with the Fed, then what? A return to the gold standard? Should Bernanke give another speech saying “okay, so we caused that one too. But, uh, we won’t do it again. And this time we really mean it”? You might be able to get Congress to give you $700 billion dollars no questions asked by using some aggressive sales tactics, but if Paulson and Bernanke had come to Congress and said “we must return to free banking within 48 hours or the planet will expolode!” I somehow think it wouldn’t have worked.
I’m sure there are other possible explanations that I’m missing. Thoughts?
Comments are closed.
I think it’s just the opposite of #2. The reputation of the Fed as being, more or less, independent places them above reproach. I think there was a public perception under Greenspan that questioning the Fed on the economy was like questioning the pope on Catholicism.
I personally don’t blame the Fed because I’m not convinced that they did more harm than good. Now that we face the risk of deflation, I’ve noticed that the gold standard crowd has fallen silent.
Now that we face the risk of deflation, I’ve noticed that the gold standard crowd has fallen silent.
Not silent, you just have to know where to look.
I think it depends where you read. Barry Ritholz has been of the belief the fed dropped too low for some time now. One person obviously doesn’t make a movement, but one doesn’t have to search back alleys to find it.
I think 4 and 2 are pretty decent arguments. With number 2 I would probably emphasis the credibility aspect more than anything else. One doesn’t have to look far to find congressmen making glowing statements about Greenspan.
I think the greater issue overall is that people’s theoretical models are breaking down. Certainly one can find people in the I-told-you-so camp, but for various reasons they aren’t taken seriously. Some would claim malice. I think it is more that when one is in punditry, one is on the both sides of arguments so much that there is no way to disprove a pundit since they haven’t had to actually act.
First point: you mention that nobody talks about blaming the Fed, and instead focus on Feddie/ Fannie/ CRA. This is incorrect. For as long as I can remember, economists have been warning about Fed policy. Go back and you will see much hand-wringing over the so-called “Greenspan put”. It was a huge issue, among academics, popular economists like Krugman, and in places like the Financial Tmes and the Economist. In short, respectable places. On the other hand, those who blame poor people (Fannie/ Freddie/ CRA) are decidedly less respectable and certainly less knowledgeable.
But in response to your question: well, there’s no easy answer. Those who focus too much on the Fed are not thinking globally, and we must thinkn globally. As Bernanke himself stressed a few years back, when things were relatively calm, the key issue was the global savings glut. In short, many countries in Asia started saving far more than they invest, running up huge current account surpluses. The counterpart of excess savings is of course export-led growth, and this was China’s strategy. It maintained this strategy by keep the exchange rate artificially low, which it did by running up huge reserves (the savings was largely on the official side). What did that mean for the US? Well, (i) the US was buying these Chinese exports, leading to a large current account deficit; (ii) China was investing in US assets, which kept returns artificially low. What the Fed did was to accomodate this process. There are many who argue that– had it not done so– there would have been a recession.