Getting it Right about Greenspan
We were not planning to write about former Fed Chair Alan Greenspan or his book, but regular (and thoughtful) commenter Mike C. convinced us otherwise. He observed that if we liked Bernanke, we probably had liked Greenspan as well. Mike went on to cite several of the popular criticisms about Greenspan and we made a brief reply.
It is not our mission at "A Dash" to defend Greenspan. History will treat him well. That assessment judgment is a good one, despite the many recent attacks on his record. No one can serve in such a prominent position for nearly twenty years, making so many decisions, without generating controversy and dissent.
Why Should We Care?
What convinces us to take up this topic is our ongoing desire to help our readers achieve better investment returns. One of the biggest traps is underestimating and misunderstanding government. Some pundits believe that if they can find a few specific errors in the Greenspan record, it shows the weakness of the Fed as an institution. This empowers the pundit to pretend to be as intelligent and informed as the collective body of people working for the Fed.
If you are a journalist or a blogger building traffic, disparaging the Fed may work well. If you are making investment decisions, it is better to understand the Fed than to pontificate about what they should be doing.
Everyone who wants to criticize Greenspan points out that he "advised" homeowners to take adjustable rate mortgages at exactly the wrong time. Former Dallas Fed President Bob McTeer explains on his blog what really happened:
"…what about the chairman luring unsuspecting consumers into
adjustable rate mortgages they couldn’t afford? The origin of this
charge is his speech on Feb. 23, 2004, to the Credit Union National
Association. In a technical discussion of "Mitigating Homeowner Payment
Shocks," the chairman noted fixed-rate mortgages had the advantage of
allowing homeowners to prepay debt when interest rates fall but don’t
require higher payments when rates rise.
His research indicated, however, that this advantage was probably
overpriced by the market. "Homeowners pay a lot of money for the right
to refinance and for the insurance against increasing mortgage
payments. Calculations by market analysts of the ‘option adjusted
spread’ on mortgages suggest that the cost of these benefits conferred
by fixed-rate mortgages can range from 0.5 percent to 1.2 percent,
raising homeowners’ annual after-tax mortgage payments by several
thousand dollars. Indeed, recent research within the Federal Reserve
suggests that many homeowners might have saved tens of thousands of
dollars had they held adjustable-rate mortgages rather than fixed-rate
mortgages during the past decade, though this would not have been the
case, of course, had interest rates trended sharply upward."
Somehow, I doubt the chairman’s geek speak sent Joe Six-pack running off to apply for an ARM he couldn’t afford."
Readers will note that the speech was about a pricing model, not market timing.
Causing the Housing Bubble
In reviewing public policy decisions historians or analysts often use a concept called the counterfactual. This approach is designed to thwart the kind of thinking that many know more commonly as "Monday morning quarterbacking." What would have happened if Truman had not approved dropping the atomic bomb? What if Bush had not invaded Iraq? We know what did happen, but not what would have happened.
Bob McTeer uses this concept to describe the Fed’s thinking:
Policymakers use cost-benefit analysis in making decision. They
choose between likely alternatives A and B by comparing the expected
benefits of each to the expected cost of each. Choosing A doesn’t mean
there were no benefits of B or no costs of A. It just means A’s
expected benefit/cost ratio was higher than B’s.
Critics may later "discover" the chosen alternative A had costs or
downsides. Well, of course it does; the point is they were deemed to be
smaller relative to benefits than the B alternative. B’s costs,
however, remain invisible and are ignored because B wasn’t chosen. Even
so, alternatives are still relevant to evaluating outcomes.
McTeer provides a strong defense of the Greenspan decisions, pointing out the need to avoid a low-probability effect ("when disinflation threatened to degenerate into outright deflation") that had serious global consequences. (Reader note: His blog is updated only occasionally, but is well worth watching).
After reading McTeer’s defense of Greenspan, you might still disagree with his decisions, but you should have a better understanding of what really happened.
We wonder how many readers just took the standard criticisms as gospel truth, never checking out the facts. Sometimes the Internet Punditry is not the best source of information.