Greenspan Strikes Back
Samuelson, Robert J., Newsweek
Byline: Robert J. Samuelson
The 'Maestro' explains what went wrong.
Rarely has a public figure's reputation suffered a reversal as dramatic as Alan Greenspan's. When he left the Federal Reserve in early 2006 after nearly 19 years as chairman, he was hailed as the "maestro" and credited with steering the country through numerous economic shoals. Four years later, his policies are widely blamed for fostering the 2007-09 financial crisis. Now Greenspan is offering an elaborate "not guilty" defense.
The indictment of Greenspan is straightforward. Lax regulation by the Fed of financial markets encouraged dubious subprime mortgages. Easy credit engineered by the Fed further inflated the housing "bubble." Greenspan's rebuttal comes in a 14,000-word article for the Brookings Papers on Economic Activity, a journal from the think tank of the same name.
Greenspan is in part contrite. He admits to trusting private markets too much, as he already had in congressional testimony in late 2008. He concedes lapses in regulation. But mainly, he pleads innocent and makes three arguments.
First, the end of the Cold War inspired an economic euphoria that ultimately caused the housing boom. Capitalism had triumphed. China and other developing countries became major trading nations. From the fall of the Berlin Wall to 2005, the number of workers engaged in global trade rose by 500 million. Competition suppressed inflation. Interest rates around the world declined; as this occurred, housing prices rose in many countries (not just the United States) because borrowers could afford to pay more.
Second, the Fed's easy credit didn't cause the housing bubble because home prices are affected by long-term mortgage rates, not the short-term rates that the Fed influences. From early 2001 to June 2003, the Fed cut the overnight fed-funds rate from 6.5 percent to 1 percent. The idea was to prevent a brutal recession following the "tech bubble"--a policy Greenspan still supports. The trouble arose when the Fed started raising the funds rate in mid-2004 and mortgage rates didn't follow as they usually did. What unexpectedly kept rates down, Greenspan says, were huge flows of foreign money, generated partially by trade surpluses, into U.S. bonds and mortgages.
Third, regulators aren't superhuman. …