The desire to rescue a damaged reputation is a powerful motivator. That is one conclusion to draw from a new 48-page paper, entitled The Crisis, written for the Brookings Institution by Alan Greenspan, the 83-year-old former chairman of America’s Federal Reserve. A man once hailed as the world’s outstanding central banker is now routinely blamed for the asset bubble and subsequent collapse. This is Greenspan’s attempt to set the record straight.
Excerpt of the report
To prevent a future financial crisis, the primary imperative must be increased regulatory capital and liquidity requirements on banks and significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades, Greenspan says.
He offers his views about regulatory reform, reflecting on moral hazard and how to address the “too big to fail” problem, which he re-terms “too interconnected to be liquidated quickly.” He knocks the idea of a “systemic regulator,” part of a package of reforms currently being discussed on Capitol Hill, asserting that asset bubbles cannot be prevented and trying to diffuse them would in fact stunt economic growth.
“Unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible. Assuaging their aftermath seems the best we can hope for. Policies, both private and public, should focus on ameliorating the extent of deprivation and hardship caused by deflationary crises,” he writes.
Protesting too much
There is something odd about central bankers denying any responsibility at all for long-term rates, which are, in principle, based partly on an assessment of a stream of short-term rates. Nor is it clear that low short-term rates were as irrelevant as Greenspan, and also Bernanke, suggest. Jeremy Stein of Harvard University, a discussant of Greenspan’s Brookings paper, points out that low policy rates may have mattered a great deal for income-constrained borrowers. He points out that adjustable-rate mortgages were used much more in expensive cities, a trend that became more pronounced as the fund rates fell.
By looking only at the effect of monetary policy on house prices, Messrs Bernanke and Greenspan also take too narrow a view of the potential effect of low policy rates. Several economists have argued convincingly, for instance, that low policy rates fuelled broader leverage growth in securitised markets.
Monetary policy may be a blunt tool to deal with asset bubbles. But that does not mean it is irrelevant. Interestingly, one American central banker has a more nuanced view, arguing that “in the current episode, higher short-term interest rates probably would have restrained the demand for housing by raising mortgage interest rates … In addition, tighter monetary policy may be associated with reduced leverage and slower credit growth.” That was Janet Yellen, president of the San Francisco Fed, who is likely to be Bernanke’s new vice-chairman.
