One of the more interesting questions about the Housing Bubble Era of 2001-2008 actually has to do with what happened in the years before its rise. Why didn’t the LTCM failure, the “Asian” Financial Crisis (which certainly seemed like a big crisis in Russia at the time), the collapse of the NASDAQ bubble, and the revelation of massive accounting fraud all during the 1997-2000 period prompt some kind of more meaningful action. At the time, I can recall that there was a lot of talk in the air of the need for reform.

John Quiggin recalls:

Neither of these things happened. Advocates of the efficient markets hypothesis, in general, simply ignored the dotcom fiasco, and went on as if nothing had happened. The accounting scandals at Enron and other companies produced the Sarbanes-Oxley Act, which sought to reform corporate governance. But the Act was limited and largely ineffectual. Within a year or two, the conventional wisdom of the financial markets was that Sarbanes-Oxley was an over-reaction to isolated cases of fraud, and that a new push for deregulation was needed.

Financial institutions could disregard the failures of the dotcom bubble because of the (seemingly successful) operation of the Greenspan put. Rather than let the financial sector suffer the consequences of the bursting bubble, Greenspan relaxed monetary policy and inflated a whole new bubble, this time in housing.

This is a somewhat strange problem. Whatever you think of Greenspan’s overall legacy—and I think it’s appropriate to take a very dyspeptic view of his fiscal policy interventions in 1999-2001 and of his interest rate policy in 2004—I think it’s a bit hard to regret that he acted swiftly and decisively to keep the world out of a major recession at the turn of the millennium. The millennial recession was not a fun time for the aversely affected, but relatively few people were aversely affected because it was relatively short and shallow. Letting things fall apart would have led to millions of additional unemployed people, state budget crises, cutbacks in critical social services, etc., etc., etc.

But it really does seem that the success of these operations was taken as a reason to avoid any serious systematic reform. And you can feel the same kind of thing happening today. It’s disturbing.

Greg Ip explains that Alan Greenspan could have avoided that housing bubble-born financial crisis, contrary to his protestations otherwise. Felix Salmon concurs in part:

Alternatively, says Ip, Greenspan could have taken the regulatory approach: requiring 20% downpayments or mortgage insurance for all mortgages, for instance, or requiring stricter underwriting at the originator level. But of course, these moves, as Ip says, would never have been implemented by Greenspan, the great deregulator. [...] But I certainly agree that if the US had followed the lead of pretty much every other country in the world and simply regulated its lenders, a lot of the worst excesses of the bubble could have been avoided. I don’t know where major regulatory overhaul stands on the Obama administration’s list of priorities, but I do hope that by the end of this administration, we will no longer be in a position where lenders can lend out billions of dollars to homeowners with essentially no regulatory oversight whatsoever.

I think there’s a bit of a contradiction between the two highlighted sentences and it speaks to the core paradox underlying a lot of the discussion over financial regulatory reform, namely that it seems that regulators largely already had enough authority to avoid this problem. Looking back with 20/20 hindsight the issue isn’t so much that we needed better “rules” as it is that we needed regulators we took seriously the idea that cracking down on private sector funny business is their job. Instead, we seem to have mostly had regulators who regarded the laws on the books as an unfortunate and anachronistic departure from a pure laissez faire ideal. So you got things like the SEC prosecuting celebrities on tenuous charges, but no real oversight of a mortgage sector run amok. When you look back at the trajectory leading up to the crisis, the problem of “deregulation” isn’t so much that there’s some particular rule that was removed during the Greenspan Era that could have saved us as it is that the mindset that drove the legislative agenda of deregulation ultimately proved paralyzing to policymakers. If you decide that, in theory, minimal regulation is desirable because rational self-interest will create a self-policing market then this theory will color your perception of a bubble—specifically, you won’t see the bubble (this is, as they say in the philosophy departments, the interdependence of fact and theory). I’m not really sure what kind of overhaul prevents that problem. What you need are better people—people less in thrall to a heroic Randian vision of capitalism.

I’m not entirely sure what to make of what Alan Greenspan has to say on his own behalf. But I am quite sure that he’s dodging what I would think would be the main issue Alan Greenspan needs to address regarding Alan Greenspan and the housing bubble, namely the time Alan Greenspan fueled the bubble in 2004 by urging people to go get Adjustable Rate Mortgages. Now I don’t know how much impact that advice had. Or how much impact advice given in the other direction might have had. But I do know that it was weird for Greenspan to even be commenting on the issue. And that his advice was bad advice. In retrospect, it looks disastrous. Even at the time, many observers found it bizarre.

At the time, recall that Greenspan was treated as an oracular figure. An economic miracle-man who’d run the show from Reagan through Bush and Clinton into Bush II. An irreplaceable “maestro” whose unique genius was the architect of our prosperity. So I’m inclined to say that his remarks on all kinds of subjects had influence.

In retrospect, he says we were in the early days of an unsustainable worldwide housing bubble that it would have been inappropriate for the Fed to pop by raising interest rates. He could have said that at the time. “Some people say current housing prices are sustainable, others say they’re an unsustainable bubble that I should pop with interest rates; in my judgment, both are wrong—the bubble is real but interest rates are the wrong cure.” Instead, Greenspan urged people to run out and get ARMs!

Jesse Eisinger and Felix Salmon talk about bank nationalization:

Over the past couple of weeks, I’ve learned that nationalizing banks is an evil Scandinavian notion. Here in the United States, what we need to do is to subject banks to a “stress test.” If banks fail that stress test, they need to be taken into receivership. In receivership the banks will be purged of their toxic assets, and then recapitalized with new private owners. The “cleaned” assets can then be held in an entity that manages them and either tries to sell them off at the best possible price when the panic ends or else hold them to maturity. And anyone who calls this “nationalization” will be forced to read Rebel-in-Chief and Bush Country and then learn to recite passages from memory.

Remember: Nationalization is bad for you! Very bad! Against the grain! Someone just needs to tell Alan Greenspan to stop using the scary n-word.

Krugman talks about Alan Greenspan:

What was the problem with Greenspan, and where and when did he go wrong?

Greenspan is the real thing. He believes the Fed can be the designated driver, the one who takes you home safely after the party has gotten crazy. So he brushed aside any worries about regulating and taking precautionary measures. His belief in the perfection of free markets led us into the ditch we’re in now.

The interesting quirk in the fabric, though, is that it isn’t really free markets as such that Greenspan believed it. Rather, it was belief in the combination of free markets and central banking. He didn’t believe that the free market would operate uncorrected and flawlessly, he believed that the Federal Reserve’s central planning functions could be done so effectively on a post hoc basis that there was no need for any form of preventive regulation. Real market fundamentalists go in for a lot of goldbug nonsense. Fundamentally, the Greenspanist combination of massive skepticism of government intervention with overwhelming confidence in the power of the all-knowing and benevolent masters of monetary policy seems strange and unsustainable. But it is, of course, easier to sustain if you yourself are the central planner.

Wow. You don’t hear admissions like this every day:

“I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms,” Mr. Greenspan said.

Referring to his free-market ideology, Mr. Greenspan added: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”

Mr. Waxman pressed the former Fed chair to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.

“Absolutely, precisely,” Mr. Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

Greenspan is, of course, hardly unique in having been mistaken about some important public policy issues. He was, however, an unusually powerful official — arguably the second most important member of the government after the president — for an unusually long time. But beyond that, for a long time he managed to acquire an air of infallibility about him that was totally unique among political figures. He was treated as an oracle to be interpreted, not as an official to be scrutinized. It was, I think, a strange and unhealthy moment in the life of our country. At the end of the day, appointing people so brilliant that they’re never wrong about anything isn’t a real option in terms of thinking about ways to run the government.

Daniel Davies blogged way back in 2002 that the Fed’s most likely approach to boosting economic growth was to facilitate the creation of a housing price bubble:

Cleverer readers at this point will be formulating an objection. The objection goes along the lines of:

“Yeah, yeah, laughing boy, but what happens when the housing bubble bursts then?”

Which is a damn good question to ask, particularly since the official policy of the Federal Reserve appears to be “hmmm yeh, never thought of that, I suppose we’d be kind of fucked”. Looks like it falls to me to come to their aid, with a solution that smacks of genius.

For all the back-and-forth bluster about Fannie Mae, regulation, “Wall Street greed,” etc. there seems to me to have been remarkably little focus on policymakers decision-making with regard to this issue. One reason there hasn’t been a ton of focus on it is that a lot of smart, well-informed people saw this risk and thought the Fed was right to basically ignore it. But the very fact that the Fed had — or at least was widely thought to have had — good reasons to behave in this manner is all the more reason to shine some scrutiny. Since nobody ever says “my plan is to be corrupt and incompetent” there’s relatively little value in just saying over and over again that corrupt and inept public officials are undesirable. We do, by contrast, need to talk about how and why well-regarded public officials wound up making serious mistakes. There are, presumably, lessons to be learned here.