Alan Greenspan: Feted for Failure

Alan Greenspan was at the wheel, apparently asleep, when the US economy drove off a cliff. Why on earth is he still lionised?

by Dean Baker

The Brookings Institution stands alongside Harvard, Yale, and Princeton, among the nation's elite intellectual institutions. This is why it so striking that it chose to invite former Federal Reserve board chairman Alan Greenspan to give the keynote address at a forum on reforming the home mortgage finance system last week.

It would be difficult to imagine a more disastrous failure than Alan Greenspan. Tens of millions of people are unemployed, under-employed, or have given up looking for work altogether, as a direct result of Greenspan's ineptitude. Millions of families are facing the lost of their homes. More than one quarter of mortgage holders are underwater with their mortgages.

The huge baby boom cohorts saw most of their life's savings disappear when the collapse of the bubble destroyed their home equity. They are now approaching retirement with almost nothing to rely upon other than their social security.

This is the direct result of Alan Greenspan's incompetence as Fed chair. He either did not recognise the $8tn housing bubble or somehow did not think it was a big deal. This was a monumental misjudgment. The housing bubble was really hard to miss for anyone who can read a chart and knows arithmetic. For 100 years, nationwide house prices had just tracked the overall rate of inflation. Suddenly, in the mid 90s, coinciding with the stock bubble, house prices began to substantially outpace the overall rate of inflation.

By 2002, house prices had already risen by more than 30 percentage points in excess of the overall rate of inflation. At the peak of the bubble in 2006, the inflation in house prices had exceeded the overall rate of inflation by more than 70 percentage points, creating that $8tn bubble in housing wealth.

There was no remotely plausible explanation for this, based on the fundamentals of either the demand or supply side of the housing market. Population growth and household formation were much slower during the bubble years than in prior decades. Income growth had been healthy in the late 90s, but went in reverse in the 2000s. On the supply side, the country was building homes at near record rates, so supply constraints obviously could not explain the runup in prices.

Anyone looking for an explanation would also have to explain why rents were going nowhere. The fact that the vacancy rate had already hit a record high as early as 2002 should have been another really big bright warning sign that housing was in an unsustainable bubble. If it was impossible for competent economists to miss this assessment, it should also have been impossible for them to think it could deflate harmlessly. The bubbles in residential and non-residential construction led to enormous overbuilding in both sectors. The "wealth effect" associated with the $8tn transient housing bubble was generating close to $500bn in annual consumption.

This meant that the combined drop in construction and consumption demand from the collapse of the bubble was almost certain going to be in excess of $1tn. Did Greenspan think he had something in his bag of tricks as Federal Reserve board chairman that would allow him to quickly replace more than $1tn in annual demand?

Absent some new source of demand (which has not appeared), it was inevitable that the collapse of the bubble would lead to a prolonged period of high unemployment. This was all 100% predictable; but Greenspan did not predict it – because he was not doing his job.

Incredibly, in spite of this disastrous performance as Fed chairman, Alan Greenspan is still being feted in elite circles. Perhaps this is due to the fact that the people who sit in these elite circles openly celebrated Greenspan as he drove the economy off a cliff. He was declared the "Maestro" by one of the country's top reporters. At the annual meeting of central bankers in Jackson Hole, Wyoming, the leading lights of the economics profession debated whether he was the greatest central banker of all time, as he prepared to leave his post.

In other words, Greenspan may have ruined the lives of tens of millions of people and cost the lives of tens of thousands (yes, people die because of inept economic policy: they kill themselves, they don't get healthcare that they need, and they die from alcoholism and despair), but he does not bear the blame alone. Most of the people who hold top positions in policy and academic circles share blame for disaster – refusing to do the simple analysis that would have allowed them to see this disaster coming.

The pain and suffering caused by Alan Greenspan's incompetence vastly exceeds the harm that our worst enemies could even dream of inflicting on the United States. Yet, apparently, he can always count on a position of honour at the Brookings Institution. Heckuva job, Alan!