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Greg Ip on Alan Greenspan

From the Economist:

He had the power | Free exchange: ALAN GREENSPAN’s defence of the Federal Reserve in the formation of the housing bubble restates a familiar argument—it raised short-term interest rates but long-term interest rates did not follow, and housing is most sensitive to long-term rates.... Mr Greenspan asserted on a number of occasions that while America might have local housing bubbles, there was no national housing bubble. Yet he now asserts there was a global housing bubble. It has always puzzled me how he could go from seeing local bubbles to a global bubble without at some point diagnosing a national bubble. By failing to diagnose a national housing bubble until it was already well inflated, the Fed under Mr Greenspan escaped the obligation to do anything about it.

But had the Fed recognised it, should, or could, it have done anything about it? Mr Greenspan argues that irrespective of whether it should, it could not, because it did not control long-term interest rates. I disagree.... Yes, the linkage between the short- and long-term rates weakened. But at some point, it probably would have reappeared. The Fed could have gotten the long-term rate up had it raised the short-term rate enough. And even if the long-term rate remained stable, the economy, and housing demand, would eventually have wilted as other components of financial conditions tightened.

How much is enough? It’s hard to say, but perhaps 8% or 10%. The problem is that this would have been so draconian, that the entire economy would have tanked.... This is a legitimate defence of the Fed's actions. But saying the Fed had the power to stop the bubble but chose not to exercise it is different from saying it was powerless.... There was, of course, an alternative between letting the bubble inflate and inviting recession. Had Mr Greenspan and his colleagues concluded housing prices were too high and there was value in taming them, they could have used regulatory tools instead of monetary policy. They could have insisted on a margin requirement for home purchases—no one could put down less than 20% unless they obtained mortgage insurance. (At the peak of the bubble, the widespread use of second liens made 100% loan-to-value mortgages without insurance commonplace.) This would have been politically difficult since it would have deprived lots of people the opportunity to own a home.... It would have also contradicted Mr Greenspan’s own deregulatory impulses...

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