Thursday, December 10, 2009

Unlike Hurricane Katrina the Housing Bubble Was a Man-Made Disaster: Both Greenspan and Bernanke Should be Held Responsible for the Great American Taxpayer Robbery

The U.S. Fed's penchant for solving all economic problems with a singular tool (monetary policy), while relegating all regulatory tools to the back of the cupboard, has clearly decimated the global economy. Had the Fed pursued sensible regulations such as capping bank leverage, regulating derivatives, re-instating Glass Stegall, enforcing a 10-20% down payment on all home purchases, higher taxes on flipping properties, and higher margin requirements on futures trading in oil and essential food commodities - the twin housing and commodity bubbles of 2007 & 2008 would at the very least, not have blow up to such massive proportions. Instead Greenspan and Bernanke after lowering interest rates pursued a hands off policy, choosing to wait and clean up the mess later. Even today regulation continues to be merely the subject of academic debates at the Fed.
Their myopia (on not being able to discern if an asset bubble has formed) and dogmatic pursuit of academic theories (such as free-market economics and the belief in the market's self-correcting mechanism) have come at an immense cost to the nation and to the world. An asset bubble problem that could have been solved for $0 with some well-timed regulation, is now costing us in the trillions of dollars to clean up. More importantly, the housing asset bubble has caused serious and permanent damage to the labor force. As the bubble inflated, it sucked in capital and human resources from other productive industries. Millions of people became employed in real estate and related industries. Now that the bubble has burst, it will take years before these these people can be re-trained with a new skill set and are able to integrate back in the traditional workforce. Regardless of the billions Obama promises to throw at the problem, how can a nation create millions of jobs overnight to reabsorb people specialized in real estate and related skills? This problem cannot be solved in the short term, and unemployment is likely to remain very high for many years to come.
So now on the eve of Bernanke's reappointment as the Fed Chairman, we once again find ourselves relegated to the role of mere spectators, watching the prime accused in the great American taxpayer robbery, get reelected. After all it was our trillions that Bernanke is using to clean up the mess he helped create. But, apart from Congressional posturing, little seems to have changed. Dean Baker of The Center for Economic and Policy Research (from whose writing we have borrowed part of our title for this post), wrote a great piece titled "Yes It is Bernanke's Fault", here is a capture of his writing from that piece:
As the senate debates Federal Reserve chairman Ben Bernanke's reappointment, it is striking how the media views blaming Bernanke for the Great Recession as being out of bounds. Of course Bernake bears much of the blame for America's economic collapse.
He was either in, or next to, the driver's seat for the last seven years. Bernanke was a member of the board of governors of the Federal Reserve since the summer of 2002. He served a six-month stint as head of President Bush's council of economic advisors beginning in the summer of 2005 and then went back to chair the Fed in February 2006.
This crisis is not a weather disaster like Hurricane Katrina; it is a man-made disaster that was brought about by seriously misguided economic policy. And, after Alan Greenspan, Bernanke was better positioned than any other person in the country to prevent this disaster.
The basic argument is very simple. The US had an enormous housing bubble. This bubble drove the economy ever since the last recession in 2001. It propelled the economy directly through a building boom that sent housing construction to record levels. Indirectly, it led to a consumption boom as people spent money based on the $8 trillion in housing equity that was temporarily created by the bubble.
When the bubble collapsed it was inevitable that it would lead to the sort of disaster that we are now seeing. We lost close to $500bn in annual demand due to the collapse of housing construction. The building boom created an enormous glut of housing. There will be little need for new construction for several years in the future.
The disappearance of trillions of dollars of bubble-generated housing equity led to a plunge in consumption. Annual consumption has fallen by close to $500bn. If we add in a loss in demand of close to $200bn associated with the bursting of a bubble in commercial real estate, the collapse of the bubbles led to a fall in annual demand of close to $1.2tn. The Fed has nothing in its bag of tricks that allows it quickly replace $1.2tn in demand.
In spite of the heroic efforts at obfuscation by many economists, there is not really much to dispute in the above story. Add in the fact that the bubble was both recognisable and preventable, and you have a very solid indictment of Bernanke.
This is not about mumbling "irrational exuberance," it's a question of using the Fed's full research capacities to document the existence of a housing bubble (they actually did the opposite) and then disseminating this research as widely as possible. If this proved inadequate, the Fed also had substantial regulatory powers to curb the deceptive subprime loans that helped inflate the bubble in its later stages.
If talk and regulation failed, then the Fed could have used interest rate hikes. A policy of raising interest rates with the explicit target of bursting the bubble – for example, a commitment to raise rates until house prices fall, – would almost certainly accomplish its goal in fairly short order.
Bernanke and his sidekick, Greenspan, chose to take none of these measures. Instead they insisted everything was fine the whole time. Things were not fine and the country is paying the price. And yes, it is very much Bernanke's fault.

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