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Thursday, August 23, 2007

Warning, Bursting Bubble Ahead!

The post above this one on Greenspan and the subprime crisis reminded me of this. There seems to be this idea that nobody was warning about the dangers of the housing bubble before it burst. But some people were. This was Paul Krugman just under two years ago writing about Greenspan and the bubble:

Greenspan And The Bubble, by Paul Krugman, Commentary, NY Times,  August 29, 2005: Most of what Alan Greenspan said at last week's conference in his honor made very good sense. But his words of wisdom come too late. He's like a man who suggests leaving the barn door ajar, and then -- after the horse is gone -- delivers a lecture on the importance of keeping your animals properly locked up.

Regular readers know that I have never forgiven the Federal Reserve chairman for his role in creating today's budget deficit. In 2001 Mr. Greenspan, a stern fiscal taskmaster during the Clinton years, gave decisive support to the Bush administration's irresponsible tax cuts, urging Congress to reduce the federal government's revenue so that it wouldn't pay off its debt too quickly.

Since then, federal debt has soared. But as far as I can tell, Mr. Greenspan has never admitted that he gave Congress bad advice. He has, however, gone back to lecturing us about the evils of deficits.

Now, it seems, he's playing a similar game with regard to the housing bubble.

At the conference, Mr. Greenspan didn't say in plain English that house prices are way out of line. But he never says things in plain English.

What he did say, after emphasizing the recent economic importance of rising house prices, was that ''this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent.'' And he warned that ''history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.'' I believe that translates as ''Beware the bursting bubble.''

But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: ''While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely.''

Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by ''the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages.'' But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that ''American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.''

If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath.

How bad will that aftermath be? The U.S. economy is currently suffering from twin imbalances. On one side, domestic spending is swollen by the housing bubble, which has led both to a huge surge in construction and to high consumer spending, as people extract equity from their homes. On the other side, we have a huge trade deficit, which we cover by selling bonds to foreigners. As I like to say, these days Americans make a living by selling each other houses, paid for with money borrowed from China.

One way or another, the economy will eventually eliminate both imbalances. But if the process doesn't go smoothly -- if, in particular, the housing bubble bursts before the trade deficit shrinks -- we're going to have an economic slowdown, and possibly a recession. ...

So there's a rough ride ahead for the U.S. economy. And it's partly Mr. Greenspan's fault.

    Posted by on Thursday, August 23, 2007 at 12:33 AM in Economics, Housing, Monetary Policy | Permalink  TrackBack (0)  Comments (19)


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