Alan Greenspan, RIP

Instalment 1

Alan Greenspan died today at age 100. I knew him a little. There’s so much to say about him, most of it good.

I have other deadlines today. That is why this is Instalment 1 of my RIP. I will post somewhere between one and three more in the next week or so.

For now, I’ll post what I wrote in a Wall Street Journal roundup on March 27, 2009. The roundup was titled “Did the Fed Cause the Housing Bubble?” Mine was the lead piece and I answered no. Others who wrote were Gerald O’Driscoll, Todd Zywicki, David Malpass, Judy Shelton, and Vincent Reinhart.

My piece is actually a shorter version of longer pieces I wrote with Jeff Hummel. I asked the Journal if we could be co-authors, but the editors wanted every piece to be sole-authored.

Here’s my WSJ piece:

Don’t Blame Greenspan

By David Henderson

It’s become conventional wisdom that Alan Greenspan’s Federal Reserve was responsible for the housing crisis. Virtually every commentator who blames Mr. Greenspan points to the low interest rates during his last few years at the Fed.

The link seems obvious. Everyone knows that the Fed can drive interest rates lower by pumping more money into the economy, right? Well, yes. But it doesn’t follow that that’s why interest rates were so low in the early 2000s. Other factors affect interest rates too. In particular, a sudden increase in savings will drive down interest rates. And such a shift did occur. As Mr. Greenspan pointed out on this page on March 11, there was a surge in savings from other countries. Although he names only China, some of the Middle Eastern oil-producing countries were also responsible for much of this new saving. Shift the supply curve to the right and, wonder of wonders, the price falls. In this case, the price of saving and lending is the interest rate.

But how do we know that it was an increase in saving, not an increase in the money supply, that caused interest rates to fall? Look at the money supply.

Since 2001, the annual year-to-year growth rate of MZM (money of zero maturity, which is M2 minus small time deposits plus institutional money market shares) fell from over 20% to nearly 0% by 2006. During that time, M2 (which is M1 plus time deposits) growth fell from over 10% to around 2%, and M1 (which is currency plus demand deposits) growth fell from over 10% to negative rates.

The annual growth rate of the monetary base, the magnitude over which the Fed has the most control, fell from 10% in 2001 to below 5% in 2006. Moreover, nearly all of the growth in the monetary base went into currency, an increasing proportion of which is held abroad.

Moreover, if the Fed was the culprit, why was the housing bubble world-wide? Do Mr. Greenspan’s critics seriously contend that the Fed was responsible for high housing prices in, say, Spain?

This is not to say that the Greenspan Fed was blameless. Particularly disturbing is the way the lender-of-last-resort function has increased moral hazard, a trend to which Mr. Greenspan contributed and which current Fed Chairman Ben Bernanke has put on steroids.

But to the extent that the federal government is to blame, the main fed culprits are the beefed up Community Reinvestment Act and the run-amok Fannie Mae and Freddie Mac. All played a key role in loosening lending standards.

I’m not claiming that we should have a Federal Reserve. We simply can’t depend on getting another good chairman like Mr. Greenspan, and are more likely to get another Arthur Burns or Ben Bernanke. Serious work by economists Lawrence H. White of the University of Missouri, St. Louis, and George Selgin of West Virginia University makes a persuasive case that abolishing the Fed and deregulating money would improve the macroeconomy. I’m making a more modest claim: Mr. Greenspan was not to blame for the housing bubble.

Mr. Henderson is a research fellow with the Hoover Institution, an economics professor at the Naval Postgraduate School, and editor of “The Concise Encyclopedia of Economics” (Liberty Fund, 2008).

Addendum: Here’s one of the pieces I co-authored with Jeff Hummel. The intellectual content is due mainly to Jeff.