Pointing Fingers

Adam Davidson at Planet Money recently asked, “Who Do We Blame?” Which, I think, is a perfectly legitimate question. While the most important things are getting ourselves out of this crisis and reducing the chances of another one happening, asking who is at fault for this one is a reasonable exercise, for at least two reasons: first, it responds to our basic human curiosity; second, since many of the parties involved care only about their reputations (Bush, Clinton, Greenspan, Paulson, etc. have enough money for several lifetimes), going after people’s reputations is one of the few ways to create some measure of accountability. Politicians who inveigh against “pointing fingers” usually have something to hide.

I started writing a comment on the Planet Money thread, but they have a character limit on comments, and it’s hard for me to write anything in fewer than 1250 characters. So I emailed them my response and, what do you know, they put it up as a post on their blog. To save you any suspense, I think that if you are going to blame any individual (as opposed to, say, a whole category of activity, like “lax loan underwriting”), it should be Alan Greenspan, for reasons described further in that post.

Update: My friend Dave Sohigian blames an entire generation.

27 thoughts on “Pointing Fingers

  1. when you write that rising stock prices make savings more expensive you are losing me. One just buys a smaller number of stocks and let that appreciate. I have been a critic of Greenspan for many years so I agree with your main point.

  2. “Blaming individual[s] … also doesn’t work. In each case, if that … CEO had behaved differently … he would have been fired.”

    You’re probably right that if anybody could have done it, Greenspan probably could have pulled it off. But if he had tried to raised interest rates in say 2004 to shut down the housing bubble, perhaps even he would not have held onto his job.

  3. Actually, I think that Greenspan is much more to blame for his strong laissez-faire views concerning regulation than for not trying to prick asset bubbles. The latter is a tricky business.

    It was not too difficult to foresee though that given, limited liability, credit default swaps were one type of intertemporal contract unlikely to be honored if the housing bubble crashed. And stories about bank lending to unsuitable borrowers (both consumer credit and mortgages) were all other the popular press at least as far back as 2006 in the UK.

    Central bankers and supervisory agencies should have known (and possibly would know) better.

  4. “Whom”. As in, “Whom do we blame?”

    Pedantry aside… Had Greenspan not slashed interest rates in 2002, who knows? By 2005 we might have been cursing him for “creating” a 3-year recession.

    I am no fan of Greenspan’s, but I also do not recall very many people criticizing his moves at the time. A lot of his critics today sound to me like Monday-morning quarterbacks…

  5. I agree, James. Greenspan justifiably bears blame.

    One reason I feel more comfortable with Bernanke at the Fed than Greenspan is that there is much more of the “Prudent Man” about Bernanke. In the ’90’s Greenspan vigorously resisted the regulation of CDS’s. Had these instruments been recognized for the insurance product they most certainly are (and regulated accordingly) perhaps some of the excess would have been tempered. Going a step further, had the underwriters of mortgage backed securities been required to retain liability (as a matter of prudence) perhaps the entire mess could have been avoided.

  6. It seems to me that the bursting of the tech stock bubble and resulting (minor) recession of 2001 underlay the low interest rates responsible for the current bubble. If Greenspan had pricked the tech bubble in about 1998 (say, by increasing margin requirements), there might not have been a recession in place at the time of 9/11. After that event, the possibility of a major confidence collapse made low interest rates necessary. One can argue that Greenspan should have raised the post-9/11 rates sooner, but without the pre-existing recession, it might not have been necessary to lower rates so drastically.

  7. 1. Under US law, when somebody commits unintentional manslaughter with their car, they go to Jail. They didn’t intend to kill, but they pay. In the same way every bank CEO, top executives and board of directors must pay for this mess. This is the only solution.

    2. All economists, including Simon Johnson are simply apologists for the bankers, and criminal policy makers who created this mess.

    3. No more bailouts. Simply nationalize the banks, fire the “best and brightest”, prosecute them under RICO, and tax evasion laws. Let counterparties fail. They took the risk. Now pay.

    4. Let the government take over the currency, as required by the constitution.

    5. If you do these, financial markets will stabilize, and confidence will return, economy will be nursed back to health.

    6. There is no such thing as too big to fail. Let the banks fail, counterparties loose their money.

    7. This is daylight robbery going on. And, if can’t see that you are a fool.

  8. Consider what Galbraith wrote in his 1954 book “The Great Crash”:

    “No one was responsible for the great Wall Street crash. No one engineered the speculation the preceded it. Both were the product of the free choice and decision of hundreds of thousands of individuals. The latter were not led to the slaughter. They were impelled to it by the seminal lunacy which has always seized people who are seized in turn with the notion they can become very rich. There were many Wall Streeters who helped to foster this insanity….There were none who caused it.”

    Having invoked this view, I should say that if I had to pick any single culprit, I’d agree with James. Not so much for keeping short-term rates low (remember that the Fed was properly worried by the fact that U.S. employment kept declining for nearly 2 years after the 2001 recession was officially over) but for dismissing the housing boom as a series of regional phenomena, fostering the idea (as were most economists at the time) that these were uncorrelated adjustments.

  9. This is what I meant. If GE is trading at $50, then your $10,000 401(k) contribution buys you 200 shares. If the price goes up to $100, then the same contribution only buys you 100 shares. For the same amount of money, you can only buy half as much of GE. Assuming that the value of GE on the day you retire (say, 30 years from now) is independent of its stock price today, then you’re only getting half as much for the same price. Put another way, the higher the price, the less likely you are to see the appreciation.

    I know this could get into a debate about fundamental values and the like, but my basic point is that if prices are higher, you get less stuff for your money, and it does not work out in the long term.

  10. This really becomes a philosophical question (since I’m not proposing any kind of lawsuit or prosecution). If you were the guy in charge, and you were wrong – but almost everyone else around you was wrong, too – are you to blame? I would say yes.

  11. James,
    Greenspan was just a government-employed banker who lent money to other bankers at a cheap rate. He didn’t blow up the entire world with that money. He didn’t maximize his short term gain by CHEATing rating agencies, regulators, clients, public, and even their own companies.

    Me thinks he’s not the droids we’re looking for.

  12. The one exception to the dishonest economists that rule the academia and policy making is Nouriel Roubini.

  13. Greenspan was in charge when the seeds of disaster were sown. To that extent he must accept responsibility. However, from a historical perspective he may have been in a “no win” situation. Without the “housing boom” the U.S. economy would have gone into recession at any time in the last 10 years. In retrospect we would have been better off to have gone into recession sooner than later. But at the time it would have been Greenspan’s recession.

  14. I certainly think “Easy Al” bears some of the blame. But we had an entire system where many, many people made bad bets in an effort to get something for nothing. And there were several persons of wealth and power well aware of what was happening, but who chose to cynically encourage and exploit the mania for their personal gain.

    Greenspan’s philosophy is dead wrong, but at least he is honest, and I do think that counts for something.

    Do you really believe he could have single-handedly prevented the crisis? I actually wonder what would have happened had he tried.

  15. A few points to consider. First, the price of the stock at purchase may be equal to, greater or less than the intrinsic value. That relationship along with the prospects for the business, the economy, interest rates and taxes as well as supply and demand for the stock will determine how it trades. The same set of factors will determine the price at retirement. If the business does not create value over time that can be expected to be reflected in the future price as well. There is no reason in economics or logic why the purchaser must get more in the future, especially if you factor in capital investments. If you recognize that most businesses fail, you will see that individual company shares are a “loser’s game”.

  16. Seems to me that although Greenspan certainly deserves his share of the ‘credit’, the bulk of the problem is systemic.
    Rules were changed one at a time to improve the balance sheet or perceived balance sheet of various players. Rules were changed to allow banks to over leverage. Rules were changed to keep hedge funds unregulated. Rules were changed to force the repeal of Glass Steagle act. And on and on it goes. There was no public clamor for any of these stupid changes that together put us eyeball deep in shit with only a short straw.
    This is not a failure of monetary policy as much as it is a lack of democracy. These changes were all made to please the moneyed interests who hire out lobbyists’ with fists full of campaign donation cash. Politicians work in the interest of those who pay their way into office. Unless and until the public funds campaigns, politicians will continue to give too much favor to the special interests.

  17. With all due respect –

    Let us assume that Greenspan was the individual whose actions singularly contributed the most to this crisis.

    If true, then this prompts the question: how did he acquire so much power?

    Which then prompts the observation: Any system which grants an unelected official this much power certainly is more at fault than the individual. No system of government can rely exclusively on the competence and/or integrity of a single individual to secure its long term prosperity, liberty, and survival.

    We – all of us – had many years of warning. Yet as the years passed, and dire predictions failed to materialize, we grew complacent and comfortable with our debt. We listened, eagerly, to those who told us that all of this was normal and even beneficial.

    Ultimately, therefore, it was the power if ideas that destroyed us. We succumbed to the siren song of the unfettered free markets, which echoed from (nearly) every noteworthy economist in the country.

    There is no way the sequence of events that preceded this catastrophe – the dismantling of so many regulations, the crippling of the SEC, the unwinding of rules, the lax attitude toward leverage, the failure to enforce consumer protection laws, the utter faith in economists, the deaf ear turned toward those who suffered at the hands of distorted international competition, the extremely asymetric compensation schedules for executives – none of this could have happened without the intellectual cover provided by the field of economics and various think tanks that supported it.

    To say that the fault lies with Greenspan is to say that the way to have avoided this crisis was to have someone at the helm other than Greenspan – who for a long time was the hero of economists everywhere.

    If this was the only way to have avoided this crisis, then I fear from this country. Surely, there must have been a more enduring bastion of defense that we could have erected against the corruption and destruction we are now witnessing?

  18. Having said that, James’ post on Planet Money seems to suggest we need a theory of asset price stability to go along with our theory of CPI (inflation).

    Now _that_ is definitely true. And very challenging.

  19. Bravo James!

    And while you are at it, may we please add Mr. Paulson for not giving Lehman the 6 billion dollar loan so that all the companies (Goldman et al) that bet on Lehman going down got paid off with the full faith and credit of a USBAILOUTVIA AIG’s backdoor!!! And for his insistence on adding “unlimited” authority to the TARP which enabled him to pass more money to the sacret 9, that fateful weekend after TARP one passed…and maybe while we are at it, include the fact that he engineered the purchase of Merrill Lynch by Bank of America giving the Merrill bunch (bankrupt otherwise) 2/3of a BAC for every Merrill share?…..all of these actions effectively passed the disease engineered by the former Fed chair onto the balance sheet of the USA and causing those who buy credit default swaps on the US dollar to not be able to afford them anymore!

    Our thin ice is melting.

  20. I think the point that Greenspan would not have instantly become competed or fired out of existence is the key one in laying blame here; more than if he could actually single-handedly have stopped it.

    But even the “single-handed” argument is not all it’s cracked up to be. Had Greenspan, at the time, used his freedom of action to squawk loudly and do something, it would have given cover to more sober-minded voices in boardrooms that might have urged enough caution to soften the endgame of where we’ve ended up.

  21. As much as I would love to blame Greenspan, I think he made the right choices at the time.

    The problem with including asset prices in the equation when setting monetary policy is that you risk mismanaging the money supply and choking off true economic growth.

    The price of bread is set only by today’s bread supply, today’s money supply, and today’s need for bread. In contrast, the price of an asset is set by today’s money supply, today’s asset supply and the discounted present value of the perceived future stream of income from that asset. The perceived future stream of income is the wild card in the mix, and its is what makes asset prices fundamentally different than bread prices. Sometimes an increase in an asset price arises from a perceived increase in the future stream of income from an asset that turns out to be correct. Sometimes an increase in an asset price arises from a perceived increase in the future stream of income that turns out to be a mirage (think dot com bubble). The price of bread doesn’t have this problem. People always know exactly what a loaf of bread is worth to them, and it doesn’t depend on successfully predicting the future.

    So, a central bank is on pretty solid ground basing monetary policy on the prices of consumables. If prices of all consumables start rising its almost certainly because money supply growth is outstripping real economic growth. On the other hand, an asset price rise may have more to do with perceptions of future income than it has to do with money supply. If the central bank reduces the money supply to stop an asset price rise that does not stem from a too-large money supply then the just reduced the money supply below its optimum point for economic growth and probably triggered an recession for no good reason.

    If a central bank errs on the side of caution and squashes all rises in asset prices, they will end up often causing needless recessions by trying to prevent asset price rises that are based on true increases in long term income production. If they try to distinguish good asset price rises from bad asset price rises, they will get it wrong a substantial part of the time, so we will have the worst of both worlds: periodic bubbles punctuated with unnecessary recessions.

    If you want to blame someone, blame the people who decided to let the Chinese keep their currency undervalued.

  22. Exactly. For the reasons given in my comment below, basing monetary policy on asset prices requires being able to accurately predict the future income from assets, which is indeed “very challenging.” Also, in order to prevent asset price bubbles this theory of asset price stability has to have enough credibility to overcome the majority opinion. By definition, during a bubble the majority thinks the prospects of future income from an asset are very high. This theory of asset price stability has to be solid enough to convince the majority that they are wrong.

  23. From a post by Russ to TIpping Point I copy this perfect answer to the question. It is a culture that has taken over America from TIp to Top. He characterizes it thusly:

    Therefore, whereas innovation normally refers to creating some new real value, and talent refers to innate ability at some real endeavor, here innovation refers only to finding new ways to seek and collect rent, the talent referred to is that of a con man, and the pivotal figures are the lobbyist, the lawyer, the PR flack, the captured regulator, the corrupt politician.

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