Sunday, April 10, 2011

Blind idealogue Alan Greenspan

I've been reading Johnson & Kwak's Thirteen Bankers, and just saw a quote from Alan Greenspan that epitomizes a lot.

The Fed had been reviewing whether subprime mortgage lending should be more highly regulated. A 2000 Treasury-HUD report had found evidence of abusive "predatory lending" practices. A brief side-note here: the law and economics movement has at times debunked, or at least seriously questioned, theories that sound a bit like this. Predatory pricing, for example, has been challenged as a realistic business strategy in most circumstances where it is alleged (e.g., by rivals who can't match someone's low price). But "predatory lending" makes easy, obvious, and straightforward economic sense as a business strategy, so long as home values keep rising. You lend to a sucker who can't keep paying once the cushy early period ends, then you kick him out and have a chance of getting the home for below-value in the foreclosure sale. (Plausible even though the sale is public, since real estate markets can be thin, and sales can be under-publicized. Plus, you still break even if someone else assumes the full mortgage liability.)

Securitization presumably changes the story to one in which the original lender is merely indifferent to whether the borrower defaults, rather than welcoming it. Once the loan economics have been transferred to a big collective pool, it's other people's problem. Subprime lenders simply wanted to make as many loans as possible for the transaction fees. And downstream players were notoriously assuming that real estate prices would keep on rising forever, thus keeping borrower default a non-problem.

Then-Fed governor the late Ned Gramlich urged that the Fed step in to regulate subprime mortgages more. The banks that were making millions from the scam screamed bloody murder. And of course Greenspan backed them, barring any regulatory change. But what I found especially notable was the following Greenspan statement:

"Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending," etc. (from Johnson-Kwak, p. 143.)

What's wonderful about this statement is not just the fact that it was untrue (at least, if one interprets it as asserting that the lenders actually were risk-pricing appropriately, not just that they were "able" to do so if they wanted). Nor is it just the fact that inside players at the time knew it was untrue. (They were counting on real estate prices to keep rising, and at least implicitly on a bailout if things turned ugly, NOT on appropriate pricing of credit risks.)

No, what's wonderful about it is that Greenspan asserted it in the complete absence of any supporting evidence. He believed it because that is his theoretical view on how the economy operates. He didn't need no stinkin' evidence, it just had to be true.

And this notwithstanding the fact that one didn't need a theory of individual-level irrationality for it to be false - everyone could be acting rationally pursuant to their actual incentives and it could potentially be false. To believe what he did, you need a crude and ignorant set of assumptions about how collective market institutions always get it right - no matter what incentives individuals actually have. He truly was (and still is) our era's supreme Mister Magoo.

When you combine Greenspan's anti-regulatory record with his serially bubble-priming monetary policy and the crucial political role he played in 2001 in helping President Bush to destroy U.S. budget surpluses and put us firmly on the road to long-term default, Greenspan is pretty clearly #1 in U.S. history in a singular sense. He has done more lifetime harm to our economy than any other U.S. public official who has ever lived. (Indeed, among all individuals who have ever lived, I would think that only those who waged war on the U.S. could otherwise compete with him in this regard.)

To be fair, lots of other people share in the blame for recent economic and regulatory policy (and they come from both political parties). Plus, one has to think about 1929. But while there the overall harm may have been greater (at least, scaled to contemporary population and the size of the economy), no one individual from that era is entitled to claim nearly as high a share of the blame - e.g., certainly not the unlucky if inadequate Hoover.

UPDATE: Re-reading this post a couple of hours later, while I'm still comfortable with what it says about Greenspan, the theory of history it evinces could be criticized as too much of a "great man" (or in this case "bad man") theory. There were broader social and ideological forces behind what Greenspan did that made his policies, if not quite inevitable, at least (a) far more rewarding to him than any alternative set of policies he could have followed and (b) highly likely to be followed no matter who held his position. But that doesn't make individual responsibility either wholly irrelevant or meaningless.

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