Matt Yglesias

DeLong Defends Alan Greenspan

Alan Greenspan’s come under a lot of retroactive criticism for having kept interest rates so low in the wake of the tech stock crash in order to help spark the housing boom that’s now come undone. Brad DeLong considers the issue of whether or not this is a fair criticism, and comes down tentatively on Greenspan’s side. I tend to agree with Brad about this. If you’re faced with the choice between “severe recession now” or “mild recession now and possibility of severe recession later” I think it’s difficult to say that picking the “severe recession now” door is the right one. You have to keep in mind, after all, that the “severe recession now” scenario hardly ensures an absence of serious future recessions.

Meanwhile, even in retrospect I don’t see any serious argument that the situation that existed as of January 2005 made the Panic of 2008 inevitable. He lists three real Fed mistakes that came later and contributed to the crisis:

— The Federal Reserve and the Treasury decided to nationalize AIG rather than to support AIG’s counterparties last fall, allowing financiers to pretend that their strategies were fundamentally sound rather than things that would have shut down their firms had the Feds not paid AIG’s bills.

— The Federal Reserve and the Treasury decided to let Lehman Brothers go into an uncontrolled bankruptcy last fall in order to try to teach financiers that having an ill-capitalized counterparty was not riskless and that people should not expect the government to come to their rescue always.

— The long-ago decision was made to eschew principles-based regulation and allow the shadow banking sector to grow unregulated with respect to its leverage and its compensation schemes in the belief that government regulation of finance should be minimal and that the government’s guarantee of the commercial banking system was enough to keep us out of messes like the one we are currently in.

Closer to home, I think you can very fairly tag Greenspan with the charge that having implemented the policy he implemented in 2001–2002 he developed a striking lack of candor about what was happening as of 2004–2005. There was plenty of time for policymakers to start waving people off the implicit assumptions they’d started making about housing prices. The trouble, however, was the trouble you’ll always have when it comes to bubble-popping. George W Bush didn’t want to say that prosperity was being based on a mirage, he wanted to say that prosperity was being based on his wise leadership. Many Bush critics—Paul Krugman, say—were happy to make the mirage argument. But then you had Harry Reid (D-NV) leading the Democratic opposition in the Senate and also representing one of the frothiest bubbles in the country. And individual critiques aside, the general point is that as long as the bubble lasts it’s mostly beneficial to most people, so nobody accountable to the voters is going to want to end the party or even point out that the party must end.

But the Fed is supposed to be insulated from this kind of pressure and more able to call it like it is.