Wednesday, November 19, 2008
The Housing Bubble: Greenspan or Asian Savers?
UPDATED BELOW
In today's Mises.org article, I take on Henderson and Hummel's recent Cato piece that said it was a foreign savings glut, not Fed policy, that caused the housing bubble.* The conclusion:
UPDATE: * One angry emailer took me out to the woodshed and said that H&H never claimed foreign savings were responsible for the housing bubble, but that instead foreign savings were responsible for the low interest rates. I still think everyone (including H&H) agrees that the low interest rates helped the bubble, so it's a distinction without a difference. I think it is pretty clear though that Hummel himself thinks a foreign savings glut is a necessary component of the explanation, and more relevant than Fed policy; see here. I am waiting to hear back from either of them on the matter; I will of course issue a clarification / retraction at this blog (and on the Mises blog tied to the article) if I have misrepresented their view.
In today's Mises.org article, I take on Henderson and Hummel's recent Cato piece that said it was a foreign savings glut, not Fed policy, that caused the housing bubble.* The conclusion:
David Henderson and Jeffrey Rogers Hummel have tried to exonerate Greenspan from his alleged role in the housing bubble. However, to do so they must rely on novel transformations of the conventional monetary measures, in order to demonstrate "tight" Fed policy, when all of the conventional indicators show a very "loose" policy precisely when the boom was at its greatest. Furthermore, Henderson and Hummel offer an alternative thesis—a global savings glut—that hardly fits the most basic of facts. Global savings rates were lower for most of the housing boom than in the preceding decade, and global savings rates are higher now (amidst the bust) than they were during the boom that they allegedly fueled.
Putting aside the details, we can also step back and ask ourselves, does it really make sense that one of the worst financial crises to grip the world was caused because people started saving too much? Or does it make a lot more sense to blame it on huge central-bank injections of phony credit into the markets? How two economists who appreciate the strength of the free market could opt for the former hypothesis—despite the dubious evidence for it—is puzzling indeed.
Naturally, there is more to the story of the housing boom than simply saying, "The Fed chairman did it." A full explanation would involve the Chinese government, Fannie Mae and Freddie Mac, and the ratings agencies that gave high marks to dubious mortgage-backed securities. But the original Misesian insight has withstood the test: it still seems that the Fed was a necessary condition for the worst speculative bubble in world history.
UPDATE: * One angry emailer took me out to the woodshed and said that H&H never claimed foreign savings were responsible for the housing bubble, but that instead foreign savings were responsible for the low interest rates. I still think everyone (including H&H) agrees that the low interest rates helped the bubble, so it's a distinction without a difference. I think it is pretty clear though that Hummel himself thinks a foreign savings glut is a necessary component of the explanation, and more relevant than Fed policy; see here. I am waiting to hear back from either of them on the matter; I will of course issue a clarification / retraction at this blog (and on the Mises blog tied to the article) if I have misrepresented their view.
Comments:
Here's a personal question that I find myself asking lately, as someone who is self educated (and a newb) in austrian/free market economics:
With the apparent universal adoption of Keynesian economics by the entire mainstream economic school, how do you continue to convince yourself that Austrian economics is right...
In other words, what sources can we turn to that empirically demonstrates that the Austrian business cycle predictions are right on this one, and the credit injections aren't going to work.
With the apparent universal adoption of Keynesian economics by the entire mainstream economic school, how do you continue to convince yourself that Austrian economics is right...
In other words, what sources can we turn to that empirically demonstrates that the Austrian business cycle predictions are right on this one, and the credit injections aren't going to work.
When you talk about the rating agencies, don't forget both the perverse incentives they face:
- they are paid by debt-issuers who want the best rating possible, not inverstors, as David Zetland noted yesterday - http://aguanomics.com/2008/11/fixing-credit-rating-agencies.html -
- and the demand for ratings isn't driven so much by investor desire to manage risk as by regulations that restrict assets that regulated entities may purchase and mandate capital based on ratings.
As a result, the whole rating system is perverted.
- they are paid by debt-issuers who want the best rating possible, not inverstors, as David Zetland noted yesterday - http://aguanomics.com/2008/11/fixing-credit-rating-agencies.html -
- and the demand for ratings isn't driven so much by investor desire to manage risk as by regulations that restrict assets that regulated entities may purchase and mandate capital based on ratings.
As a result, the whole rating system is perverted.
Zachary, as a fellow newb, I've also been wondering the same thing. Milton Friedman did some empirical tests and concluded that the Austrian business cycle theory was wrong. Other famous economists, e.g. Gordon Tullock, have come to the same conclusion.
In the end though, when I read Mises, Hayek and (particularly) Rothbard, I come to the conclusion that the Austrians are generally more historically aware. Their theories fit with what we know about economic history. They don't get so caught up in being mathematicians that they forget about history.
Besides, Mises predicted the Great Depression of the 1930s! A bunch of Austrians predicted the present financial mess! And they were quite specific predictions, not vague doom and gloom stuff. Even if one doesn't accept everything about the ABCT, their basic insight about Alan Greenspan's excessively loose money policies has been accepted by a lot of non-Austrians.
In the end though, when I read Mises, Hayek and (particularly) Rothbard, I come to the conclusion that the Austrians are generally more historically aware. Their theories fit with what we know about economic history. They don't get so caught up in being mathematicians that they forget about history.
Besides, Mises predicted the Great Depression of the 1930s! A bunch of Austrians predicted the present financial mess! And they were quite specific predictions, not vague doom and gloom stuff. Even if one doesn't accept everything about the ABCT, their basic insight about Alan Greenspan's excessively loose money policies has been accepted by a lot of non-Austrians.
# posted by 
: November 20, 2008 at 10:01 AM
: November 20, 2008 at 10:01 AM
The Blackadder Says:
I haven't read the article yet, but I wanted to say that I thought the accompanying picture (of the piggy bank exploding) was really cool. It was a perfect pictorial representation/critique of the idea that current woes were caused by "too much saving."
I haven't read the article yet, but I wanted to say that I thought the accompanying picture (of the piggy bank exploding) was really cool. It was a perfect pictorial representation/critique of the idea that current woes were caused by "too much saving."
# posted by : November 20, 2008 at 12:07 PM
: November 20, 2008 at 12:07 PM
One issue that I've not seen addressed directly by the Austrians is the high (obscene?) salaries of bank and hedge fund CEOs. I'm not suggesting that these salaries caused the financial problems, but there is a strong view among the general public that this was a major contributing factor.
I think there is high likelihood that govts will impose restrictions on executive pay. So what is the Austrian view?
I think there is high likelihood that govts will impose restrictions on executive pay. So what is the Austrian view?
# posted by : November 20, 2008 at 3:20 PM
: November 20, 2008 at 3:20 PM
Good question, Anon from Oz.
My own view is that Austrians view selfishness/greed as a part of human nature that the market does a better job of harnessing than does government regulation, and that in this case the high salaries reflect underlying problems related to government:
- first, the Fed, Bush and Congress bear responsibility for the bubble that fuelled executive greed and helped ease market discipline on executive pay; and
- second, the high executive visible in this sector also reflects a socialization of risk, both by the government agencies and regulated banks, and by the investment banks as they moved from partnerships to publicly-listed firms (with the willingness of shareholders to control internal risks obviously less effective than the incentives/ability of executives to milk the equity of the firms).
I agree that regulation of executive pay seems likely, but this is liklely to prove counterproductive in the long run and is in any case a focus on symptoms rather than causes.
My own view is that Austrians view selfishness/greed as a part of human nature that the market does a better job of harnessing than does government regulation, and that in this case the high salaries reflect underlying problems related to government:
- first, the Fed, Bush and Congress bear responsibility for the bubble that fuelled executive greed and helped ease market discipline on executive pay; and
- second, the high executive visible in this sector also reflects a socialization of risk, both by the government agencies and regulated banks, and by the investment banks as they moved from partnerships to publicly-listed firms (with the willingness of shareholders to control internal risks obviously less effective than the incentives/ability of executives to milk the equity of the firms).
I agree that regulation of executive pay seems likely, but this is liklely to prove counterproductive in the long run and is in any case a focus on symptoms rather than causes.
I think we should also address a point Mish has been hammering away at for years: China printing like mad to keep their currency low relative to the dollar does not in fact constitute savings. His reasoning is as follows:
Thanks to the Fed, there’s been plenty of liquidity for consumption in the US, but that consumption is coming off the productivity of the rest of the world (a point Schiff makes over and over again). This general trade imbalance should cause US interest rates to rise as consumption increases without corresponding increases in production and savings domestically. However, FCBs (particularly China) are sterilizing our flood of dollars by printing their own currency (again, particularly the Yuan) and using the dollars to buy US securities. Thus, FCBs themselves are buying US securities with newly created credit, not foreign investors with oodles of savings.
Your thoughts, Bob?
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Thanks to the Fed, there’s been plenty of liquidity for consumption in the US, but that consumption is coming off the productivity of the rest of the world (a point Schiff makes over and over again). This general trade imbalance should cause US interest rates to rise as consumption increases without corresponding increases in production and savings domestically. However, FCBs (particularly China) are sterilizing our flood of dollars by printing their own currency (again, particularly the Yuan) and using the dollars to buy US securities. Thus, FCBs themselves are buying US securities with newly created credit, not foreign investors with oodles of savings.
Your thoughts, Bob?
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