Greenspan and the three bears

Who is to blame for the mortgage mess? A Greek chorus of gloomy economists blames the former Fed chairman.

Published March 19, 2007 6:04PM (EDT)

Alan Greenspan, in April 2005:

Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country...

With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The widespread adoption of these models has reduced the costs of evaluating the creditworthiness of borrowers, and in competitive markets cost reductions tend to be passed through to borrowers. 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 to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.

Could the maestro have possibly been more wrong? We can argue until the cows get home whether subprime mortgage problems are going to spread into the wider economy, but one thing is currently beyond dispute. Lenders manifestly failed to "judge the risk posed by individual applicants and to price that risk appropriately." Instead, in the absence of responsible government supervision, they made a ton of loans to bad credit risks and got burned.

Greenspan's 2005 comments, made at the height of the housing boom, have been eagerly seized upon by those whose knives have long been out for the former chairman. The bears are running wild. In his most recent, and typically gloomy, look at the global economy, Morgan Stanley's chief economist Stephen Roach lambastes Greenspan for his role in creating the current mess.

In early 2004, he urged homeowners to shift from fixed to floating rate mortgages, and in early 2005, he extolled the virtues of sub-prime borrowing -- the extension of credit to unworthy borrowers. Far from the heartless central banker that is supposed to "take the punchbowl away just when the party is getting good," Alan Greenspan turned into an unabashed cheerleader for the excesses of an increasingly asset-dependent U.S. economy. I fear history will not judge the Maestro's legacy kindly.

Roach is, as ever, worried about the potential negative impact of housing bust "spillovers" on the global economy. So far, he notes, consumers haven't stopped spending -- but that's exactly the problem. "To the extent the U.S. economy is now flirting with 'growth recession' territory -- a sub-2 percent GDP trajectory -- while consumer demand remains brisk, a pullback in personal consumption could well be the proverbial straw that breaks this camel's back."

Roach's dour forecasting, however, is positively ebullient when compared to the wild rant unleashed by economist Nouriel Roubini this morning. Roubini needs to cut back on the coffee. Sure, his 6,200-word "blog post" has some entertaining moments -- the blame for the subprime mess, he declares, lies with... market zealot and fanatics and voodoo economics ideologues who captured U.S. economic policy in the last six years in the same way in which a bunch of neo-cons hijacked U.S. foreign policy to bring "democracy" to the Middle East while instead leading the country into the Iraq and Mid-East quagmire and now disaster.

According to these ideologues -- listen for example to Larry Kudlow extolling every evening on CNBC the virtue of unregulated wild-west cowboy capitalism -- government is always utter evil and the economy could never have a financial or economic crisis if taxes are low, government spending is minimal and government intervention and regulation of the economy and of financial systems is inexistent. This nonsense about bubbles, financial crises and recessions being impossible unless the government over-regulates the economy and/or makes monetary policy mistakes is the main religious dogma of this cabal, an axis of ideological zealotry that goes from the WSJ editorial page to a gang of voodoo economic hacks and to some segments of the financial television.

Who doesn't love reading the phrase "voodoo economic hacks" 10 times before breakfast? But Roubini's main point, that the "subprime carnage" could have been avoided if government was doing its job and restricted the creation and implementation of all those "innovative" mortgage properties that Greenspan was so effusive about, could have been expressed in a tenth the space without losing (and perhaps even gaining some) impetus. The man needs an editor.

Elsewhere in the econoblogosphere, considerable attention is being paid to a post made on Friday by economist Kash Mansouri, who looks at the data coming in on bad bank loans to the real estate industry and concludes that we may be fast approaching a debacle that will match the destructive capacity of the great Savings and Loan crisis of the 1980s. In other words: recession, dead ahead. Mansouri doesn't explicitly pin the blame on Greenspan, but it all comes back to whether lenders adequately were able to judge risk. And they weren't. Greed got in the way, as it always does.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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