Is Greenspan to Blame for the Housing Crisis?

Could be, but the bubble wasn't all bad

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The same housing downturn and credit crunch that nudged Ben Bernanke's Fed to act last week also forced his predecessor, Alan Greenspan, to answer some tough questions on his Age of Turbulence book tour. Is the so-called Maestro to blame for the now-popping housing bubble? Did he keep interest rates too low for too long earlier this decade (an "insurance policy" against deflation, Greenspan countered during interviews) and ignore the dangers of out-of-control subprime lending? "I had no notion of how significant these practices had become until very late," Greenspan now admits.

That's hardly breaking news to investment adviser Tim Iacono. He's the creator of a website called The Mess That Greenspan Made and bashes Greenspan for not having used his "bully pulpit" to raise awareness of the growing subprime danger. Indeed, ensuring the safety and soundness of America's financial institutions is one of the Fed's jobs. But Prof. Allan Meltzer of Carnegie Mellon University, a Fed historian, directs his scorn at the supposed Wall Street wizards who loaded up on subprime-backed debt. "No one put a gun to their heads and made them buy that stuff," Meltzer says.

As for the "too low for too long" argument, Meltzer partially lets Greenspan off the hook by noting that the Fed has had an increasingly tough time influencing long-term interest rates, including mortgage rates. From June 2004 to July 2006, the Fed took the federal funds rate up from 1 percent to 5.25 percent. But long rates didn't take the Fed's hint and fell for most of 2004 and 2005.

A "conundrum," Greenspan famously called it at the time. But here's the answer: The global spread of capitalism has increased inflation-dampening competition throughout the world and allowed investors to accept lower yields when investing in bonds. What's more, globalization has boosted incomes, in Asia and beyond. That has expanded the pool of savings that can flow into U.S. debt, forcing rates lower. The result, according to a 2006 paper by economist Tao Wu at the Dallas Federal Reserve Bank, is a "substantially weakened" Fed.

Then again, Greenspan might want to embrace his role in all this. Just as the Internet bubble left behind Google, eBay, and 90 million miles of fiber optic cable, the credit bubble upgraded America's aging housing infrastructure and created a host of online services—Realtor.com, Zillow—that have permanently shifted the balance of power from real-estate agents to consumers. As Australian economist and bubble-ologist Jason Potts puts it, "A bubble is good for growth because it creates a low-cost environment for experimentation." Even if it eventually pops.