Befuddled by Bubbles: The Greenspan/Bernanke Era at the Fed

Between 2000 and 2008, two of the largest financial bubbles in history - in technology stocks and housing, respectively, - suffered spectacular collapses.  Opinions vary, but some market commentators believe at the peak of the tech bubble, total stock market capitalization exceeded 180% of US GDP.  To put this in perspective, the tech stock bubble was over twice the size of the 1920's stock market bubble! (1)  As large as the bubble in tech stocks was, it was child's play compared to the housing bubble.  When the US housing bubble collapsed, the credit losses were so large the entire worldwide banking system was considered to be in mortal danger. 

One of the primary forces behind the 1913 founding of the Fed was to prevent financial crises.  Logic then dictates if a major motivation behind forming a central bank is the prevention of a financial crisis, then a financial crisis that breaks out under the nose of a central bank must be due - at least in part - to mistakes of that bank.  The Fed's mistakes and its subsequent leading role in causing the housing bubble will be seen by reviewing speeches given by Alan Greenspan and Ben Bernanke that praised the housing bubble era Fed.  In addition, a review of statements made in the wake of the tech bubble's collapse will reveal senior Fed officials taking positions diametrically opposed to positions Alan Greenspan claimed formed the basis for the Fed's policy toward bubbles - namely allowing bubbles to burst and dealing with the consequences later.  

From its March 2000 peak to its October 2002 bottom the NASDAQ declined 80%.  Throughout the 1990s no one cheered on the "new economy" more than the "maestro," Alan Greenspan.  After the bubble collapsed, Greenspan recognized a need to explain his and the Fed's actions while the tech bubble grew.  In August 2002 Greenspan gave a speech at the Fed's annual conference in Jackson Hole, WY.  In this speech, which Jim Grant called "self-exculpating revisionism" (2), Greenspan offered this rationale for the Fed's actions during the late 1990s;
"The struggle to understand developments in the economy and financial markets since the mid-1990s has been particularly challenging for policy makers...We at the Federal Reserve considered a number of issues related to asset bubbles - that is, surges in prices of assets to unsustainable levels.  As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact - that is, when its bursting confirmed its existence."

Less than two years later, in January 2004, Greenspan would congratulate himself on the apparent success of the Fed's strategy.  In doing so, he would expose the Fed's role in creating the far more ruinous housing bubble.  
"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful...As I discuss later, much of the ability of the U.S. economy to absorb these sequences of shocks resulted from improved structural flexibility.  But highly aggressive monetary ease was doubtless also a significant contributor to stability." (3)
The "monetary ease" - slashing interest rates - Greenspan was taking credit for here was not helping the economy heal.  Instead, it was fueling an enormous bubble in housing whose negative consequences can best be described as world altering.  

One month later, in February, Greenspan's partner in criminal economic ignorance, Ben Bernanke, gave a speech titled, "The Great Moderation."  In this speech, Bernanke would, unknowingly, provide further evidence of the Fed's enormous role in causing the housing bubble.  Bernanke claimed the Fed's monetary policy was a source of stability, and helped to reduce variations in economic output.  The irony in giving this speech at this time should not be lost.  Bernanke's speech, like Greenspan's, betrays a total ignorance of the enormous housing bubble that was only a few weeks from topping!  (Homeownership peaked in April 2004.)  With just these two speeches, the enormous ignorance and criminal incompetence of the Greenspan/Bernanke Fed is demonstrated.  This ignorance and incompetence then played an enormous role in causing the housing bubble.  

The Fed's bubble befuddlement was not limited to a few speeches.  For years on end Fed officials took positions in contradiction to those established by Greenspan in his Jackson Hole speech.  For example, in July 2005 and in his capacity as the head of the president's council of economic advisors, Ben Bernanke was asked on CNBC if there was a housing bubble.  He does not answer by saying bubbles can't be seen until after they burst.  Instead he says the following;
"Well, I guess I don't buy your premise.  It's a pretty unlikely possibility.  We've never had a decline in housing prices on a nationwide basis, so what I think is more likely is house prices will slow, maybe stabilize, might slow consumption spending a bit.  I don't think it will drive the economy from its full employment path."

Later, in October 2005, other Fed officials would also contradict Greenspan's Jackson Hole speech.  By then homeownership had already peaked and the housing bubble had started to collapse.  Amazingly - and evidence that enormous economic ignorance infects the Fed to its core - two Fed economists investigated if there was a housing bubble.  They - erroneously, of course - concluded home prices were "high, but not out of line." (4)  Obviously, if Fed officials were investigating to see if a housing bubble existed, then they believed it could be observed without first having to collapse.   

Because the Fed continues to be dominated by economic cranks who never grow tired of hearing themselves talk, the most damning indictment of the bubble era Fed comes from other Fed officials.  The most loquacious of these officials is current St. Louis Fed president James Bullard.  Bullard's largest failing would appear to be his attempts to give a sense of scientific legitimacy to Fed policies.  In fact, these policies are based on nothing more substantial than the ephemeral and erroneous notions bouncing inside the heads of Bullard and his equally doltish Fed colleagues.  Nevertheless, Bullard does commit the mortal Washington DC sin of telling the truth from time to time.  Among the truths Bullard has betrayed was the one concerning the obvious nature of the recent tech stock (2000) and housing (2008) bubbles.  In a September 2013 interview Bullard said, "The bubbles we had in the past were gigantic and obvious." (5) Later, in a November 2013 interview, he said the housing and tech bubbles were "blindingly obvious." (6)

Amazingly, even Alan Greenspan would contradict Alan Greenspan.  Here is "Mr. Chairman," as CNBC lovingly refers to him, discussing the collapse of Lehman Brothers in a October 2013 interview, "We missed the timing badly on September 15, 2008.  (The day Lehman went bankrupt.)  All of us knew there was a bubble." (7)  So which is it, Mr. Chairman?  Can bubbles be identified before they pop - as you indicate here - or do you have to wait until after they pop to confirm their existence as you said in Jackson Hole?

The review here demonstrates both the leading role the Fed played in creating the housing bubble - the January and February 2004 speeches - and the mutually exclusive positions the Fed took on bubbles.  In spite of being exposed in what is either a self-exculpating lie - (bubbles can only be seen after they burst) - or a sign of gross incompetence - (the failure to see two of the largest bubbles in history) - no Fed official has ever been asked to to explain or rationalize the Fed's contradictory positions on bubbles.  Whether anyone from the Fed is ever forced to do so or not, it is obvious the Fed has much to answer for concerning all the economic hardships induced by their bubble befuddlement. 

 

Peter Schmidt
05 AUG 2018

ENDNOTES
(1) Mark Faber, "The Monetization of the American Economy," DailyReckoning.com, January 16, 2002 https://dailyreckoning.com/the-monetisation-of-the-american-economy/

(2) Jim Grant, Mr. Market Miscalculates, Axios Press, Mt. Jackson, VA 2008, p. 241

(3) Risk and Uncertainty in Monetary Policy," Remarks by Alan Greenspan at the Meeting of the American Economic Association, San Diego, CA, January 03, 2004  https://www.federalreserve.gov/boarddocs/speeches/2004/20040103/default.htm

(4) Jonathan McCarthy and Richard W. Peach, "Is There a Bubble in the Housing Market Now?" Federal Reserve Bank of New York, 2005 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=923867

(5) Steven C. Johnson, "Fed Need Not Rush to Taper While Inflation is Low," September 20, 2013 Reuters https://www.reuters.com/article/us-usa-fed-bullard/fed-need-not-rush-to-taper-while-inflation-is-low-bullard-idUSBRE98J0BI20130920?feedType=RSS&feedName=politicsNews

(6) Matthew J. Belvedere, "Fed's $1-trillion a year QE Pace Torrid," CNBC.com, November 4, 2013 https://www.cnbc.com/2013/11/04/feds-bullard-weve-made-substantial-progress-in-us-labor-markets.html

(7) Matthew J. Belvedere, "Bubbles and leverage cause crisis: Alan Greenspan," CNBC.com, October 23, 2013 https://www.cnbc.com/2013/10/23/something-fundamentally-wrong-with-the-way-i-look-at-the-economy-alan-greenspan.html