Alan Greenspan blames Irrational Risk-Taking and not his Keynesian Policies for the Subprime Mortgage Crisis

Posted by PITHOCRATES - October 26th, 2013

Week in Review

Since the Keynesians took over monetary policy we’ve had the Great Depression, the inflation racked Seventies, the dot-com bubble/recession of the late 1990s/early 2000s and the subprime mortgage crisis.  It’s also given Japan their Lost Decade, a deflationary spiral that started in the late Eighties that they are still fighting today.  As well as the sovereign debt crisis still ongoing in Europe.  So Keynesian economics has a record of failure.  Yet governments everywhere embrace it.  Why?  Because they love having the power to create money.  Especially when it’s ostensibly for helping the economy.  Which it never does.  As efforts to do so resulted in the carnage noted above.  But it always gives a good excuse for another surge in government spending.  And Keynesians love government spending.

Why does Keynesian economics fail?  Alan Greenspan, former chairman of the Federal Reserve whose policies helped create some of this carnage (dot-com bubble and subprime mortgage crisis), explains (see Greenspan ponders the roots of a financial crisis he failed to foresee by Martin Crutsinger, The Associated Press, posted 10/21/2013 on The Star).

Now, Alan Greenspan has struck back at any notion that he — or anyone — could have known how or when to defuse the threats that triggered the crisis. He argues in a new book, The Map and the Territory, that traditional economic forecasting is no match for the irrational risk-taking that can inflate catastrophic price bubbles in assets like homes or tech stocks.

This is why the Soviet Union lost the Cold War.  Because their managed economy failed.  As all managed economies fail.  Because it is impossible to know the decisions of hundreds of million people in the market.  These people making decisions for themselves result in economic activity.  But when governments try to decide for them you get Great Depressions, debilitating inflation, bubbles and nasty recessions.  As well as the collapse of the Soviet Union.

People only took irrational risks when the Federal Reserve (the Fed)/government interfered with market forces.  The dot-com bubble grew because the Fed kept interest rates artificially low.  So was it irrational for people to take advantage of those artificially low interest rates and make risky investments they otherwise wouldn’t have made?  Yes.  But if the Fed didn’t keep them artificially low in the first place there would have been no dot-com bubble in the second place.

Was it irrational for people to buy houses they couldn’t afford when the Clinton administration forced lenders to qualify the unqualified for mortgages they couldn’t afford?  Was it irrational behavior for people to buy houses they couldn’t afford because of artificially low interest rates, ‘cheap’ adjustable rate mortgages, zero-down mortgages, interest only mortgages and no-documentation mortgages?  Yes.  But if the Fed/government did not interfere with market forces in the first place to increase home ownership (especially among those who couldn’t qualify for a conventional mortgage) there would have been no subprime housing bubble in the second place.

The problem with Keynesians is they call anyone who doesn’t behave as they hope to make people behave with their policies irrational.  That is, people are irrational if they don’t think like a Keynesian and therefore cause Keynesian policies to fail.  But before there could be irrational exuberance there has to be a climate that encourages irrational exuberance first.  For if we went back to the banking system where our savings rate determined our interest rates as well as the investment capital available there would be no bubbles.  And no irrational exuberance.  What kind of a banking system would that be?  The kind that vaulted the United States from their Founding to the number one economic power in the world in about one hundred years.  And they did that without making money.  Unlike today.

Q: The size of the Federal Reserve’s balance sheet stands at a record $3.7 trillion, reflecting all the Treasurys and mortgage-backed securities the Fed has bought to push long-term interest rates down. You have expressed concerns about this size, which is more than four times where the balance sheet stood before the start of the financial crisis. What are your worries?

A: My basic concern is that we have to rein this thing in well before the demand for funds picks up and makes it very difficult to rein in. (Inflation) is not immediate. It is down the road. But historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn’t hit (with higher inflation).

The balance sheet is four times what it was before the Great Recession?  That’s an enormous amount of new money created to stimulate the economy.  And yet we’re still wallowing in the worst economic recovery since that following the Great Depression.  I don’t know how much more you can prove the failure of Keynesian economics than this.  About five years of priming the economic pump with stimulus stimulated little.  Other than rich Wall Street investors who are using this easy money to make more money.  While the median household income falls.

Keynesian economics attacks the middle class.  While enriching the ruling class.  And their crony friends on Wall Street.  These policies further the divide between the rich and everyone else.  Yet they continually say these same policies are the only way to reduce the divide between the rich and everyone else.  The historical record doesn’t prove this.  And those familiar with the historical record know this.  Which is why the left controls public education.  So people don’t learn the historical record.  Because once they do it becomes harder to win elections when you’re constantly lying to the American people.

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Rational Choice Theory

Posted by PITHOCRATES - June 10th, 2013

Economics 101

Trying to Predict which Choice People will Choose is Difficult

People.  They’re the worst.  A joke on Seinfeld.  But so true in economics.

People look out for their best interests.  Everything they do that they have power to do they do to improve their station in life.  When they buy gas they choose the station with the lowest price.  When they get a mortgage they go to the lender with the lowest borrowing costs.  When they go shopping they go to the store with the best sales.  Most of the time.

Some nights people may stop at a pizzeria on the way home from work.  Take the food home.  And scarf it down in front of the television.  Sometimes people may go out to dinner at an expensive restaurant.  Enjoying a fine dining experience.  At a fancy restaurant.  Taking their time.  Savoring every course.  A fine wine.  A decadent dessert.  Two very different choices.  Takeout pizza.  And a fine dining experience.  Trying to predict which choice people will choose is difficult.  Especially when the same people may choose one option one night.  Then the other option on another night.

You can’t reduce People’s Decision-Making Process down to a Mathematical Equation

Choice.  What will we choose when given choice?  That is the million dollar question.  For being able to predict how human beings will choose will make the one who can predict choice very wealthy.  Stores would know exactly what to sell.  Investors would always know what stocks to buy.  And television executives would only put television shows on air the people will love.  But stores often have huge sales to unload merchandise that isn’t selling.  Investors lose money in the stock market.  And every fall television executives bring a slew of new shows to air.  Most of which will be off the air by next season.

Yes, people are rational.  And they typically choose to maximize their utility.  That is, getting the most bang for their buck.  But they are human.  They think.  A lot.  And when they consider everything before making a choice they may choose what to others is irrational.  Even if it’s not to them.  That’s the problem with people.  You can’t reduce their decision-making process down to a mathematical equation.  But economists try.  As do politicians.

But their efforts rarely get the people to do what they want.  During a recession they will implement policy to change people’s decision-making process.  They’ll expand the money supply to lower interest rates.  To encourage people to borrow money and buy things.  Like houses.  And cars.  Even if they weren’t even thinking about buying a house or a car.  The hope is that if these people start buying things they weren’t previously going to buy it will generate economic activity.  And pull the country out of recession.

Left to their own Devices the People will make the Best Decisions

But it rarely works.  If it ever works.  A recession is like a cold.  You can take a lot of over-the-counter cold medicine to ease your discomforts.  But you can’t cure it.  You just have to let it run its course.  So it is with a recession.  A recession is a correction.  Prices correct to market values.  And supply corrects to match demand.  Suppliers cut back on production.  And lay people off.  This is the painful part of a recession.  People losing their jobs.  But they have to.  Because there are too many people producing more than others are buying.  But once the recession runs its course the economy can start growing again.  And business will start hiring again.

Trying to prevent this correction with low interest rates will only delay the correction.  Worse, it will encourage people into irrational behavior.  Such as borrowing money to buy a house during a correction.  Getting a mortgage that will soon be worth more than the value of the house.  Once the correction resets housing prices to market values.  While some people make these irrational decisions others make rational decisions.  Refusing to increase production or to hire more people when the government floods the market with cheap money.  Because they know that it will at best delay the correction.  So they won’t act as the government hoped they would.  Leaving the economy in recession.  So it can run its course.  Like the common cold.

Because recessions must run their course the government should not intervene.  They should not try to influence the decision-making process of the people.  For left to their own devices the people will make the best decisions.  Which is why countries with free market economies have healthier economies than countries with managed economies.  And why when the government does not intervene in the economy recessions are shorter and less painful.  Because the correction that must happen happens.  In the shortest time possible.  But when government intervenes we get things like the Great Depression.  And the Great Recession.

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