Greenspan vs. Taylor

And supposedly I am the King of Strawman....and a Parody of Myself.

Posted by: murigeo | Mar 12, 2009 4:22:06 PM

All true.

I don't follow. The editor said that the issue covered the monetarist (read: economic) as well as the politics and finance.

Gaming the money supply is not what I call "economic fundamentals". I mean things like the supply of labor or some critical raw material or miles of paved roads or the demand for particular goods, like gasoline or housing. I'm talking about the real economic actors in the real economy, not monetary authorities.

Preface to the German-language edition of


The General Theory of Employment, Interest and Money (1936)

Those who quote Keynes should, you know, actually read Keynes.

Posted by: maximus

Doesn't say that in the English version. You sure Mises and some other Germans aren't foisting an urban ledgend upon the guillable? You really believe keynes advocated a totalitarian state?

And supposedly I am the King of Strawman....and a Parody of Myself.

Muirgeo,

You seem to acknowledge that order emerges biologically.

Elsewhere you've noted that man is social by nature, yet you deny that order emerges socially.

Amazing that you don't see the inconsistency.

Quoting Keynes here is like throwing two cats into bunch of pigeons, muirgeo. :\

Posted by: Gil

Well or like quoting Darwin to a bunch of creationist. They need to hear it.

I give up. I guess it is all about politics and finance. Economic fundamentals don't really affect anything.

I don't follow. The editor said that the issue covered the monetarist (read: economic) as well as the politics and finance.

... other authors treat the contributions of the Basel rules, mark to market, Fannie, Freddie, the CRA, and the legal cartel of rating agencies.

I give up. I guess it is all about politics and finance. Economic fundamentals don't really affect anything.

link to the Barrons article cited above.

Who is ultimately responsible?

If it's a systemic issue, then we all are to the extent that we support the system as it is.

The theory of aggregate production that is the goal of the following book can be much more easily applied to the conditions of a totalitarian state than [it can] under the conditions of free competition and a considerable degree of laissez-faire.

John Maynard Keynes

Preface to the German-language edition of


The General Theory of Employment, Interest and Money (1936)

Those who quote Keynes should, you know, actually read Keynes.

From Barrons....

The standard construct of the economy used by virtually all forecasters, from the Federal Reserve on down, is basically Keynesian, with varying opinions about how the model works. That none of them predicted the current crisis is telling, and indeed damning of the approach.

What definitely is ignored in academe is the Austrian school of economics, especially for baby boomers brought up on Samuelson's economics text, which was pure Keynesian orthodoxy. I did not learn the names von Mises and Hayek or their ideas until a decade or more after graduation (with a degree in economics, by the way.)

The Austrian view is a mirror image on the right to Minsky's from the left. The economy, if left alone, is self-correcting, say the Austrians. But central banks' inflationary expansion of credit produces booms and malinvestments, which inevitably lead to a crashes and depressions.

The only prevention for boom and busts are sound money, which is impossible with government-controlled central banks. Once the bust comes, the only cure is to let it run its course; allow the malinvestments go bankrupt and let the market reallocate the capital to productive uses....

The Austrian prescription, of course, was rejected first by the New Deal of Franklin D. Roosevelt, and now by massive response by both the purportedly conservative Bush administration and now the Obama administration. First came the $700 billion TARP last year to stabilize the financial system, followed by the $787 billion fiscal stimulus enacted last month. Across party lines, it's accepted that government's role is to prevent the economic pain that would come of "liquidate, liquidate, liquidate."

But the Austrians were the ones who could see the seeds of collapse in the successive credit booms, aided and abetted by Fed policies, especially under former chairman Alan Greenspan. While he disavows (again) the responsibility for the boom and bust, most recently on Wednesday's Wall Street Journal Op-Ed page ("Fed Policy Didn't Cause the Housing Bubble," March 11), monetary policy played a key role in creating successive bubbles and busts during his tenure from 1987 to 2006...

Austrian economists assert the current crisis is the inevitable result of the Fed's successive efforts to counter each previous bust. As the credit expansion pumped up asset values to unsustainable levels, the eventual collapse would result in a contraction of credit as losses decimate banks' balance sheets and render them unable to lend. That sounds like an accurate diagnosis of the current problems.

In the meantime, both Western democracies and autocratic governments such as China are actively utilizing the ideas of both Keynes and Friedman alike in enacting massively expansionary fiscal and monetary policies to counter the crisis resulting from the severe contraction in credit.

If these policies are successful, perhaps governments will adhere to Austrian principles to prevent a new boom and bust. That is for the next cycle, however. To paraphrase St. Augustine, governments may be saying, "Make us non-interventionist, but not yet.

Fabian Socialism is an astounding belief that the wickedest of men will do the most generous of things for the greatest good of everyone. - Oil Shock

No libertarian believes that wicked men will do good things purely for the benefit of others. WHich is the reasons why all Keynesians starting from Keynes himself has always been trying to destroy strawmen. Isn't funny that Keynes, like many of the liberals of today was born with silver spoon in his mouth, went to the equivalent of liberal breeding grounds like Harvard, where as many prominent libertarian contemporaries came from a more real world humble backgrounds, went to more schools and had more humble educational backgrounds?

Quoting Keynes here is like throwing two cats into bunch of pigeons, muirgeo. :\

sam grove: "We are malinvested in many areas:

... Well, maybe highways do, but I have my


doubts."

sam grove : "Maintenance is one of the negative factors not properly accounted for when road construction is planned."

Haven't toll roads demonstrated that highways can have positive financial values? I think most toll authorities take maintenance into account during construction planning. I have no doubt that private ownership or private management of toll roads will ensure that maintenance costs are included in planning.

Highway funds cannot achieve a positive return on investment as long as urban commuters subsidize rural voters.

Sold Out; How Wall Street and Washington Betrayed America

This American Life; The Giant Pool of Money

Greenspan lowering interest rates to the desires of Wall Street and Multinational corporate interest is just one small piece of this puzzle. In fact it's no puzzle. The whole state of the world and our economy is simply the result of bending government policy to the desires of the super wealthy. Wall Street cares nothing about productivity, they care nothing about free markets, they care nothing about market competition nor the invisible hand of the market... they ultimately are looking for fast easy money anyway they can get it. This usually is best accomplished by switching money from production to speculation. It's the best and fastest way to earn lots of money without having to do any real work or produce any real value or real product. Simply give Wall Street everything it wants and this is the end result. Simply look at the major legislation passed over the last 30 years and you will see the building blocks which resulted in this fiasco. Piece after piece of legislation was put together to this specific end ultimately resulting in the CDO. ll just one big coordinated plan to squeeze the last bit of equity out of the lower classes especially when it became clear they could not get their hands onto social security for now. It's proof positive of the dangers of allowing the wealthy elite to circumvent democracy and promote the interest of an elite few over the interest of the many. Its the rock solid evidence for why unregulated free market capitalism does not work and is an idea that is an abject failure when attempted to be put into place in the real world.

The two best resources to understanding this situation in its entirety are HERE and HERE.

"My first instinct was to let the market work, until I realized ... how significant this problem became."_GW Bush

"Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."

John Maynard Keynes

John Allison isnt BBT's CEO anymore. Kelly King is...Allison is still chairman, though.

Mike: I wonder if those Chinese know what they have done to us.

They probably imagined that we'd raise more of our children here to plow more of our land to grow more food for them to eat in their old age, but we raised fewer children to build ourselves bigger castles instead. Now, we'll print money to buy back their Treasury notes, and they'll buy whatever we're selling with the money we're printing, because that's all they can do.

They fucked up. They trusted us.

John Allison is the CEO of BB&T -- in fact, he is the longest tenured CEO of all the major financial institutions. Here is a link to a presentation wherein he shows precisely how the government caused this crises:

Allison on the Crises

By lowering interest rates and creating new money in the economy, the Fed alters which investors (both banks and borrowers) have access to capital.

The Fed only lowered short-term rates on T-bills to lower, in turn, the rate on overnight interbank lending. The same two words ("interest rate") label all interest rates, but all interest rates are not identical for this reason.

When the Fed raises the price of T-bills through open market operations, it can create cash reserves in banks, but it doesn't create opportunities to lend the cash profitably for 15-30 years. The banks are not compelled to lend this cash, overnight or otherwise. If banks lend the cash, they accept the risk of loss (we hope). If they borrow at low overnight rates to lend long, they accept a greater risk. This risk of loss is what Greenspan could not and did not change when he lowered the Fed's target for overnight lending between banks.

Prudent borrowers with rational economic outlooks and expectations of interest rates will not invest in projects which will fail if interest rates increase.

Right. An expectation of the interest rate on T-bills over the next quarter is not the only thing prudent creditors expect.

However, by lowering interest rates too far, the funds available for investment can exceed the number of investments which are long-term viable, leaving investments which only work as long as rates are low.

Funds available for investment are not automatically invested. Profitable investment requires more than cash reserves on creditors' books. If a creditor doesn't perceive these opportunities, he leaves the reserves on his books. Simply entitling creditors to extend more credit does not magically create the creditors' incentive to lend. That's why all the cash the Fed has created lately hasn't stimulated a lot of lending lately.

Because many banks and investors have incorrect expectations of future interest rates and economic climate, ...

The Fed does not create banks' expectation of the future economic climate. Interest rates on T-bills are not the economic climate. They're more like tomorrow's temperature, accompanied by no hint of the humidity or the wind speed or direction or anything else about the weather, including the temperature the day after tomorrow.

In fact, cash reserves are only devices for measuring tomorrow's temperature. Generating the heat is not something that banks alone can do.

... some of these people and firms will be inclined to make use of these excess funds and invest in projects only viable in the short-term.

If the projects are really viable in the short-term, that's fine.

The result is profits while rates are depressed, ...

Profits on short-term investments, while short-term rates are low, are fine. If you borrow short-term to produce lots of flags for the Bicentennial celebration, that's fine. Expecting to sell so many flags after the celebration is tragically short-sighted.

If rates are held too low for too long, I can imagine entire firms and industries being created which are simply not viable under ordinary economic conditions.

But the Fed only held short rates on T-bills low for a few years, and it didn't hold long rates low at all. Long rates were low for other reasons. They were low worldwide, not only in the U.S. How did the Fed manage that?

What you're saying about low long-term interest rates could be true, but simply blaming the Fed for the low long rates is a mistake. Long rates have been low for other reasons. Rates on ten year Treasury notes boggle the mind right now. It's like "safe" entitlement to tax revenue is all anyone wants to buy.

Why is that? Just look at the population profile. It's not rocket science. We've never had such a large proportion of the population expecting to consume for decades without producing anything in all of human history, and this proportion is so large because we've just experienced a period of historically low investment in the world's most valuable capital, human labor.

We didn't really invest to meet all of these retirement expectations. That's the problem. It's a big part of the problem anyway, but it's not the part we're discussing, because we're neck deep in denial right now.

Or in other words, ABCT + heterogeneous expectations explains why the Fed dunnit.

Your analysis of the effect of low long-term interest rates could be spot on, but the Fed didn't do it. That's Greenspan's point and the point you're missing.

But another part of the problem is that we have not made the real long term investments needed to realize the historically unprecedented retirement expectations of the "baby boom" (which is really a baby bust). To make these real investments, we must now go back in time a few decades and have more children.

Its also worth noting that the Fed is always depressing interest rates, so the notion that short-term rates can't affect long-term rates is only true in the short-term.

Even if short rates are always low, lending long to someone who ultimately doesn't repay the loan is still a loss.

Banks do not lend at the Fed funds rate. They borrow at this rate. Lowering the Fed funds rate can lower the rate at which banks borrow, but it doesn't lower their spread. The spread depends upon the banks' perception of the risk of lending.

A "long-term" loan is a loan for which this risk is long-term, not simply a loan for which the cost of funds is fixed over a long term. The cost of funds is only one factor in the long-term risk assessment.

Another factor is the number of home buyers in the future able to afford the houses we build presently, and countless other factors exist, like the possible death of a borrower before he repays the debt. Politics and finance are not everything.

While I don't want to lay all the blame on the Fed, I think it may have more blame than most people believe.

Martin said:

Greenspan has a point. The Fed is not faultless, but anyone who wants to lay all of the blame for the "crisis" at Greenspan's feet must explain how low interest rates on T-bills and overnight lending between banks can translate into low rates on 15-30 year loans secured by home mortgages.

Because many banks and investors have incorrect expectations of future interest rates and economic climate, some of these people and firms will be inclined to make use of these excess funds and invest in projects only viable in the short-term. The result is profits while rates are depressed, and insolvency when they return to normal (or above-normal) levels. If rates are held too low for too long, I can imagine entire firms and industries being created which are simply not viable under ordinary economic conditions.

Note that the people who have incorrect expectations aren't necessarily investors themselves. They may be depositors, lenders, borrowers (e.g., homeowners), or anyone who makes a financial decision based on future expectations of low interest rates. They may also be assisted by people who do know what is going on, and want to make a quick buck before the bubble bursts.

Or in other words, ABCT + heterogeneous expectations explains why the Fed dunnit. Its also worth noting that the Fed is always depressing interest rates, so the notion that short-term rates can't affect long-term rates is only true in the short-term.

Sure there were other culprits (imbalances, incentive structure, Fannie etc) but the Fed is squarely in there.

And here's another reason the unprincipled obfuscating whore should not be taken seriously, correlations and all:

Greenspan before Congress

The former Fed chief also said he was often following the "will of Congress" during his long tenure and did "what I am supposed to do, not what I'd like to do." WSJ here

Martin: of course we aren't ... that's why we're doomed.

with the possible exception of road maintenance.

Maintenance is one of the negative factors not properly accounted for when road construction is planned.

I forgot to put prohibition on the list, it has cost a lot and has had absolutely no fiscal return.

Mike: They are saving a lot in China and interest rates are dropping.

Jim : (fear) We are all going to die! How will we stop ourselves from selling houses at low interest rates to people who can't pay back the loans?

Mike: We can't stop ourselves! When I plug the numbers into the Standard Equation it says the no money down, interest-only, floating-rate payment on a $400,000 home is only $1,250 per month. Plus insurance and taxes, but we can ignore those. We can sell every house that we can borrow or build. Who is going to save us from ourselves?

Jim: (thinking) Well, the interest rate is low, but we only have enough money to float two houses. Also, have you seen the loan applications? The dregs. I wouldn't loan to them. So, we are saved.

Mike: Not so fast. The government FanFred Store is buying anything with the title LOAN stamped on the top. Something about making housing affordable on an equal basis, to both the good and bad credit risks. We can build the houses, make the loans, and sell them to FanFred. We'll make a nice profit on every loan, as long as we turn it over while the ink is wet.

Jim: Why would they buy such bad loans?

Mike: What do we care? We would be supporting public policy. We aren't going to lie or anything. They say we would be doing a good thing for the country.

Jim: (blood rising) Feel that energy! What a great public policy. Why, there is almost no limit to the people who can take out a loan now. We don't have to be saved, we are going to be rich, as long as we don't hang on to any loan overnight.

Mike: I wonder if those Chinese know what they have done to us.

These things have no positive financial returns.

Absolutely. Given the needs we face in the immediate future, we should be slashing expenditures on all of the stuff you listed, with the possible exception of road maintenance. I suppose I'm still a road socialist.

But of course, we aren't.

The problem doesn't occur at an instant in time. It's a long period marked by many significant events. The peak of the payroll tax surplus last year is such an event.

This peak in the surplus marks the point at which a supply of the rent peaks relative to the demand for it. From now on, demand for the rent grows faster than its supply.

Taxes exceed benefits for another ten years, based on pre-recession estimates, but since the surplus is really an additional source of general tax revenue, the pressure to raise other revenue to maintain current expenditures begins immediately.

Another significant event is the peak in the size of the U.S. labor force. That occurs in around a decade too. China's labor force also peaks in the next decade. Japan's labor force has already peaked.

And as the labor force peaks, the population of elderly, and would be retirees, simultaneously grows rapidly, placing downward pressure on the productivity of the remaining labor force who will support this growing elderly population in addition to other work. This process is beginning now and will be well underway a decade from now.

We are malinvested in many areas:

empire

subsidies (all of them)


highways


bureaucracy


AMTRACK


mass transit


etc.

These things have no positive financial returns.

Well, maybe highways do, but I have my

doubts.

Part of the problem is in the failure to look at jobs as a cost rather than a benefit, and also, the delusion that money creation, per se, results in wealth creation.

The financial system collapse may be more symptomatic rather than systemic. That is, it may be a distraction from fundamental issues of which the bubble popping is but one symptom.

Did you know about collateralized debt obligations and credit default swaps then?

yes, I came to know about CDOs and MBSs in 2005. I came to know about other exotic derivatives like CDS, CPDO etc in 2006.

Did you ever wonder what happens when the population ages in an unprecedented fashion?

yes, I think that problem is few years away.

Martin, what makes you think the CDO's poorly incorporated the risk?

Apparently, the price of many of these securities fell so precipitously that the market for them became illiquid because the holders couldn't part with them at market prices without suffering severe losses.

Doesn't that essentially mean that the holders paid prices for the CDOs that didn't rationally incorporate the risk, in the market's opinion at least?

I suppose the holders paid prices reflecting the advertised expected yield, and I suppose the precipitously falling price reflected the market's perception that the expected yield was much less than originally advertised, largely because losses from defaults were expected to be greater than anticipated, even greater than default swaps incorporated into the CDOs could cover, so I suppose the securities didn't rationally incorporate the risk.

But I don't pretend any special expertise here. I'm only describing what I understood to be Greenspan's position.

Greenspan didn't create the CDOs that poorly incorporated the risk.

Martin, what makes you think the CDO's poorly incorporated the risk?

Finally. Took Greenspan long enough to get this out there.

As I have been saying all along, the Fed did lower short-term rates, only some of which influences the long end of the curve, and most of which has little or no effect on ARM rates (those ran off LIBOR).

As Taylor argued in this piece, it was (largely) Greenspan’s artificially low interest rates which were to blame for the explosion of "monetary excesses," including and especially speculation in the housing market.

Not really, or probably not as Taylor asserts. Taylor needs to produce some empirical evidence of the price elasticity of money demand in this instance, which he fails to do (maybe I missed it). That evidence should serve to illustrate the reluctance of weak buyers to participate in a (hypothetical) higher rate environment.

Further, it is highly unlikely, given the (intended) short-term speculative nature of these "flipper" loans, that the participation rate would have been significantly different at Fed funds 2% vs. Fed Funds 7%. They don't care; they're using the money (hopefully) for such short durations.

So Greenspan doesn't bear nearly as much responsibility here as is commonly thought. He's certainly taken an unwarranted beating from the hyperbolically uninformed, financially illiterate left-wing press. He didn't help himself any with those foolish "market failure" comments.

I'm still not a fan of his, though.

Demographic changes undoubtedly have important economic effects, but blaming the housing bubble on them is rather like blaming next summer's heat wave on the fact that we are emerging from an ice age.

It's a crisis of misconception.

Read this page at Japan's Statistics Bureau, similar to the U.S. Census Bureau.

And the GAO here.

And in Europe.

And China.

The facts are well known, and the implications are painfully obvious, and the time for these implications is now, not decades in the future. The payroll tax surplus peaked last year. It would have peaked even without the recession.

So according to Martin, this isn't a crisis of capitalism...it's a crisis of conception.

Russ, I have enjoyed many podcasts from Econtalk, including the last one by John Taylor.

Please, could you get Taylor for another interview to comment on Greenspan's article.

Also, getting a podcast with Greenspan would be nice as well.

Thanks!

-Pingry

We malinvested. A single Fed chairman turning a single financial knob didn't do it for us.

Hundreds of millions of people, all responding independently to similar incentives, malinvested similarly, and now we all expect someone else's investment to make up for the investments we didn't make.

We want to collect rents on houses, but too many of the houses are empty, because we built the houses without building people to occupy them.

That's what's happening, in large measure at least, and the denial is thicker than pea soup.

Then concluded that greenspan was to blame.

Did you know about collateralized debt obligations and credit default swaps then?

Did you ever wonder what happens when the population ages in an unprecedented fashion?

Did you ask yourself what happens when an historically unprecedented proportion of the population tries to retire after systematically investing much less in the most valuable resource than the generations preceding them?

This resource is labor, and "investment in labor" does not describe student loans or luxury town homes. It describes raising children. We raised far fewer children, per capita, than our parents, and raising children is literally creating labor, and labor is the most valuable resource.

That's not my theory. It's Julian Simon's theory.

Shock,

Your points are well taken, however, they do not address Greenspan's specific points.

I agree with Bonner, Greenspan was something of a populist with regards to his monetary policy. However, if we ignore the effects of the long-term interest rates (that is, the effects within the context of the current crisis) we may be dooming ourselves to repeat history.

Greenspan's policies may be have even been the primary cause of the crisis, but crises rarely have a sole cause. We shouldn't ignore secondary and tertiary causes simply because we don't like the person/entity that brings those causes to our attention.

Libertarian writer Bill Bonner wrote in his 2005 book, An Empire of Debt: Rise of an Epic Financial Crisis, the following ( and more ) about Greenspan:

We see something in Alan Greenspan's career - his comportment, his betrayal of his old ideas, his pact with the Devil in Washington, and his attempt to hold off nature's revenge at least until he leaves the Fed - that is both entertaining and educational. It smacks of Greek tragedy without the boring monologues or bloody intrigues. Even the language used is Greek to most people. Though the Fed chairman speaks English, his words often need translation and historical annotation. Rarely does the maestro make a statement that is comprehensible to the ordinary mortal. So much the better, we guess. If the average fellow really knew what was being said, he would be alarmed. And we have no illusions. Whoever attempts to explain it to him will get no thanks; he might as well tell his teenage daughter what is in her hotdog.

Alan Greenspan is the most famous bureaucrat since Pontius Pilate. Like Pilate, he hesitated, but ultimately gave the mob what it wanted. Not blood, but bubbles. Greenspan's role in the empire is more than that of a Consul or a Proconsul. He is the Prefect. He is the quartermaster who makes sure empire has the financial resources it needs to ruin itself.

BTW, there is a similar discussion going on here

To look the other way because the crowd already knows that the Fed is to blame? Sounds positively Pilate-esque.

I don't know about the crowd, but I blamed greenspan as far back 2005. I started taking interest in housing bubble in 2004 and then did some research. Then concluded that greenspan was to blame.

I agree with Kevin and Martin, the Fed isn't innocent in the matter but they aren't wholly to blame either. I think a closer examination of Greenspan's objections is warranted.

Pilate's role in history does little to illuminate the questions Greenspan suggests and Martin asks. I know all the cool kids are scoffing at AG's op-ed apologia today, but like the Pilate analogy their derision is unhelpful.

The article actually raises questions that could lead to meaningful lessons about this crisis. To look the other way because the crowd already knows that the Fed is to blame? Sounds positively Pilate-esque.

Sure Martin. Pilate washed his hands, so he had not part in the crucifixion.

Martin, have you heard of Adjustable rate mortages, teaser rates, low intro rates, negative amortization etc? The interest on these loans were tied to the short term rates.

I've heard of them, but I've never had one. Regardless, creditors borrowing short to offer these terms know that the terms are sensitive to changes in short rates, and they also know that they're lending long, not short, so they know they're risking defaults when short rates rise. The long-term risk calculation is still there.

So Greenspan's point is that securitization masked this risk rather than accounting for it rationally. Even if creditors borrowed short to lend long this way, Greenspan didn't create the CDOs that poorly incorporated the risk.

Then there's the fact that the housing bubble existed, and was far more inflated, outside of the U.S., in markets denominated by other currencies. How does Fed policy on short term rates explain that?

Greenspan again blames China and now throws Taylor in front of the bus to boot. And Bernanke has thrown in for Greenspan, at least in absolving the Fed of any responsibility.

I have to give it more thought, but on its face, it seems disingenuous to complain that monetary policy and housing capitalization were decoupled while simultaneously admitting monetary policy fell off the Taylor rule prediction. Why would you expect to see any coupling before clearing the excess liquidity?

Put another way, you might expect coupling along the Taylor rule (or with tighter monetary policy)--since the Taylor rule is empirically derived mostly from data where they were coupled--but why would you expect coupling if monetary policy has been overly loose?

You can't go back and make the Fed more closely follow the Taylor rule in those years, so I suppose we may never know for sure. But the Fed surely had many more tools in its money-tightening arsenal than it employed at the time.

I suspect the Fed was timid because of its own fear of recession. If it had known what was going to happen, maybe it would've been less timid.

I have to question the first part of this line: "The solutions for the financial-market failures revealed by the crisis are higher capital requirements and a wider prosecution of fraud -- not increased micromanagement by government entities."

Didn't I read on this blog that "higher capital requirements" are what caused i-banks to get into the exotic instruments game, since regular banks could no longer take the sort of risks the market was demanding?

Isn't this the "unintended consequences" lesson of the crisis? Every time the government tries to prevent the next crisis, such as by increasing capital requirements, they cause complex work-arounds to spring up that are actually worse for the system than simply letting businesses determine their own requirements.

Isn't this also akin to the "black market effect"? In this case, legal work-arounds sprung up, so I guess you'd have to call it a "gray market" effect.

Martin, have you heard of Adjustable rate mortages, teaser rates, low intro rates, negative amortization etc? The interest on these loans were tied to the short term rates.

Greenspan has a point. The Fed is not faultless, but anyone who wants to lay all of the blame for the "crisis" at Greenspan's feet must explain how low interest rates on T-bills and overnight lending between banks can translate into low rates on 15-30 year loans secured by home mortgages.

"As I noted on this page in December 2007, the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005."

I don't dispute this point, but ignoring the role of population aging is incredible. China didn't only grow rapidly. It grew rapidly by exploiting the "demographic dividend", essentially by killing hundreds of millions of its own children and eating its own seed corn, thus freeing more of the labor of its citizens of child bearing age.

This policy doesn't slow labor force growth until decades later. It's now decades later.

China is not unique in this regard, of course. Japan is the world's poster child for population aging. Some European states are close behind, and so is Europe generally. So is the U.S. but to a lesser degree.

"That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble. (The U.S. price bubble was at, or below, the median according to the International Monetary Fund.)"

Another good point. I spent a lot of time in Europe in the last few years, and the bubbles over there make our bubble look like Bazooka Joe's hiccup. Not surprisingly, Europe also has a more aged population.