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May 10, 2009
David Warsh, Proprietor


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True Confessions of the Crisis: Up-Close and Top-Down

We are a very long way from having a broadly agreed-upon story of the crisis that quietly commenced on the afternoon of June 20, 2007.  That was when  two Bear Stearns real estate hedge funds began to come apart, ushering in a long period of nervous waiting for fear eventually to subside (it didn’t) or panic to break out (it did). Nevertheless, a couple of unusually interesting accounts have appeared recently, one by the New York Times reporter who was covering the Federal Reserve Board, the other by a Bush appointee who, conceivably, might have defused the crisis altogether had he been heeded.

“Why did you do it?”  That’s Alan Greenspan, interrupting, on the first page of Busted:  Life Inside the Great Mortgage Meltdown  – shocked, appalled, perplexed and finally curt – as Times reporter Edmund L. Andrews mentions, in the course of interviewing the Fed chairman in December 2007, that he thinks he’s about to lose his own family’s home to foreclosure. “I felt like a teenager who had just told his father that he had crashed the family car.”

Greenspan had been expounding on the origins of the sub-prime crisis in various species of criminal fraud, committed by borrowers, lenders or both. It wasn’t his job to police the riff-raff, the great central banker explained.  Perhaps the reporter should interview the director of consumer affairs?  Or the general counsel?  “Deceptive and unfair practices sound very unfair until you try to define them.”

He was stopped short, though, when Andrews volunteered, “Let me tell you about my own personal experience with these mortgages.” If anybody should have avoided catastrophe, it was the 52-year-old newsman. He’d been a Times reporter for sixteen years; since 1999, he had covered the Fed.  Yet in December 2007 he was squarely behind the eight-ball.  He had bought a house with one of those no-documentation mortgages; he had diminished his nominal equity by borrowing cash against the house to pay down credit card bills.

But Andrews didn’t feel as though he had committed fraud, or that he had he been defrauded in turn. He had been aided at every step by loan officers, underwriters, banks, Wall Street firms, and rating agencies – a long chain of promoters that now seemed to stretch up all the way up to the revered policymaker with whom he was sitting. Blaming the borrowers, or the faceless bureaucrats of the consumer affairs division, suddenly seemed beside the point.

It was a cathartic moment. Was his interviewer the first person Greenspan had known personally to have been caught in the mortgage meltdown? He certainly wasn’t the last. The Fed chairman ended his own discomfiture that day with a broad grin and a joke. If the reporter had been sufficiently anxious to have avoided default to this point, probably the lenders’ models had been correct after all:  “I bet they’ve made money on you already.”  But for Andrews, the discomfiture was just beginning.

The result is Busted, a fascinating meditation on the experience of the crisis from the point of view of those facing foreclosure. Why Andrews found himself in dire straits was easy enough to explain. His marriage had come apart, he had fallen in love with a long-ago friend in similar straits (an Argentino mother of four, no less, living in Los Angeles, whom he had first met in high school in the days when his CIA father was stationed in Buenos Aires). Together they had bought a home – for $460,000, with 10 percent down with an adjustable rate mortgage – in a good school district in suburban Maryland in which to finish raising the children of their recombinant marriage.

There are other stories of sub-prime borrowers in the book as well, of upwardly-mobile Hispanics and African-Americans lured to disaster in developers’ tracts in suburban Virginia and southern California.  Mostly, though, Busted is a thorough account of the mechanics of one couple’s humiliation and impending ruination at the hands of various representatives of the mortgage-lending industry, rendered as absorbing as any soap opera by Andrews’ unflinching attention to the intimate details of his married life.

There is no happy ending, at least not yet. “As I write in February 2009, I am four months past due on my mortgage and bracing for foreclosure proceedings to begin,” the book concludes. Thus while Andrews’ account of his ordeal does plenty here to whet one’s appetite for the details of foreclosure relief, which may or may not appear in tomorrow’s newspapers,  the greater value of this acute personalization of a very complicated story awaits repurposing in a different medium.

Busted would make a dandy movie – one in which Andrews gets to keep his house.

At the opposite end of the spectrum is Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, by John B. Taylor, of Stanford University. No one needs to turn this compact little book into a film.  Its basic argument is summarized in a chart of the federal funds rate since 2000 that The Economist ran in its issue of October 18, 2007 (slide six in this Taylor presentation).  The lower line shows the monetary policy that Alan Greenspan pursued since 9/11. The upper line shows the target that was suggested by the eponymous “Taylor Rule.”

Taylor proposed his algebraic formulation to guide monetary policy in 1992. It is one of a whole family of target mechanisms developed in the 1980s and ’90s designed to bolster central banks’ credibility as they sought to control inflation – policies considered, until recently, to have worked quite well. His rule took an extremely simple form, making it something on whose exercise presumably all market participants could agree: the federal funds rate should be one and a half times the inflation rate, plus one half the GDP gap (the distance between current output and the level of its normal trend), plus one. The central bank thus would tighten as inflation accelerated, and ease when unemployment loomed. Had the rule been followed, Taylor argues, there would have been no boom, no bust. “The Great Moderation” of cyclical swings would have continued.

Why the departure? Alan Greenspan had plenty of reasons for the considerable monetary easing that followed the 9/11 bombings. No one wanted the US to fall into a prolonged recession, much less a Japanese-style deflation; George W. Bush was planning to go to war in Iraq. Though it would be clear only in retrospect, the economy already had been shrinking since March 2001; monetary
easing ended the shallow recession in November, after only eight months. If the Fed had tightened instead, the accompanying political heat would have required all the president’s attention.

So instead the Fed explained that interest rates would remain low “for a considerable period of time,” and that when they eventually began to rise, it would be “at a measured pace” – which, as the chart shows, is exactly the path that interest rates ultimately took. Before long, a new reason for the easy money was discerned.  There was a “global savings glut,” originating mainly in China. The central bankers were powerless to control the boom.

The problem with such a “counterfactual” exercise is that Taylor was there in Washington all along – in the administration, in fact, as Under Secretary of the Treasury for International Affairs from 2001-05.  It was a big job, overseeing all the elements of the US “war on terror” that involved international finance. Later he wrote a book about it: Global Financial Warriors: the Untold Story of International Finance in the Post 9/11 World appeared in 2007.

But even though Taylor had loyally remained silent on the administration’s monetary policy throughout, when the time came to replace Alan Greenspan in January 2006, he had been nowhere on George W. Bush’s list. Not until the summer of 2007 did Taylor finally air his dissent, at the Jackson Hole conference of central bankers and economists staged annually in August by the Federal Reserve Bank of Kansas City. That tells you something about how dominant was the consensus that Alan Greenspan had been doing the right thing.

That meeting took place barely three months before reporter Andrews contributed his own more personal critique, confessing his embarrassment to the Fed chairman.  It was just about the time that market participants all around the world were waking up to the gravity of the situation, and dramatically revising their estimates of Greenspan’s reputation.  It will be years before a consensus evolves about the US government’s role in causing and prolonging the crisis. Both of these confessions, different as they are, will turn out to have been important contributors to the process.   

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