Question

please kindly summarize Greenspans bubbles by Paul Krugman

Answer 1

The Greenspans bubbles by Paul Krugman :

• Most of what Alan Greenspan said at last week's conference in his honor made very good sense. But his words of wisdom come too late. He's like a man who suggests leaving the barn door ajar, and then -- after the horse is gone -- delivers a lecture on the importance of keeping your animals properly locked up.
• Regular readers know that I have never forgiven the Federal Reserve chairman for his role in creating today's budget deficit. In 2001 Mr. Greenspan, a stern fiscal taskmaster during the Clinton years, gave decisive support to the Bush administration's irresponsible tax cuts, urging Congress to reduce the federal government's revenue so that it wouldn't pay off its debt too quickly.
• Since then, federal debt has soared. But as far as I can tell, Mr. Greenspan has never admitted that he gave Congress bad advice. He has, however, gone back to lecturing us about the evils of deficits.
• Now, it seems, he's playing a similar game with regard to the housing bubble.
• At the conference, Mr. Greenspan didn't say in plain English that house prices are way out of line. But he never says things in plain English.
• What he did say, after emphasizing the recent economic importance of rising house prices, was that "this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent." And he warned that "history has not dealt kindly with the aftermath of protracted periods of low-risk premiums." I believe that translates as "Beware the bursting bubble."
• But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: "While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely."
• Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by "the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages." But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage."
• If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath.
• How bad will that aftermath be? The U.S. economy is currently suffering from twin imbalances. On one side, domestic spending is swollen by the housing bubble, which has led both to a huge surge in construction and to high consumer spending, as people extract equity from their homes. On the other side, we have a huge trade deficit, which we cover by selling bonds to foreigners. As I like to say, these days Americans make a living by selling each other houses, paid for with money borrowed from China.
• One way or another, the economy will eventually eliminate both imbalances. But if the process doesn't go smoothly -- if, in particular, the housing bubble bursts before the trade deficit shrinks -- we're going to have an economic slowdown, and possibly a recession. In fact, a growing number of economists are using the "R" word for 2006.
• And here's where Mr. Greenspan is still saying foolish things. In his closing remarks he suggested that "an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports and a corresponding improvement in the current account deficit." Translation, I think: the end of the housing bubble will automatically cure the trade deficit, too.
• Sorry, but no. A housing slowdown will lead to the loss of many jobs in construction and service industries but won't have much direct effect on the trade deficit. So those jobs won't be replaced by new jobs elsewhere until and unless something else, like a plunge in the value of the dollar, makes U.S. goods more competitive on world markets, leading to higher exports and lower imports.
• So there's a rough ride ahead for the U.S. economy. And it's partly Mr. Greenspan's fault.

The Greenspan's bubbles:

A chart from a project I’m working on. PE ratio for S&P 500, from Shiller (10-year moving average of earnings, on right scale.) Real house prices from Case-Shiller, left scale.

About the denominator:

• Several commenters have suggested using the price-rent ratio or the price-wage ratio instead. I’ve done that — the truth is that none of these make much difference, because rents more or less tracked the CPI as a whole, and real wages haven’t gone much of anywhere. So although this looks like a bit of an apples-and-oranges comparison, the numbers really are comparable.

Paul Krugman's Switch on the Housing Bubble:

Advocate:

• The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Opponent:

• Some say the worst is already over. Mr. Greenspan, who’s been an optimist all the way, now argues that the latest data on new-home sales and mortgage applications suggest that housing has already bottomed out. Business investment is still growing briskly, and so far consumers haven’t cut their spending. So maybe this is as bad as it gets.
• But I think the pessimists have a stronger case. There’s a lot of evidence that home prices, although they’ve started to decline, are still way out of line. Spending on home construction remains abnormally high as a percentage of G.D.P., because banks are still lending freely in spite of rapidly rising foreclosure rates.
• This means that home sales probably still have a long way to fall. And you don’t want to make too much of the fact that some housing indicators have turned up; those indicators tend to bounce around a lot from month to month.
• Moreover, much of the good news in the latest economic report is unsustainable at best, suspect at worst. Almost half of last quarter’s estimated growth was the result of a reported surge in automobile output, which some observers think was a statistical illusion, not something that really happened.
• So this is probably just the beginning. How bad can it get? Well, you don’t have to go far to find grim forecasts: Merrill Lynch predicts that the unemployment rate will rise from 4.6 percent now to 5.8 percent by the end of next year.
• In case you’re wondering, I don’t blame the Bush administration for the latest bad economic numbers. If anyone is to blame for the current situation, it’s Mr. Greenspan, who pooh-poohed warnings about an emerging bubble and did nothing to crack down on irresponsible lending.