A (Partial) Defense of Greenspan

Over at Real Time Economics, Brian Blackstone points out that the Fed will likely bring down the fed funds rate this week to 1.0 percent from 1.5 percent . Writes Blackstone:

Ironically that same ultra-low rate in 2003 and 2004, and the slow pace of tightening after, has been blamed in some circles for the housing bubble that led to the economic and financial storm gripping the world right now.

Last week, Alan Greenspan finally admitted that he bears some blame for the subprime debacle since his view that markets should mostly be left to fend for themselves had so clearly gone off the tracks. But besides this mistake in not pushing for stronger regulations, what role did Greenspan's move to lower interest rates to one percent play in the current crisis?

A recent paper by Atif Mian and Amir Sufi about the subprime crisis tried to answer this question. Right away, the first issue is that there's no comparable time in the U.S. where interest rates fell to one percent. Instead, Mian and Sufi looked at another time when rates were lowered by a large amount, from 8 percent to 3 percent in the early 1990's:

What happened to the real estate market after that dramatic decline in rates? The following two charts show how mortgage origination and house prices changed for subprime versus prime areas in cities across the country. The text is quite small, for a larger version look at Figures 9A and 9B here.

Origination in subprime versus prime areas actually went down for a while after rates started to fall while housing prices in prime areas outpaced gains in subprime regions. That pattern is pretty much the exact opposite of what we saw in the 2000's.

This isn't complete proof that Greenspan's low-rate policy is not to blame for our woes, but it suggests that you need other things (like securitization and conflict-of-interest-ridden ratings agencies) to cause the kind of mess we're in right now.

I wrote about another one of Mian and Sufi's papers on corporate lobbying and the mortgage mess here. The paper I wrote about in this post is actually mostly about narrowing down the cause of the crisis to securitization. You can watch Sufi give a very lucid presentation of it here.