Dec/Jan 2014

Bedtime for Maestro

Making sense of macroeconomics—and its discredited poster boy, Alan Greenspan

Helaine Olen


THERE IS A DIFFERENCE BETWEEN the sexes that has always fascinated me. We women—we’re always apologizing: We could have; we should have . . . Men, on the other hand, they always have an explanation, an excuse. Even if they are, like once-celebrated former Federal Reserve chairman Alan Greenspan, standing over the violently debauched corpse of our present economy, the knife in their hands still dripping blood, there is always a reason why they didn’t do it.

They are so practiced at this art that even as they claim “I should have known,” they are, in fact, offering up all the reasons why they absolutely could never have figured it all out till it was far too late.

Don’t believe me? Let’s take the case of Greenspan, the onetime wisest of all Washington wizards of economic policy, formerly known as “The Oracle” or “The Maestro.”

Greenspan, who led the Federal Reserve from 1987 to 2006, was the great enabler of the housing bubble. Not only did he repeatedly refuse to use Federal Reserve authority to intervene in the subprime-mortgage markets, he also encouraged the bubble’s expansion, by urging Americans in 2004 to make the switch from the traditional thirty-year fixed home loans to adjustable-rate mortgages.

American households, the Maestro then claimed, were managing their debt levels well. As for that idea that the cost of housing was going up at an unsustainable rate? Pshaw. Not to worry. There’s never been a nationwide downturn, and, anyway, consumers can’t flip homes the way they can flip stocks.

Clearly, Greenspan had never read the many books in real estate guru Robert Kiyosaki’s Rich Dad, Poor Dad franchise, or spent a boring Sunday afternoon or sleep-challenged Saturday night channel surfing. If he had, he might well have stumbled upon an infomercial by a housing huckster like Robert Allen or Carleton Sheets, or the hosts of the high-bubble cable reality show Flip This House. A great rising chorus was telling American home buyers in no uncertain terms to treat their mortgages as just another convertible asset, readily transformed into ever-greater reserves of cash.

Greenspan, you see, prided himself on his way of reading the statistics. Unfortunately, he was about to discover that numbers don’t always speak the way we would like. Here is one fact that later emerged that many were already suspecting at the time: By 2006, more than a third of all mortgage monies were going to people who already owned at least one residence, with the percentage creeping up to almost half in states such as California, Florida, Nevada, and Arizona—which were, as it happened, about to become the epicenter of the bursting housing bubble.

When it was all over, Greenspan made some vague remarks of regret. Our present economic crisis “turned out to be much broader than anything I could have imagined,” he told Congress in 2008. He was in a state of “shocked disbelief” that “self interest” on the part of financial institutions had not acted to stop them from overdosing on toxic mortgages.

After that, Greenspan decided to look to the emerging discipline of behavioral finance “to understand how we all got it so wrong, and what we can learn from the fact that we did,” as he puts it in the opening of his new book, the unrelentingly dull and unpersuasive The Map and the Territory.

Note that the “we” here is not delivered in the royal usage. When it comes to sizing up culpability for the 2008 collapse, Greenspan wants it understood that we all did it. Mistakes were made, as the saying goes. And who better than the man who made many of those mistakes to tell us what they were and how they can be prevented in the future?

How could it have happened? Greenspan had access to the “Federal Reserve’s macroeconomic model of the U.S. economy,” of which he says, “Despite the fact that the model missed the collapse of 2008 along with virtually all other models, its historical record has been better than most.”

Since the model couldn’t have been at fault in any fundamental way, Greenspan takes up the mantle of behavioral finance—a discipline seeking to wed the findings of psychology and economic analysis to explain the many ways in which human behavior fails to mirror people’s own rational self-interests. “I have come around to the view that there is something more systematic about the way people behave irrationally, especially during periods of extreme economic stress, than I had previously contemplated,” he writes, as if sharing some new and exciting insight into human nature never before revealed.

Greenspan is a well-known Ayn Rand acolyte who fervidly believes in the empirically challenged doctrine of neoclassical economics known as the rational-market hypothesis. In his world, 2008 is The Fountainhead, but with an alternative plot twist: Instead of Howard Roark dynamiting his architectural masterpiece when it hasn’t been built to his specifications, it blows up spontaneously because other architects meddled with the perfect design.

So who messed with Greenspan’s economic vision? Well, all of us. We couldn’t help ourselves. Behavioral finance tells him so. Greenspan goes on to offer up a rather pedestrian and turgid tutorial on such concepts as “herd behavior,” “dependency,” and “home bias” and how they contributed to causing the crisis that destroyed his reputation. Given his shaky command of these bewildering new concepts, you can get a better explanation of these things in any number of places, including via a random Web search or by picking up a copy of Behavioral Economics for Dummies.

Let’s pause a moment here to savor the larger irony at play—the territory, if you will, that dwarfs Greenspan’s all-but-indecipherable mapping effort. This is, after all, the man who presided over the demise of the stock bubbles of the 1980s and the dot-com boom, well before the great debacle of 2008. In hastily repackaging the alleged wisdom of behavioral finance as a bold new explanation for how economic policy goes awry, Greenspan has fallen for yet another bubble, though this one is of the intellectual sort.

According to Lexis-Nexis, the use of the phrases “behavioral finance” and “behavioral economics” by English-language media outlets has more than quadrupled in the period between 2006 and 2012. Barely known outside of academic circles a decade ago, these terms are ubiquitous today, as an explanation for . . . well, almost anything financial. The theory underlies such best sellers as Predictably Irrational and The Upside of Irrationality, by Dan Ariely, and perennial Obama-administration favorite Nudge: Improving Decisions About Health, Wealth, and Happiness, by economist Richard Thaler and White House regulatory czar Cass Sunstein.

In this sense, Greenspan’s argument in The Map and the Territory, much like many of his pronouncements from Fed headquarters, serves as something of a market indicator. The longer the economic crisis continues, the more we’ll be hearing about the wondrous interactions of psychology and finance from the powers that be. Why? Behavioral finance, while commonly presented as some sort of revolutionary school of thought, all too often doesn’t actually seek to challenge the system so much as explain it and manipulate it. As Boston University professor and retirement guru Zvi Bodie once told me, much of what we call behavioral finance is simply what used to be termed “consumer psychology,” gussied up in a more respectable format. No matter what the founders or practitioners of the discipline intended, behavioral finance is frequently used to sell people on stuff that might or might not be good for them.

The full implications of this insight should, it need hardly be stipulated, directly contradict the belief system that guided Greenspan through his long tenure at the Fed: the uncritical embrace of the core neoclassical dogma, which preaches that markets will always act in a disinterested manner to ensure the best possible returns. But since that would hit a little too close to home for someone like Greenspan, The Map and the Territory offers, over and over again, baldly self-justifying accounts of the roots of the 2008 crisis and its aftermath.

The problems at the ratings agencies, which regularly issued AAA grades to bonds and other vehicles that were soon to wear an F for “failure”? Why, this was just more evidence of the woolly and irrational character of consumer behavior. As Greenspan writes in one of countless befuddled asides, steeped in epic na´vetÚ: “Despite decades of experience, the analysts at the credit-rating agencies proved no more adept at anticipating the onset of crisis than the investment community at large.”

Instead of honestly accounting for this enormous market failure, Greenspan attributes it to a “euphoria” that led to an “underestimation” of risk. In reality, of course, the banks submitting credit-default swaps, collateralized debt obligations, and all the other exotic instruments of the bubble for the AAA seal of approval were also paying the credit raters’ fees. As Matt Taibbi reported earlier this year in Rolling Stone, internal e-mails written in 2004 by Brian Clarkson, the future president of Moody’s Investors Service, advised that “the issuer could take its business elsewhere unless the rating agency provides a higher rating.” You don’t need to read a book on behavioral finance to understand how that could cause a problem for Moody’s employees—and for the millions upon millions of workers and investors who wound up depending, in one way or another, on such flawed judgment calls for a significant chunk of their livelihoods.

And who was responsible for the housing bubble? In Greenspan’s telling, it was those shady players Fannie Mae and Freddie Mac—government-sponsored entities charged by Congress with meeting a reckless and unsustainable “expanded affordable housing goal.” Here again, Greenspan has sought to package a hoary piece of right-wing mythology (one with distinctly racist overtones, it should also be noted) as a specimen of behavioral-finance wisdom—and once again he’s failed. As economist Mark Zandi recently pointed out in the Washington Post:

At the start of 2002, before the housing boom got going, the two agencies’ market share accounted for almost 54 percent of all mortgage debt. By summer 2006, the bubble’s apex, their share had fallen to only 40 percent. It is difficult to see how the agencies could have been responsible for inflating the housing bubble at a time when they were losing a full 14 percentage points of market share. Indeed, the opposite was true, as their position in the housing market rapidly diminished.

What’s more, Greenspan’s ideological spinning of the Fannie and Freddie saga, like much of the rest of The Map and the Territory, conceals his own exuberant role in puffing up the bubble. Back in 2007, he announced that while “subprime is risky, it’s so urgent that we get broad ownership, especially of homes, that from a societal point of view and from an economist’s point of view, there’s no question in my mind . . . that it is worth it.”

It’s truly astonishing to see the sort of fundamental material that the man regarded not long ago as a modern seer either willfully distorts or negligently overlooks. “In the aftermath of an actual crisis, we will find highly competent examiners failing to have spotted a Bernie Madoff,” he writes at one point. In reality, of course, the forensic accountant Harry Markopolos was frantically trying for nine years to convince the SEC to take a look at the Madoff fraud. And meanwhile, market players ranging from a number of hedge-fund heads to JPMorgan Chase stand accused by various parties, including Madoff trustee Irving Picard, of looking the other way.

And just as it overtaxes Greenspan’s imagination to envision the competent prosecution of fraud, so, too, does the prospect of more expansive financial regulation offend his sense of the perfect virtues of the financial markets. Greenspan frets, for instance, that the 2010 Dodd-Frank legislation to reintroduce some restraints on the most destructive excesses of Wall Street may well create “regulatory-induced market distortion.” After all, Greenspan argues, most American financial regulation is already “jerry-built” and “too complex.”

What he omits to mention, of course, is that one of the reasons such market rules are routinely jerry-built is that the financial-services industry makes sure they are. Indeed, three years since Dodd-Frank was signed into law, its provisions are still the subject of furious lobbying by the financial-services sector as it seeks to get rulings to favor its interests over those of its customers. No one, it need hardly be added, is able to match the billions that Wall Street has spent on bending Dodd-Frank to its will in order to ensure that the measure might still serve the interests of the American public.

Greenspan also strikes all the duly approved notes of alarm over entitlement spending. He warns that Social Security is facing a crisis—though Greenspan, like nearly all of our professional austerity-mongers, never pauses to note that the simple fix of lifting the current payroll tax cap, currently set at $113,700, could make a huge dent in the program’s projected shortfalls. As for Medicare, if the Maestro is aware that Americans now pay twice as much for medical care as the citizens of any other country with single-payer or government-sponsored medical care, he’s not letting on. Instead, he contends that the medical establishment gets away with overcharging because people will make doctor bills their “highest priority” when they fall ill; what’s more, he chides, Medicare is “a virtually free good to beneficiaries.” He also takes pains to echo the blame-both-sides consensus on Washington’s various partisan deadlocks, insisting that the current political impasse in the nation’s capital is a result of the increased spending on such programs. There’s no mention of why or how one of our national parties appears to have gone off the wing-nut deep end—and has, as I write, orchestrated the economically disastrous shutdown of the federal government in an ideologically and strategically incoherent bid to block the legal extension of health-insurance benefits to fifty million Americans.

At least Greenspan’s book provides some useful context in explaining how official Washington power players acquire such delusional folk beliefs—via some inadvertently revealing confessional asides about his social world. The problem of “a striking shift” in our politics, for instance, was “brought to my attention by the staunch conservative three-term senator from Utah, Robert Bennett.” No mere first-termer, it seems, will do for our Mr. Greenspan. He was first introduced to life in Washington at dinner parties hosted by Joseph Alsop and Katharine Graham. In this flurry of A-list name-dropping, there is, of course, scarcely any mention of the millions of people who have been foreclosed upon, or who have lost their savings or their jobs in the economic catastrophe that followed the collapse of what we can call the Greenspan bubble.

Economist Tim Harford, on the other hand, has made a career of demystifying many of the central assumptions of economic thinkers and policy makers—the sort of endeavor that’s likely to get you barred from exclusive DC social gatherings if done right. In The Undercover Economist (2005), Harford sought to lay bare many of the abstruse models of behavior that govern our day-to-day lives. If, for example, you ever wondered what’s really been driving up the cost of private-sector health care in America, Harford’s book spelled out the basics with admirable clarity: People with preexisting conditions are more likely to buy it, while those who are healthy are more likely to gamble they will remain healthy and go without, setting off a cascade of policy price increases that will eventually render the product unaffordable to almost everyone.

Harford’s latest book, The Undercover Economist Strikes Back, expands the range of his analysis to take in the broader sweep of macroeconomic planning. As such, it’s a more entertaining treatment of the subject than Greenspan’s labored apologia, and a vastly more informative one into the bargain. Harford’s style is accessible, engaging, warm, witty, and fun, and he takes us on a romp through some of the denser thickets of macroeconomic thinking. He draws on easy-to-understand examples: a botched babysitting cooperative on Capitol Hill illustrates how when people save too much money for a rainy day—or, in this case, hoard chits good for babysitting services in case of future emergency child-care need—the economy will slowly stall out into a recession. A rational decision by multiple individuals is catastrophic for the group.

Along the way, Harford takes on more than a few quasi-sacred shibboleths in our current economic and political environment. He has little patience, for example, with people who would claim easy access to televisions and in-home Internet service means poverty is no longer such a terrible thing. “Do you really want to lump these things in with haute cuisine, designer handbags and champagne?” he asks. “Imagine your child comes home from school and tells you about the classmate whose family lacks the money to buy a television. Are you seriously going to say, ‘Don’t be silly, son, that family isn’t poor’?”

Harford goes on to speak up for the universal social benefits of early education, pointing out that some studies show an early investment in kids from lower-income families translates into everything from higher lifetime earnings to lower rates of teenage pregnancy—all outcomes that many would-be budget cutters should find desirable, if saving money were their true goal. He also suggests studying whether direct cash transfers to families in poverty in return for, say, greater investment in their children’s health or education may make more economic sense in the long run: “Children in extremely dysfunctional families may need help most of all, and yet will likely be excluded.”

Harford, who writes for the Financial Times, clearly views economics as a way of improving individual lives. Yet he isn’t proposing some revolutionary response to the recent failure of traditional macroeconomic economic planning, any more than Greenspan is. And that brings you to the book’s occasional flaw: Harford’s conversational voice is so beguiling—and ultimately so fun—that it’s easy to get lured into his vision. When it comes to the stubborn question of income inequality—a key contributor to the Great Recession as well as one of its likely long-term legacies—he gives scant attention to laws and policies that have increasingly favored employers over workers. Instead, he argues that the growing wage gap is most likely a result of “an unholy alliance of indifferent schools and technological change.” Such forces certainly don’t help, but as Greenspan’s book reminds us in copious detail, the real culprit at the heart of our economic woes is a guiding set of policy assumptions administered at the behest of a plutocracy.

Helaine Olen is the author of Pound Foolish: Exposing the Dark Side of the Personal Finance Industry (Portfolio, 2012).

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