Dr. Jonathon Rodgers must be commended for his carefully reasoned article on the Bahamian economy and the causes of the U. S. recession (see Tribune Business, May 5, 2010, p. 2B). While it adds to the public dialogue, much of his thesis can be properly challenged. Let’s look at the U. S recession.
The authority cited by Dr. Rogers on key issues is Joseph Stiglitz, a Professor at Colombia University, a former World Bank Chief Economist and a Nobel Laureate who considers himself to be an outstanding critic of “free market fundamentalists.” Consistent with this description Dr. Rodgers concludes -
It was the financial institutions that created the mess and the American Government that bailed them out.
In all countries with a paper currency the Government controls the quantity of currency in circulation and indirectly the amount of credit outstanding. This function ranks with the maintenance of the rule of law as the most important of all Government responsibilities. It determines whether a country will experience -
• Inflation possibly with a speculative bubble or
• Low inflation (stable prices) and growth or
• Deflation with falling production and employment.
In the case of any country, the objectives of the central bank can pit it against the political interests of the president and legislature when it, for instance, properly limits the growth in credit outstanding.
I contend that, while financial executives and institutions both contributed to and greatly profited from the Housing Bubble, the chief causal factor was a Government that failed in its responsibilities.
Incestuous Relations. Dr. Rodgers states that “there is an incestuous relationship between the Fed and the banks because supposedly it is responsible for the oversight of the same banks who actually own it.” One may call this a “conspiracy theory” or a conflict of interest. Neither describes a unique complex reality.
The Fed was created in 1913 as a solution to the recurring banking panics created by a paper currency and a fractional reserve banking system that consisted of many private banks operating in 48 different legal jurisdictions. “The Fed conducts the nation's monetary policy by influencing the volume of credit and money in circulation. [It] regulates private banking, works to contain systemic risk, and provides certain financial services to the U.S. government, the public, and financial institutions.” (Wikipedia)
The Governor, the Governors of the 12 district banks and the Board of Governors are appointed by the President subject to Senate confirmation. Yes, the Fed’s shareholders are private banks who get central banking services, regulations, reporting requirements and a small dividend each year.
Nevertheless, the Fed is responsible to the President with Congressional oversight. Yes, its work is highly technical and not very glamorous; it is staffed by those experienced in banking and finance; and it operates within a political environment. It is easy to see “incestuous relations” in such a complex institutional arrangement; and this can distort objectivity.
M3 & Boom-and-Bust . There are three different measures of the quantity of money in circulation:
“M1” is the sum of the actual currency (that can be legally tendered in the exchange for goods and services) that is held outside banks, travelers checks, checking accounts.
“M2” is the sum of M1 plus savings deposits, money market accounts, small denomination time deposits and retirement accounts.
“M3” is M2 plus the large time deposits, Eurodollar deposits, dollars held at foreign offices of U.S. banks, and institutional money market funds.
The role of money in the Great Depression was not defined until the mid-1950s by Milton Friedman at the University of Chicago. His quantity theory of money and its subsequent refinement remained a key element in the Fed’s monetary and credit management. An annual growth of 2% up to 4% in M3 was deemed acceptable.
However, in November 2005 Alan Greenspan, Governor of the Fed, and Ben Bernanke, Governor of the New York Fed, stopped publishing the M3 money supply data. The reason given at the time was that “the costs of collecting the underlying data and publishing M3 outweigh its benefits.” This was a surprise since M3 gives a much better indication of the evolution of credit creation in the economy than M1 or M2...and, for instance, the European Central Bank considers M3 to be the most important monetary aggregate.
At the time the decision was made, M3 started growing at 8% per year; and it exploded upward to just short of 18% per year in 2008 (as reported in Shadow Government Statistics) and plummeted to a minus 4 percent in 2010.
Why did the Fed stop publishing the M3 data?
Alan Greenspan and Ben Bernanke followed a clear expansionist monetary policy especially after 2000. Real short-term interest rates (that is nominal rates adjusted for changes in consumer prices) started low, below 1%, and turned negative between late 2002 and late 2005. It really paid to borrow and spend...an apparent real no-brainer.
Since consumer prices remained low and stable and productivity was increasing, Greenspan and Bernanke minimized the importance of the unsustainable rise in housing (asset) prices. That is...they did so until it was too late; then they eliminated the officially published M3 warning sign.
Johan Van Overtveldt, the economic historian, concluded -
“The Fed’s responsibility for the housing bubble is considerable. This conclusion has important implications, among others, for what is structurally probably the worst derailment in the American economy: the extreme increase in relative consumption expenditures and its mirror image of disappearing personal savings as the basis of the huge external deficit of the United States.” (Bernanke’s Test, p. 97)
One should note that Congress passed a number of laws between 1964 and 1999 that granted the Fed powers to affect lending practices both at the consumer and financial banking levels. Alan Greenspan never used them.
When looking for the Government’s hand in the Housing Bubble one must also look at its well intention effort in the housing market. It started in the 1930s with Government trying to provide funds (or liquidity) to this market. With the civil rights movement the objective became the end of discrimination in lending. With time the lending standards degenerated to “Sub-prime”, the riskiest of all loans, “Ninja Loans - No Income...No Job...No Assets.”
It is easier for the public and politicians to focus on the predatory lenders to ill-informed home buyers or the Wall Street financiers who ingeniously packaged these loans, sold them around the world and made a fortune. They “earned” their commissions; the mortgage holders suffer the possible loss of their newly acquired homes; and the politicians propose remedies, pontificate about Goldman Sachs and wait for their just returns at the polls.