And Krugman sees the housing bubble bursting, and blames Greenspan

New York Times
August 29, 2005

Greenspan and the Bubble

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.