Tuesday, January 5, 2010
Wisconsin Real Estate Viewpoint Blog
Stephen Malpezzi shares one of the titles on his "Reading for Life" book list.At Wisconsin, we’re big on the idea of “lifetime learning.” The few years you spend in Madison in Bucky’s warm embrace are only the beginning of your real estate education. We want to partner with your education over the following 50 years, too. And, consistent with the Wisconsin Idea that the university has no boundaries, we want to be a part of your education even if you’ve never been lucky enough to set foot in Mad City.In my urban economics courses, I try to find time to point out books and articles outside that course’s curriculum that fit that lifetime learning model. In that spirit, from time to time I’ll use this blog for short book reviews.Let’s start with one of my recent favorites, In Fed We Trust: Ben Bernanke’s War on the Great Panic; How the Federal Reserve became the Fourth Branch of Government. If the full title is a little long, the double subtitles do give a fair view of the contents. The book was written by David Wessel, the Wall Street Journal's economics editor, and frequent contributor to National Public Radio. He is a very interesting and generally reliable voice on economic matters.In Fed We Trust tells the story of the fall 2008 economic crisis, through the perspective of the actions of Fed Chairman Bernanke and a small group of policymakers, including Henry Paulson at Treasury, Timothy Geithner (then at the New York Fed), Kevin Warsh at the Fed, and others like FDIC’s Sheila Bair and the SEC’s Christopher Cox.We're still in the middle of the economic crisis, and academics will argue over the causes and the policy responses for decades. Nevertheless, this book is a terrific first look. It's a clear and readable narrative focusing on a particularly critical time. Other books and articles dig deeper into the root causes, and present more data and analytics – see, for example, Restoring Financial Stability: How to Repair a Failed System, edited by Viral Acharya and Matthew Richardson; or Jim Barth’s Rise and Fall of the U.S. Mortgage and Credit Markets.The broad outlines of the crisis are familiar. Over the long run, house prices in the U.S. rise slightly more than inflation, on average (see: Malpezzi and Maclennan, The Price Elasticity of Supply of New Housing in the U.S. and the United Kingdom, Journal of Housing Economics, 2001). But as my colleague Morris Davis and I show in this chart, starting around 1996, U.S. house prices began a decade-long run-up, increasing an inflation-adjusted average of 7 percent per year, clearly an unsustainable situation. Nevertheless, many borrowers, lenders, investors, and some analysts and policymakers appeared to believe large real house prices could be sustained indefinitely, in defiance of history and logic. After the 2007 turn in housing markets, and the subsequent collapse of mortgage backed security and other markets, by September 2008, U.S. financial markets and indeed the entire economy stared into an abyss. This book is the story of the small group of key officials whose responses to that crisis plausibly they kept us from falling into the abyss.We all know that will never know the true counterfactual – exactly what would've happened to the economy really if the actions described in this book had not been undertaken. Based on the available data and reportage, my personal view is that it would have been extremely dire indeed. A complete freeze up of the global financial system could have led to a much larger contraction in real economic activity and does walk taken us down a path of deflation and extreme unemployment from which recovery would take years – see Japan’s experience. During this period Bernanke et al. dealt with massive failures at Bear Stearns, Lehman Brothers, AIG, IndyMac, Fannie and Freddie, and others.It's interesting to contrast Bernanke with his predecessor Alan Greenspan. As an economist, by all accounts Greenspan is an excellent clarinet player. As a fellow data freak, I have to admit to a certain admiration for Greenspan's eclectic data-diving. But even data freaks need a good conceptual framework, and an ability to do serious empirics that make sense of the data; or at least we have to understand the frameworks and empirics of others. A good economist also needs to know when to step back and give up on a particular view. Keynes’ famous statement, “When I find I’m mistaken, I change my mind. What do you do?" comes to mind. Bernanke went into the crisis with many of the same prior beliefs as Greenspan, more or less. But it’s impossible to overestimate the importance of this difference between the two men: when events showed their prior beliefs about the economy’s workings, and the Fed’s appropriate policies, were mistaken, Greenspan was left only with an ideology, and his deep yet by then irrelevant knowledge of the more obscure economic statistics. Bernanke had the flexibility to adjust his conceptual framework, and move into a mode that was demanded by events. Nor did his flexibility devolve into a paralyzing uncertainty about the actions to be taken, once he believed he understood the situation.Especially at this early stage it’s important not to turn hagiographic and believe Bernanke, or his policies, are better than they were. Nevertheless, from everything we know at this writing, we can be thankful we had Bernanke at the helm of the Fed in 2008. Henry Paulson by contrast comes across the way he did to many of us watching C-SPAN and reading the newspapers at the time: someone who was surprisingly ineffective at communicating just what they were doing or why. Last year more than once I found myself yelling at the television set as Paulson would again fail to articulate a focused diagnosis of the crisis or a clear rationale for their actions. Nevertheless, I have sympathy for Paulson’s position, too. As Treasury vacillated between a planned reverse auction to set prices for dodgy assets and flooding the market with liquidity, I did and still find it hard to be certain from Madison how much of the financial institutions’ problems were liquidity and how much was insolvency. Knowing the difference is the key, and it’s hard: I’m reminded of what I sometimes tell our students: “If you’re not confused, you’re simply not yet thinking clearly.” This book won’t sort out everything we need to know about the crisis and its aftermath; that book hasn’t been written, and I’m not sure it ever will. But In Fed We Trust is a great, readable start.For a focus on liquidity as the prime issue, see work by John Cochrane.One of the economists consistently emphasizing the role of insolvency has been Nouriel Roubini.For more general discussion see Wisconsin Real Estate's insights on the crisis.