Do you blame the housing market on the Fed or the 'glut'?

Krugman and Wells argue that Fannie, Freddie and the Fed are innocent; the big bad global glut fed the boom that led to the crash.

Charles Krupa / AP
A builder maneuvers a roof truss over the second story of a home under construction in Derry, N.H., Nov. 16. The housing industry remains near record lows. Who's responsible?

In two substantial New York Review of Books articles, Paul Krugman and Robin Wells offer their views on various explanations of the property bubble and ways to get out of the slump. On the latter front, they advocate aggressive deficit spending by the federal government and quantitative easing by the Federal Reserve— No surprise to anyone who reads Professor Krugman’s writings.

Regarding the causes of the bubble, they favor the “global savings glut” explanation. This view absolves the Federal Reserve from having spiked the punch bowl at the intertwined credit and real estate parties—by keeping interest rates exceptionally low from 2002 to 2005. It is remarkable that Krugman and Wells dismiss the case against the Fed without even bothering to mention the work that argues and presents evidence for the Fed’s pivotal role in causing the crisis—namely, Stanford professor John Taylor’s book and articles, including a Wall Street Journal piece.

Why does this matter? If the Fed fueled the twin bubbles, then its current actions may bring more of the same. Chairman Ben Bernanke is proceeding to inject money into the system via additional quantitative easing, possibly blowing new bubbles, whether in gold, junk bonds or some other asset.

What is more, if the Fed itself is a menace on that level, then we’re truly in danger as the same bureaucracy gets even more powers to do whatever it wants, thanks to the Dodd-Frank Act Congress passed this year.

If, instead, the past bubbles were caused by a global savings glut and the Fed is off the hook, then it is more plausible that QE2 is harmless, if not beneficial. Krugman and Wells cite the eponymous Taylor’s rule in defense of quantitative easing but ignore recent research by Professor Taylor.

Here is a quote from Taylor regarding the supposed global glut: “The main problem with this explanation is that there is actually no evidence for a global saving glut. On the contrary, … there seems to be a saving shortage. … the global saving rate – world saving as a fraction of world GDP – was very low in the 2002-2004 period especially when compared with the 1970s and 1980s.”

If you think about it, during the time in question some countries like China saved a lot but other countries, notably the United States, did not save. The savers were balanced by the non-savers. Certainly there was – and still is – global imbalance, but not an overall surplus.

What do Krugman and Wells say about the lack of evidence of a global glut? They don’t say anything. I suppose it is much easier to pretend no such question exists.

In any case, they write that the Fed could not have done otherwise in the years following the 2001 recession because recovery from that recession was too slow. Similarly, Krugman argues for aggressive policies now on the ground that the current recovery is too slow. Maybe recoveries are hampered by hangovers caused by the Fed’s serial stimulations. Yet more stimulation is like telling someone to have another drink when they wake up with a bad hangover. True, some people will do that, but it’s not really the way to recovery.

Fed chiefs, former and current, have espoused the global glut argument and Alan Greenspan responded to Taylor’s critique. Jerry O’Driscoll showed the problems with Greenspan’s reply.

Krugman and Wells are inclined to present government entities in the best light—they also defend mortgage buyers Fannie Mae and Freddie Mac. They criticize Raghuram Rajan, author of the one of the books they review – Fault Lines: How Hidden Fractures Still Threaten the World Economy – for suggesting that these government-backed giants made mortgage credit easy. That, according to Krugman and Wells, is “a politically motivated myth.”

So, Fannie, Freddie and the Fed are innocent; the big bad global glut fed the boom which led to the crash. If you believe that, you’ll give me a government-backed mortgage for this bridge I’m buying in Brooklyn.

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