Yesterday's MarketBeat excerpted my post on Alan Greenspan, which got me thinking about how to resolve his bundle of contradictions. This morning the answer popped into my head -- having survived under seven different presidents in Washington, Alan Greenspan is a better politician than economist.
The Fed Chair is appointed by the president. Thus, in order to be appointed and reappointed, Greenspan needed to support the policies of whomever was in office during his term at the Fed. For instance, under the current president, Greenspan supported $1.6 trillion worth of tax cuts along with the subprime market -- which broadened home ownership -- a key political goal. And now that he has left Washington, Greenspan is trying to appeal to a different constituency -- historians who will ultimately write his legacy.
By supporting the subprime market and the securitization of these dodgy mortgages, Greenspan was appealing to a politically broad set of constituents that helped the president and -- by extension -- Greenspan stay in office. How so? Subprime opened up the housing market to people who otherwise would rent, rather than buy. This appealed to the president and to those who ended up buying homes. And it also appealed to Wall Street which made hundreds of billions off securitization -- a fraction of which found its way to the president's re-election campaign.
So why is Greenspan a weaker economist? Because he supports subprime -- just not it's securitization. I think a top-notch economist would realize that subprime would not exist without securitization. How so? Because securitization gets mortgages off the books of the companies that originate them. And if those subprime mortgages -- 47% of which had no documentation of the borrower's income -- had stayed on the originators' books, then the loans would not have been made.
Why not? Because no lender seeking to keep his job would ever originate a mortgage which was virtually guaranteed to go bust and cost the lender's employer money. But by selling the mortgage to an investment bank -- which in turn packaged it with others and sold the package to European investors -- that cost of that bad credit loan would be born by a bank whose employees could not vote in a U.S. presidential election.
With two million foreclosures expected by the end of 2008 and a global credit crunch unfolding, Greenspan's support of subprime and securitization is thus looking like it was great political strategy and lousy economic strategy. But in Washington, politics often trumps economics. And in this case, the short-term illusion of prosperity kept Greenspan in office while the costs of his subprime securitization strategy began being paid after his term ended.
However, now that Greenspan is playing for historians, he's hoping to spin his record to make himself look like a better economist than he really is.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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