Analytical Wealth

These days it’s relatively easy to find criticisms of the Fed and of former chair Alan Greenspan, once “The Maestro” he’s now the Prat who ruined the economy. However most of the criticism comes from the business media, money managers, financial analysts, *cough* bloggers, etc. It’s rare to see harsh criticism of the Fed by someone with the credentials of Anna Schwartz, the renowned economist who co-write a book with Nobel Laureate Milton Friedman on the role of the Fed in enabling the great depression.

(From the Telegraph) “The high priestess of US monetarism - a revered figure at the Fed - says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. "The new group at the Fed is not equal to the problem that faces it," she says, daring to utter a thought that fellow critics mostly utter sotto voce...

"They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence," she told The Sunday Telegraph. "There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for," she says.

Schwartz remains defiantly lucid at 92. She still works every day at the National Bureau of Economic Research in New York, where she has toiled since 1941.

Her fame comes from a joint opus with Nobel laureate Milton Friedman: A Monetary History of the United States. It revolutionised thinking on the causes of the Great Depression when published in 1965. The book blamed the Fed for causing the slump. The bank failed to use its full bag of tricks to stop the implosion of the money stock, and turned a bust into calamity by raising rates.

"The book was a bombshell," says British monetarist Tim Congdon. "Until then almost everybody thought the free-market system itself had failed in the 1930s. What Friedman-Schwartz say was that incompetent government bureaucrats at the Fed had caused the Depression"…

… According to Schwartz the original sin of the Bernanke-Greenspan Fed was to hold rates at 1 per cent from 2003 to June 2004, long after the dotcom bubble was over. "It is clear that monetary policy was too accommodative. Rates of 1 per cent were bound to encourage all kinds of risky behaviour," says Schwartz…

… "Liquidity doesn't do anything in this situation. It cannot deal with the underlying fear that lots of firms are going bankrupt," she says. Her view is fast spreading. Goldman Sachs issued a full-recession alert on Wednesday, predicting rates of 2.5 per cent by the third quarter. "Ben Bernanke should be making stronger statements and then backing them up with decisive easing," says Jan Hatzius, the bank's US economist.”

You can read the rest of the article in its entirety here; it’s a good read that discusses some of the details of the great depression in the context of our current woes.

Reading the article a couple of thoughts come to mind:

During the housing boom, a lot of pundits, analysts, bloggers and the like warned of a pending economic calamity, and there were undoubtedly some highly placed economists who felt the same way. Yet, no action was taken to avert a crisis by raising interest rates, imposing tighter regulations on mortgage lending, etc. The fact that only the bullish believers in an unsustainable economic pattern were listened to, is tantamount to economic malpractice.
It’s important to understand that we’re dealing with a crisis of economics AND confidence right now. Added liquidity not only doesn’t help restore confidence, it doesn’t resolve the underlying economic issue of companies losing money on bad investments/losing money in general.
Following from the above, if business leaders, the Fed and politicians don’t confront the actual problems the economy is facing, the actions they take to help the economy will be largely ineffective. Perfect examples are the various home owner bailout programs that focus on reducing interest rates, as opposed to people buying homes they can’t afford.
If the people at the controls of the economy are not up to the task, then we need to be prepared to deal with some potentially dire consequences.
Will the Fed truly learn from its past mistakes and prevent future credit and asset bubble related crisis?
What will be the eventual cost of the Fed’s current actions, be they positive or negative?
If someone of Anna’s position and caliber is stepping forward to deliver such harsh criticisms, what kinds of things are being said behind closed doors at the Fed and the NBER?

While it’s easy to dwell on the past and focus on who did what wrong and when, “the mistake is behind us” and we have to forge a new set of policies and strategies to move the economy forward. The key isn’t just to cure the economy of its current malaise, but to establish sustainable economic patterns and sound fiscal policies that will prevent a similar crisis from happening in the future.

Sources:

The Telegraph: “Anna Schwartz blames Fed for sub-prime crisis” – Ambrose Evans-Pritchard, January 14, 2008.