Greenspan, and the nation by extension, was a victim of his own misguided ideology and the denial of the government’s role in controlling the economy. By denying that government should even have a role the right-wing libertarians lose touch with reality at the most fundamental level and distort their reasoning to fit a false narrative in everything beyond that.
During the tech boom and Clinton’s mismanagement of the resulting vibrant economy, the Fed was caught up in exuberance over surplus government sector budgets and even projected “surplus as far as the eye can see”. This is a natural result of the mistaken perception of business as the “creator” of money and productivity/prosperity. Anyone who understood simply accounting with dual entry spreadsheets should have been able to counter this, but humans are often reluctant to even look for chinks in structures when things are working.
“If it ain’t broke, don’t fix it” can describe most of human progress, only jolted off the status quo trajectory by the shock of failure and emergencies. Several economists were shouting warnings about sustained surplus budgets but were discounted as cranks in spite of the fact that the most basic sectoral math and America’s economic history supported them. The previous six times the economy produced a sustained surplus for the government sector ended badly, but everyone believes they are exceptional and will succeed where others had failed.
The economy is divided into three basic sectors that are separated by how each interacts with the money supply. They are 1) the federal government: 2) The private sector (all of us, including states): and 3) The foreign sector. Only the federal government and the foreign sector have the potential of adding to, or subtracting from, the overall money supply, and the foreign sector is unlikely to ever add significantly in the foreseeable future. That leaves the government sector as the only net source of the US dollar. The private sector, including banking, can only shuffle those dollars around or project negatives into the future by lending sufficiently to “roll over” debt via GDP growth.
By accounting standards, all three sectors must, and will, always balance to zero. The very technology that drove the boom was largely imported from foreign sources, assuring the foreign sector of surplus, and Clinton’s fiscal policy drove down any input from automatic stabilizers and government spending in general. This meant that the private sector was guaranteed to be in deficit and charged with feeding the surpluses of the other two sectors. Simple logic would tell any reasonable person that such a condition isn’t sustainable.
At the first slowdown of GDP growth, the increased money supply needed to feed economic expansion is not available under surplus federal budgets and defaults in private sector lending began to mount to create instability. That instability is evident to the market traders long before it is felt in the general economy and investors begin to pull back into positions that favor safer bonds, which are in short supply if the government is not spending in deficit. By increasing deficits, Bush steered us away from a full depression that would have otherwise resulted from Clinton’s recession, but his conservatism made the recovery insufficient to supply the demand for safe Treasury vehicles.
The combination of a general population needing to leverage its debt to maintain its living standard and a shortage of secure investment vehicles for investors was a natural catalyst to produce something like the default swaps that proved so dangerous to the economy. The US housing market has always been considered the second choice for safe investment, so the resulting boom in mortgage lending at relatively low interest provided the answer to both consumers and investors, only needing the default swaps to connect them.
Simply lending for mortgages doesn’t involve existing bank reserves, as banks create reserves for loans, balancing them with the borrower’s contract as an asset. The default swaps created the needed connection to the presumed safe investment in US housing with those looking for a safe haven for their excess reserves that would normally purchase Treasury bonds were they available. Almost all of the failed mortgages were the product of third party loan originators who held no risk and had every motivation to qualify any potential borrower to provide mortgages to bundle into aggregate vehicles for investors.
In the end analysis, it was Clinton’s surplus budget and Bush’s lackluster deficit spending that created the great recession with an anemic money supply, not the consumer’s qualifications. The whole thing could have been prevented by Greenspan understanding basic spreadsheet accounting prior to engaging in his career as an economist, but that applies quite well to most orthodox economists and is problematic at the highest levels, even among those with prestigious awards.
