Phil Gramm’s U-Turn

Phil Gramm, November 2008:

“There is this idea afloat that if you had more regulation you would have fewer mistakes,” he said. “I don’t see any evidence in our history or anybody else’s to substantiate it.” He added, “The markets have worked better than you might have thought.”

Phil Gramm, January 2009, via Justin Fox:

Some financial markets need regulation. Gramm went through a whole laundry list on mortgages. His free-market-guy side led him to carve out an exception for loans that banks hold onto their books, but he now thinks all securitized loans and all federally guaranteed loans need to meet some basic standards: 5% (he’d prefer higher) down payments, an end to 100% up-front compensation of mortgage brokers (he wants their compensation on a loan spread out over five years), limits on home equity loans that wouldn’t allow them to reduce equity to below 10% of the home value, etc. He never got into a philosophical discussion of why mortgage markets couldn’t come up with these standards on their own.

I generally admire it when a public figure changes his mind, and this case is no exception. The need for more/better regulation might be obvious to most of us, but it never was to Gramm, and so his U-turn is impressive. And I actually agree with Gramm rather than Fox when it comes to monetary policy. In case it’s not clear, Justin first lays out Gramm’s view, then adds his own:

The Fed blew it in 2001-2002. Not because Greenspan’s an idiot, but because it was a different sort of recession than all the other post World War II recessions (a bubble deflation as opposed to an inventory cycle) and so the standard Fed response of cutting interest rates wasn’t the right move because much of the economy wasn’t in a recession. “We inadvertently stimulated an industry that was already in boom conditions,” Gramm said. “This changed everything. It changed consumption behavior, it changed lending behavior.” There’s something to this, but I think the distinction between types of recessions is a little glib. We’re now in the middle of another collapsed-bubble recession, and cutting interest rates doesn’t seem to have been the wrong thing to do. It just hasn’t been nearly enough.

There is a world of difference between a collapsed-equity-bubble recession and a collapsed-debt-bubble recession. The former is generally economically benign, while the latter can be devastating. Cutting interest rates just because stock prices have fallen is silly. But cutting interest rates because bond yields are soaring makes sense.