Remarkably, as short-term interest rates rose, medium and long-term interest rates did not, something that was referred to as a "conundrum."
One hypothesis is that foreign central banks that were accumulating trillions of dollars finally figured out that they were likely to be holding these reserves for years to come, and could afford to put at least some of the money into medium-term US treasury notes yielding -- initially -- far higher returns than T-bills.
The housing price bubble eventually broke and, with prices declining, some have discovered that their mortgages are larger than the value of their house. Others found that as interest rates rose, they simply could not make their payments.
Too many Americans built no cushion into their budgets, and mortgage companies, focusing on the fees generated by new mortgages, did not encourage them to do so.
Just as the collapse of the real estate bubble was predictable, so are its consequences: housing starts and sales of existing homes are down and housing inventories are up. By some reckonings, more than two-thirds of the increase in output and employment over the past six years has been real estate-related, reflecting both new housing and households borrowing against their homes to support a consumption binge.
The housing bubble induced Americans to live beyond their means -- net savings have been negative for the past couple of years. With this engine of growth turned off, it is hard to see how the US economy would not suffer from a slowdown. A return to fiscal sanity will be good in the long run, but it will reduce aggregate demand in the short run.
There is an old adage about how people's mistakes continue to live long after they are gone. That is certainly true of Greenspan. In Bush's case, we are beginning to bear the consequences even before he has departed.
Joseph Stiglitz, a Nobel laureate in economics, is professor of economics at Columbia University and was chairman of the Council of Economic Advisers under US president Bill Clinton and a chief economist and senior vice president at the World Bank. Copyright: Project Syndicate
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