As the Fed chairman in February 2000, Greenspan appeared before a Senate committee and explained why he was raising interest rates. Inflation had yet to pick up, but the powerful advance of technology stocks had fueled such strong growth that price pressure seemed likely. Of course, Greenspan could not know that he was right. ... Greenspan was greeted with a torrent of abuse. Then-Sen. Paul Sarbanes, Democrat of Maryland, charged that the Fed's preoccupation with runaway tech stocks harmed the job prospects of inner-city youths. Sen. Jim Bunning, Republican of Kentucky, railed that higher interest rates threatened the economy more than inflation. "I think people hear what you are saying and conclude that you believe that equities are overvalued," said then-Sen. Phil Gramm, the committee chairman. "I would bet that equity values, given what's going on, are not only not overvalued, but may still be undervalued."While I dispute some of Mallaby's finer points, such as the housing bubble being less obvious than the tech bubble, it does demonstrate the social incentive to look the other way. As I've said before, when everybody's getting rich, nobody wants to step in and stop the party.
Remember, this exchange took place in February 2000 — one month before the tech bubble spectacularly imploded. If Greenspan was assailed for raising interest rates then, imagine the reaction if he had increased rates really aggressively around 2005, when the real estate bubble was a good deal less obvious than the tech bubble had been. Or imagine the reaction if Greenspan had unleashed a regulatory clampdown on home lending in the teeth of the consensus that rising homeownership was wonderful. Regulators cannot anticipate bubbles with certainty, as Greenspan rightly says. And they may not act even when bubbles seem probable, as Krugman contends, because the lack of certainty makes it difficult to face down angry members of Congress.
Human regulators are human-beings before they are regulators, and humans are naturally herd animals.