Economic analysis

Alan Greenspan: A 'serial bubble blower'?

Some blame Alan Greenspan for the U.S. downturn. He insists they're wrong.

Alan Greenspan is the new Forrest Gump. No, seriously. Read the former U.S. Federal Reserve chairman’s new memoirs. Page after page finds him at the junctures of modern history. There he was, in the 1940s, playing saxophone in a 14-man jazz ensemble with Johnny Mandel, who went on to write the theme song to M*A*S*H. Or take that afternoon in 1974, when Greenspan attended Senate confirmation hearings to become president Richard Nixon’s top economic adviser; later that night Nixon resigned. And then there was the time in late 1989 when he went behind the Iron Curtain to explain capitalist finance to Soviet economists; a month later some people tore down that wall. As Greenspan might have put it in his Fedspeak days: the best available evidence suggests that life is consistent with a box containing confectioneries of a chocolate variety.

You never know what you’re gonna get.

A year and a half after Greenspan made his last interest rate move, the world is finding out just how true that can be. During his 18 years at the Federal Reserve, Greenspan attained cult status among investors for shepherding the American economy through a series of potentially crippling crises, from 1987’s Black Monday stock rout to the 9/11 terrorist attacks. It was a period of phenomenal wealth creation, not just in America, but around the world, and no policy-maker enjoyed so much clout.

Yet now, with the octogenarian economist on the road promoting his book, The Age of Turbulence: Adventures in a New World, some economists are taking a second look at Greenspan’s legacy. They question some of the Fed’s moves in recent years — in particular, whether Greenspan effectively created the housing bubble that’s now in the process of bursting, and whether he enabled the Bush administration to rack up huge deficits. Greenspan told Maclean’s, in a telephone interview, that he has no regrets about any of the decisions he made. “There’s no such thing as policy that’s purely riskless,” he says. “But I would say the number of times in which we had policies in which the deficit part was greater than the benefits were relatively few.”

There’s no question the ripples of the Greenspan era will be felt for a long time to come. He served under four presidents as an economic adviser, and then as chairman of the Fed, the arms-length body that sets short-term interest rates and controls the amount of money in the U.S. economy. During Greenspan’s reign, the economy thrived, inflation remained relatively low, and unemployment fell to its lowest levels in decades. It was not for nothing that they called him maestro.

Greenspan left the Fed in 2006, and in the view of experts, unloaded a heaping pile of trouble on his successor Ben Bernanke. Over the past few months the Fed has had to grapple with the threat of a slowdown in the U.S., triggered by the collapse of the housing bubble. The tear began in the subprime mortgage sector, which saw loans issued to pretty much any homebuyers, regardless of their dismal credit. As interest rates rose, many homeowners couldn’t keep up with their payments. The real danger, though, lay in the fact many hedge funds packaged those subprime mortgages and sold them to investors. What might have remained a painful situation limited to a niche sector of the market has instead spread across the globe.

Some blame Greenspan for letting the housing sector get out of hand, just as mania formed around tech stocks in the late 1990s. Critics argue that in both cases, the central bank kept interest rates too low, for too long, sparking out-of-control speculation by investors. Stephen Roach, the chief economist at Morgan Stanley, called the Fed under Greenspan a “serial bubble blower.”

There were, of course, reasons interest rates were cut in the first place. After the terrorists brought down the World Trade Center, serious action was needed. At the same time, Greenspan says he feared the U.S. was headed for a period of deflation that threatened to drag the American economy into a slump. So the Fed slashed and slashed. By 2003, short-term interest rates were just one per cent, where they would stay into 2004, even as economists warned trouble was brewing.

Today, Greenspan says there was nothing the central bank could have effectively done to stop the housing bubble from forming. Yes, he says, he did miss just how big the subprime market had become. But there were other factors at play. He blames larger geopolitical forces for driving down long-term interest rates, and therefore mortgage rates. For instance, when the Fed did begin to jack up short-term rates, the housing market blinked, then went right back to its real estate-flipping ways. “Obviously, if we had raised the federal funds rate to 50 per cent or 100 per cent, we could have broken the back of the economy and the housing boom would have disappeared,” he says. “[But] any expectations we had that we could somehow suppress the housing bubble that was emerging were dashed.” Still, as critics point out, there’s a long way between two or three per cent and total economic ruin.

Greenspan has also taken heat for creating the environment that let U.S. deficits get out of control. Since the Republicans swept to power in the White House and Congress, America’s balance sheet has been bathed in red ink. The country owes close to US$10 trillion in debt, with massive annual deficits forecast far into the future. For a free-market libertarian and Republican like Greenspan, it’s been a difficult pill to swallow. But the fact is, he shares some of the blame.

America had been enjoying huge budget surpluses under the Clinton presidency. In 2001, in fact, Greenspan’s fear wasn’t that America had too much debt, but that by 2006, the debt would be completely paid off and the government would be left with US$500 billion a year in excess. It was a serious miscalculation on the part of budgeting officials. The surpluses were purely the result of the dot-com stock market boom, and they would vanish within months. But not before Greenspan made a fateful speech before Congress that advocated a tax break. His words gave weight to President George W. Bush’s US$1.35-trillion tax break, versus a smaller tax break proposed by Democrats, even though Greenspan didn’t favour one over the other. Things only got worse once the Iraq war got underway, and spending went through the roof. “My biggest frustration remained the President’s unwillingness to wield his veto against out-of-control spending,” Greenspan wrote in his book. “The Republicans in Congress lost their way. They swapped principle for power.”

But that begs the question: why didn’t Greenspan use his clout to put more pressure on the government to tighten its belt? Again, as with the housing boom, he says he did everything within his power. “The fascinating thing is I must have spent 100,000 words in testimony before the Congress [warning about out-of-control deficits] and it all fell on deaf ears,” he says. “You can’t be more public than in a congressional testimony. If it doesn’t work there, you’ve had it.”

Greenspan did indeed urge Congress to reinstate a deficit control mechanism that was set to expire. But as Greenspan himself has already shown, it’s not the quantity of words a Fed chairman uses, but the quality. His simple phrase “irrational exuberance,” uttered in 1996 to convey his concerns about a forming stock market bubble, carried more weight than any of the other thousands of words he spilled on the subject.

Whatever the criticism, Greenspan continues to wield great power, even after so long away from the Fed. When stock markets reached an all-time high last week, traders attributed the euphoria to comments by Greenspan that the credit crisis appeared to be easing. Even Cuba’s Communist leader Fidel Castro scored a copy of his book, showing it off during a recent TV interview. It’s almost as if there are two Fed chairmen. Bernanke, the guy who actually has his hand on the monetary lever, and Greenspan, the one who moves markets with mere words. The worry is that as Greenspan speaks out about what he sees coming down the line — he thinks the chances of recession are less than 50/50, and he predicts a long-term increase in inflation — he could hamper Bernanke.

Greenspan insists he will never criticize any decision made by the Fed, at least not publicly. But he has no plans to pipe down. “I’d like to believe [the markets] moved when I spoke in the last year and a half, but I frankly doubt it,” he says. “The implication is I should just not talk about what my profession is, which is economic forecasting, which has been my profession since 1948. Unless I’m going to retire and become an archaeologist, I’m not sure what people want me to do.” And besides, he says, no one can move markets the way billionaire Warren Buffet can, and no one is telling him to shut up.

Then again, no one has played such a key role in American history and politics for so many decades. Well, except maybe for that dim-witted shrimp farmer.


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