Alan Greenspan Age Of Turbulence

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Once a speculative mania gets going, it rapidly becomes self-reinforcing. Rising asset values draw more players to the table and provide collateral, which allows for additional borrowing. Before long, the process of speculation itself becomes a driving force in the economy, at which point bringing it to an end is politically problematic and economically costly.

Greenspan’s experience in the dotcom era should have demonstrated to him that the best way to control a speculative boom is to prevent it from developing in the first place. But rather than putting the brakes on what was happening in the credit markets, he celebrated it in a spirit reminiscent of Ayn Rand, the author he idolized and befriended as a young man. In 2004, as the subprime boom was cranking up, he advised homeowners to switch from fixed-rate mortgages to adjustable-rate loans. And in April 2005, in a speech that probably now haunts him, he said, “Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial-services industry throughout the history of our country…. Where, once, more-marginal applicants would simply have been ­denied credit, lenders are now able to quite efficiently judge the risks posed by individual applicants and to price that risk appropriately.”

For far too long, Greenspan denied the evidence before his eyes, insisting there was neither a real estate bubble nor any sign of problems emerging in the financial sector. Now that delinquency rates on subprime loans are running at 40 percent in badly affected areas—including the Inland Empire, east of Los Angeles—and some of the biggest mortgage providers, such as New Century Financial and American Home Mortgage Investment Corp., have gone bankrupt, Greenspan has come up with a new argument. “These adverse periods are very painful, but they’re inevitable if we choose to maintain a system in which people are free to take risks,” he said in August.

Because of his Randian view of the world, there is no reason to doubt that Greenspan believes what he said, but it raises the question of whether he was ever a suitable choice for Fed chairman, given his understanding of the job. The reason the Fed was set up, in 1913, was to preserve financial stability—to break the historical pattern of ruinous boom-and-bust cycles. Central banks maintain stability by limiting the types of risks people can take, either by raising the cost of borrowed money or by enforcing regulations. If all else fails and panic breaks out, they inject liquidity into the system by acting as a bank of last resort, which is what the Fed and other central banks were forced to do over the summer.

Given Greenspan’s inaction during his final years in office, our current crunch was pretty much inevitable. In addition to reducing interest rates to 1 percent, he rejected calls for more vigorous oversight of the mortgage industry. Instead of outlawing such dubious practices as the provision of “2-28” loans—which lure borrowers by offering them cheap rates for two years and then sock them with enormous increases in their monthly payments—the Fed issued vague “guidance” letters that most lenders ignored.

Greenspan’s reluctance to act as a ­financial cop was nothing new. During the ’90s, in addition to ruling out higher margin requirements for stock trading, he championed the repeal of the Glass-Steagall Act, the New Deal legislation that prevented commercial banks and investment banks from competing with each other. Alan Blinder, who served as Greenspan’s deputy from 1994 to 1996, described his former boss as “the great anti-regulator.”

Other past colleagues of Greenspan’s have admitted that serious policy errors were made. In a speech last November, Richard Fisher, the president of the Dallas Fed, said that the federal funds rate “was held lower longer than it should have been,” which “amplified speculative activity in the housing and other markets.” Asked at one of his public appearances about Fisher’s comment, Greenspan replied, “In retrospect, I know of nothing we would have done differently.” The closest he has come to a mea culpa was when he told the Wall Street Journal, “We tried in 2004 to move long-term interest rates higher in order to get mortgage interest rates up and take some fizz out of the housing market. But we failed.”

He certainly did, and the fact that the Chinese government and other foreign investors were making his job harder by pouring money into Treasury bonds is no excuse. Rather than ruminating over the conundrum of why long-term interest rates were so low, he should have been taking vigorous action to burst the credit bubble. For a Fed chairman to have one speculative bubble inflate during his tenure is an indictment; to have two of them qualifies him as a serial bubble blower.

Greenspan did get one thing right, though: his retirement date. Were he still at the Fed, he would be responsible for cleaning up the mess he helped create. While his successor, Ben Bernanke, watches anxiously to see who the next casualty of the credit squeeze will be—a Wall Street investment bank? a big hedge fund? a private equity firm?—Greenspan will be busy signing autographs at Borders and Barnes & Noble. If you want to question him about all of this, get there early. The lines will be long.

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