Alan Greenspan should emulate Donald Rumsfeld. When you err badly as a policy maker and do enormous harm to the nation, hunker down and keep your mouth shut rather than demean yourself with lame excuses. That is what Greenspan does in the CNBC documentary House of Cards that first aired Thursday and will be shown several times this week.
Parallels between the two men are many. Both are extremely bright and capable, with success in the private sector as well as in government. Both are decisive, with the self-confidence to make difficult decisions.
Moreover, as in classic Greek tragedy, for both, that confidence swelled to hubris, the excessive pride that leads heroes to bad decisions that bring about their own downfall — and often that of their nation.
The Federal Reserve under Alan Greenspan failed badly in the last half of his near-two decade tenure. It failed in the most basic function of any central bank — regulating the money supply so as to maintain a stable price level. And it failed as a financial market regulator. These two failures — to prudently manage the money supply and to regulate the banking sector — are key causes for the ongoing global financial crisis and growing recession.
That is not to say the Fed is the only culprit. Many other factors played a part, including large persistent federal budget deficits financed by borrowing abroad, decades of ill-reasoned policies to foster homeownership, a somnolent Securities and Exchange Commission, a fragmented financial regulatory system, irresponsible management of financial institutions and a society that turned a blind eye to folly because times seemed good.
Nor is this to say that Greenspan bears sole responsibility for mistakes by the Fed. He was a chairman, not a director. He was only one of seven Fed governors. And the presidents of all 12 Fed district banks cooperated with these governors in the years of excessive money growth that fed the real estate and financial market bubbles that finally popped in 2007.
But he did earn substantial blame. When appointed in 1987, Greenspan was seen as a conservative who would err on the side of avoiding inflation. But as the 1990s wore on, it seemed that whenever push came to shove, he consistently opted for lower interest rates, which require faster money growth.
Indeed, this instinct was so widely observed that many on Wall Street talked of the “Greenspan put” — that whenever economic growth slowed, the chairman would tromp on the monetary gas pedal.
The upshot was that in Greenspan’s last decade as chair, the money supply grew about twice as fast as the real economy as a whole. Decades earlier, Nobel Laureate Milton Friedman had argued that letting money growth exceed growth in the output of goods and services was a prescription for inflation.
It was, but it did not show up in the consumer prices watched by the Fed. These remained remarkably stable, in part because cheap imports from Asia erased retailers’ ability to raise prices that had existed until the 1980s. Instead, excess money funneled into housing and stock prices.
Greenspan’s term at the Fed also encompassed a period of looser regulation of financial institutions, including the final abolition of banking laws instituted after the stock market crash and economic crisis that began in 1929. It was a time in which he and other regulators argued that, in many cases, the best oversight was to let financial institutions oversee themselves; market forces would prevent them from taking on excessive risk.
Finally, at a crucial moment in 2001, Greenspan overstepped his monetary policy role to support federal tax decreases that would help once again to double the national debt during one presidency. The resulting high debt and dependence on foreign financing not only contributed to the bubble but now poses major impediments to corrective action.
In CNBC’s documentary, Greenspan once again argues that the Fed had nothing to do with the bubble or the current recession. These, he implies, are random events of the kind that occur for no reason every century or so. Moreover, he argues, there is nothing the Fed could have done to limit the growth of the bubble, save raise interest rates so violently that the economy would fall into a recession with unemployment of 10 percent.
This is malarkey. Yes, by 2006, there was no longer any easy way to climb down from a perilous perch. But with the money-supply growth at twice the rate of output year after year and with the Fed’s interest-rate target holding at one-fourth or less of its long-term averages, quarter after quarter, it insults the public’s intelligence to argue the Fed and its chairman bear no fault.
Moreover, as the bubble grew apace, warnings of risky and dishonest mortgage practices became louder and more numerous. Ed Gramlich, one of Greenspan’s most capable colleagues on the Fed Board, raised these issues with him personally, to no avail.
No Fed official was as conscious of his public image as Greenspan, once basking in the fawning title of “maestro.”
If he persists in making statements like his recent ones, the image that he’ll be left with will be far less flattering.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.