His Fault
Sep 12 2007
Alan Greenspan’s just-released memoir, The Age of Turbulence, is aptly titled. In his two decades as chairman of the Federal Reserve Board, Greenspan presided over Black Monday, the stock market collapse that occurred 20 years ago this month; the Asian financial crisis; the demise of Long-Term Capital Management; and the dotcom bubble.
Greenspan’s book will make headlines over the next few weeks, in part because of his surprisingly downbeat assessment of the economy and financial markets. But even though he left the Fed more than a year and a half ago, his recollections aren’t of merely historical interest. The current turmoil on Wall Street is largely a result of policy decisions he made during his final years. By keeping interest rates too low for too long, he encouraged a borrowing-fueled speculative binge, which has now given way to a credit squeeze. By failing to crack down on the mortgage industry, he allowed subprime hucksters to peddle dubious loans, which the financial industry’s math whizzes packaged for investors. Coming on top of his role in creating the internet-stock mania a decade ago, the mistakes Greenspan made—now playing out in home foreclosures and hedge fund collapses—will surely color historians’ views of his long tenure, if not his own account of it.
The 81-year-old New Yorker has lived a remarkable life. From Washington Heights, where he was born; to Times Square, where in his youth he played the clarinet in a swing band; to Wall Street, where he made his name; to Richard Nixon’s 1968 campaign, when he entered politics; to Gerald Ford’s White House, where he chaired the Council of Economic Advisers; to Foggy Bottom, where for 18 years he occupied a big office overlooking Constitution Avenue, he proved to be a brilliant survivor—the best that Washington has seen since J. Edgar Hoover.
Since leaving the Fed, he has continued to make news, if not always in ways he would like. Within weeks, he started making off-the-record appearances before select audiences: hedge fund managers, investment bankers, and the like. Inevitably, some of his remarks slipped out, causing disruptions in the markets. In February, he said a recession was possible before the end of 2007—a comment that contributed to a 416-point fall in the Dow. In May, he put the chances of a recession at one in three. Two weeks later, he rattled international bourses by saying that a bubble had developed in the Chinese stock market and a “dramatic contraction” was inevitable.
When Greenspan was chairman of the Fed, his public statements were famously delphic. While he is entitled to make a living—he reportedly charges $150,000 a speech and received an $8.5 million advance for the book—there is something jarring about his late-life discovery of clear, declaratory English. His predecessor, Paul Volcker, was barely heard from for years after he retired, and Greenspan’s failure to follow that example has perplexed some of his former colleagues. In January, the governor of the Bank of England, Mervyn King, who heads the panel that sets British interest rates, made an indirect but well-aimed swipe at Greenspan when he remarked about his own predecessor, “I’ll say only that I am very grateful to Eddie George that he has not been in the newspapers or on the radio commenting on what the committee is doing.”
Now, when managing an economy, emergency action is sometimes called for. A market collapse twinned with a large-scale terrorist attack was something new and frightening. By the middle of 2002, however, it was clear that for whatever reason—low interest rates, the Bush tax cuts, increased military spending—the economy was staging an amazingly robust recovery. At that point, history and economic orthodoxy suggested that the Fed should have been tightening policy rather than loosening it.
Again, Greenspan went his own way. Citing fears (which proved to be misplaced) of Japanese-style deflation spreading to the United States, he kept the federal funds rate at 1 percent until June 2004, by which point the economy had been growing steadily for more than two years. By failing to tighten monetary policy, Greenspan created an apparently limitless supply of cheap credit.
After adjusting for inflation, the cost of cash was close to zero. Investment banks, hedge funds, and other financial operators were able to obtain money at minimal cost and use it to finance risky investments. To a lesser extent, so could ordinary Americans. In a feat of levitation almost without precedent, the prices of nearly all speculative assets moved in the same direction: U.S. stocks went up; foreign stocks went up; residential real estate went up; commercial real estate went up; oil went up; gold went up; sugar went up; coffee went up; Treasury bonds went up; junk bonds went up. To make money, all you had to do was suit up, buy something, and sit back and watch it grow.
In the real estate market, lenders competed frantically to make loans, and speculators flipped condos like burgers. With so much cheap money sloshing around, lenders had to work hard to find enough borrowers to mop it all up. At any one point, there is a limited population of folks who (a) need a new mortgage and (b) are capable of servicing one. So the lenders extended their attention to people who wanted loans but couldn’t afford them; hence the rapid growth of interest-only mortgages, no-doc loans, and even “ninja” mortgages (no income, no job or assets). In the beginning, money-center banks like Citigroup and Bank of America shied away from issuing loans to low-grade borrowers. But as specialist mortgage providers, including Washington Mutual and New Century Financial, started to eat away at their market shares, the respectable bankers became convinced that they had no choice but to compete with them. On Wall Street, meanwhile, a parallel race to the bottom was under way. Firms like TCW Group and BlackRock were busy packaging subprime loans into mortgage-backed securities, credit-default obligations, and other exotic instruments, which were then unloaded on gullible investors searching for a higher yield than Treasury bonds were providing. As the innovative newcomers started to make hefty profits, established investment banks like Bear Stearns, Goldman Sachs, and Lehman Brothers raced to catch up. Eventually, even firms that had shunned the risky new field of structured credit, such as Morgan Stanley, joined the fray.