Column: So long, Mr. Greenspan…

by Mathew on October 24, 2005

Here’s a column I just finished posting at globeandmail.com about departing Federal Reserve Board chairman Alan Greenspan:

“During the U.S. presidential election campaign in 2000, Senator John McCain was asked what he would do if something were to happen to Federal Reserve Board chairman Alan Greenspan. The Senator replied: “God forbid, I would do like they did in the movie ‘Weekend at Bernie’s.’ I would prop him up and put a pair of dark glasses on him.”

In a single sentence, Mr. McCain summed up just how much the U.S. stock market, and as a result much of the American economy, had come to rely on the central banker known in some circles as “The Maestro.” The Senator’s joke also hinted at the very real truth that the Federal Reserve chairman’s presence alone — rather than any specific act by the central bank — was enough to soothe investors.”


Within months, however, Mr. McCain’s comments would be cast in a whole new light. As he spoke, the tech-stock boom was already beginning to lose some of its steam, and stock markets had begun a long free-fall. By the time the bottom arrived, more than $8-trillion (U.S.) in theoretical market value had vanished, and plenty of people were more than happy to blame Mr. Greenspan for helping to destroy it. After all, hadn’t he spoken in a much-quoted speech in 1996 about the market’s “irrational exuberance?” If only the Fed had taken the appropriate action, the theory went, everything would have turned out fine.

It’s hard to imagine anyone less suited to this kind of public attention than Alan Greenspan. A soft-spoken and now fairly elderly man (he turns 80 next year) with large, defiantly unstylish glasses, Mr. Greenspan carries a battered, overstuffed briefcase to his regular meetings on Capitol Hill, and looks a lot like the retired accountant or economics professor he might otherwise have been. In an earlier life, he was a saxophone-playing jazz musician and part of the circle of intellectuals around writer-philosopher Ayn Rand, with whom he reportedly was close.

One of the downsides to being the world’s most powerful central banker is that you get blamed for anything bad that happens to either the U.S. economy or the U.S. stock market, and in some cases the economies and markets of other countries too. Mr. Greenspan is no exception. Among other things, he has been blamed for the 1991 recession, the currency crisis of the mid-1990s, the stock-market bubble of the late 1990s, the economic slowdown that followed, and what some see as the current real-estate bubble.

He was even blamed by some for the stock-market collapse of 1987, despite the fact that he was only named to the Fed job two months before. That barb might have hit especially hard, considering that Mr. Greenspan’s father was a stockbroker who was ruined by the stock-market crash of 1929.

It’s worth noting that Mr. Greenspan’s infamous comment about “irrational exuberance” wasn’t meant as a description of the U.S. stock market. In fact, the phrase appeared in a question posed by the Fed chairman to his audience at the time, which was made up of other central bankers. The question was “How do we know when irrational exuberance has unduly escalated asset values?” But the simple fact that Mr. Greenspan — who became famous for not saying much, and taking a long time to not say it, as someone once said — would even raise that question caused a panic. That reaction said more about irrational exuberance than anything the Fed chairman did.

The uncomfortable conclusion one comes to after reading Mr. Greenspan’s comments over the years, at least for those who would prefer to see the U.S. central banker as omniscient, is that he asked that question because it was one he himself was wrestling with, and has continued to wrestle with since. How much attention should a central bank pay to the stock market? The classical view of the Fed is that its job is to control inflation, not to try and micro-manage a specific asset class (that is, stocks).

Although some economists have said that this view needs to change, it is clear that Mr. Greenspan doesn’t agree (and neither does his successor Ben Bernanke, who has written a paper on the subject). In a speech to an economics conference in 2002, the Fed chairman effectively responded to his critics by saying: “The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion.”

Mr. Greenspan said history shows that only a sharp increase in short-term interest rates — one that “engenders a significant economic retrenchment” — would be enough to slow a bubble, and that this in turn would have a substantial negative effect on the U.S. economy. In fact, Mr. Greenspan suggested it was hubris to assume that central bankers could diagnose a bubble at all. “We recognised that, despite our deep suspicions, it was very difficult to definitively identify a bubble until after the fact — that is, when its bursting confirmed its existence,” he said.

In many ways, Mr. Greenspan’s critics made the same mistake his many fans have, which is to assign almost superhuman qualities to a man who, while brilliant, is as mortal as anyone. This hero-worship itself contributed to the “moral hazard” or “Greenspan put” that some market watchers have referred to, a mindset that encouraged investors to take larger and larger risks, confident that they would be rescued by The Maestro. Was that Mr. Greenspan’s fault? Hardly. But it has become part of his legacy.”

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