With Greenspan and the economy, a lot of knowledge proved to be a dangerous thingby Martin Sandbu / November 17, 2016 / Leave a comment
Published in December 2016 issue of Prospect Magazine
In retrospect, it is easy to see what happened. The 2008 crisis was triggered by the mother of all bank runs: a panicky loss of confidence in the financial system, which had loaded up on lousy mortgages that remained unsafe even though they were wrapped up in new and exotic ways. Financial institutions had made too many loss-making investments, but the bubble they had inflated delayed the day of reckoning—until it didn’t.
The surprising thing is not what happened, but that so few people saw it coming. And even that is not quite right. Many did see enough to know the risks. Some of them were even in a position to do something about it. If they did not do so, it was because either they wilfully ignored the dangers or found the potential remedies worse than the disease. In short, they thought the boom was worth having.
Eight years after the crisis—in the wake of a US election campaign fuelled by the political fallout of economic tough times, and with a previously unthinkable President-elect having been chosen—this sanguine faith seems like an obvious delusion. As Donald Trump’s America dawns, we can see that financial laissez-faire has ultimately proved ruinous not only for the economy, but for the liberal political order. But the 1990s and early 2000s were very different times. It was as though economic policy-makers had fallen under a collective spell. At the heart of it all was the chair of the US Federal Reserve from 1986 to 2005, supposedly “the world’s best central banker,” and the man who more than anyone else was responsible for casting that spell: Alan Greenspan.
The ascent of this shy child of Jewish immigrants was hardly written in the stars (except for his doting mother, to whom some of his self-belief can be attributed). But Greenspan’s career illustrates the extraordinary upper-Manhattan milieu of his 1930s youth. Young Alan, a gifted saxophone player and for a while a working musician, practised with the even more gifted Stan Getz. A few years above him at George Washington High School was Henry Kissinger, who would decades later become a rival in White House power games. Greenspan made it first in business as a consultant, then in government by matching his unsurpassed knowledge with a huge appetite and talent for politics.
The cult of Greenspan culminated with his valedictory appearance in August 2005 at the annual central bankers’ conference in Jackson Hole, Wyoming. Greenspan’s 18-year reign as Chair of the Fed, under four different presidents both Republican and Democrat, was nearing its end. His assembled colleagues were celebrating not just Greenspan but also how he reflected their collective achievement of permanently taming (so they thought) the boom-and-bust business cycle, an outcome they called “the Great Moderation.” It was an orgy of professional self-congratulation unsurpassed in the recent annals of central banking—unless you count European Central Bank (ECB) boss Jean-Claude Trichet boasting in 2009 that the euro had brought unprecedented stability at a time of crisis. The attitude of the financial world is best captured by the title of Bob Woodward’s 2000 book on Greenspan: Maestro.
Sebastian Mallaby’s more sceptical book is more soberly entitled The Man Who Knew—not necessarily a flattering sobriquet. As the crisis unfolded, Greenspan’s public image as an infallible expert imploded as quickly as America’s overheated housing market. He slid humiliatingly from the rock-star economist who could do no wrong to having the blame for the crisis pinned on him. Notoriously, Greenspan admitted in a congressional hearing a month after Lehman Brothers’ collapse that he was distressed at finding “a flaw in the model that I perceive… defines how the world works.” Was this the man who “knew”? If not outright sarcastic, Mallaby’s title has a double if not a triple or quadruple meaning. For what, exactly, did Greenspan know?
Above all, Greenspan was the man who knew data. From early on, he was recognised as unbeatable both on his raw knowledge of detailed economic statistics and his instinctive grasp of the bigger picture. In particular he recognised, before almost anyone else, the leap in productivity that the US economy experienced in the 1990s, when the information technology revolution blazed through workplaces and computerised previously labour-intensive tasks. His analysis meant he could check the Fed’s institutional eagerness to cool the economy: he knew it could take a higher growth rate without overheating. Partly as a result, the 1990s saw a flourishing job market (labour force participation peaked in 2000), strong growth and low inflation: a Goldilocks economy that ran not too fast and not too slow. Greenspan’s calls were truly to his credit. More subtly, Greenspan knew to distrust academic economists’ theoretical models because they could not capture the full complexity of the evolving relationships within the economy. His empiricism derived partly from his temperament and love of data, but was also a reflection of his career path. He was a business economist and consultant for decades, being paid (handsomely) for his detailed knowledge of economic facts. He never held a conventional academic position, and felt no deference to canonical economic literature.
His obsession with data won Greenspan his entry to politics. A former colleague brought him into the 1968 Richard Nixon election campaign, in which he quickly made himself indispensable as a polling data expert. For the rest of his career, he remained ensconced in the inner circles of Washington politics.
His command of the facts may have opened the door, but a different kind of knowledge advanced his career. Greenspan knew how to play the Washington political game—he was “a master of passive aggression,” Mallaby writes. He knew how to ingratiate himself with the powerful, or at least how not to alienate them. He quickly learnt which fights to pick, which not to, and which he would make others fight for him. He knew to make himself available to journalists; he dated many glamorous women, including some of the era’s best-known television journalists. He eventually married one of them, Andrea Mitchell, when he was 71 and she was 20 years younger. His first marriage, more than 40 years earlier, had lasted barely a year.
Greenspan was not content with just being “the man who knew”; he also did his best to be perceived that way. Mallaby recounts as many tennis matches and games of golf, lunches and state dinners with power brokers, as he does policy meetings. Greenspan relished Washington’s social bubble and could play the status game with the best of them. He browbeat Federal Reserve colleagues, and used his influence to fill the board with governors he favoured and to try to keep away those who would challenge him. He was perfectly comfortable with both the power and the glory of being a consummate Washington insider.
That goes some way towards explaining why “the man who knew” did not act on his knowledge. What most strikes the reader in 2016 is how exceptionally well-equipped Greenspan was to foresee the 2008 catastrophe. His low opinion of theoretical models should have inured him against the naive view that markets left to their own devices tend towards equilibrium. As early as 1959, he wrote a paper on how stock market fluctuations influence real economic activity in a self-reinforcing (non-equilibrating) way: a stock market boom makes companies expand, which speeds up the economy and justifies further stock price rises. When the bubble pops, the process goes into reverse and depresses growth. The implications for monetary policy is an active research area today.
In the late 1970s, Greenspan warned against consumption bubbles driven by growing housing debt, which was then being intensified by the looser reins given to the large governmental mortgage companies Fannie Mae and Freddie Mac: they would buy mortgages from lenders and package them into securities they would sell on with a government guarantee.
But he also “knew” that government should not substitute for private market decisions. Greenspan was a devotee of Ayn Rand, the arch-libertarian novelist and polemicist. He “knew,” for example, that antitrust policy inhibited freedom. And in one of the most damning episodes in Mallaby’s account, Greenspan also apparently just “knew” that the Great Society programme—Lyndon Johnson’s efforts at reducing poverty—was the cause of riots spreading across the country in the 1960s. His argument was that Johnson’s agenda indulged the poor and African-Americans in their belief that the government owed it to them to improve their situation. Especially dismaying to read is Greenspan’s memorandum to Nixon in the wake of Martin Luther King Jr’s assassination by a white supremacist in 1968. It argued that the Republican candidate should attack his presumptive presidential rival Robert Kennedy for supposedly being soft on violence—an accusation which in US politics is often racially loaded.
Time and the responsibilities of office smoothed the hardest edges of his politics, at least when it came to putting his ideas into practice. But his Randian libertarianism was not merely a youthful fantasy. Greenspan was nearly 30 when he befriended Rand; over 40 when he slandered Johnson and Kennedy.
While Mallaby doesn’t say so directly, his book invites us to trace Greenspan’s failure to act more strongly against the build-up of debt in the 2000s back to his defining characteristics: libertarianism uneasily balanced against political expediency, and a tolerance of intervention whenever financial markets looked likely to collapse under the weight of their own past excesses.
We see this in Greenspan’s attitude to bailouts. Within the Gerald Ford administration, he took a strong but unsuccessful stance against New York City’s municipal request for aid. But during the string of bank and market collapses that rolled on every couple of years from the 1980s on—Continental Illinois, Bankers’ Trust, Black Monday, the Mexican and Korean debt bubbles and Long-Term Capital Management among them—Greenspan was increasingly acting first and rationalising later when it came to government intervention. He saw the need for providing central bank liquidity to the markets; he did not resist taxpayer-funded action by the Treasury. No wonder Wall Street felt the Fed had their back. He even tolerated Fed colleagues strong-arming bankers into collective support for troubled firms: but he was loath to do this last bit himself. His scepticism about government intervention remained unabated— even when he was the government.
“His admission was that he had held onto his ideology—that government could not improve private decisions”
But if Greenspan’s libertarianism did not hamper government efforts to “clean up the mess” after market excesses, it obstructed any meaningful attempt at preventing those excesses to begin with. Mallaby draws up a long charge sheet. Greenspan outmanoeuvred Brooksley Born, the regulator who in 1998 pushed for tighter rules on derivatives. He torpedoed efforts to streamline the patchwork of financial regulators in order to protect the Fed’s turf, but also pushed back against attempts to increase the Fed’s regulatory responsibilities. And he blessed the financial deregulation passed by Bill Clinton’s administration at the end of the 1990s.
That was not the only accommodation Greenspan—very much a Republican—made with Clinton. They found an early rapport in the wonkishness they had in common. But on policy, too, the division of power between them worked to the satisfaction of both. The deficit reduction policy passed by Clinton in his first year in office was music to Greenspan’s fiscally conservative ears, and he responded by lending all his authority in support of tax increases. Despite interest rate increases in the years that followed, the economy remained vigorous, and by 1995—so in good time before Clinton’s 1996 re-election campaign—they could be cut again. Greenspan’s hunch that booming productivity could be sustained facilitated the presumption for easy money, which served the President well. All in all, it suited Clinton’s “third way” image—a centrist with meticulously “responsible” economic policies—to work with a Republican who, in any case, was by then seen as so successful that everyone wanted him on their team.
Bill Clinton reappointed Greenspan twice. Hillary Clinton may have given private speeches to Goldman Sachs, but—even if she had won—she would have felt more obliged to take on Wall Street than her husband’s administration ever did. For example, she said in the campaign that it must be possible to break up banks that are too big to fail. America has now swung to the right, but there is nonetheless much less trust of Wall Street self-regulation than there was when the Clintons were in the White House. The post-crisis consensus that central banks must stabilise the financial cycle through regulatory tools—in addition to fighting inflation (or deflation) through appropriate interest rate-setting—leaves much of Greenspan’s pre-crisis worldview in tatters. Indeed in the ninth decade of his life, Greenspan has belatedly endorsed this new theoretical consensus. But practice, too, has left him behind: formal inflation-targeting and transparency about the Fed’s decisions—now considered elements of best practice—were both developments he resisted in his own day.
Here, then is the conundrum: how could a man who knew the dangers of unstable finance better than most other economists wash his hands of them? He was in good company: almost everyone was under Greenspan’s spell. But so was Greenspan himself. Mallaby is clear-eyed in calling out his subject’s errors, but his judgement on Greenspan’s record is ultimately sympathetic. Mallaby makes two claims. The first is that “by the time Greenspan became Fed chairman, his ideology was mostly gone… he was a pragmatist.” The second is that “if Greenspan had demanded a bolder response to the challenge of leverage, megabanks, and derivatives… the best guess is that he would not have made a real difference.”
But to this reader at least, Mallaby’s own book suggests differently. An ideology held well into midlife rarely wanes in old age. Greenspan grew up in another era: Mallaby suggests he came of age too soon to be comfortable with the popular culture of the 1950s, let alone the 1960s. And by Greenspan’s own admission in the “I found a flaw” testimony, until the crisis hit he had held on to his ideology (a term he accepted) that the government could not improve on private decisions. As for the power to make a difference, Mallaby leaves no doubt about Greenspan’s ability to influence policy when he really wanted to, especially at the apex of his career during the 2000s boom.
Greenspan represents an old and powerful strain of American politics. Long before Trump, that strain was strong in the old Republican Party. It combined an aversion to government intervention in the economy or indeed society with a natural patrician ease with elites running affairs. It is an ideology that celebrates great leaders and individual responsibility over bureaucratic systems and collective action.
It is a worldview that has now proved to be self-destructive—the old Republican anti-government rhetoric (remember George W Bush’s complaint about regulatory “overreach”?) has combined with unabashed elitism to pave the way for the Trumpian groundswell that this year left Greenspan admitting he had no one to vote for. But for making sense of the man, note that it is a worldview which was flattering for a self-made man, as Greenspan was by the late 1950s, and an outsider who had broken into the political elite by the 1970s. Note, too, that it is an ideology that elevates the maestro conducting the economy with flair, and marginalises the technocrat painstakingly designing intricate regulatory systems.
Greenspan was a creature of his times and was shaped by prevailing cultural, political and economic trends. In the end, it is too simple to think Greenspan ran the economy. Just as much, the economy ran him.