The Prosecution’s case against Alan Greenspan
by Gonzalo Lira
Posted originally September 3, 2010
Should Alan Greenspan, the former Chairman of the Federal Reserve Board (1987–2006), be tried for Crimes Against the Economy, put up against a concrete wall, handed a cigarette, offered a red blindfold, and then executed by firing squad?
“What, me worry?” Yes—absolutely. No question. (And this coming from an anti-death penalty, anti-abortion Catholic.) Herewith, the case for the prosecution. There are four main charges against the so-called “Maestro”:
One — Irresponsible market liquidity, which created rampant moral hazard:
The Accused was instrumental in creating the pernicious policy mentality of “providing markets with necessary liquidity”—essentially, throwing money at every problem.
This first started within days of Greenspan’s assuming the role of American central banker: The frenzy that caused the stock market crash of October 1987 was doused by Greenspan’s pledge to provide “all necessary liquidity, should the need arise”. This instantly soothed the markets as surely as a hit soothes a heroin junkie — within a few months, it was as if the panic had never happened.
After that, and throughout his tenure and that of his successor, Greenspan applied the same remedy, time after time, to every single problem. He became the living embodiment of that old saw: “If all you have is a hammer, every problem looks like a nail”. Or maybe Curtis Mayfield’s famous refrain would be more apropos: “I’m your pusher-man”.
This addiction to market liquidity reached a peak with the Long Term Capital Management (LTCM) fiasco of the Fall of ‘98. LTCM made a series of bad bets that went sour due to the Russian Crisis — therefore, to pay off its losses, LTCM would have to stage a fire-sale to come up with the cash. To avoid this disorderly unwind and subsequent fire-sale — which would have led to an across-the-board run on LTCM’s counterparties, and eventually a wholesale market panic — the Fed under Greenspan organized LTCM’s counterparties, and effectively underwrote the firm’s break-up, providing essentially a bridge loan to finance the whole mess.
Whether LTCM should have been bailed out by the Fed in order to effect an orderly unwind is debatable. Some believe that LTCM had to be bailed out, others believe it should have been allowed to fail, and let the chips fall where they may.
What is not debatable, however, is that, as a direct result of LTCM, two things happened: One, every Wall Street firm realized that, if they were ever hard-up for cash, Easy Al would come through with liquidity—which meant effectively that firms could begin figuring out ways to leverage themselves even more, in the pursuit of profits. They were one and all confident that Uncle Al would bail them out with liquidity, if they ever got into any real trouble.
The other thing that happened was what didn’t happen. Once the bail-out and liquidation of LTCM was carried out, Greenspan failed to learn the obvious lesson from the experience: Sophisticated financial products created under his chairmanship had directly led to the collapse of the firm, and put at risk the entire U.S. financial markets.
If brainiacs like Merton and Scholes, with killer-traders like John Meriwether at the wheel, could drive LTCM off a cliff, what about the hoi polloi of Wall Street, strapping the same financial weapons of mass destruction as Merton, Scholes & Meriwether had been wielding? What kind of trouble could they get themselves into, with all of these fabulous “innovations”?
Did Greenspan put a stop to such suicidally risky practices after LTCM? In a word: No. Which leads directly to the second charge—
Two — The Fed’s Do-Not-Touch-the Financial-Services-Sector Policy
The Accused was instrumental in creating a Do-Not-Touch attitude towards the banks, both investment and commercial—which of course led the financial sector to pursue incredibly stupid products and strategies: All in the name of “maintaining financial markets’ ability to innovate”. These “innovations” were directly to blame for the Global Financial Crisis, as they created unsustainable liabilities which sooner or later would lead to system-wide collapse. As what happened.
LTCM was the canary-in-the-coal-mine: What occurred in 2007–‘08, and the virtual freezing of the financial markets on September 18, 2008, was a direct result of the Fed’s failure to regulate the financial markets. It’s what happened when the aforementioned hoi polloi on Wall Street did more or less what Merton, Scholes & Meriwether had done — only magnified. Not only that, in this urge to “innovate”, Greenspan was key in having the Glass-Steagall Act repealed in 1999. This allowed commercial lenders to act as investment banks.
The timing of this repeal has to be emphasized: This was just over a year after the LTCM fiasco. Effectively, repealing Glass-Steagall meant that commercial banks could build their own LTCM’s right in the comfort of their own back yards. Yet here was Greenspan, egging on the repeal of the Act.
There was a reason why Glass-Steagall existed: Precisely so as to prevent large commercial banks from using their assets to become gigantic LTCM’s.
But Alan Greenspan — knowing full well the history of Glass-Steagall, and ignoring the object lesson of the LTCM debacle of a mere fourteen months earlier — ushered in the era of commercial banks as hedge funds with a smile: Or in other words, he was the midwife of the monsters now known to us all as the Too Big To Fail banks.
All in the name of “financial innovation”. I’m sure Dr. Victor Frankenstein said something similar, back in his day.
Three — Subsidized money, which radically distorted the Economy:
This is probably the biggest crime Alan Greenspan committed as Federal Reserve Chairman: The so-called “Greenspan Put”.
For the twenty years of his tenure, the Accused—supposedly an avowed free marketeer—subsidized the cost of money. Rather than let the Fed funds rate more or less mirror what banks were lending among themselves, and tighten interest rates when the economy overheated (as his predecessors had done), Greenspan instead goosed the markets: His “targeted” Fed funds rate was forever undercutting what the financial markets were dictating, as to the true price of money.
What happenes when a good — any good, including money — is subsidized? Simple: It creates market distortions. And the higher the subsidy, the greater the distortive effect.
The market distortions Greenspan’s monetary policies created led to one asset bubble after the other—each of which was bound to pop, as they eventually did. Each of which was worse than the last, which they were: Equities, dot-coms, tech, real-estate — they all ballooned, then they all popped. The latest bubble — which I have argued is the Final Bubble — are of course Treasury bonds.
The reason these bubbles popped was that the “market innovations” previously discussed, combined with Greenspan’s guarantee of liquidity, as well as the subsidized money, led to an unprecedented expansion of credit through various non-regulated, over-the-counter products, such as Mortgage Backed Securities and other Collateralized Debt Obligations.
This is why there was such a severe distortion in asset prices in the American economy starting in 1987: Rampant credit creation, a product of the Greenspan Put. It was not supply-and-demand that led assets to accrue value exponentially and seemingly without reason: It was the unregulated, uncontrolled expansion of credit, brought about by the cheap, subsidized money Greenspan was pumping out into the economy.
Furthermore, the Accused was aware of the serial bubbles blistering through the U.S. economy, and in fact warned against these bubbles—and yet did nothing, even though he had the power as Fed Chairman to stop them.
Who can forget that famous line: Irrational exuberance. Nobody can — it’s simply too memorable, too on-the-money. However, everyone seems to forget when Greenspan uttered that famous line: December 5, 1996. Before all the bubbles — that’s when Greenspan said those famous words. He anticipated the bubbles — yet allowed them to percolate, and then pop.
This regime of subsidized money not only created the various bubbles — dot-com, tech, real-estate — which finally burst in September 2008 with the Global Financial Crisis. This regime has created the condition for the final bubble — the bubble in U.S. Treasury bonds.
The subsidy in money that Greenspan created allowed the U.S. Federal government to go into more debt than it can possibly repay in real terms. It allowed the Federal government to go into much more debt than it would have been able to, if interest rates had been market-dictated. Current U.S. debt pays interest of 25¢ for every dollar borrowed — that interest would have been higher much earlier, had Greenspan not subsidized money. This would have curtailed U.S. Federal government borrowing at a much more manageable level to GDP, instead of the 100% debt-to-GDP ratio it is today, and 110% ratio it will in all likelihood be next year.
This excessive debt level of the U.S. Federal government insures that Treasury bonds will never be repaid in real terms. The market is aware of this situation — the bond market is aware that Treasuries are in a bubble, floating on nothing but air. Therefore, when — not if—the bubble in Treasury bonds finally bursts, there will be a run on comodities, most likely, which will start the hyperinflationary phase of the current Global Depression. From here, the endgame of the U.S. economy.
Unfortunately, the profession and academic discipline of Economics—and all of its current practitioners—are unaware and unprepared for the popping of the final bubble. Which leads to our final charge against the Accused—
Fourth and finally — Turning Economics into a religion with the “We Are Right Because Our God—Math—Is On Our Side” Fallacy, and marginalizing the heterodox
Because of the length of his tenure, and because of the prestige that the Federal Reserve has traditionally embodied within the academic discipline of Economics, the Accused created a rigid, inflexible, and supremely arrogant mind-set within the Federal Reserve itself, as well as in the Economics profession as a whole.
Greenspan didn’t accentuate currents of thought within Economics. Rather, he fomented a near-religious approach to math-based macro-economics, while ignoring the human aspect of society and of people. In other words, Greenspan fell for the McNamara Fallacy—and made sure that the rest of the discipline of Economics fell for the same fallacy as well, by dismissing the ideas of the heterodox, and marginalizing them from professional consideration.
Greenspan certainly didn’t invent math-based macro-economics. Math has been part of the game since Adam Smith. (And by the way, don’t let my history and philosophy degrees fool you — I’m a big old math geek. High-end philo eventually turns into math, JSTYK.) But Greenspan certainly made math-based macro reasoning not only de rigueur — he effectively excommunicated anyone who did not share his McNamara Fallacy.
Such a meretricious approach gave priority to quantitative measurements of macro-economic performance, rather than qualitative distinctions among policy options. In other words, “more in numbers is good, better in quality is irrelevant”.
This has led economists and Economics as a discipline—across all schools of thought—to value aggregate levels of whatever metric they were interested in, rather than qualitative differences which are not so easily measured. On the political Left and Right — especially among the elites, to which Greenspan shamefully catered to — each side has become addicted to measuring the health of the U.S. economy by its aggregate demand levels (on the Left), and by its aggregate asset levels (on the Right).
Yet during the twenty years of Greenspans’s tenure, though both metrics improved drastically, there is no question that the American economy deteriorated. Why? My brothers and sisters on the non-elite Left complained — bitterly — about how workers in third world countries were being exploited worse than slaves, to make the goods and products which American consumers were herded like cattle into demanding.
Meanwhile, my brothers and sisters on the non-elite Right complained — bitterly — about how American workers were being laid off in massive numbers, entire industries ripped out of the country and outsourced overseas, leaving only fast-food jobs and dead cities, all in the name of “Globalization”. Both of these complaints are perfectly true and accurate. Both of these complaints stem from the same drive that Greenspan had such an integral part in encouraging: Quantitative improvements in aggregate demand levels and aggregate asset value levels as the only measures of economic “progress”.
These two metrics were considered by the Fed under Greenspan as the only “serious” metrics by which to measure economic performance. And thus it was inculcated among America’s political and business elites as the only measure of an economy’s worth.
But they are most certainly not. Anyone with eyes that see and a mind that works can tell you that a healthy economy is not how much you buy, or how much your stock price rises. A healthy economy is dependent on the worth of the work: The sense that people in the economy have that they are building something worthwhile, and not merely selling something worthless, or providing a meaningless “service”.
But these human measures of worth were dismissed by Greenspan’s calculations. They did not fit his equations, or the equations of all the other economists who wanted to be taken “seriously” by the high-priests of the Federal Reserve.
His famously opaque pronouncements as Chairman also led Economics as a discipline to favor opacity over clarity, obscurantism over elucidation. It wasn’t Greenspan’s fault that his Congessional testimony and various speeches were so famously hermetic; as a central banker, he had to maintain a poker player’s dispassion, so as not to unnecessarily influence the markets. But it was his fault that he seemed to encourage such oracular dictates from the profession itself. Ask any reader of technical Economics papers: They are incomprehensible. And that’s being kind.
Thus his Delphic opacity, combined with the undue reverence for math-based ratiocinations, plus the near-religious dismissal of all criticisms from the “uninitiated heathen” outside the white marble halls of the Fed and academia, led Economics as a profession to completely miss out on the Global Financial Crisis, and the subsequent (and currently under way) Global Depression.
In other words, because of Greenspan, Economics failed to call the biggest crisis in our lifetimes.
Regarding the past three years of crisis: Collectively, economists and Economics have tried to wash their hands of the whole mess, by acting completely surprised while shouting to the rooftops, “Whocouddaknownit?!?” (For my foreign friends and readers: “Who could have known it?!?”, or in other words, “Who could have predicted that this once-in-a-lifetime crisis could have happened?”)
Well, the fact is, a lot of people knew this was going to happen — and they said so. They in fact bet that it would happen. Michael Lewis’ fine new book describes three such people who made fortunes off of these bets. But not only traders, many people outside of Wall Street realized something was rotten in Denmark.
Many housewives realized that there was something wrong — I personally know one, in fact: My mother. She was approached by her bank, and offered (cajoled, wheedled and sweet-talked, actually) into getting a second mortgage on her home: “Rates are so low! And house prices in your area are booming! Go on! Give yourself a treat! Take out a second mortagage and spend-spend-spend!”
To this, my mother asked the obvious question: “But what if house prices fall?” She was answered, “They can’t fall.” And she asked, “Why not?” “Because they can’t.” “Yes, but why not?” Back and forth it went for a while, until the loan officer shook his head, said my mother was “difficult” (I could have told him that), and didn’t call her again. He probably found an easier mark.
But my point is, If a housewife, without any sophisticated training in economics, could figure out the obvious, yet an entire discipline failed… then maybe the discipline’s torch-bearer has led them down the wrong path.
Greenspan: It’s Greenspan.
To conclude: The Accused — Alan Greenspan — reneged on his sworn mandate to maintain low inflation and full employment, and instead pursued a policy of maintaining — and increasing — aggregate asset values, whatsoever the cost. In other words, he actively pursued bubble-creation and inflated asset values, to the benefit of the financial services industry, and to the detriment of the U.S. and world economies as a whole.
He furthermore created rampant moral hazard, and declined to carry out his sworn duty to regulate and monitor financial markets, and to curb usurious or unsafe financial products and services. Finally, he created the conditions that—quite possibly—will lead to a Treasury bond collapse and a hyperinflationary catastrophe.
The Prosecution rests its case.