Greg Ip | April 09, 2008
ALAN Greenspan's reputation is under siege, and he's incredulous.
Hailed three years ago as "the greatest central banker who ever lived", the retired chairman of the Federal Reserve now is being criticised for his management of the US economy before he retired in 2006. The Fed's low rates and laissez-faire regulatory oversight during his final years are widely blamed for sowing the seeds of today's financial crisis - one that began in the US housing market and is now battering banks, stock markets, borrowers and consumers around the world.
For much of his 18 years atop the world's most influential economic institution, Greenspan was lionised for the economy's performance. Now, he notes, he's being second-guessed for it.
"I was praised for things I didn't do," Greenspan said during one of three interviews at his sun-drenched office in Washington, DC.
"I am now being blamed for things that I didn't do."
Now 82 years old, Greenspan wants to set the record straight before the ink dries on the first draft of the financial crisis's history. He doesn't deny that he cares about his reputation. But the larger issue at stake, he says, is getting the lessons of the crisis right.
"The (wrong) evaluation of this period - and how to avoid the problems associated with it - will give you the wrong answers and the wrong policies," Greenspan says.
The scrutiny of Greenspan's record has taken on urgency now that the Bush administration and congressional Democrats are skirmishing over how to overhaul US financial regulation. If Greenspan's critics prevail, financial companies will likely face tighter oversight and less freedom in the products they offer. If Greenspan's views carry the day, the trend towards self-policing will continue.
A repudiation of Greenspan's monetary policies could tempt the Fed to raise interest rates relatively quickly after the current crisis passes, and even attempt to deflate future bubbles with higher interest rates.
Greenspan says he doesn't regret a single decision. In his view, many critics are ignoring evidence in his favour and failing to assess the process by which he made decisions. To prove his point, he draws on texts of old speeches and news clippings and even a letter, written by a now-deceased colleague, downplaying a policy disagreement the two once had.
His tone modulates between earnest, bemused and dismayed. No stranger to controversy, he easily brushes off the comments of long-time antagonists. He chuckles at political cartoons, such as one likening his recent memoir, The Age of Turbulence to OJ Simpson's If I Did It.
The criticisms that get under his skin are those from friends and former colleagues, many of them respected economists who backed his policies at the time but now say, in hindsight, that the calls were wrong.
"I do take it seriously if my peers think I have misstated the facts," he says. "But where's the evidence? Too many people make accusations by assertion. I think it's improper."
Greenspan still has many admirers. His memoir has sold about a million copies. He collects six-figure fees to answer questions for audiences, typically assemblies of financial professionals. He has signed consulting contracts with three firms, including Germany's biggest bank, Deutsche Bank; the world's biggest bond-fund manager, Pacific Investment Management; and Paulson & Co, a hedge fund that made billions betting against housing. Hillary Clinton recently called for his inclusion on a panel to advise on the foreclosure crisis.
The prevailing view among critics faults Greenspan on two main counts.
First, they say, his Fed lowered rates too much from 2001 to 2003 to cushion the economy from the bursting dotcom bubble. Then it took too long to raise them again. Low rates fuelled mortgage borrowing, driving home prices to unsustainable heights.
Second, they say, the Fed was lax in its regulatory role. The central bank failed to press for stiffer rules for underwriting mortgages to people who ultimately couldn't afford them, they say. Also, they say, the Fed failed to anticipate banks' exposure to risky home buyers, leaving them with too little capital to absorb the eventual losses on those mortgages.
At the time, Greenspan expected his policy to boost housing because the rest of the economy was relatively unresponsive to lower interest rates. Based on decades of his own research, he believed a buoyant housing market would spur consumers to borrow against home values and spend more. This would not produce a housing bubble, he predicted, because it was difficult to speculate in homes and the memory of the 2000 tech-stock bust remained fresh.
Greenspan now admits he was wrong about the improbability of a housing bubble. Yet he has long maintained that bubbles are an unavoidable feature of a dynamic economy. He pulls out a 1999 speech and shows, underlined in green marker, passages in which he warned of recurring but unpredictable patterns of overconfidence followed by investor panic. He does not share some foreign central bankers' belief that their job is to defend against excessive asset-price inflation: no sensible policy, he maintains, could have prevented the housing bubble.
"I am reasonably certain that I am right here," Greenspan says. If proved wrong, he adds, "I will change. I do not have a vested interest in holding wrong ideas."
When Greenspan left the Fed in January 2006, the economy was strong, inflation was low and prices of stocks and houses were buoyant. But seeds of crisis began to germinate a few months later.
Home prices stopped rising. House construction turned down. Delinquencies mounted on sub-prime mortgages, home loans made to borrowers who didn't qualify for, or weren't offered, regular mortgages. That triggered the collapse of several mortgage lenders and hedge funds. In August last year, the troubles spread to banks in Europe and the US. In September, Greenspan released his memoir. As discussion of the book saturated newspapers and television, his successor, Ben Bernanke, delivered the first of six interest-rate cuts to date aimed at countering the crisis.
Opinions of Greenspan trended down with the economy. Last month, senator Chris Dodd - a Connecticut Democrat who in 2005 said Greenspan commanded "tremendous respect" in the Senate - laid the blame at his feet. Dodd, chairman of the Senate Banking Committee, charged that Greenspan's policies had left "millions and millions of American consumers" facing foreclosure.
Anti-Greenspan sentiment has cropped up on blogs such as The Mess That Greenspan Made and Greenspan's Body Count, the latter a tally of deaths purportedly linked to the real-estate bust. Hedge-fund manager William Fleckenstein's book Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve, released in January, is now in its fourth printing.
Greenspan says many of the criticisms against him are unjust. He is particularly perturbed by attacks over a 2004 speech in which he suggested that more borrowers would benefit from adjustable-rate mortgages. Interest rates were at a historical low at the time, which means that those who held on to the mortgages would have seen rates adjusted upward.
Greenspan says the speech merely pointed out that many people who get a 30-year mortgage move or refinance long before it matures. Eight days after giving the speech, he says, he clarified his comments to say he didn't mean to disparage 30-year fixed-rate mortgages.
"I find it profoundly disturbing" that critics cite the recommendation and not the retraction, he says, tapping his fingers on the table in front of him.
"In all seriousness, this is really quite unfair."
He has also thrown himself into analysing the current crisis, immersing himself in economic data as he did at the Fed - though now without 200 PhD economists to assist him. The questions his clients currently ask go to the heart of his own legacy: What drove the housing and mortgage bubbles? How far will they deflate? What will happen to the economy?
Unable to find out how many homes are bought with sub-prime mortgages, Greenspan spent several months designing his own data system. Some of what he has learned is going into a new chapter for the paperback edition of his book, to be released in August. It will explain events after last June, when he finished writing the original.
The biggest question mark over Greenspan's record is his decision to slash interest rates to 1 per cent in 2003 and wait to raise them until 2004, and then only slowly. In this debate, Greenspan and his critics seem to speak different languages.
Critics talk about the events that followed - an overheated housing market and a rapid build-up of debt on Main Street and Wall Street, much of which is now painfully unwinding. Such critics are now in the majority: In a recent Wall Street Journal survey of 55 economists, 84 per cent said the Fed was too slow to raise rates.
Two members of the policy-making Federal Open Market Committee at the time - William Poole and Robert Parry, presidents of the Federal Reserve banks of St Louis and San Francisco - have both recently argued that, in hindsight, rates were too low for too long.
Greenspan focuses not on events that followed the policy but on the thinking behind it. "I don't remember a case when the process by which the decision making at the Federal Reserve failed," he says.
He says rock-bottom interest rates actually went against his "19th century" aversion to easy money. "My inner soul didn't feel comfortable," he says. He justified the policy by noting that at the time, inflation was falling persistently and the risk of deflation - though small - seemed real, despite his prior assumptions that it was impossible with a dollar unlinked to gold.
To prevent deflation, the Fed spurred growth by keeping interest rates low. At the time, he notes, the only dissenting votes on the Fed policy committee were those who wanted to set rates even lower. The Fed, he said, initially raised rates gradually to give businesses and investors time to prepare. In 2004 and 2005, it raised rates faster than private economists expected.
That judgment is now being questioned by Greenspan's peers, including Stanford University economist John Taylor. The Treasury Department's top international hand from 2001 to 2005, Taylor is famous in academic circles for his Taylor Rule, a formula the Fed and other central banks use as a guide to setting interest rates.
At a 2005 Fed conference in Jackson Hole, where the world's monetary elite gather each year, Taylor agreed with a study presented there by two Princeton economists who concluded that Greenspan was history's greatest central banker. Taylor credited Greenspan for the nation's "extraordinary economic performance", praising in part his "timely" rate cuts in 2001 to 2003 and, later, his "well telegraphed" rate hikes.
Taylor struck a different note last August. Speaking at the same Jackson Hole event, he used his own model to argue that rates were kept too low for too long, overheating housing prices and setting the stage for a bust. He repeated the charge before Congress in February.
The critique is painful for Greenspan. The men have been friends since the mid-1970s, when Greenspan was chairman of then president Gerald Ford's Council of Economic Advisers and Taylor was on staff. Greenspan later hired Taylor to work with his consulting firm, Townsend-Greenspan & Co.
Earlier this year, Greenspan invited Taylor to lunch at his office and challenged his former protege's assessment. In Greenspan's view, if the Fed's policies were to blame, the housing bubble would have been mostly limited to the US. Yet, he argued, many other countries had housing bubbles, too. A better culprit, he suggested, was the glut of savings globally. Savers were competing to make loans, keeping long-term interest rates low in many countries and fuelling housing demand.
Taylor countered that there was no savings glut, citing data that showed world savings equalled world investment. Greenspan called Taylor's data "irrelevant". Interest rates are affected by intended investment rather than actual investment, Greenspan argued, adding that intentions are hard to measure.
The discussion, if arcane, was vintage Greenspan. The former Fed chief has long differed from conventional economists in his disdain of models and his readiness to second-guess economic data. While that has given him insights that escape his peers, it has also created chasms in the ways he and they see the world.
Taylor says he stands by his 2005 praise of Greenspan's tenure as a whole. "Monday-morning quarterbacking" of a few episodes, he says, "shouldn't change the overall assessment".
Greenspan's regulatory record has also come under review. The Federal Reserve is charged with supervising banks and enforcing and interpreting consumer-protection laws such as the Home Ownership and Equity Protection Act. Today, Greenspan's hands-off oversight is routinely cited for lax lending standards that steered many borrowers toward mortgages they ultimately could not afford.
Greenspan says that on regulatory issues, he deferred to the Fed's staff or to the Fed governor in charge of consumer matters. Former Fed officials concur but some add that senior staff reflected Greenspan's distrust of regulation. Without a prod from its chairman, they say, the Fed was often slow to expand consumer protection.
Greenspan scorns the notion that he intimidated others into falling in line. "What I find amusing is that history is being rewritten with me being portrayed as a force that overwhelms and persuades all these highly educated, very intelligent people to do my bidding," he says. "That's just silliness. It's a terrible rewrite of history."
The Fed took several steps to tighten oversight of sub-prime lending, but until last year, none were aimed at the type of adjustable-rate sub-prime mortgages whose phenomenal growth in 2005-06 is at the root of the current crisis. Greenspan notes the Fed lacked good data on those mortgages.
On at least one occasion, Greenspan did resist colleagues who urged further oversight. In 2000, then-Fed governor Edward Gramlich, who was in charge of the Fed's consumer affairs, proposed to Greenspan that the Fed's staff examiners look for abusive lending practices in banks' lightly regulated mortgage affiliates.
In an interview with The Wall Street Journal last June, three months before his death, Gramlich said that at the time, he generally considered sub-prime loans a good thing. He didn't then know the extent to which the loans would become a problem, but he wanted the "Fed to be a leader" in cracking down on predatory lending.
Greenspan recalls that he demurred, saying that the Fed should not have oversight of these lenders. Shady operations could portray their Fed-regulated status as a seal of approval, he suggested, giving them unearned credibility with customers.
Since the interview with Gramlich was published, it has been cited repeatedly as evidence of Greenspan's neglect. Asked about it, Greenspan draws a piece of paper from his desk. It is a letter in Gramlich's shaky handwriting, written a few days before his death last September.
"You were a magnificent central banker and a great leader," Gramlich wrote. "I truly wish the press would stop kicking you around on this sub-prime supervision issue. What happened was a small incident."