Celebrating Greenspan’s Legacy of Failure
One of the most interesting and weirdest tenures ever for a Fed chairman
Bloomberg, August 11, 2014
On this day in 1987, Alan Greenspan became chairman of the Federal Reserve Board. This anniversary allows us to take a quick look at what followed over the next two decades. As it turned out, it was one of the most interesting and, to be blunt, weirdest tenures ever for a Fed chairman.
This was largely because of the strange ways Greenspan’s infatuation with the philosophy of Ayn Rand manifested themselves. He was a free marketer who loved to intervene in the markets, a chief bank regulator who seemingly failed to understand even the most basic premise of bank regulations.
The stock market was having a scorching year in 1987, up 44 percent during the first seven months of the year. Stocks peaked within weeks of Greenspan being sworn in. He was still settling into the job when Black Monday came along and U.S. markets plummeted 23 percent on Oct. 19.
Welcome to Wall Street, Mr. Chairman.
The contradictions between Greenspan’s philosophy and his actions led to many key events over his career. The ones that stand out the most in my mind are as follows:
1. The 1987 Crash: The day after Black Monday, the Federal Reserve issued the following statement: “The Federal Reserve System, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the financial and economic system.” The Fed added substantially to reserves through open market operations, and cut the federal funds rate to 6.5 percent from 7.5 percent. Markets finished 1987 slightly up on the year.
The lesson learned by Greenspan was simply: It’s easy to clean up after market volatility. The worst one-day crash in history was “resolved” with some minor course corrections by the Fed.
History has shown, however, that this was the wrong lesson. And the Fed’s “mission creep” (as termed by Michael Panzner) would continue throughout Greenspan’s tenure.
2. FOMC chastises its chairman for cutting rates between meetings: During the 1990–1991 recession, markets were dealing with a variety of macroeconomic factors: the S&L crisis, a real estate slump, the first Persian Gulf War, and a spike in energy prices had all taken their toll. Greenspan decided on his own to cut rates half a point, days prior to the February Open Market Committee meeting. Indeed, why he acted solo is a question yet to have a satisfactory answer. It led to a near open revolt of FOMC governors; as the New York Times put it, they “curtailed the authority of its chairman, Alan Greenspan, to reduce rates on his own.”
3. The Greenspan Put: In July 1995, the Fed cut the funds rate 25 basis points. What made this so odd was that it followed a string of seven rate increases over the previous 12 months. There was another 25 basis point rate cut in December, and yet another in January of the following year.
There was no real justification for these cuts. The mid-1990s economy was growing nicely, and the stock market was up significantly, over 34 percent. In 1996, equities tacked on another 20 percent for the year.
Wall Street correctly figured out that these cuts had put a floor under equity prices. Thus the “Greenspan put” was born. The subsequent modification of this policy was a statement now known as the Irrational Exuberance speech.
4. Slashing Rates in 2001-02: Amid the 2001 recession, and immediately following the Sept. 11 attacks, the FOMC brought rates down to new lows. Rates were under two percent for three years, and at one percent for a full year. This was simply unprecedented, and the impact was severe. Everything priced in dollars ramped higher. Inflation expanded rapidly, Gold began a decade-long bull market, and oil increased from about $20 to almost $150. The housing market took off, and rose faster and higher than ever before, setting up the inevitable denouement.
5. The Flaw: Greenspan ultimately conceded there was a “flaw” in his market ideology. Easy Al, as traders had taken to calling him, recognized that allowing radical deregulation of credit markets was a mistake, as was opposing rules on derivatives and ignoring the subprime and non-bank lenders at the heart of the financial crisis.
It’s worth noting that, Greenspan’s intellectual hero, Rand, also turned her back on her own philosophy, living off of Social Security and other government aid before she died of cancer in 1982.
In the end, a central banker cannot be both concerned with asset prices yet comfortable with collapsing bubbles. These are inherently contradictory beliefs. That is why Greenspan’s tenure was both disastrous and fascinating.