WEEKEND READS

Prophet and loss: Alan Greenspan and the making of 2008 financial crisis

alan-greenspan-reuters (File) Alan Greenspan | Reuters

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.

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 in 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.

ALAN SHRUGGED

In 1959, at the annual meeting of the American Statistical Association, a 33-year-old economist named Alan Greenspan argued that central banks should beware of letting financial markets get too comfortable. The Federal Reserve’s success in smoothing economic fluctuations in the 1920s, he said, had led to the dangerous belief that “the business cycle is dead.” The crash and depression that followed were “inevitable” consequences of that cavalier attitude toward risk.

Sound familiar? As Fed chairman from 1987 to 2006, that same Alan Greenspan presided over what was called “the Great Moderation,” a period when business-cycle downturns were muted and investors became convinced that the Fed had their backs. Greenspan hadn’t forgotten his earlier worries: A few months before he stepped down, he cautioned that “history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.” Sure enough, it didn’t.

The risk that financial excess would lead to trouble was a central theme in Greenspan’s economic work, as Sebastian Mallaby reminds readers again and again in his excellent biography “The Man Who Knew.” So why did this Man Who Knew fail to act upon his knowledge?

Well, for one thing, there’s the question of what exactly he should have done. Mallaby, whose previous book was a sympathetic (and engrossing) history of hedge funds, doesn’t buy the argument that the deregulation of financial markets that began in the 1970s and accelerated in the 1990s was all a mistake — or that Greenspan could have stopped it if he wanted to. You may disagree.

What Mallaby cannot forgive was Greenspan’s tendency in his later years at the Federal Reserve to bend over backward to avoid upsetting financial markets. In 1994, Greenspan’s Fed brought on a bond-market crash to stop a feared resurgence of inflation. But in late 1998 and early 1999, and again in 2004 and 2005, Greenspan steered the Fed away from actions that might have tamped down financial exuberance.

Why? The answer at the time was that there was little threat of inflation, and the Fed’s main job is keeping consumer prices stable. But Greenspan understood how asset bubbles could harm the economy. A more convincing answer is that while Greenspan was (and is) a more capable economist than he gets credit for these days, he was an even better politician. And committing the institution he ran to a battle that it might not win and that he wasn’t absolutely certain needed fighting was not the kind of thing a smart politician did.

This view of Greenspan as a political animal is central to Mallaby’s account. It is also, along with the often amusing depictions of Greenspan’s personal life, what makes it so much fun to read. In his autobiography, published in 2007, Greenspan depicted his rise to power as a series of lucky coincidences. Mallaby describes in detail how Greenspan climbed to the top, and it’s a much more interesting story.

It is not heroic like the biographies of 19th-century business titans that Greenspan read when he was young. It is instead an archetypical second-half-of-the-20th-century tale of a young man of modest means rising to lofty status in business and in government by dint of intelligence, diligence, quirky charm and a Machiavellian streak. Greenspan comes across in these pages (and in person; I’ve met him twice) as a decent, thoughtful, likable guy. Just not as an innocent, and also not as a hero.

You may be familiar with two landmarks of Greenspan’s early years: He was a professional jazz musician and a disciple of the extreme-libertarian novelist/philosopher Ayn Rand. Greenspan’s stint as a clarinet and saxophone player in a second-tier swing band started when he was 18; his Rand infatuation began in his late 20s.

In between, he had excelled as an economics student at New York University, taken a job at the business group now known as the Conference Board and on the side started studying for a Ph.D. in economics at Columbia University with the famous empiricist Arthur Burns. Then the veteran economic consultant William Townsend, impressed by Greenspan’s Conference Board writings, asked the 26-year-old to become his partner. Greenspan agreed, dropping his graduate studies, and the firm of Townsend-Greenspan remained his professional home until he went to the Fed 34 years later. After Townsend’s death in 1958 it was his firm, and it provided a uniquely congenial platform. There was no corporate ladder to climb, no tenure committee to answer to, just clients — an ever-growing roster of investment firms and corporations — to impress with his reams of data and his insights into the truths they revealed.

It was Greenspan’s libertarianism that propelled him into politics, but his other attributes that made him successful at it. At Rand’s urging, he delivered a series of lectures in 1963 and 1964 on the “Economics of a Free Society,” inveighing against, among other things, “one of the historic disasters in American history, the creation of the Federal Reserve System.” A few years later, a Rand fan who had attended one of the lectures brought Greenspan into Richard Nixon’s orbit. He signed on as a policy adviser to Nixon’s 1968 campaign, and learned quickly — when he drafted a position paper condemning farm subsidies — that a libertarian purist wouldn’t get far in a presidential campaign. So he adapted, and found other ways to make himself useful, such as putting the IBM 1130 computer at Townsend-Greenspan to work collating and evaluating poll results, NateSilver-style.

Greenspan did not join the Nixon administration — he wasn’t going to be more than a deputy something or other, and that had little appeal. But he did stay involved, serving on the famous presidential commission that recommended the end of the military draft and a less-famous one that called vainly for deregulation of interest rates. He also played a role in the notorious effort to get Arthur Burns, whom Nixon had appointed as Federal Reserve chairman, to stop raising interest rates and bad-mouthing the economy in the run-up to the 1972 election.

Nixon’s aides had been planting negative (and false) stories in the news media to pressure Burns, to no effect. So they asked the Fed chairman’s former student to talk some sense into him. Greenspan insisted to Mallaby that he refused, but Mallaby offers ample evidence that Nixon and Co. believed that Greenspan had not only talked to Burns but had also done a bang-up job of it. In any case, Burns soon started saying positive things about Nixon’s economic policies, the Fed stopped raising rates and the Great Inflation of the 1970s was unleashed.

This is probably the biggest scoop in the book (Mallaby gives a research assistant, Jon Hill, most of the credit for it), but there are many other juicy stories about Greenspan’s subsequent rise from chairman of the Council of Economic Advisers in the Ford administration to informal minister without portfolio in the early Reagan years to boss of the Fed. These stories generally don’t make Greenspan look bad, just politically astute to a fault.

With the election of Bill Clinton, who proved endearingly willing to let Greenspan do his thing, the need for such maneuvering waned. By the time George W. Bush took office, Greenspan’s reputation was such that he was pretty much untouchable. He had gained for himself and the Fed a remarkable amount of freedom. He just chose not to use it.

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