In this week’s Credit Bubble Bulletin, Doug Noland examines “The Greenspan Episode”:
…Mr. Greenspan was the undisputed governor, architect - the promulgator of what will be recognized as an epic failure in central banking. After all, he was for almost 18 years the appointed guardian over a financial system that perpetrated the greatest Credit and speculative excess in history. He dominated monetary policy like no other central banker in history. Chairman Greenspan not only negligently failed to act to reign in dangerous excesses, he became a vocal proponent for virtually all aspects of “Wall Street finance.”
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Anyone that has read history related to central banking appreciates that Alan Greenspan conveniently made up new rules as he went along. He evolved into the absolute “maestro” at concocting sophisticated rationale for seemingly every troubling development that took root in contemporary (”wildcat”) finance. Greenspan was an outspoken proponent of securities-based finance; of models-based risk management; of the great benefits provided by derivatives markets; of the liquidity benefits of leveraged speculation; of “telegraphed baby-step” monetary management; and a proponent of “risk management”-based monetary management (i.e. ease aggressively to forestall even a low probability of “deflation”). He trumpeted the profound benefits emanating from the capacity for contemporary finance to better quantify, manage and disburse risk - in the process creating a more stable financial sector. Most importantly, he championed the notion that it was preferable for the system to let Credit booms and asset Bubbles run their course - and then to treat their busts aggressively with monetary stimulus to ensure little negative impact the real economy. He claimed Bubbles were only recognizable after the fact.
He evolved into the ultimate activist and micromanaging central banker, wrapped bizarrely in the cloth of a free market ideologue. It was a most precarious amalgamation. On his watch transpired historic ballooning of the government-sponsored enterprises, of Wall Street balance sheets, and of the size, power and influence of the leveraged speculating community. Worse yet, it’s my view that he used these sectors as key inflationary mechanisms. The Greenspan Episode will be seen from a historical perspective as central banking lunacy. It was the exact intoxicant for market participants and politicians to wallow in during a spectacular boom.
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Fundamentally, the Federal Reserve “pegged” short-term interest rates, inviting leveraged speculation. I am not of the view that there is a specific interest-rate that is “right” for the system. But exceptionally low rates telegraphed to the leveraged speculating for the purposes of stimulating the acquisition of risk assets and reinflating asset markets is nefarious central banking. And never combine telegraphed “pegged” low interest rates with assurances that the Fed will always be there to sustain marketplace liquidity (underwrite securities prices), while cutting rates aggressively to mitigate bursting Bubbles. Once that path is taken there is no turning back; the central bank is held hostage by the fragility associated with escalating system leverage, speculative excess, and an increasingly maladjusted and vulnerable real economy.
Greenspan now warns against over-zealous regulation and the intrusion of governments into the competitive marketplace. Well, he should have considered these inevitable consequences when he disregarded Credit and asset Bubbles. And to admit to such mistakes to ensure a sounder monetary policy regime going forward would be statesmanlike - which he apparently is not. And while the focus these days is on government programs and regulatory reform, it is my hope that meaningful discussion emerges with regard to a sound “analytical framework” for our central bank.
