The Alan Greenspan Era

Arthur Levitt Chair, Securities & Exchange Commission (1993-2001)

Alan is a good friend, and I knew him before I came to Washington and knew him well when he was there. We played golf and tennis together; we saw a good deal of one another.

He was probably the most highly respected and most revered person in the city at that time. He was more than an economist. He is a very broad-gauged individual with large numbers of friends and a tremendous following in Congress, where people hung on every word -- most of which they didn't understand, but because it was Alan, they thought it was great.

Now, keep in mind, I have a theory about these government jobs, whether it be chairman of the Federal Reserve or head of the SEC or the FTC [Federal Trade Commission] -- to some extent, the Wizard of Oz jobs. It's not the rules; it's not the regulations -- it's what they say. It's the issues they stake out and how they come across.

Alan was a great wizard. No one understood what he said, but he said it in such a way that everybody bought it. Everybody hung on every word. And he was a good enough politician that he had great respect on both sides of the aisle, and very few people wanted to take him on or challenge him, because he knew so much more than they did, and if he didn't, he certainly appeared to.

In a nutshell, what was his economic philosophy?

It's been reported pretty broadly that Alan was a laissez-faire, Ayn Rand, free-market economist. I think that's simplistic. He was much more than that. He was thoughtful, careful, measured, not at all impulsive, very traditional and pretty set in his ways. …

... As the 2000s are going along and 9/11 has happened and other things start to happen, what's he doing? What's he worrying about?

I think Alan worried about the markets all the time. Alan cared passionately about U.S. markets, probably knew more about them than anyone in the history of the country. Was extremely thoughtful, sensitive, intelligent. Was not close-minded, was open to hearing presentations. He was firm in his philosophy, and we certainly differed in a number of respects, but I would have to say that I regard Alan Greenspan as one of the greatest public servants in modern history, in spite of what some regard as his failure to anticipate the problems in an overleveraged environment. We were lucky to have him as chairman of the Fed.

He didn't seem to be concerned about where's the regulation, how do we manage this bubble?

I would say that more often than not, I had to prove to Alan why this regulation or that regulation made sense. I've always regarded the Federal Reserve as being the banker's protective association -- more concerned with safety and soundness than investor protection.

My obsession was investor protection. I couldn't care less about safety and soundness; that was part of the system. But if you don't have the confidence of investors, if you don't have the protections that are offered by private rights of action and the enforcement activities of the SEC, you have a universe of investors that don't trust, and we can't have markets that aren't trustworthy.

After the 2008 meltdown last fall when he sits before Congress, ... it's got to be an incredibly painful moment for him, that sort of mea culpa moment. What did you think when you saw that happening to him?

I thought that this is a stand-up guy that is realistic; that knows that life in Washington places people at the mercy of factors that are very often beyond their control; that good markets made all of us in that era look smarter than we really were. And when things change, we pay a price for that.

And I think all of us who went through this period all made mistakes, and wish that we had done some things differently. I don't think there's anybody who's served more than a year or so in Washington that wouldn't say the same thing.

David Wessel The Wall Street Journal; author, In Fed We Trust

The chairman of the Federal Reserve has an enormous amount of power that comes with the job -- the power, of course, to move interest rates in one way or another that affect how the American economy works, in terms of how much we have to pay to borrow, how much businesses pay to borrow, how much we make on our savings, and all that stuff.

But Greenspan's power in the '90s and early 2000s went far beyond the tools that just happened to come with the job. He was the wise man. He was the one who members of Congress sought out at hearings for his blessing about their particular proposal about taxes.

He was the one to whom Bill Clinton went, very early in his tenure, to validate his deficit-reduction plan and to sort of assure the world that Bill Clinton was of sound mind and could actually manage the U.S. economy.

And Greenspan had a very clear -- he was not at all secretive about it -- ideology about regulation. He really didn't think that regulators could do very much to stop people from doing what they were going to do anyway. He thought that he would cite his experience on the board of JPMorgan as evidence that the banks knew a lot more than the bank examiners would ever know, and that the best thing that could happen would be to let the banks and other big investors who had a lot of money in the game police the poker table.

His view was that they were sophisticated. They had a lot at stake, and if things were going wrong, it would be in their interest to do something about it.

And I thought one of the most fascinating moments of the recent period is when Greenspan goes before [Rep.] Henry Waxman's [D-Calif.] committee, and Henry Waxman asks him, "Was your worldview wrong?" And Greenspan says yes, that it turns out that sophisticated money investors do not always do what is in their interest or in the interest of the system.

I think that confession tells you almost everything you need to know about what he got wrong in the '90s.

What must that have been like for him that day? …

I think it was pretty difficult. Let's remember: When Alan Greenspan left office at the beginning of 2006, he was, as George Bush put it at the time, a rock star. He had served four presidents. He was seen as almost a miracle worker. The American economy had had some of its best years under his tenure, even thought it had had to undergo the shocks of a stock market crash, a terrorist attack, a couple of wars, a presidential election that almost challenged the foundations of our democratic legitimacy.

Through all that, we had extraordinary growth. We had waning unemployment. We had not much inflation. And we had this great technology boom that he had foreseen -- the Internet and all -- that would help increase productivity so the economy should grow stronger.

So he was celebrated in a way that we hadn't seen before in someone who had a job like the chairman of the Federal Reserve. Remember, his predecessor, Paul Volcker, had been pilloried for putting the economy through a wrenching recession to break the back of inflation. Greenspan was the one who brought us the New Economy. Everything was going to be wonderful. It was never going to rain again in America.

And so, when he retired, he had become almost papal-like in his infallibility. And then, soon after he leaves office, the whole thing falls apart, and the book -- I think it's kind of funny. He wrote a book about his time, called The Age of Turbulence, as if he had presided over a turbulent age, the end of the Cold War, the changes in the world economy. But the age of turbulence really began after he left.

So I think he went from being a hero to being a villain, probably.

I think he believes -- and I think he's right -- he got more credit for the good times and more blame for the bad times than he deserves. And that hearing before Henry Waxman was kind of his way of saying to people, "I recognize I got it wrong," which is not something that comes easily to him. …

… How much of what actually happened rests at his feet?

I think it's wrong to say that one person is responsible for the worst calamity to hit the U.S. economy since the Great Depression itself. What makes it extraordinary is the number of people and institutions that failed. …

But if you were making the list, the 10 or 12 things that accounted for this, you'd have to put the Federal Reserve and Alan Greenspan on the list. There are people who say, with hindsight -- and I think that's important -- that he kept interest rates too low too long, and that encouraged this borrowing and speculation.

I think that's probably right, but only with hindsight. There are people who say -- and I think they have a much stronger case -- that he did not use his regulatory powers in ways that, in retrospect, were prudent. And there was some evidence at the time that there was some need for that.

I think that his approach to regulation, his ideology, if you will, held him back. A different Federal Reserve chairman, perhaps even the current one, Ben Bernanke, might have been more aggressive on that. …

He had this really interesting metaphor, which was the economy was like a very big and sophisticated airplane. And in the old days, the airplanes would shake a lot. But then they got modern electronics, and the modern electronics would compensate for the turbulence. So the plane would shake less, because these very sophisticated electronics would absorb the turbulence.

And in his mind, the real economy, the one where we all live and work, was like the airplane, and the financial markets were the sophisticated electronics. So there would be a lot of volatility sometimes in financial markets, and there would be all these sophisticated instruments -- in the case of the financial system, these derivatives and stuff -- and they would be absorbing the risk so the economy could be more stable.

And you know, it made a lot of sense, because one of the things that distinguished the economy of the '90s and the 2000s was the economy itself was pretty stable. It was called by some economists "the great moderation." We didn't have the big booms and busts of inflation and then higher interest rates and then recession that had marked earlier periods in American history.

So he believed, and he convinced a lot of other people, that the financial system was helping to stabilize the real economy. And if you messed with it, you would have more turbulence in the real economy.

Joseph Stiglitz Council of Economic Advisers (1993-1997)

Greenspan, remember, always said that he was a believer in Ayn Rand, a believer in free market. Little bit curious for a central banker, because what is central banking? It's a massive intervention in the market, setting interest rates. So to me, that kind of perspective, to say, "I believe in free markets, but I'm going to accept the job at central banking," is a contradiction. You almost have to be schizophrenic.

The question is, what should be the interventions in the market? And we know we want some regulation -- how far do we go? And over the years, there's been a well-developed theory about when markets fail. We have a long historical experience and lots of economic theory.

Interestingly, some of the economic theory that was developed in the last quarter century -- my own work talking about what happens when there is imperfect information, which is, of course, at the centerpiece of financial markets -- explains that the reason that the invisible hand seems invisible so often is that it's not there. Markets are often not efficient. We can identify the nature of those failures -- not perfectly, but we can -- and say, "These are the instances in which we need government intervention."

And I think that many of these protagonists didn't really understand those basic economic ideas. They were wedded to, you might say, the outmoded ideas of free-market economics, which assume perfect information, perfect competition, perfect markets, perfectly informed market participants, no exploitation -- all assumptions that are totally irrelevant to a complex modern economy.

But it looked to them, as at first the tech bubble and then the housing bubble grew, with relatively little, from their point of view, government intervention, that in fact there was an invisible hand, and it was all good, and it was guiding us along, yes?

If they had thought about it for a minute, they would have realized that the visible hand of the government had been there over and over again.

Just think about what the banks had done abroad. They had repeatedly, repeatedly viewed bubbles, misallocated capital, and government -- U.S. Treasury, IMF -- had repeatedly come and rescued them. We had the Latin America crisis at the beginning of the '80s, involving almost every Latin American country. We had the Mexican crisis in '94-95. We had the Korean crisis, the Indonesian crisis, the Thai crisis in '97. We then had the Russian crisis and the Brazilian crisis in '98. We had the Argentina crisis. The list is long, involving hundreds of billions of dollars, again, in government intervention.

So yes, the economy did work, but it was because the government kept bailing it out. It kept bailing out the financial sector. So they made a fundamental misinterpretation. ...

In the fall, after the meltdown, Alan Greenspan goes before the Congress, and he does a sort of mea culpa. What did you make of that?

I think it was a moment of honesty. I think he had genuinely believed in self-regulation, which I view as an oxymoron. Now, as an economist, we realized that the whole notion of self-regulation was an absurdity, because one of the reasons for regulation is what we call externalities. A failure in a bank or a failure of the financial system has an effect on everybody. And the bank is looking only at its direct cost and benefits, not on the cost on the rest of our society. And it's those external effects that provide the motivation for government regulation. ...

He didn't admit to that problem, but what he did admit to is he thought that at least the bankers would have enough rationality that they would look after their self-interest; that they would not engage in excessive risk taking to the point that they would put their shareholders and bondholders in jeopardy. But to me, if you look at the incentive structures that were confronting the managers of these banks, they had incentive structures that encouraged excessive risk taking and shortsighted behavior. ...

Do you think it was hard for Greenspan to say that?

Yes, I do, because it was so much part of his mind-set and his conviction. I think Greenspan was honestly doing what he thought was best for the economy for a long period of time. He was a public servant, and we should never forget that. For 18 years, he worked very hard, night and day, for what he thought was in the interest of the American people. And he did this, I think, with a particular mind-set and talking to a particular group of people that helped shape that mind-set with a particular set of beliefs. He could have gotten a lot more money if he had been in the private sector. So he really did sacrifice a great deal to pursue what he thought was in the public interest. ...

Mark Brickell Chair, International Swaps and Derivatives Association (1988-1992)

[What did Greenspan think of derivatives?]

We can go to the public record to answer that question. He had said that he perceived derivatives to be one of the greatest innovations in recent financial history; that the contracts -- because they helped businesses and banks and governments manage the risks to which they were already exposed more efficiently than they could have done before -- were doing something that was useful for the financial system.

And to see that business, which had grown up inside the banking system, jeopardized by the creation of legal uncertainty where it hadn't existed before, would have elicited a strong reaction from anyone who understood the business and the banking system as well as he did. …

Michael Greenberger Director, CTFC Division of Trading and Markets (1997-1999)

When I went to work with [Brooksley Born] and she was telling me, "This is what you're up against," she told me that she had had this lunch with Alan Greenspan, and he had said to her probably that she and he were going to have a disagreement about something, and the subject was fraud. And he didn't believe that fraud was something that needed to be enforced or was something that regulators should worry about, and he assumed she probably did. And of course she did. I've never met a financial regulator who didn't feel that fraud was part of their mission, but that was her introduction to Alan Greenspan.

What does it tell you -- what did it tell her -- that he didn't believe fraud was a problem?

From what it told her and from what I could see in my observations of Alan Greenspan was that this was a man who was living almost in another era; that he was a total believer that the markets were self-correcting. For example, the reason he thought that fraud shouldn't be the worry of regulators is, well, if somebody committed fraud in the business community, the rational workings of the market would be that people wouldn't do business with that person, and therefore they would die on the vine. And so the free market self-corrects and takes care of fraudulent actors. ...

... Is there something about him by then? Is [he] just untouchable?

Yes. Look, the economy, by and large in this period, is booming. There are hiccups. You have the Asian financial crisis, the default on the Russian ruble. Later on, you have the Long-Term Capital Management fiasco. But basically it's an upward move. We're in the middle of the dot-com bubble. ... He is a force to contend with. He's very, very highly regarded, although there's an understanding that he's coming at issues from a very orthodox free-market view, and he's not happy with the regulatory structure. He's tolerating it. He's not happy about it.

Roger Lowenstein Author, When Genius Failed

Alan Greenspan was a financial consultant, who was hired by Jerry Ford, first to be head of his Council of Economic Advisers in the '70s. ...

He did a very good job chairing the Social Security commission for Ronald Reagan and brought together disparate points of views, and got some changes there.

And so he's picked as Fed chief, and he's a Fed chief unlike, say, Paul Volcker, who preceded him, who didn't have a particular ideology. ... Greenspan had an ideology, which is along the lines of Ronald Reagan -- less regulation, less government, more markets.

And in particular, when he saw these innovative instruments in markets, derivatives, he really got kind of weak-kneed for them. … He had a great love and respect for, and maybe infatuation with, the powers of free-market innovation. …

… Arthur Levitt said, "He was the wizard, and he was the best wizard I ever saw." In what sense?

He was unintelligible. … It was almost a joke, the way he would speak. It was so imponderable, the sentence constructions. … He so qualified everything. The circumlocutions were so complex that you couldn't understand practically what he was saying. And you know, people tend to think, "Wow, I can't understand him, he must be smart." And he is smart.

If you read his memoirs, they're engaging and surprisingly plainspoken, pleasingly so. But that was not how he was. So that was one element of his wizardly-ness.

He was very willing to go with arcane data, indicators that hadn't been widely watched. He was very willing to say, "In the bad old days of high inflation, people were very afraid to let the unemployment rate get too low." You didn't mishear me. I mean, unemployment's a bad thing. Low unemployment's a good thing, but not for central bankers, because they're worried if unemployment was too low, companies would have to pay too much for labor, and then inflation would go up.

And Greenspan would say, you know, maybe we can let this ride a little more, just because more people are getting work, nothing bad is happening, and maybe the economy is so productive that it won't result in price increases. And that basically happened.

The simplest answer for why he was viewed as an oracle is if you take the period -- he came in right before the market crash of '87. Of course, that was a rough start, but they managed through it. From that point on, markets had a 12-year glorious run, really, around the world. Equity markets went up. Interest rates went down. Inflation went down.

So chicken and egg. Did Greenspan cause it? Are we right to call him a wizard? Or was he running the ship in a buoyant period? I'm sure it's some of each. But good things were happening around the world. …

If one crossed him, how could he be?

I can't answer that.

Nobody crossed him?

People were intimidated by him. The Fed is a collegial, a consensual body. The governors are equal in terms of their votes -- something like the Supreme Court, where there's a chief justice, but they all get one vote and everything. And the interest-rate moves are supposed to be dictated by the group.

However, that really, really was a truth that described a larger fiction, because it became Greenspan's Fed. And nobody did cross him. Nobody really disagreed with him. But very occasionally he would get one vote the other way, almost a show, but I don't think ever two.

And there was no doubt who was maneuvering interest rates. It wasn't the Board of Governors; it was the governor. It was Alan.