Greenspan and The Age Of Ignorance
Posted by: Brian Dennehy
In coming days much will be written about 2008, what went wrong and who is to blame. Bankers will be blamed by most. Greedy bankers? It’s a bit like blaming a rabid dog for biting you. The base instincts of bankers are a constant through history. The real blame lays fairly at the door of the variable actors in this tragedy – the central banks, particularly Alan Greenspan. It is not clear that we are now in a better place, on the contrary.
This is the third in our series marking the 10 year anniversary of the Great Financial Crisis, when, according to later testimony, the UK banks were within hours of closing all cash machines. It was not an exaggeration to say we were on the verge of Great Depression II. To understand what went wrong requires going back in time a little.
“The results of the unregulated activities of the investment bankers… were disastrous.”
That was the conclusion of a US Senate investigation – but it was 1934, and it was exploring the reasons for the Great Depression. Little had changed by the time another Senate committee got together to uncover what happened in the period leading up to Autumn 2008.
In pursuit of profit, the committee concluded that the investment banks didn’t just make loans which they knew were likely to fail, causing extreme social hardship…
“They built a conveyor belt that fed these toxic loans into the
financial system like a polluter dumping poison into a river.”
Strong stuff, and they continued:
“The thread is unbridled greed, and the absence of a cop on the beat to control it”
The unbridled greed is a given through history. But what about that cop?
Call A Copper
In 1978 Charles Kindleberger published his classic “Manias, Panics, and Crashes”. He believed that markets work well on the whole, but occasionally get overwhelmed and need help, in particular to prevent severe damage to the wider economy.
At such times central banks and governments have a roll to intervene, was his thesis. Hardly controversial today, yet at the time this was regarded as a provocative challenge to those who believed that bubbles and manias should be allowed to run their course – let bubbles burst and from the ashes a new upswing will emerge if you just let nature take its course.
Hail Alan Greenspan
In 1987 the Kindleberger view began to take hold when a young Alan Greenspan arrived to head up the US Federal Reserve just 3 months before The Crash. After the markets closed on Black Monday he publicly announced that the Fed was ready to pump money into the economy to stop the Wall Street rout. He was publicly minded to save not just the economy, but also the stock market.
Other than uttering those words he didn’t need to (publicly) do a huge amount more in the coming days – markets quickly recovered their poise. It was what he did in subsequent years which laid the foundation the fragile world in which we now find ourselves.
Until he resigned in 2006 (good timing!) he went on a mission. He no longer needed to save the world as in 1987. His mission was to put the US economy (and by extension much of the world) on steroids – at least it is difficult to reach another conclusion from the facts.
For example, he cut rates 11 times in the 18 months following the end of the 1990/91 recession, building a launching pad for the dot com bubble. He came to the markets rescue time and time again. With record rates of 1% in 2003/4 he provided the hot air for a series of bubbles, in the US and beyond, which were to bring the world to its knees in 2008.
These bubbles simply would not have happened without the reckless actions of Greenspan.
The Greenspan mantle was passed to Ben Bernanke, and then Janet Yellen. Neither acknowledged the need to take action to deal with bubbles in US equities or bonds, which are now measurably somewhat greater than in 2008.
No one disputes the need for the extreme action which central banks and governments took 10 years ago. But emergency action (such as almost zero interest rates) persisted long after the emergency was over, which has meant the fire lit by Alan Greenspan from the late 1980s has had even more fuel thrown over it.
In 2017 Janet Yellen proclaimed “I don’t believe we will see another crisis in our lifetime”. In July 2005 Bernanke said a housing bubble “is a pretty unlikely possibility”. And Greenspan denies responsibility for everything, and has spent the last 10 years telling anyone who will listen that whatever happened wasn’t his fault.
The Art Of Central Banking
The intervention which Kindleberger encouraged is art – it is never to be presumed, and always to be in doubt, otherwise investors assume they will always be bailed out, and so would take bigger risks and get into more debt… Yet this is precisely the environment which Greenspan created, and his successors have sustained.
Here we are on the 10th anniversary of the Great Financial Crisis, and the debt pile is greater, the quality is worse, and the US stock market is markedly more over-valued.
If Kindleberger was here today I think he would be highlighting the mantra of his contemporary, Hyman Minsky – stability breeds instability. He believed periods of prosperity, inflated by debt and financial innovation and speculation, give way to financial instability. He went further and said that the financial system is inherently unstable, fragile, and prone to crisis.
Don’t stray too far away from the emergency exit.
* The title is inspired by “Greenspan’s Bubbles – the age of ignorance at the Federal Reserve” by William Fleckenstein – recommended if you would like to read more about the remarkable Greenspan tenure.