Greenspan’s Bubbles by William Fleckenstein

Former Federal Reserve chairman is a main character in the economic collapse of 2008, despite his three years spent trying to turn down the role. The role of the Federal Reserve warrants substantial discussion when looking at the events of last year, not only for their actions and inactions in the years prior to the meltdown, but also for their dramatic actions during the crisis, and the role they will play in the future. But Bill Fleckenstein’s book is not about the Federal Reserve, per se, so I will hold those comments for a future review (David Wessel’s In Fed We Trust is coming up very soon in my reading list). Fleckenstein’s book was a specific analysis of Alan Greenspan, the famous Federal Reserve chairman who served as head of the central bank from 1987 to 2006. Deemed the “maestro” by an adoring press and adoring Congress, I suspect Fleckenstein would like to use a different word. This book is a devastating analysis of the reign of Greenspan, and it warrants a close look if we are to be serious in our evaluation of the 2008 meltdown.

Fleckenstein’s underlying thesis is that Alan Greenspan’s entire time as the head of the central bank was defined by his propensity to cut interest rates when they did not need to be cut, and to leave them low for far too long. The asset bubbles we have experienced in the last decade are Alan Greenspan’s fault, per Fleckenstein, as his easy monetary policy created a culture that condoned speculative risk taking, and encouraged moral hazard. Fleckenstein does one thing very, very well to defend his thesis – he uses Greenspan’s own words as his primary evidence over and over again. Fleckenstein appears to have caught Greenspan in a massive lie, citing his repeated quotes throughout the pre-dotcom meltdown, as well as the pre-housing meltdown, that we were not in bubbles, and contrasting those with post-crash quotes from Greenspan that asset bubbles can not be identified as a matter of basic definition. Greenspan can not have it both ways. He can not say that they looked to see if we were in a bubble and concluded we were not, but then say years later that bubbles are fundamentally unidentifiable. Greenspan is almost pathological in his denial of wrong-doing in the midst of the 2008 meltdown. And while some of us may be tempted to look at the specific policy errors of 2002-2005 to indict Greenspan, this book finds that conclusion insufficient in its identification of Greenspan’s wrongdoing. The problem of this Fed chair did not begin in 2002, but rather, existed throughout his entire reign.

Greenspan is an interesting character. I can not claim to be a sympathetic observer of his, as I truly find his unwillingness to own his mistakes in this crisis repugnant. It seems surreal to me that he never admitted that increasing margin requirements would have been a good idea at subduing the tech bubble of the late 1990’s, and it seems positively extra-terrestial to me that he will not admit the 1% fed funds rate that he left in place for all of 2003 was an utter disaster. By utter disaster, I am accusing the Fed chairman of pouring gasoline all over the fire that had already ignited. And I am further charging him with refusing to pull out the firehoses, or call the fire authorities, once it was up and burning. But, I am not accusing him of lighting the fire. I believe that is my one minor critique of Fleckenstein’s fine book: He is far too hyperbolic in the nature of the criticism he throws Greenspan’s way. The central bank enabled this to balloon into a bubble of epic proportions, and they are responsible, but I still see the genesis of the housing bubble as being in political policy errors (see my Thomas Sowell review here). Regardless, Greenspan is obstinate beyond words in accepting any blame, and I have no doubt that history will not be so kind.

But there is something else that Fleckenstein does that needs to be addressed. He not only calls out Greenspan for a career of bailing out speculators, but he slams Greenspan for his role in justifyng the speculation itself. One thing he does not do is criticize the very institution of the Fed itelf (at least not in this work). In fact, he praises at times the legacies of past Fed chairmen, Paul Volcker and William McChesney. I do not have the impression that Fleckenstein is necessarily going after the existence of the central bank. But he makes a very valid point here: if there is going to be a central bank, the job description needs to be limited to stabilizing asset prices. A strong dollar – a reliable currency – this is their true charter. Fleckenstein happens to sure my view that the dual mandate of the Humphrey-Hawkins Full Employment Act is the real sin of the Federal Reserve (the notion that they are to simultaneously achieve full employment, and price stability). The Federal Reserve should be focused on one mandate, and one mandate only, and that is the preservation and integrity of the U.S. dollar. Price stability, not full employment, is their chief end. What Humphrey Hawkins has done in produce success in exactly zero of their two mandates. However, I believe Fleckenstein caused me to realize something for the first time through this book, and it goes beyond the failure of Full Employment Act (which he does not address in this book), and it goes beyond Greenspan’s failure to identify or remedy asset bubbles, even as most of society could see the bubbles forming. It is Greenspan’s pioneering assumption of the role of “economy cheerleader”, that I think is most disturbing.

Throughout the tech boom of the 1990’s, Fleckenstein writes, Greenspan preached to any audience who would listen the sermon of “productivity” and “new economy”. In the mid-2000’s, he could not be quieted on the beneficial role that mortgage equity withdrawal was playing in stimulating the economy. I am not as uncomfortable with the massive flaws and errors in Greenspan’s sermons as I am the mere existence of the sermons themselves. Alan Greenspan was completely and totally out of bounds to assume the role of market cheerleader. It is beyond inappropriate for a central banker to do anything other than call balls and strikes. Market observers and speculators may form their own opinions about what is happening in the economy at given times; they do not need to have the undue influence of the Federal Reserve chairman while they do their work. When someone in the position of authority and reputation as the chief central banker of the world decides to preach the new paradigm of eternal productivity, he encourages others to join particular sides of trades that may be wholly inappropriate. That influence is not welcome. Greenspan has done a lot to tarnish his legacy, but I believe the “age of bubbles” Greenspan reigned over should be known as the era in which the Federal Reserve chairman decided to take on the role of economic deity in our society. He was not good at it, because it was not his proper role. Our markets function better without central bankers playing the role of cheerleaders.

The subject of bubbles is one that I will be continually addressing throughout this series. Alan Greenspan helped to exacerbate them, and denies culpability. He has repeatedly demonstrated an economic ignorance about where bubbles comes from, how to identify them, and how to best get out of them. That is his legacy. And Fleckenstein has done yeoman’s work in exposing it.

I close with the following quote from the September 7, 2002 issue of The Economist, cited by Fleckenstein in this fine work:

“The correct test is not whether a bubble can be deflated without some loss of output. Rather, it is whether the early pricking of a bubble causes less pain than letting it grow only to burst later. The longer a bubble is allowed to inflate, the more it encourages the build-up of other imbalances, such as too much borrowing and investment, which have the power to turn a mild downturn into something nastier.”