Now in a new book called Bubble Man: Alan Greenspan and the Missing 7 Trillion Dollars, Peter Hartcher, the former Washington bureau chief for the Australian Financial Review, condemns Greenspan for the stock market crash of 2001. Greenspan’s failure to take the exuberance out of “irrational exuberance,” says Hartcher, had “dreadful consequences.”
Contrary to traditional thinking, Hartcher asserts that it is (or ought to be) the job of the nation’s central bank to put a stop to manias in asset markets, such as stocks or housing, even if other benchmarks of economic performance–such as inflation and growth–look balanced and healthy. And if that’s so, isn’t Greenspan responsible for failing to take action that would have spared many investors, preserved the retirement funds of hardworking Americans and prevented the economy from suffering a recession that threw many people out of their jobs?
The answer, I think, is mostly “no,” but Hartcher makes an aggressive case to the contrary. The essence of his argument is this: Minutes of the Federal Open Market Committee meeting of Sept. 24, 1996, show that Lawrence Lindsey, then a committee member and later head of President George W. Bush’s National Economic Council, asserted that there was a stock-market bubble and that the Fed should prick it. If left alone, the bubble could rival the overvalued markets in the United States in the 1920s or Japan in the 1980s. Greenspan appeared to agree about the state of the market. “I recognize that there is a stock market bubble problem at this point, and I agree with Gov. Lindsey that this is a problem that we should keep an eye on,” the Fed chairman replied. He assured Lindsey that the Fed could increase margin requirements, further limiting the amount of money investors can borrow to buy stocks. “I guarantee that if you want to get rid of the bubble, whatever it is, that will do it,” Greenspan said.
Just two and a half months later, on Dec. 5, Greenspan uttered the now famous words “irrational exuberance” in a speech to the American Enterprise Institute, albeit in the form of a question. “How do we know when irrational exuberance has unduly escalated asset values which then become the subject of unexpected and prolonged contractions, as they have in Japan over the past decade?”
Then he did nothing. Hartcher quotes the Nobel laureate economist Joseph Stiglitz, who in his book, The Roaring Nineties, asks, “If he [Greenspan] thought share prices were heading out of control–if he feared the wider effects of a bubble–why didn’t he go ahead and act?”
In addition to raising margin requirements, the other tool at Greenspan’s disposal would have been a sharp rise in short-term interest rates. That year–starting in September 1996–is a crucial period in Hartcher’s account, perhaps the only time that Greenspan could have raised interest rates without harming the economy. The quarter percentage point increase in March 1997 wasn’t enough; the market kept climbing. By July 1997, the Asian financial crisis had hit, and the Fed had to maintain low interest rates so that a healthy American economy would be an engine of growth for the rest of the world. Then in fall 1998, the Fed again loosened the monetary reins after the sharp fall in the value of the ruble and the collapse of Long Term Capital Management, a hedge fund whose downfall spread panic throughout the financial world. “He had missed his best and last opportunity to temper the madness by raising interest rates,” Hartcher writes.
Not only did Greenspan fail to raise rates or margin requirements, but also in the late 1990s, the Fed chairman actually began to talk in glowing terms about the New Economy, conceding that technology had helped increase productivity. Hartcher writes that Green-span “surrendered in the face of political difficulty,” “clasped the whole madness to his aged breast with the zeal of a convert,” and “sought to hide himself in the orthodoxy of the day and the madness of the crowd.”
(Perhaps to compensate for writing about a dry topic like monetary policy, Hartcher employs an occasionally overwrought prose style, writing, for instance, of the “lewdly seductive slut of greed,” and compares rational market theory to cannibalism–doing so in graphic detail.)
Hartcher says that Greenspan, rather like the free-spending American consumers, mortgaged his future (his long-term legacy) for the sake of the present (his short-term popularity). Writes Hartcher, “Alone among all the many participants and enablers and bystanders and regulators in and around the Great American Bubble, Alan Greenspan had all five of the elements necessary to try to manage it in the national interest.”
Hartcher does raise the fundamental question about the Green-span era. Maybe inflation and economic growth aren’t the only two guideposts for the Fed. Sharp increases in stock or housing prices clearly spur people to spend more because they feel rich–however fleeting their paper fortunes may turn out to be. That spending, in turn, can distort our economy. This is something the Fed already analyzes when it’s trying to predict future behavior, calculate investment, and calibrate its policies. But should it move more aggressively and target bubbles so that they don’t harm the economy when they explode?
The problem with this proposition is that the size of the bubble looks clearer in hindsight. In late 1996 and early 1997, when Hartcher suggests Greenspan should have moved to tame the stock market, the market’s levels were modest compared to what they were two or three years later. And perhaps Greenspan thought he had time, not realizing that crises in Asia and Russia would later prevent him from raising interest rates for fear that a slowing of the American economy would mean disaster abroad.
Because Greenspanrarely gave interviews to journalists for direct quotation, Hartcher’s book contains no interview with the Fed chairman. So the closest thing we have to Greenspan’s direct response (at least until his own multimillion-dollar memoir appears) is set out in the afterword my Washington Post colleague Bob Woodward wrote for the fall 2001 paperback edition of his Greenspan book Maestro. In the years since the hardcover was published, voices began to challenge the monetary pope’s near infallibility. Woodward writes that Greenspan “believed he had done all he could. He had spoken in 1996 and all the stock market did was go up.” Greenspan felt to speak out more about stock market dangers “would be fighting human psychology–the perceived self-interest and greed of investors.” The Fed chairman thought he could have raised rates, “but that would have meant raising the Fed funds rate to something like 15 percent–an unimaginably authoritarian and inappropriate action by unelected officials such as himself.”
Greenspan colleague, former Federal Reserve Board governor, Laurence H. Meyer, provides more nuance. In his memoir, A Term at the Fed, Meyer states that the Fed should have acted more aggressively to pop the bubble either in March 1997 or once the global financial turmoils ended. Still, Meyer offers several strong reasons for why the Fed hesitated.”[H]ow confident could we be in our ability to estimate fundamental [stock market] value? And how willing should we have been to substitute our judgment for that of millions of investors?” While Hartcher says Greenspan missed an early opportunity to tighten monetary policy and stop the mania, Meyer wrote: “Were equities substantially overvalued in December 1996? At the time, I didn’t think they were and I still don’t.”
Meyer also notes that while the stock-market bubble was concentrated in technology stocks, raising rates or margin requirements would hurt all companies. “The concentration of the bubble in a narrow segment of the market suggests the need for a scalpel, whereas monetary policy affects the whole market, acting more like a hammer,” Meyer wrote. Raising interest rates also would have increased unemployment. Meyer said “I was more concerned with protecting jobs than with the interests of equity owners.”
The biggest flaw of Hartcher’s book is this: Just as Greenspan’s admirers gave him more credit than he deserved, Hartcher, by blaming Greenspan for the flaws of the 1990s’ economy, gives Greenspan credit for having more power than he actually possessed.
As Hartcher himself concedes, a whole host of factors other than Greenspan’s failure to intervene helped create the stock-market bubble: excitement about a technological revolution, corrupt corporate executives, unprofessional accountants and unscrupulous investment bankers, lax securities regulation, and gullible investors. To blame the central bank is to minimize the responsibility other institutions, corporations, and individuals share for the economy’s failings.
By overemphasizing the damage done in the market and economic downturn in 2000-2001, Hartcher skews the answer to the question of whether Greenspan or any other Fed chairman ought to use the powers of his office to protect investors from bubbles given the Fed’s other, arguably bigger, responsibilities. The hot economy of the late 1990s had real benefits for many workers, especially those lower down on the income scale who didn’t have any stock portfolios. And while a disproportionate chunk of economic gains flowed to America’s wealthy, some job gains among middle- and lower-class Americans were real and a surprising number survived the recession.
Meyerpoints outthat Green-span made a calculated decision to avoid slowing down low-inflation economic growth in order to pop a stock market bubble. Did Green-span make the wrong choice? If your sole concern is stock prices, perhaps he did. If your primary concern is income growth among average Americans and fighting unemployment among the poorest Americans, then arguably he didn’t.
Hartcher describes some of the perils that lie ahead, but fixing them will not be the sole, or perhaps not even the principal responsibility, of Ben Bernanke or any other Fed chairman. The fault, dear readers, lies not with our central banker, but with ourselves.
Steven Mufson covers energy for The Washington Post. He covered economic policy from 1990 to 1993 and later served as the papers Beijing bureau chief