Greenspan and the unintended making of the Great Recession

Kyran Fitzgerald

We will soon mark the 10th anniversary of the collapse of Lehman Brothers — the event that more than any other sparked what has now become known as the Great Recession.

Back then the recently retired chairman of the US Federal Reserve, Alan Greenspan, had long been feted as a great hero of business.

But he was coming under increased criticism as cracks in the financial system started to appear. Mr Greenspan presided over the US economic and financial system for almost two decades.

When he stepped down, early in 2006, his colleagues fawned over him, yet within a matter of months, the critics would be circling.

It would be left to his successor, Ben Bernanke, to preside over a remarkable recovery with considerable assistance from the White House under Barack Obama, elected to office, in November 2008, as the sheer scale of the crisis had become clear to the wider public.

Mr Bernanke may have slain the great dragon of deflation, but time will tell whether the easy money or quantitative easing (QE) strategy he presided over will also end up in the dock of history, along with many of the grand governing economic strategies that have preceded it.

It is now widely accepted that QE has served to massively boost global asset prices, boosting the wealth of some of the very people whose irresponsibility served to bring about the Great Recession.

Savers and retirees, in particular, have suffered along with renters, particularly the young.

Wall Street has rebounded while ordinary people and “the US Main Street” businesses — the intended beneficiaries — have largely lost out.

They face the horses of a commercial apocalypse in the form of technological disrupters such as Amazon.

Despite this, one suspects that the verdict on Mr Bernanke will be largely favourable.

The picture in the case of Mr Greenspan is an altogether more complex one.

A recent biography by Sebastian Mallaby sets out, with considerable success, to capture this remarkable individual, who was born in 1926 and brought up by a single mother with the support of her parents, in modest circumstances, on Manhattan’s 163rd Street.

A talented musician, he played the clarinet in a professional jazz band before opting for academic life.

By the mid-1950s, he was a statistician, building up a successful consultancy business.

Politics beckoned. He served as a campaign adviser to Richard Nixon before joining the administration of Gerald Ford as chairman of his Council of Economic Advisers.

A protege of the right-wing controversialist, Ayn Rand, he never lost his belief in the virtues of the free market.

In 1987, he succeeded Paul Volcker as chairman of the US Federal Reserve, the de facto global central bank.

Mr Volcker was famous for having wrung inflation out of the system by means of a hawkish interest rate strategy that brought an economic recession in its wake.

Mr Greenspan was fortunate to preside at the bank over a long economic recovery that began in the middle of the President Ronald Reagan years.

It was the high point of globalisation, marked by the opening of capital markets.

He forged a close relationship with President Bill Clinton despite differences in age and outlook.

The pair revelled in the “don’t worry, be happy” world of the 1990s which came to a shuddering halt with the

bursting of the dotcom bubble and the with the attacks on September 11.

In the late 1990s, a crisis in East Asia and later, Russia, came close to sparking a financial conflagration.

The collapse of the derivatives firm, LTCM, with losses in equity of $2bn (€1.72bn) threatened a liquidity crunch. A crisis was staved off as creditor banks agreed to a recapitalisation.

Yet the Fed chairman told Congress that, in his view, “hedge funds such as LTCM contributed to a sophisticated pricing system” and were “one of the reasons why the use of capital ( in the US ) is so efficient”.

After the dotcom bust, Mr Greenspan became concerned that the US would be hit with a Japanese-style depression and with that in mind, pushed down borrowing costs with consequences that would prove to be disastrous.

The Fed chairman had become convinced that the cost-reducing effects of innovation and globalisation were such that a tough anti-inflation policy was no longer required.

The result was an asset bubble of frightening proportions, one that looks remarkably similar in its timing and impact to that in Ireland at the time.

The George W Bush administration does not come well out of all of this.

By then, 100% loan-to-value loans were the norm. Adjustable rate mortgages offering an early repayment holiday to borrowers became the norm.

Borrowers were no longer required to provide documentary evidence of their credit history. Companies like Countrywide encouraged staff to engage in non-stop cold calling. Successful salespeople were offered trips to the Super Bowl.

Mr Greenspan presided serenely over the Bacchanalian excess.

A Fed governor, Edward Gramlich, held hearings into abusive practices but as Mr Mallaby notes, he failed to “connect the dots between abusive lending and systemic risk”.

Federal rules were introduced in 2001 to control the activities of lenders.

Initially, they impacted on close to 40% of borrowers, but industry efforts at circumvention ensured that by 2005, a mere 1% of borrowers were covered by the rules.

The Fed chairman did warn in February 2004 about the “extraordinary thin buffers of capital” and a “systemic risk sometime in the future”. Yet he did not act on these warnings.

Ultimately, Mr Greenspan preferred to put his head in the sand as the years caught up with him. He ultimately was unwilling to face down the Bush administration.

He was not alone in taking the soft option. Funds flowed in from European banks whose lending activity was barely regulated by the ECB.

The central bankers, adept when it came to developing macroeconomic models, were at sea when it came to analysing and taking the reins of the runaway wild horse that was the financial sector in the high point of globalisation.

ECB bankers such as Jean Claude Trichet most definitely have a case to answer. They and their political counterparts were the engineers behind a financial structure — the euro project — that ended up riven with cracks. If they had been engineers behind real structures, they might well have faced many awkward days in court.

There are a few people who emerge well out of Mr Mallaby’s account.

As president of the Reserve Bank of New York, the future President Obama-era treasury secretary Tim Geithner ought to increase Wall Street’s buffers, but to little avail as traders grew ever more headstrong.

By the summer of 2007, almost one in six subprime mortgages were delinquent.

In July, two hedge funds run by Bear Stearns collapsed. That September came the run on the British lender Northern Rock.

We were on our way, though few of us fully realised it at the time.


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