Greenspan\'s Reputation at Risk as Recession Odds Grow

Date: Friday, January 11, 2008
Author: Rich Miller, Bloomberg

The next bubble to deflate may be Alan Greenspan's reputation.

Hailed as perhaps the greatest central banker who ever lived when he left the Federal Reserve in 2006, Greenspan is under attack from critics ranging from the New York Times to economists at the American Enterprise Institute for his handling of the 2000-2005 housing boom. The former Fed chairman has taken to the media to defend himself, writing in the Wall Street Journal and appearing on network television.

``He's had a bubble reputation that derived from the growth of U.S. household wealth,'' said Edward Chancellor, author of ``Devil Take the Hindmost: A History of Financial Speculation.'' ``As that goes down, his standing as a superstar will suffer.''

At stake is not only Greenspan's legacy but also the future of policies he espoused during 18-1/2 years atop the central bank. Critics blame his aversion to regulation and reluctance to use interest rates to puncture asset bubbles for the boom in mortgage lending and house prices that has since gone bust, threatening to throw the economy into recession.

In an interview, Greenspan said such criticism ignores limits on what regulation and monetary policy can achieve.

Fed Chairman Ben S. Bernanke has already moved away from the laissez-faire approach of his predecessor by proposing new restrictions on subprime mortgages.

High Marks

Academics, including Princeton University professor and former Fed Vice Chairman Alan Blinder, Fed historian and Carnegie Mellon University economist Allan Meltzer and Stephen Cecchetti, a former Fed official now at Brandeis University, generally give Greenspan high marks for his performance as chairman. During his tenure, the economy weathered two recessions, each lasting less than a year, and enjoyed its longest expansion ever.

Some of the earlier enthusiasm for Greenspan's tenure has been tempered by the performance of the economy, particularly the housing market, since he left. Blinder, who wrote in a 2005 paper that Greenspan might be the greatest central banker, now hedges on whether that assessment still stands.

Greenspan still merits a ``summa cum laude'' for his conduct of monetary policy, he said. The 81-year-old former Fed chief falls short of that lofty grade, though, for his oversight of the banking industry, Blinder said.

`Slow on the Draw'

``The Fed and the other regulatory agencies were slow on the draw,'' Blinder said. ``They could have made this debacle substantially smaller, not by better monetary policy, but by better regulatory and supervisory policy.''

Desmond Lachman, a former International Monetary Fund official now at the American Enterprise Institute in Washington, blames Greenspan's libertarian bent for his failure to curb lending abuses: ``That philosophy got us into a lot of trouble.''

Greenspan said in the interview that, while the Fed's bank examiners were hard at work during the mortgage-lending boom, ``we have to be realistic about what regulators can and cannot do.''

``It is extremely rare to uncover fraud other than through whistle-blowers,'' he said. ``You don't get at it through internal audits, you don't get it through outside audits and you certainly don't get it through bank examinations.''

Rates Too Low

Some economists, including Blinder, also fault Greenspan for fostering the housing bubble by keeping interest rates too low for too long. The Fed cut its benchmark rate to a 45-year low of 1 percent in June 2003, held it there for a year, then raised it only gradually, in quarter-percentage-point increments.

``For that episode of monetary policy, I would probably give him a B, where my overall grade is A or A-plus,'' Blinder said.

A simulation by Stanford University professor John Taylor suggested that much of the housing boom could have been avoided if the Fed hadn't cut rates so deeply and had raised them back up more quickly.

Meltzer said that while Greenspan was a ``great Fed chairman,'' he erred in ignoring warnings about the risks of keeping rates low.

``I think he lets himself off much too easy,'' Meltzer said, adding that he told Greenspan at the time that he was exaggerating the danger of deflation and thus making a mistake in cutting interest rates to 1 percent.

Rethinking Approach

Allen Sinai, chief economist at Decision Economics Inc. in New York, said the Fed's experience is leading other central banks to rethink their approach to asset bubbles.

``There is a growing body of thinking in central banking that one should not let these bubbles run and allow them to burst,'' he said. ``They should lean against them.''

Greenspan disagrees with such a strategy. ``There is no evidence that it works other than in computer models,'' the former Fed chief said. He noted that the stock market merely leveled off when the Fed doubled interest rates to 6 percent in 1994-95, then resumed its climb.

Greenspan maintained that the housing bubble was inflated not by the Fed's monetary policy but by a global savings glut that held down long-term interest rates worldwide. As the Fed raised its benchmark rate from 1 percent in 2004 to 4.5 percent in 2006, when Greenspan stepped down, the yield on the Treasury's 10-year note actually fell.

Greenspan also pointed out that the U.S. wasn't alone in experiencing a housing boom in the early 2000s. The IMF said in its World Economic Outlook last October that other nations, including Britain, Spain and Australia, experienced bigger house price run-ups than the U.S.

Cecchetti, professor of international economics at Brandeis' International Business School, said it's natural that Greenspan's legacy is being reassessed.

``With distance, you get perspective,'' he said. ``We'll get a much more balanced view of the Greenspan legacy as the years go by.''

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net