The Dangers of Success
What happened to “The Maestro”?
Public Domain. Source: IMF
Alan Greenspan chaired the Federal Reserve from 1987 to 2006. He’s a fascinating character: a mostly self-taught economist, a jazz clarinet player, a policy advisor and skilled political operator. He understood how political power ebbs and flows, and used that understanding to direct Fed policy for almost 30 years—an eternity in Washington.
His greatest success came when he successfully intuited that productivity was growing much faster in the mid-‘90s than initially reported in the economic statistics. That understanding led him to oppose raising interest rates prematurely, potentially killing off what turned out to be a period of exceptional economic growth. This insight is what earned him the moniker “Maestro”—applied in Bob Woodward’s early biography.
Greenspan was a devotee of libertarian philosopher Ayn Rand in his youth, and he retains many of his early libertarian commitments—as do a lot of Republicans. But Greenspan is no free-market ideologue. Indeed, his willingness to use the Fed’s lending, supervisory, and monetary powers to support the financial system during various crises was later called “The Greenspan Put.” This options-market term implied that investors could exercise a “put option” and sell their holdings to the Fed if markets got in trouble.
His legacy has been tainted, though, by the Fed’s actions—or inactions—in the period leading up to the Financial Crisis. Greenspan knew that markets could go off the rails, and he was concerned that home prices were growing too fast as early as 2004. Indeed, the Fed began raising rates in June of that year, despite the fact that unemployment was still up at 5.6%—one percent higher than it is now. The Fed would go on to raise rates at the next 16 consecutive meetings. Some people think the Fed should have been more aggressive in raising rates. But that’s 20-20 hindsight. At the time, most folks thought a gradual increase in rates would be the best way to gradually curb the excesses building up in the economy.
S&P 500 During Alan Greenspan’s tenure as Fed Chair. Source: Bloomberg
Greenspan didn’t oppose aggressive action by the Fed ten years ago because he was opposed to regulation or because he wanted let the market just sort it out. Greenspan knew—better than most folks—that financial instability can pose significant risks to the real economy. He just didn’t have a crystal ball telling him that key funding and securitization markets would collapse in 2008. No one did.
It’s inevitable that someone who dominated a critical institution like the Fed for as long as Greenspan did will be subject to criticism—both fair and unfair—for his actions, or inactions. We just need to be sure we learn the right lessons. Markets—like democracy—may be the worst way to inform policy and allocate assets. Except for all the other ways that have been tried.
Douglas R. Tengdin, CFA
Chief Investment Officer