Alan Greenspan's Window Is Always Open

Well, this is awkward. Alan Greenspan, hailed for most of his nearly two-decade run as chairman of the Federal Reserve as a market savant of the first order, is now assailed from all sides for the Fed’s apparent role in overinflating the country’s garish housing bubble. The charge is a fraught one, reports Fortune magazine’s Geoff Colvin, since should it stick, it will fundamentally reshape perceptions of Greenspan’s legacy at the central bank. Already the sweep of the emerging indictment is such, Colvin writes, that “four years after leaving the Fed as the Greatest Central Banker Ever, the longest-serving chairman, the Maestro, Alan Greenspan is the designated goat.”

But Greenspan is not a goat who will go quietly into the good night. He takes vigorous issue with the criticism of Fed policy that is now fueling all the anti-Greenspan rancor: that from the pivotal years of 2002 to 2005, when mortgages remained artificially low and housing prices continued to drift ever higher above the realm of consensual reality, the Fed failed to put the brakes on the downward drift of interest rates. This critical oversight, Greenspan’s critics charge, meant that the Fed kept pumping the derivatives-fed fiction that no serious risks were accruing in the market long past the point of any empirical support.

Greenspan’s rejoinder is that the true causes of the 2008 housing crash were global-that prices kept spiraling upward because of a global savings glut, which channeled capital’s insatiable quest for exotic new forms of market expression into the opaque wonderland of securitized debt. Emerging market economies such as China kept unleashing new investments that, Colvin writes, “naturally pushed interest rates down globally-thus the decoupling of mortgage rates from the Fed funds rate, and the global nature of the housing boom.”

To detractors who point out that this upsurge of global capital didn’t really so much, you know, exist, Greenspan has an elegant rejoinder. As Colvin summarizes, it goes as follows: “You have to look at intended saving and intended capital investment, not actual saving and investment. After all, saving and investment by definition will always balance.” The mere existence of an overabundance of capital was enough, in other words, to prompt markets across the globe to keep their mortgage rates artificially low-thereby permitting housing prices across the globe to ratchet up ever higher.

There’s an obvious let’s-change-the-subject quality to the global credit argument. It seems akin to a kid finding himself in the custody of school truant officers, blurting out “Look over there-China!” and hotfooting away from his distracted captors in the other direction. For one thing, if the glut of intended investment capital holds the markets so powerfully in its mystic sway, one might expect the bubble to have taken off when all the pent-up savings from former command economies began flooding the markets after the mid-nineties collapse of communism. Nothing of the sort occurred, of course-many of those funds flowed into currency and tech markets, which hosted bubbles of their own, to be sure, but nothing anywhere near as calamitous as the one that crashed to Earth in 2008.

And whatever power one attributes to hulking reserves of intended global investment capital, the U.S. economy certainly hasn’t been neck deep in savings over the past few decades-quite the opposite, in fact. Household savings rates hit zero in mid-2004, and went into the negative column in 2006-the first time households gave up saving since the bleak Depression year of 1933. Wall Street responded to this development not with the tonic of fiscal restraint, but by treating spiraling debt as though it were in fact capital. And while the U.S. investment economy continuing burrowing down this rabbit hole, Greenspan’s Fed looked placidly and indulgently on.

Indeed, Greenspan’s track record on the fallout from securitized debt strongly suggests that the failures of his Fed regime were not so much technical-misreading the proper market cues at a critical juncture in the mounting housing crisis-as they were ideological. It’s bracing in this regard to revisit the Fed’s role in the famed derivatives-fueled crisis of the late-nineties, the rescue of the Long-Term Capital Management hedge fund.

It’s quite remarkable, in hindsight, to note the many structural affinities between that bailout-which permanently moved the term “Too Big to Fail” into the nation’s political lexicon-and the market conditions that produced the housing meltdown a decade later. When the fund seized up in 1998, rolling financial crises in Asia and Russia helped persuade Fed regulators that LTCM’s failure would grievously distort securities prices in U.S. markets, and Greenspan, largely accepting the fund’s explanation that it got swept up into an unforeseeable run of bad luck, organized a Fed-orchestrated buyout. (The overall market wasn’t in the same free fall that it would be in 2008, so the government didn’t siphon cash directly into the fund, but rather marshaled a consortium of banks to raise the necessary capital.)

In his excellent chronicle of the episode, When Genius Failed, financial journalist Roger Lowenstein revisits the main objection to the Fed’s plan-that it would create what’s called a moral hazard by emboldening swashbuckling speculators in derivative markets to believe that the Fed would always protect them against the mortal consequences of their bad decisions. But, as Lowenstein goes on to argue:

Greenspan’s more consistent and longer-running error has been to consistently shrug off the need for regulation and better disclosure with regard to derivatives products. Deluded as to the banks’ ability to police themselves before the crisis, Greenspan called for a less burdensome regulatory regime six months after it. His Neolithic opposition to enhanced disclosure-which, because it allows investors to be their own watchdogs, is ever the best friend of free capital markets-served to remind one of the early Greenspan who (in thrall to Ayn Rand) once wrote, ‘The basis of regulation is armed force.’

And Lowenstein’s estimation of the core lesson the Fed failed to heed in the whole LTCM mess has an especially prophetic ring for those of us condemned to live in the wreckage of its long-term policy aftermath:

If the Long-Term episode proved anything, it is that the system of disclosure that worked so well with regard to traditional securities has not been able to the job with respect to derivatives contracts. To put it plainly, investors have a pretty good idea about balance-sheet risks; they are completely befuddled with regard to derivatives risks…. Why, then, does Greenspan endorse a system in which banks can rack up any amount of exposure that they choose-so long as that exposure is in the form of derivatives?

Why, indeed? Hey, look over there-India!

Chris Lehmann is definitely too big to fail.