The One-Eyed Chairman (Page 3)

Bubbles and Meltdowns

Greenspan's finance-friendly passivity was demonstrated most fatefully when the stock market developed its infamous "price bubble." The chairman refused to take preventive action. Some $6 trillion was lost by investors in the meltdown, but Greenspan treated it like an unfortunate act of nature. Government does not know enough, he insisted, to intervene in such situations. All it can do is clean up the mess afterward. Greenspan was frequently compelled to do so.

The governing culture at the Fed was also changed dramatically under Greenspan's tutelage. Libertarian clones were appointed to various top positions--officials who take principled pride in their refusal to act as vigilant regulators. The president of the Richmond Federal Reserve Bank warns of the danger of policing the banking industry's "predatory lending" practices too stringently. The Chicago Fed president attacks public schools as a government monopoly. A Federal Reserve governor (and former bank lobbyist) testifies on the need for the Fed to provide larger subsidies for the major banks.

The contrast with Greenspan's predecessor, Paul Volcker, is instructive. Volcker was a savvy and imperious career regulator, adept at befogging politicians and willing to impose harsh discipline on the economy (his long, brutal recession in 1980-82 launched the process of disinflation that Greenspan completed). But Volcker also distrusted the lemming-like behavior of bankers and the faddish enthusiasms of financial markets. He managed his monetary policy close to the vest, hoping to keep the "money guys" off balance and a little intimidated by the Fed's power. Greenspan wanted markets to trust him, even like him. If he provided ample "information" and sprung no surprises, he thought financial-market participants would behave in reasoned, responsible ways. Never happened. But they did like him. They knew he was on their side.

While many contradictions accumulate around Greenspan's governance, none are more obvious than this: The chairman ruled like a one-eyed king, who chose to see only half of the reality before him. He applied rigorous discipline to the real economy, always ready to slow things down to block any price inflation in goods and services, especially in wages. Often he erred deliberately on the side of pre-emptive toughness--tamping down economic growth even when there was no price inflation at all.

Yet the king simultaneously ignored the truly ferocious price inflation under way in financial markets during his long tenure. If working-class wages rose smartly, that was a sign of inflation threatening prosperity. If stock prices rose explosively, that was evidence of good times ahead. For true believers in the conservative orthodoxy, there was no contradiction--capital was growing, unions were being decimated. If you embraced "efficient markets" theory, you would naturally be reluctant to go against the stock market's soaring valuations. If you thought markets were self-regulating, you could count on them to correct themselves. In a way, they did--eventually and violently--by succumbing to a massive "correction"--much to the sorrow of millions of hapless investors, pension funds and others who had gotten no timely warnings from their government about what was ahead.

Greenspan could not claim ignorance. In private meetings with Federal Reserve Board colleagues as far back as 1996, he was repeatedly warned of the dangers posed by the growing stock-price bubble. He declined to take any action or even warn the public. Yale economist Robert Shiller, whose book Irrational Exuberance impressively predicted the coming bloodbath, was a rare critic. A public official who fails to alert investors to such risks "is no better than a doctor who, having diagnosed high blood pressure in a patient, says nothing because he thinks the patient might be lucky and show no ill effects," Shiller wrote.

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