Greenspan’s Bubbles The Age of Ignorance at the Federal Reserve by William A. Fleckenstein with Frederick Sheehan McGraw-Hill © 2008 208 pages Focus Take-Aways Leadership & Management • Before he became chair of the Federal Reserve, Alan Greenspan was chair of the Strategy president’s Council of Economic Advisers. Sales & Marketing • While there, he had a very bad record as a forecaster of interest rates. Finance Human Resources • As a consultant to Charles Keating Jr., the notorious savings and loan manipulator, IT, Production & Logistics Greenspan lobbied for deregulation of the industry. Career Development • Nevertheless, as Fed chair, he became one of the most powerful regulators in the Small Business U.S. financial system. Economics & Politics Industries • He is at least partially responsible for encouraging two bubbles: the technology Intercultural Management stock bubble and the real estate bubble. Concepts & Trends • He ignored or refused to see evidence of these bubbles developing. • His remedy for the stock market bubble created the real estate bubble. • Greenspan debased the U.S. currency, creating turmoil in the U.S. financial system. • He seems incapable of admitting his errors and was not a “maestro.” • The U.S. will be paying for Alan Greenspan’s errors for a long time to come. Rating (10 is best) Overall Applicability Innovation Style 7 8 7 7 To purchase abstracts, personal subscriptions or corporate solutions, visit our Web site at www.getAbstract.com or call us at our U.S. office (1-877-778-6627) or Swiss office (+41-41-367-5151). getAbstract is an Internet-based knowledge rating service and publisher of book abstracts. getAbstract maintains complete editorial responsibility for all parts of this abstract. The copyrights of authors and publishers are acknowledged. All rights reserved. No part of this abstract may be reproduced or transmitted in any form or by any means, electronic, photocopying or otherwise, without prior written permission of getAbstract Ltd (Switzerland). Relevance What You Will Learn In this Abstract, you will learn: 1) How Alan Greenspan’s career in finance evolved; 2) How he equivocated prior to his appointment to chair the Federal Reserve; 3) What Greenspan did as Fed chair; and 4) Why Greenspan’s legacy is a costly catastrophe. Recommendation This book states the argument of those who oppose Alan Greenspan, the former chair of the U.S. Federal Reserve. William A. Fleckenstein and Frederick Sheehan, who sometimes seem to go a bit over the top in the intensity of their attacks, write that Greenspan, despite his reputation, was no “maestro.” Instead, they report he was a poor manager with a habit of either deception or self-delusion. The authors support their argument by drawing heavily on extensive quotations from Greenspan’s testimony before Congress and on minutes of the Federal Reserve Open Market Committee meetings. Although getAbstract might wish for less fervor in this presentation, it forwards this book to policy makers, financial services executives and others who wish to understand the downside of Greenspan’s policies and how he may have contributed to the U.S. economy’s current dilemma. Abstract “Greenspan cut Maestro Greenspan? rates enough Alan Greenspan was an economic consultant before and after he served as chair of while he was still the president’s Council of Economic Advisers (CEA) from 1974 through 1977. When sanguine about the President Ronald Reagan appointed Greenspan as chair of the Board of Governors of economy to get it the Federal Reserve in 1987, the nominee faced tough questions from Senator William growing again. Yet he didn’t recognize Proxmire, who noted that Greenspan had built a terrible record at predicting interest the recovery rates during his tenure as chairman of the CEA. Greenspan replied, “That is not my – just as he missed recollection of the way the forecast went.” So Proxmire read his predictions aloud. the economic Greenspan replied, “Well, if they’re written down, those are the numbers.” contraction.” In fact, Greenspan’s career before he became Fed chair was full of blunders and even, arguably, ethically questionable conduct. Greenspan’s forecasts as chair of the CEA were not simply wrong; in retrospect, they seem colored by his tendency to say what was politically expedient. During the 1980s, Greenspan worked hard on behalf of Charles Keating Jr., a notorious savings-and-loan (S&L) looter. In a letter Greenspan wrote to the “Greenspan apparently had Principal Supervisory Agent for the Federal Home Loan Bank of San Francisco, he praised little interest in Keating’s management of Lincoln Savings and Loan, saying he had shown “outstanding nipping problems success in making sound and profitable investments.” A few years later, regulators seized in the bud, that institution and Keating’s name became forever linked to S&L fraud. preferring instead to clean up Greenspan’s tenure at the helm of the Fed was consistent with his earlier actions. He whatever mess he presided over a regime of easy money that had dire consequences for the financial left behind with the same actions system in the U.S. and, indeed, the entire world. Low interest rates on bank certificates that started of deposit and on bonds led people to the stock market in search of higher returns. One the problem.” consequence of this was the equity market bubble of the 1990s. After the bubble burst, Greenspan continued to open the money spigots, and the flood of liquidity went into the housing market, creating the biggest real estate bubble in American history. Meanwhile, Greenspan’s Bubbles © Copyright 2008 getAbstract 2 of 5 Greenspan ignored the fact that banks were getting more and more deeply involved in exotic, difficult-to-understand securities markets, such as mortgage-backed securities. “Greenspan delivered his notorious Stock Market Bubbles ‘irrational Bubbles are uncommon and relatively easy to recognize. During tulip mania in the exuberance’ speech Netherlands in the 17th century, everyone seemed to be making a killing in tulip bulbs, one on December 5, of which might cost six times the average annual income. Then, quite suddenly, the bubble 1996, but nothing he said before popped. No one wanted tulip bulbs anymore and many people faced financial ruin. or after indicates that he actually Similarly, the stock market bubble of the Roaring 20s was exhilarating while it lasted, took his own until it crashed and sent the world into the Great Depression. Central bankers had nothing message to heart.” to do with the tulip bubble, but a lot to do with the Roaring 20s, and Greenspan’s Fed outdid even the Fed of the jazz age. Demographics, technology, round-the-clock market coverage on cable television and artful accounting by U.S. corporations all played their part in the speculative mania of the 1990s. However, the stock market bubble couldn’t have happened without Greenspan. He kept the money flowing with low interest rates. “The equity bubble The Fed first began loosening money in 1989 and continued the trend until 1992, collapsed and overstimulating the financial markets. Interest rates stayed at about 3% until 1994, when Greenspan drove the Fed boosted them slightly. Greenspan claimed before a meeting of the Federal Open interest rates down Market Committee (FOMC) that the rate increase had taken the air out of what might to one percent in the wake of that have become an equity market bubble. Then, in Senate testimony in the summer of 1994, collapse. That gave Greenspan explained that even though the economy had been doing well, he was worried rise to the real about how the rate increase would affect the financial markets. In 1995, Greenspan’s Fed estate bubble.” began to cut interest rates again. Fiddling with Inflation Greenspan labored under the delusion that the stock market was rising because American productivity was breaking growth records. He interpreted the surging stock prices not as a bubble but rather as a sign that rational investors in an efficient market were responding “Greenspan, through his to new information about productivity. He thought that standard inflation statistics irresponsible overstated real inflation, and that with the right kind of accounting for investments in monetary policy, technology, stock prices would look more reasonable. had fomented massive speculation Indeed, statisticians were doing some interesting fiddling with inflation numbers in that drove Internet the mid-1990s. The Senate Finance Committee appointed the Boskin Commission to stock prices to such examine the consumer price index (CPI). However, the findings of the Commission high levels that they were completely were to some extent determined by its purpose, which was to reduce the government’s incomprehensible.” estimate of inflation rates and thereby reduce the amount of money the government had to spend on entitlement programs that adjusted for inflation. It achieved its objective using these three tactics: 1. It stopped using geometric calculations of period-to-period CPI changes and started using arithmetic calculations. “Many people 2. It used price increases in substitute goods in calculations; increases in beef prices would learn the might thereby be cushioned by decreases in chicken prices. hard way that speculating was 3. It used “hedonic adjustments,” which suggest that if the price of a commodity rises, fun while it worked, quality improvements rather than inflation account for at least some of the increase. yet disastrous when it didn’t.” The downward adjustment of the inflation rate had pernicious consequences, not the least of which was enabling the Fed chair to claim that inflation was not a problem. Greenspan’s Bubbles © Copyright 2008 getAbstract 3 of 5 The “Greenspan Put” At the end of the 1990s, financial crises in Southeast Asia and Russia caused problems “Greenspan for a massive and somewhat mysterious hedge fund: Long Term Capital Management.