Alphachatterbox: Sebastian Mallaby on Alan Greenspan, The Man Who Knew

Matthew Klein: Sebastian, thanks for coming. I want to start towards the end of the narrative. Let’s place ourselves in 2002. I want you to give us a sense of the world that Greenspan was operating in, the choices that he made, the choices that maybe he could have made differently, and whether or not that could have actually led to a different outcome than we had in terms of the bubble and the financial crisis.

Sebastian Mallaby: The background to 2002 was obviously 9/11. The attack on the United States shocked people so much that what was already following the collapse of the NASDAQ bubble -- falling inflation and falling growth -- fell off the cliff. Inflation expectations as measured by the Michigan survey fell to a record low right after 9/11.

So in this context the Fed became extremely preoccupied by the danger of Japan, of a deflationary-type trap. And the Fed responded by cutting interest rates aggressively. They believed in the notion that you shouldn’t keep your powder dry because if you keep it dry and you save up those interest rate cuts, growth will slow so much that it won’t work anymore. They were in terror of the zero lower bound. People forget this today of course, we think of the zero lower bound debate as being a modern one following from 2008, but it was very much in people’s minds in 2002. So that was what Greenspan faced. What he did was he cut rates aggressively down to 1% in 2003, and hoped that monetary stimulus would get the system out of the shock of both the NASDAQ bubble collapsing and the 9/11 confidence shock.

MK: So looking back with the benefit of hindsight, I feel like a lot of the narrative of Greenspan focuses on -- or at least the modern narrative of Greenspan -- focuses on the idea that the crisis and the bust as something he should have seen coming. The title of your book suggests that in fact knowing or being aware is very much a theme of Greenspan. It’s easy to underrate him.

So to what extent were the policies in this whole pre-crisis period -- both on the monetary and the regulatory side -- things that, looking back, Greenspan should have done a lot differently? I ask because a lot of people, looking back, they say “well because of all the other global forces that we talk about, the global savings glut, the shortage of safe assets, the commodity boom, whatever, there wasn’t anything that could have been done differently.”

00:05:53

SM: Well you’re right, the title of the book is The Man Who Knew and that is because I do think that he knew that finance could be very unstable. He was particularly aware of this in the 2000s when, in the transcripts, as you know well, he was discussing financial instability quite openly with his colleagues.

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So what he decided to do about that was to essentially take a couple of shots at it through regulation but to ignore it on the monetary side, on the interest rate side.

On the regulatory side what he did was, first of all, he did try to pass effective regulation on crazy, subprime mortgages. There were certain insurance products that were being bundled into the subprime mortgages that were clearly abusive. And in late 2001 the Fed adopted new rules to limit those. Greenspan also went out and testified -- with the backing of the White House -- in favour of limiting the size of Fannie and Freddie because he saw them as the central source of systemic risk at the time.

And what happened was that neither of these regulatory efforts came to anything. The new mortgage rules were adopted but they were easily circumvented by the industry which just tweaked the products and carried on as if nothing had happened. The Fannie and Freddie push for regulation for limits on portfolio size was beaten back by a barrage of TV ads that the mortgage giants put up to warn members of Congress that if they sided with Greenspan they would be facing a tough re-election.

So Greenspan tried because he knew there was potentially trouble. He tried with regulation and that failed. He did not try with interest rates, and that’s where I think he was at fault, because knowing now that regulation was not going to work -- and I think he frankly knew it as well; he was trying, but he was too realistic to assume that regulation would really prevent excess leverage -- he didn’t take the next step which was “okay, so regulation won’t work, so we’d better use interest rates.”

00:08:02

MK: That’s interesting because of course that’s essentially the opposite of the conventional wisdom now, that although the Fed was fine on the monetary front that it was on regulation that it should have done more and chose not to. And it’s interesting because you’re basically saying it’s the exact reverse: they really tried on regulation, that didn’t work, and so in the absence of this, more monetary tightening would have been appropriate.

SM: Yes, in the five years when I was researching the book I would say to people “I’m writing a book about Alan Greenspan” and the typical thing would be “Fantastic monetary policy! Just look, inflation came down and it was very low variance; it was on target in the 2000s, perfect interest rates. But on the regulatory side, boy did he mess up.”

That’s the standard line and, exactly as you say, I have the opposite view, which is that, on regulation, he tried. Regulation, frankly, is never very easy to implement, particularly in the United States, where you have this massively fragmented regulatory structure with all this alphabet soup of agencies. So when, for example, on subprime mortgages, Greenspan and the Fed passed new rules the supervision of the non-bank mortgage originators who had to obey those rules that was being done by the FTC which doesn’t actually have boots on the ground to go and supervise. So I think he tried on regulation and it was never going to work, so I don’t share the standard criticism of Greenspan on that. But the flipside of that is if you don’t use regulation you’d better use monetary policy.

00:09:29

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MK: So the counterpoint of this, which I think is something you were implying in your initial answer, is that the economy at the time was very weak. Inflation was so slow people worried about hitting zero bound. It was an extremely rough jobless recovery. Would it have been possible, realistically -- and I’m talking about Fed independence, which is in the law but in practice how that plays out is a tough question -- how realistic would it have been to imagine Greenspan marshalling the [Federal Open Market] committee to pursue a meaningfully tighter policy back then?

SM: Well, in my view 2002 is the wrong year to peg that dilemma. So I think in 2002 in the one year or so after 9/11 it was reasonable to be fearful of the Japanese trap. After all the real estate bubble we now know peaked in 2006, early 2007. So 2002 was pretty early, and I think it was fine at the time to run very loose policy for 2002/2003. By the time you get to 2003 and into 2004, then the argument changes. You’ve escaped the deflation threat and Japan is not happening. Inflation in 2003 in the second half was below target it was around 1.5% or so, but by 2004 it was picking up again.

That’s the point where I think Greenspan should have had a different monetary policy, and I think he could clearly have done it. Not for nothing was he called the “maestro.” He had complete control over the FOMC, the interest rates setting committee. And if he had wanted to he could have raised interest rates faster and also he could have done it with less forward guidance. I think that’s a crucial part of this discussion.

It’s one thing to hold the policy rate, the short-term rate, low. It’s another thing to guide people about longer-term rates because that just incentivises leverage.

00:11:21

MK: I want to get into this more because it’s interesting that Greenspan’s defence -- not just his defence, but the defence a lot of people make of the way monetary policy was conducted in this period -- was that they did raise rates in 2004. They raised rates relatively quickly, but long rates didn’t move. You could argue that this was a fault of forward guidance, or the fault of excess savings from other countries, or what have you. But that is a claim that people make, which is the Fed did try and it just didn’t work. You could say there’s an analogy there to the regulatory moves preventing particularly abusive mortgage products, which just didn’t work. What is your take on that?

SM: If I remember correctly, around the middle of 2004 the Fed began to tighten. It tightened by 25 basis points per meeting and this was extremely clearly telegraphed. Everybody in the markets understood, because of the Fed’s language, that it would be 25 basis points per meeting and not more. And it seems to me that -- it’s not my conjecture, it’s based on reporting and talking to people on Wall Street -- that when you are running a term transformation book, you’re borrowing short and lending long, if you’re told that the borrowing short part of your trade is stable because although it’s going to rise by 25 basis points per meeting it won’t rise more than that, you can take more risk.

Remember, in the cycle in 1994, at one point the Fed raised rates by 75 basis points in a single meeting. That would be the kind of shock that in 1994 did blow up hedge funds and leveraged trading books; that chapter of my book is called “Hurricane Greenspan.” So the Fed had the power to deter Wall Street from taking on massive leverage, but by offering this forward guidance it failed to do that. Now, there is this legitimate parallel explanation for why there was the “Greenspan conundrum”. Why did long rates not

3 go up when short rates were being raised -- in fact, they fell? And that’s when Ben Bernanke made his famous speech about the savings glut and blamed it on this excess of foreign savings coming into the US and driving down long-term rates.

That is true. We know that Chinese savings did have an influence on the yield curve. Warnock & Warnock is the paper I cite in the book which quantifies that. And I think if I remember right it was an 80 basis point difference on the ten year yield. So there was an effect there, but just because there’s an effect from foreign savings coming in, it does not follow that the central bank is impotent. The central bank can push back against that stuff. You could argue precisely that if there’s a savings glut, the central bank ought to be tightening and using forward guidance to counteract that, not just sitting there and saying passively “oh my goodness, we can’t help this, the world is difficult, there’s a savings glut.”

And the irony is that in the 1970s, Greenspan as a private consultant criticised the Fed for sitting there passively as the yield curve was distorted by the then-new arrival of Fannie and Freddie into the system, which was changing the way that mortgage rates were behaving. He said the Fed should be pushing back against this. And the same was true for him.

00:14:44

MK: I guess the big question is why they didn’t? If the tools were there and the arguments are reasonable for doing it, why did they not act?

SM: Greenspan was the man who knew; he was not the man who acted. And you’re right; you’re asking the big question. And the answer, I think, is primarily that intellectually the Fed got caught into this inflation targeting straightjacket. And it was partly a political thing. Paul Volcker, by defeating inflation, had created political legitimacy for the central bank to raise rates in the pursuit of stable prices. There was no such societal consensus in favour of using interest rates to have stable asset prices. And Greenspan didn’t want to challenge that societal understanding.

I think he could have done it, because he had the status to do so. So in my conclusion I argue that, whereas it wasn’t his fault that the alphabet soup of regulatory agencies made it impossible to do proper regulation, the power over interest rates was his -- he was one of the most imperial and powerful chairmen of all time. And so there’s no escaping the fact that he should have had a different monetary policy and he was wrong.

00:16:03

MK: And it’s not so much that he fell into the same inflation targeting consensus so much as he was concerned that the political independence that the Fed had was constrained to go outside that consensus, is that a fair way of putting it?

SM: I think it’s a bit of both. I think that, ironically, he slipped into the inflation targeting consensus even though he didn’t begin as somebody who loved it. In the 1990s, as again you know very well, other people were much keener than he was on an inflation target, and in fact others were keen on an explicit public inflation target, which he refused to go with. And he was always throughout this period

4 emphasising that “well maybe asset prices should enter into the evaluation”; that was actually a quote from him in 2004 in the transcripts, which I believe you unearthed.

So the point is that he wasn’t a straightforward inflation targeter, but he ran with the pack. He did that partly because politically it was easy and partly because he was captured by his own reputation. He didn’t want to be unpopular by bursting the bubble, and maybe a bit of his personality plays into that. So this is somebody who loved the adulation, and maybe because he was a shy person he didn’t want to confront society’s expectations too aggressively.

00:17:29

MK: I think this is a good point to transition back to the beginning of how Greenspan got to be where he was. You mentioned that he was afraid of confrontation and also had a very keen desire to be liked. You make a pretty compelling case that a lot of this has to do with his upbringing. Why don’t you tell us about how that led to his personality?

SM: Greenspan grew up in a slightly unusual way. He was born in 1926 and grew up in the 1930s. Unusually for that time his parents got divorced when he was very young. And so when he was three, his father disappeared and his mother was left there with this one child. She never remarried so he was the only male figure in her life; no other husband, no other children, and she doted on him as you would expect. There is some psychiatric theorising, lots of Freudian stuff, which one could take with a pinch of salt, that that level of maternal attention creates a special character. That it gives you, as Freud said, “the feeling of a conqueror.”

So Greenspan was caught between this sense that he was special because his mother doted on him and at the same time a shyness, a diffidence. Relative to his mother he was much less bubbly and outgoing. And he always thought of himself as a sideman, that was his phrase. In other words, he was off to the side at a party, he was not at the centre of the party. And I think that combination of knowing that he was great because his mother had doted on him, but not being able to get the appropriate amount of adulation because he was shy, forced him to get the adulation in another way. He did it through mastery of data and numbers and making a lot of money very early on, and then acquiring enormous political power.

And so by doing well at stuff, working hard, being diligent, and getting ahead, he built himself up into a position where he got the adulation he felt he deserved. And I think it was therefore extraordinarily difficult for him, once he was at the peak of his power, to contemplate risking all that status which he had worked so long to accumulate.

00:19:50

MK: And this is a very conscious thing on his part. There’s a wonderful anecdote in the book, I can’t remember who it was who said it, but they described him as a “creeper” where he insisted on being at every Washington social event, but didn’t seem to actually enjoy being there, even though he felt like he had to be there.

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SM: Yes, this is a description of Greenspan in the 1970s when he was the chairman of the Council of Economic Advisers in the Gerald Ford White House. Greenspan would show up unfailingly at these A- list parties in Washington but, as you say, didn’t look as if he was having much fun. So the question is: why was he bothering to do this? And I think it was partly a desire to get the spotlight that he was due given his powerful position in the political ladder that is Washington.

It’s probably also -- and this is something that I thought about more and more since I finished the book, oddly -- is that a key to Greenspan is his political savvy. He was a brilliant economic statistician but also a fantastic and mesmerising political actor. And showing up at those parties and being available to people, making friends – “making friends” is actually the wrong phrase for Greenspan -- but making connections, and being accessible, and building up alliances, were key to being the powerful figure in Washington that he then later became.

00:21:23

MK: So looking at the intellectual side, the interesting thing about Greenspan is that he comes of age in a period when you have the post-war Keynesian consensus, the all-time high of it, where everyone’s thinking about fine-tuning and having a big government, and “we’re never going to have a Great Depression again”, that sort of thing, and making very large mathematical models to basically predict what’s going to happen. Greenspan goes in a very different direction. How did that happen?

SM: Well it is an interesting and intriguing story. He goes to New York University in 1945 when the GI bill is paying for this generation of ex-servicemen to attend college. It must have been the most pro- government generation of American college students. And Greenspan showed up there and emerged as a high-echelon libertarian. How did that happen? I explored various theories about that; was there a particular professor that influenced him, or something?

And it turns out that, as best as I could reconstruct it -- and I did find one Greenspan contemporary from NYU who had a clear memory of this stuff who later became a professor there -- I came to the view that Greenspan became this libertarian in a completely Keynesian era because he was this loner individualist. As a child he’d been an autodidact, and also musically an autodidact. He’d spent hours and hours by himself practising musical instruments before becoming a professional musician for a bit. And that loner mentality -- the picking up of intellectual pieces of the puzzle by himself -- is what led him to a place that was completely not in keeping with the zeitgeist.

In some ways that’s what makes him a great economist later. He was able to make the productivity call in 1996 and be completely against the conventional wisdom when he said that productivity was actually accelerating way more than the data showed. He could do that because he was his own man and I think the Hayekian early phase demonstrates that clearly.

00:23:45

MK: You also make the point in the book that, in addition to his different view of the role of the state that he has in the late 40s and early 50s, he also happens to be at a place where there’s this empirical tradition of trying to figure out what the relationships are. He gets his big career start with a classic

6 demonstration of this skill set during the Korean War, doing research on commodity demand. That’s a great story. Can you explain what happened there?

SM: Well the Korean War, it was clear to Greenspan, was of great relevance to his clients. And the clients were partly steel companies, partly auto companies, I think already Alcoa the aluminium giant was in the picture and so they had a huge interest in knowing what was going to happen to metal prices. What Greenspan did was that he tried to figure out how much the Korean War was going to increase demand for key metals; which metals, how much?

And to figure that out, to figure out basically the military consumption of metal, he had to do this extraordinary sleuthing exercise. Of course, in a time of war the Pentagon was not going to release exactly how many planes it had, or how many aircraft there might be in a squadron even, how many were being shot down, and therefore how many they had to replace. All of that stuff was not public.

But what you could do is go find testimony from air force commanders from before the war, see what they said then about their military procurement and how many aircraft they had and what went into it and then find engineering manuals which described how to manufacture some of the aircraft that the military were using. And then from all these different sources you could piece together an estimate of what the consumption of metal was by looking at newspaper reports of sorties flown in the Korean War, figure out how many planes is that, how many are likely to be shot down, what’s the attrition rate, how many accidents are there even in non-combat training?

So by taking information from everywhere and then putting it all together in a painstaking fashion, Greenspan was able to provide not the perfect answer to metal trends and what was going to happen to prices because of the war, but he had the best answer anyone had, which of course made him a star among his clients.

00:26:12

MK: One of the interesting things about this period that very much relates to this is that Greenspan -- contrary to the popular myth that exists around him now, a myth that he partly propagated himself, which is that he’s a big believer in efficient markets and you can’t know when asset prices are wrong -- put his money where his mouth was. He traded commodities during this period. That’s a fascinating finding that I don’t think was anywhere else. What have you learned from that? How did he get involved and what was his experience like when he was doing this?

SM: His estranged father who had abandoned him as a child had a ne'er-do-well career in finance and would trade a bit in the commodities market based on pattern recognition, trend following types of strategies. So Greenspan I think was aware of that, and his father had tried to persuade him, as an adult, to go into business with him. He had refused, but he had become interested, as I think a lot of people were in the 50s, in studying patterns in prices. When the first hedge fund -- this is going back to a previous book I wrote -- was set up in 1949, the founder believed that the way that he would generate alpha would be through following charts. It turned out he made money by a complete different strategy, but charts were very much in the zeitgeist of the 50s.

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Greenspan was one of the chartists and he did some pretty obvious things. So, for example, he would say to himself so we know that a metal price can go up theoretically as much as it wants, there’s no limit to how high it could be, but we do know there’s a limit on the downside. It can’t go below zero. And that’s true of grains as well, any commodity obviously. So any time a price collapses way below the norm, if you buy futures contracts going long, you’re not going to lose that much because it can’t go below zero. On the other hand, if it takes off because there’s some shortage that suddenly occurs, you could make way more on the upside than you’re going to lose on the downside, so it’s an asymmetric bet. And even without really knowing the specifics of what’s going on with wheat prices, or pork belly futures, or steel, or whatever commodity you’re trading, this is an asymmetric bet. If you do it enough times you’re going to make money.

So he would do this kind of thing. He did rather well with this. He then bought a seat on the commodities exchange and he would show up at lunchtimes, stealing 15 minutes from his consulting work. He was extremely conscious about how he allocated his time. He would talk to the crazy traders yelling and screaming next to him who had no statistical knowledge of what they were trading and he would say “how do you know you should be buying just then?” And the guy would say “Well, I felt the market.” And Greenspan would say “You felt the market? What, you put your hand on the wall and felt? What does that mean?”

And the sheer intellectual mystification led him to the view that prices are driven by sentiment in the short-term, by how many people are screaming at what. That sentiment is a reflection of all kinds of things: short-term dislocations in markets because a particular procurement -- an auto maker suddenly needs a whole lot of steel so they suddenly buy and that knocks the price off where it would normally be. So he came to that appreciate at a very much personal level. Actually when he bought the seat on the commodities exchange he didn’t make that much money and he quit that after a bit, but he did appreciate that markets were full of…they’re only as efficient as people are rational and that’s not 100%.

00:29:57

MK: So the big thing intellectually he was doing during this period -- aside from getting a chance to put his empirical training into practice by thinking about the impact of war procurement on steel demand -- was getting a chance to actually see how markets really work. Actually the theoretical framework for efficient markets hadn’t been invented yet, so he didn’t have to worry about unlearning that. But the other big thing was that he started working on what would eventually become his PhD dissertation. I think one of the big revelations in this book is that you actually found his dissertation and were able to incorporate it, because basically no-one knew where it had been up until you found it in his office.

There are several really big interesting ideas in there that inform a lot of the themes of his later work, life and career. What are those? What are some of the big things you found?

SM: Well you’re right the discovery of the PhD thesis was a great moment because friends of mine at the Wall Street Journal had tried to get a hold of the PhD. They’d gone to the New York University library, which had awarded the PhD, and said “we want a copy.” And the librarian said it’s missing. And they said “What do you mean, you’re supposed to have all of them?” And they said “It’s missing. We said it’s missing.”

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And so after trying pretty hard -- I can tell this story in an FT podcast -- the end of the story is that the Wall Street Journal didn’t get what they wanted. It was not a reporting success and they went away empty handed. And they always wondered what was in that missing thesis. I ran into one of the journalists who had been trying very hard to get hold of it, years later when I was doing the research for this book, and he said “Have you got the thesis?” And I said yes, and his eyes lit up. And he said “Well I don’t expect you to say what’s in it yet, but just tell me: is it interesting?” And I said “yes!”

And the reason it’s interesting, the big idea in there, which has obviously massively ironic implications for Greenspan’s later tenure at the Fed, is essentially the Tobin’s Q idea. James Tobin got the Nobel Prize later, partly for this idea, and he had no doubt expressed it in much more elegant mathematics than Greenspan ever did. But Greenspan was there first. And the idea essentially was that asset prices drive the economic cycle through two channels. The first is the familiar wealth effect; consumers seeing their portfolios rise in value, if you’re wealthier they go out and spend more. And that’s going to drive the economy into an upswing.

00:32:22

Equally and more powerfully, companies seeing that assets are being valued more highly will go and create more assets -- they will invest. So if you think about the example of an office building. If the office building suddenly goes up by 20% in price, guess what, all kinds of real estate developers will try and build more offices because they can sell them for 20% more. And the same is true of setting up a new company. If you can sell it for more you are more likely to create the company in the first place. So investment -- and this was Greenspan’s point in the paper he first presented in 1959 -- investment and consumption are fundamentally linked to asset prices.

And therefore a central bank cannot, must not, should on no account ignore cycles in asset prices -- they must respond to a bubble. And he held this view with such passion that, observing that the central bank had failed in the 1920s to act against the bubble that eventually burst in 1929, Greenspan said “This is why central banks are no good. They do not respond to asset price bubbles, and therefore we should have the gold standard. We shouldn’t have central banks at all.” So the man who later embodied the central bank thought there shouldn’t be a central bank. And the reason he came to that view was that he thought that asset prices were the key thing you had to respond to -- which is exactly what he didn’t do later. So the ironies were just mind-blowing.

00:33:56

MK: This wasn’t an immature view. He was in his 30s at the time he wrote this.

SM: Yes, in 1959, when he presented the paper, he was 33.

MK: If I remember correctly there’s another interesting bit towards the end of that paper where he talks about how he’s concerned that the forces that led to the great depression might come back. Where looking at the 1950s there’s a big increase in household debt, from very low levels but still a very big increase. In corporate debt there’s this big increase. In stock prices, again from very low levels. He thinks are we going to repeat this. That didn’t happen obviously.

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I’m wondering: to what extent do you think this might have affected his later confidence and ability to say “asset prices are out of line,” “we’re clearly about to have a bust here,” something along those lines?

SM: I don’t know. We debated this at the time. By the way, I’m going to reiterate something I think you’ve announced already, but you contributed enormously to the understanding of all this stuff when you were helping with the research and I remember debating this with you. I think that in the end I didn’t pick up on that end part of the paper in the way that you picked up on it. And the reason is that I think that there were so many more proximate causes for Greenspan’s reluctance to prick bubbles later on that by the time he became Fed chairman in 1987 had moved on in many ways.

And I think a pivotal moment in this was when he was advising President Ford and told him that on no account should he bail out the City of New York. And that famous headline, “Ford to City: Drop Dead” could have been written “Greenspan to City: Drop Dead”. It was really Greenspan’s idea. It was his advice not to bail out New York. That proved to be completely untenable and in the end the Ford Administration did provide assistance to New York. That was Greenspan’s education in the politics of this stuff. I think by the late 1970s he’d really given up on the idea that you shouldn’t bail anything out.

And relatedly, your point about how your forecast can be wrong and therefore you don’t know if there’s a bubble, I think he went through so many cycles between 1959 when he wrote that paper and then when he became Fed chairman in 1987 that there are other things going on.

00:36:27

MK: From his professional development you also at the same time have his emergence as a political actor. This was very gradual and it started through what’s not an obvious route: he became part of Ayn Rand’s inner circle. How did that happen? He ended up becoming very close to her and you argued that, in some ways, she was like a second mother to him. Tell us that whole story from when they met in the 50s.

SM: So what happened was Greenspan was married twice. The first time was rather briefly, but his first wife, although she exited his immediate life rapidly, she had a lasting effect on him because she introduced him to Ayn Rand. I’m not going to remember exactly how old he was, but he was probably in his late 20s when he met her. At first she didn’t like him. He seemed lugubrious. He always looked dark and down and had black suits, and was not sufficiently ebullient in his praise for her, perhaps. He likewise felt that he came out of a logical positivist philosophic background -- he believed that you couldn’t know anything for sure. She on the other hand was sure about everything.

Because of the force of her intellect and the charisma of her personality, he was persuaded by her that actually logical positivism was wrong, that some things you probably could know and you shouldn’t get hung up on doubting everything. That gave him the confidence to rise out of the statistics, which he had mastered, and generalise more about how society should be ordered. So he started to think about bigger questions that he had shunned before. Things like: what is the role of antitrust? He came out and said most of it should be repealed. He adopted a series of radical libertarian positions, which were new for him because essentially he had confined himself deliberately to statistics and to data and had been reluctant to build a real worldview. From that worldview he then became interested in politics.

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Another of the great research excitements I had in this whole process was discovering the series of lectures that Alan Greenspan delivered in 1963 and 1964 when he was in his late 30s. He was basically Ayn Rand’s chief economist by this point. At the end of these speeches, which I discovered in the basement of an Ayn Rand acolyte, the message was that Barry Goldwater, the Republican nominee in 1964, needs to be supported. Not that he is libertarian enough, in Greenspan’s view -- Greenspan thought he was a bit soft -- but he ended those lectures with an explicit appeal to support Goldwater. That was Greenspan emerging from his shy statistician’s chrysalis and becoming a political butterfly.

00:39:51

MK: So it’s also interesting that in light of the support of Goldwater not being libertarian enough, this was also the same time that Greenspan was writing these furious letters. I think if I remember correctly he wrote some letter criticising the New York Times book review of Atlas Shrugged saying…I don’t remember the exact language. You probably know it better. I think it was something along the lines of “subhuman” or something for not failing to appreciate the mastery. [The actual word he used was “parasite.”] It’s pretty remarkable that someone like that who at this point, as we said, is in his 30s, would somehow turn into this smooth political operator who everybody liked many, many years later. Arguably the key moment in the beginning of that transition is when he started working for a politician who actually won, which was Nixon. I guess it was 1967 when he joined the campaign. How did that happen? How did he get introduced to Nixon, because it’s not an obvious fit when you think about his libertarianism?

SM: Well, Greenspan, through Ayn Rand’s salon, had met a young professor from Columbia University called Martin Anderson and they’d become firm friends. They were both libertarians, but Martin Anderson was different in that he was more politically ambitious. So Anderson got involved in Nixon’s campaign very early when Nixon was just considering a run in 1967. Anderson brought Greenspan in, at first to write a paper on abolishing the draft, the military draft, which was a classic libertarian issue obviously. Anderson and Greenspan produced this paper saying that the military would be more efficient and also that there would be labour market benefits if you stopped the military depending on underpaid conscripts. Of course Nixon, when he became president, adopted that policy, so Greenspan’s first political recommendation actually did become law.

It was through Anderson and through this libertarian route that he got introduced to Nixon and then was recruited into Nixon’s campaign. Then what happens is absolutely fascinating because the person who really adopted him as an ally is none other than Patrick Buchanan, the populist presidential candidate from the Republican primaries in 96, winner of the New Hampshire primary, which I remember vividly. Buchanan is an Irish political brawler coming from a very different perspective. I don't know if you’d call Buchanan libertarian, I think I’d call him a pugnacious nationalist, I don't know what…

MK: Proto-Trumpian, perhaps?

SM: Yes, proto-Trumpian. He adopted Greenspan, persuaded Nixon to bring Greenspan closer and closer to the centre. By going to visit Buchanan when I was doing the research and talking my way into Buchanan’s basement -- where there’s a very large collection of guns -- I was shown the memos that

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Greenspan wrote to Nixon during that campaign and I said, “Can I perhaps just get a copy?” When I was told yes, I leapt on the whole thing, photographed the whole lot, and was incredibly excited.

00:42:54

When you read this series of memos that Greenspan wrote to Nixon from 1967 through the end of the campaign in 1968, what you see in real time is this transformation of a libertarian ideologue into a political operative. He begins by offering economic and philosophic advice about how Nixon should stand up for freedom in all things. Then he starts tempering the message and saying, “Well, how can you sell this freedom message?” By the end of the campaign he’s forgotten about freedom completely and he’s talking about messaging, political spin, and positioning.

He’s become, by the way, the polling analyst for Nixon because Greenspan ran an economic consulting firm with a computer, a mainframe computer. He was able to crunch the numbers from regional opinion polls and give the candidate advice on how he should position his message in different parts of the country. We know, by the way, what happened to that; the Southern Strategy emerged from that, not that Greenspan himself would’ve been a supporter of that race-baiting strategy, but he did provide some of the data for it.

But anyway, that is the transition. That is the moment when Greenspan understands that he has to serve not just his principles -- his philosophic principles -- he has to serve his principal, which is Richard Nixon. He has to get the guy elected, and he throws himself into that in a big way and that is the key to his politicisation.

00:44:18

MK: One of the moments in the book you wrote that directly contradicts -- and there’s a lot more evidence to suggest that you’re right on this -- Greenspan’s own recollection is that in the summer of 1968, Nixon has this meeting of all his senior advisors off in Montauk and he’s very angry. According to Greenspan, that’s when he decides he doesn’t want to work for Nixon if Nixon wins, supposedly because Nixon is cursing and saying bad things about the people who are opposed to him. You’ve pretty persuasively argued that that meeting occurred, but that that’s not a credible explanation for why Greenspan actually didn’t get a job in the Nixon administration. What’s the real reason?

SM: So, first of all, the reason why I think this is important is that Greenspan’s image, his self-image, what most people think of him, we all think he’s this technocrat and the truth is he’s also very, very political and ambitious. So his own version of the 1968 Nixon campaign, as you say, is that he goes to this meeting in Montauk, Nixon reveals his Jekyll and Hyde personality, he’s suddenly spewing racial epithets all over the place and Greenspan thinks, “Whoa, this is not the president I would like to work for, I’m going to disengage from this whole process because I have my principles, I’m a technocrat, I’m not going to go work for somebody like that.”

Well, the truth of the matter is that Greenspan stayed engaged in the Nixon campaign way beyond that meeting. He offered extremely political advice to Nixon for the next few months. At the end of the process when Nixon has been elected and there’s the transition -- we’re now into November and December of 1968 -- and the personnel team is picking who’s going to have which job, Greenspan, and

12 this is from a memo discovered in the archives, Greenspan tells the personnel person, “Well, I would go into the administration but only for such a senior job that I’m too nervous to even say what it is.”

He evidently meant either Treasury Secretary or maybe Budget Director, but not less than that. Greenspan was running a successful economic consulting business, he was making a ton of money, he had a very good life, and he was not going to give it up for nothing. So basically the truth is it wasn’t about principles and being a technocrat and not wanting to get his hands dirty; it was simply that from a career and ambition and financial perspective it wasn’t the right move for Greenspan to go into the White House.

00:46:58

MK: In fact, as you allude to, he continued to work with Nixon in several substantive ways after he was elected, even if he didn’t have an official job. One of the really striking things, and it ties into this broader theme of Fed independence and the relationship between elected officials and the central bank, is what happened with Arthur Burns, who was Nixon’s mentor when he was at Columbia, and the Nixon administration and the role that Greenspan played in that. That was a very striking thing. What happened there and what was the reason that Greenspan got involved?

SM: So I think you’re teeing me up here for one of the stories that Greenspan does not like in this book and he tried many times to persuade me that it never happened, but the contemporary documentary evidence, as I’ll explain, is so compelling that I wasn’t willing to take his word for it. I did say in the book that he says this didn’t happen, but I think the archival evidence suggests strongly that it did.

So what happened was, in 1971, Richard Nixon was already obsessed with the 1972 re-election fight. He was determined that the Federal Reserve should cut interest rates to create strong economic growth leading into the 1972 election. Arthur Burns, the Fed chairman who Nixon had appointed as a loyalist, was not playing ball, so Nixon wanted to force the Fed into cutting rates to help his political prospects. The way they did that is Nixon and his team -- including some people who later went to jail for the Watergate stuff -- went off on the presidential yacht, the Sequoia, and they cooked up this plan that they would essentially kneecap Arthur Burns, the Fed chairman, by leaking a story to the media saying that Arthur Burns was on the one hand calling for a wage and price freeze for Americans, but at the same time demanding a 50% pay raise for himself.

Now, the first thing about the price freeze was true; Burns was saying that, everyone knew that. The second thing that Burns wanted for himself, a 50% pay hike, was complete fiction. They just made it up and they leaked it to the press. Then when the journalist showed up at the White House briefing the next day and said to the White House press spokesman, “Is this true?” The spokesman refused to deny it, so then the story really had legs. Arthur Burns was naturally horribly upset. His reputation was being dragged through the mud. He was beside himself.

00:49:30

At this point the White House reached out to Greenspan, who was close to the White House but also close to Arthur Burns, and said, “You should go speak to Burns and explain to him to be reasonable.” “Reasonable” of course meant be supportive of Nixon. Greenspan says he didn’t get the call, he never

13 would’ve done it, he doesn’t remember it and so on, but there is a handwritten note from Charles Colson, who went to jail later, saying, “In the morning called Greenspan, made the following three points, he should speak to Arthur Burns.” Then there’s a bit of a gap and then the notes say, “Greenspan calls back, reports he’s done this, done this, done this.”

Then on the White House tapes you see Nixon talking to his chief of staff, Haldeman, about what Greenspan has done. Nixon refers to Greenspan as “our friend in New York.” It’s the most bizarre thing. So Nixon is having himself tape-recorded and somehow he thinks he can fool the tape recorder by referring to people by their place, not by their name. It’s the 1970s, right? People have got these new gizmos. They’ve got tape recorders. They’ve got photocopiers. They had no idea yet how dangerous these things are and how historians are going to use them. They think they can fool us by saying “our friend in New York.”

Anyway, so Greenspan essentially went to Burns and said, “This is Washington, this is politics, if you want them to stop this kind of stuff you need to help them.” You can just look in the record what happened next. Monetary policy shifted, and in the first half of 1972, because of that shift, the economy grew annualised by 8%, more than 8% actually. There was an unsustainable splurge of stimulus that happened after this episode. I think it’s a fair conclusion right there in the data that Greenspan helped to subjugate the central bank that he later empowered through his “maestro” status.

00:51:36

MK: Jumping ahead a little bit in the chronology, there’s a fascinating parallel here with when Greenspan was relatively early on in his tenure [as Fed chairman]. He had been appointed in part because of the view that he was a Republican loyalist. Yet you have the George HW Bush administration clashing with him tremendously, arguably for similar sorts of reasons. It worked out very differently, but there’s a very interesting tension there. I’m actually just going to stay with the story because it’s interesting. What happened with Dick Darman and Nick Brady and that whole episode? It’s really interesting to see how Greenspan changed -- or at least how his behaviour changed -- when he found himself in Burns’s position.

SM: So this, you’re right, is fascinating because Greenspan was appointed as a loyalist -- a political loyalist -- and yet he did stand up to a Republican president, George H W Bush. He ran policy pretty tight after the 1991 recession, so much so that he was surprised by how weak the recovery was. I think if he had known ahead of time how much balance sheets had been impaired by the commercial real estate bust, he would’ve run interest rates a lot lower. Growth would’ve been stronger and actually Bush would’ve beaten Clinton in the 1992 election. So when George HW Bush was mad at him in 1991-1992 there was a reason -- policy was very tight.

What happened in that period was that George HW Bush would attack Greenspan and the Fed, occasionally in public. His team, his economic team would be way more vicious. The most extreme came when Richard Darman, the budget director, put it about in Washington that Greenspan was this creepy guy, 65 years old, unmarried, telephones his mother every day, isn’t this a bit like Norman Bates from the Hitchcock movie, Psycho? So he was really playing dirty. In a slightly less effective -- and almost pathetic -- way, Treasury Secretary Nick Brady tried to put pressure on Greenspan by disinviting

14 him from Washington A-list parties. He said to his assistant, “Whoosh, bang, stop! We’ll freeze him out” -- as if this would make a difference to monetary policy, just not being invited to parties.

So they tried to put pressure on Greenspan and he at this point proved himself very tough. He stood up to political pressure and defended the independence of the Fed. I think that’s the moment when people understand the lesson that beating up on the Fed, which had been the norm – the story we’ve just discussed about Nixon attacking Arthur Burns was extreme but it wasn’t out of the typical pattern. Presidents just did beat up on central bank chairs. I think that resistance by Greenspan in 1991-92 to George HW Bush taught the world a lesson, such that when Bill Clinton came in, from the get-go he resolved not to attack Greenspan in public. And that is when American central bank independence -- which was not legislated, but it evolved -- it evolved thanks to Greenspan and to his toughness in that first Bush administration.

00:55:00

MK: So speaking of Clinton, and unfortunately due to time restraints we can’t cover the entire gamut of Greenspan’s life and career, although I will say there’s a lot of other interesting stuff in the period between Nixon and George HW Bush that’s in the book that’s worth reading. But speaking of Clinton, one thing that’s interesting here is that there’s this perception that Clinton was a very savvy politician, a great manipulator. His advisors were very good manipulators in figuring out where the public pulse was and how to get people to do what they wanted.

You make a pretty compelling case that actually Greenspan outclassed them in a pretty serious way and essentially, I wouldn’t say trick, it’s a strong word, but a lot of the language that he used about expectations and bond markets and budget deficits might not have been backed up by data, strictly speaking, at least based on what the Fed staff was saying, but nevertheless led to some serious changes in actual fiscal policy. Can you elaborate what happened?

SM: Sure. “Fiscal dominance” had been the longstanding terror of central banks, the idea that the government would run big budget deficits and then just expect the Fed to de facto monetise them, but in any case there was nothing the Fed could do to really push the fiscal authority into running a sensible budget policy. Volcker had tried to testify in Congress along these lines. He had been beaten up, so the giant Churchillian hero of central banking got nowhere. The Reagan budget deficits were appalling and that showed the limits of Fed power.

Greenspan on the other hand, forced George HW Bush into a tax hike, breaking his own election pledge and, again, setting himself up for losing the election. He then did the same thing with Clinton. He basically talked Clinton into giving up some of his campaign promises and said, “Mr President, if you cut the budget deficit by running a tighter fiscal policy, you will find you will be rewarded in the bond markets. Long rates will fall, it’ll stimulate the economy. You will be re-elected down the road. Things are going to look good.” He didn’t quite say “you’ll be re-elected,” but that was the implication. Greenspan therefore got two presidents in a row to change their budget policy in a more responsible direction, and I think it’s this political skill that really is the surprise takeaway for me about Greenspan.

How did Greenspan first of all create Fed independence? It’s because he was very political and to beat back the politicians, you had to be a politician yourself. You had to know how to wield power and you

15 had to be unafraid to do that. Greenspan did this to create Fed independence. He did this to force the budget authorities into being responsible, and this empowered him then to run monetary policy. Because fiscal policy was tighter, monetary policy could be looser and he could be the benevolent maestro.

00:58:01

MK: It’s funny because during this period, in the course of 1992-1993, long-term interest rates go down tremendously and Greenspan said it was because there’s this fiscal discipline from DC. Fed research actually said, “no, it’s not,” and that leads into the interesting pattern of 1994. That’s a really fascinating story, the build-up to that, because it mimics in some ways what the debate is now, where rates have been low for a very long time in the aftermath of a credit bust, people are worried about financial stability, you have very weak jobs recovery, and then they move very quickly and some interesting things happen. Can you give us a little bit of a flavour of how that debate was going at that time and why 1994 was a surprise for people when they were doing it?

SM: Yes, I completely agree that the echoes of today are very, very strong. So there’s this amazing moment in late 1993 when the head of statistics and research at the Fed, Mike Prell, shows up at the FOMC meeting, and tells the Fed’s leadership that the reason long rates have fallen is not that inflation expectations have come down or that the budget is now tighter -- it’s basically that short rates have been very low and this has conditioned the markets into expecting “lower for longer.” Does that phrase ring a bell now?

The power of the central bank therefore over long rates is bigger than the central bank realised, which is again another reason why when we get to that conundrum in the 2000s and people are blaming the savings glut from China, it’s not that simple. Actually, the Central Bank has the power to influence longer rates if it wants to and if it is determined to do so. So in 1993 the message from the staff was, “Look, you don’t realise how powerful you are. If these long rates are very low it’s because you’ve been running short rates very, very low for a long time. Once you begin to hike the short rate therefore by extension, it’s going to shock people and that long rate is going to rise faster than you expect.”

Basically, people just ignored this. Mike Prell presented the evidence. He was viciously attacked by the Fed vice chairman at the time, who said, “That’s absurd, long rates are a reflection of inflation expectations. You’re telling me that traders of ten-year bonds are idiots, that they’re irrational, they’re just looking at the short rate, that’s absurd.” Mike Prell said, “Well, look, I’ve done the model.” They had this really personal…

01:00:36

MK: That vice chairman if I’m correct went on to be one of the big guys at Long Term Capital Management, right?

SM: Yes, and we know what happened to Long Term Capital Management. It was David Mullins. So, you’re right, that moment of the Fed staff having this pretty personal and vicious altercation in the committee is I think a relevant moment for today. Then in 1994 what happened is the Fed did raise the short rate and lo and behold the bond market freaked out. You had this “Hurricane Greenspan,” this moment when all kinds of bond traders blew up. Michael Steinhardt, the famous hedge fund guy -- and

16 it’s the way I tell this story in my book because I happen to know that story very well from writing about hedge funds in the past -- but having had a fantastic run since the 70s Steinhardt completely blew up in 1994 because of this sudden bond market convulsion which nobody at the Fed, apart from the research staff, but the leadership and Greenspan didn’t expect.

01:01:38

MK: The other big topic that most people I think believe that Greenspan was prescient and correct about, but you make some interesting arguments that maybe he actually made a mistake, is the way the Fed responded to the massive increase in productivity in the second half of the 1990s in technology. The standard narrative is basically that the Fed avoided tightening too quickly too early because Greenspan in particular realised that there wasn’t a threat of inflation that would’ve been implied by the unemployment rate. So people like Janet Yellen, for example, were worried that unemployment at 5.5% would be inflationary and wanted to raise rates in 1995-1996. Greenspan said, “No, this isn’t going to be a constraint.”

You make a pretty interesting argument in the book -- and it ties in pretty nicely to the research that Greenspan did in the 50s -- that even though consumer price inflation wasn’t an issue, in fact it ran below any reasonable measure of the Fed’s target in the second half of the 1990s, it’s reasonable to conclude the Fed may have been too loose in that period because of what was going on with asset prices, what was going on with globalisation and technological change. I’m wondering to what extent you really think that they could’ve done something meaningfully different from what they did and, related to that, if they had done something different, what would the early 2000s have looked like?

Because I feel like a lot of discussion there, and this is becoming a long question, but a lot of discussion there is that the tech bust was supposedly mild and showed the Fed could clean up after a bubble. But the reason it was mild in part is because, as we started this interview, is because the Fed was very loose and some of that looseness flowed through into a lot of unsustainable behaviour in terms of borrowing, house prices and so forth. So I feel like, again, this ties all right back into the very beginning of Greenspan’s life and career. How would you put all this together? What would younger Greenspan might have thought or done in that situation?

01:03:32

SM: Well, there’s a lot in that question. I think, first of all, the 1996 productivity call was a great moment for Greenspan. I think in his own mind that was his greatest single moment as Fed chairman. He was against the consensus and he was right about what was going on with productivity. It did follow that consumer prices, inflation pressure, was not going to be as high as people expected, therefore he could be looser and that inflation was going to be fine. I think therefore running policy a bit looser in 1996 was probably fine, 1997 was probably fine. But then you get into the later phase of the technology boom in 1998 and 1999 and then it ceases to be fine, in my view, because asset prices are really taking off in a crazy way.

The really crunch moment of this is that after the Russian default and the collapse of Long Term Capital Management in, first of all August for Russia of 1998, and then a month or so later for Long Term Capital Management, the Fed cut interest rates no fewer than three times to protect the markets from the

17 downside fallout -- and then it didn’t take back those cuts. It just left them there, took them back very, very slowly. I think the last takeback might have been late 1999 and this was just a ridiculously slow correction of a loosening that was maybe a fair response for one or two cuts. Perhaps one cut was good after LTCM, two debatable, three way over the line, but then not taking them back was the big mistake.

01:05:13

I think the larger error is not so much the productivity call. The error is only looking at inflation as the signal for when you need to tighten and not looking at asset prices at all. I think in his career Greenspan had two moments when employment was basically full, inflation was under control but it was not below target, and asset prices were going nuts. He should’ve prioritised the targeting of those asset prices. These moments are basically early 1999 and secondly 2005, when real estate was the big problem. Because Greenspan didn’t raise rates in response to this runaway asset price behaviour, you get the tech bubble which then burst in 2000 and then you get the big real estate bubble which burst just after Greenspan leaves office.

Maybe the last thing to say is to address your question of the toxic nature of the Nasdaq bust. I think that is something where the standard story I just don’t share. The standard story is “It was not a leveraged bubble. Stock market bubbles are fine. You can leave them to blow up. Fine, you can just clean up afterwards because it’s not like a credit bubble, it’s not leveraged.” Yes, up to a point. But actually, Fed policy responding to that asset price bust in technology had to be extremely loose, extremely aggressive, and self-consciously inflate real estate prices as a way of counteracting the loss of demand produced by the collapse in investment after the Nasdaq bubble burst.

So I think if you’re worried about the credit bubble in 2006, 7, 8 which of course everyone is, it’s illogical and inconsistent to be complacent about the Nasdaq bubble. It was the monetary medicine after Nasdaq that created the credit bubble. I do think -- given that Greenspan was the person who wrote that 1959 paper in which he laid out the danger of frothy asset markets and what they would do to the cycle - - it is massively ironic that the man who knew the danger of asset bubbles allowed all this to happen.

MK: Thanks very much for coming.

SM: Matt, it was a great pleasure to be with you.

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