Tuesday, September 18, 2007

Tuesdays With Greenspan

Alan Greenspan launched his new book yesterday, perfectly timed. Its titled The Age of Turbulence and has every biz commentator trying to get a soundbite on it.

An excerpt from the book, “The great problem inherent in capitalism [is] that creative destruction is often, and by a great many, viewed simply as destruction. Capitalism creates a tug-of-war within each of us. We are alternately the aggressive entrepreneur and the couch potato, who subliminally prefers the lessened competitive stress of an economy where all participants have equal incomes,” Greenspan writes.

The Wall Street Journal asked Greenspan “Many people, including some former colleagues of yours from that period, believe the Fed kept interest rates too low for too long, thereby contributing to the housing bubble and problems in subprime mortgages. Do you agree?” Greenspan agrees with the “too low, too long” charge. “We kept them too low for too long because we were effectively creating an insurance against [deflation]. The problem in making choices is that you recognize that if you miss, you can end up with interest rates too low, too long,” he replies.

As part of Greenspan's book contract, I think he has to go to all the interviews and tv shows to talk about his book.

Greenspan says basically that his critics under-estimate the dangers to the banking system and the broader economy in the early years of this decade, in trying to justify his keeping interest rates so low for so long. Greenspan raised rates in 2004. But only after he held interest rates at historically low level for three years, while the bubble, the housing bubble was forming. That was the growing perception in trading rooms nowadays - that Greenspan was largely the unwitting architect for the current subprime mess. And during that 3 years Greenspan made 13 rate cuts in that period of time. "It was our job to unfreeze the American banking system if we wanted the economy to function. This required that we keep rates modestly low," Greenspan says.

In an interview with The Financial Times, Greenspan makes lots of inflation hawkish noises and notes that he weighs the data differently from those such as economist Martin Feldstein who have called for aggressive rate cuts. “You have got to be a lot more careful in lowering rates in response to crises, ” he says. Greenspan also makes some bleak predictions about the US housing market, telling the FT that the downturn is likely to be worse than many expect. Greenspan said he would expect ‘as a minimum, large single-digit’ percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was ‘in double digits'.

As if this was a conspiracy by all media to try and help Greenspan sell his book, Newsweek is putting Greenspan on their cover this week. This is bigger than Harry Potter's next movie!!! Greenspan's views on the “moral hazard/bailout/subsidy” question about Fed cuts - “To the extent that [the Fed] interferes with the economy, we do help some of the people who are involved in rather questionable financial activities. The problem basically is that if you do effective monetary policy and stabilize the economy, you will raise all asset prices—those that are assets owned by prudent investors, but also the prices of assets of those who have taken very silly risks and should be punished as a consequence. There is no simple solution. If we do something which works for the society as a whole, we will inadvertently and undesirably bail out, if you want to put it in those terms, the people who have taken silly risks,” This is the one big contention among all investors, should the Fed step in to bail out less-than-prudent investment decisions made by some? To take the narrow road and say everyone should bear the risks and consequences of their actions is myopic and unwise. Take LTCM, should the Fed not have bailed them? That's because the consequences of leaving them to act out the consequences brings about far greater damage to the global economy, which may result in some nations losing tons in wealth and may find it near impossible to recover. Should all Asian nations be left to die and unwind on its own following the 97 crisis?? After all, it is Asia's problems right?

By keeping interest rates too low for too long, Greenspan encouraged a borrowing-fueled speculative binge, which has now given way to a credit squeeze. But his greatest failing was towards the end of his reign where he failed to crack down on the mortgage industry, he allowed subprime hawkers to peddle dubious loans.

So, would I go and buy his book, probably not. I have read books about him and by him before and never came away knowing much more. Its just amazing the way the media & investors alike would put Greenspan on a pedestal, and for what? Basically he made a career in a job whose main responsibility is to pick (a), (b) or (c). The first being to lower rates, the second to raise rates, and the third to do nothing. If you are really unconvinced, just do (c). If people keep pestering you one way or the other, just follow the tide.

The reputable Bob Woodward in the Washington Post probably summed up best when he said "As I've said many times before, the Federal Reserve is far less important than most people realize. I think the fact that it's so secretive helps keep the illusion alive,”.

1 comment:

rask3 said...


I believe asset bubbles are a function of human greed and human stupidity. Famous bubbles such as the Tulip Mania didn't happen because the interest rate was very low at that time. It happened because of human nature that can't resist the lure of easy money.

When you see others making easy money you want to jump in for a slice of the action. Even if the action is stupid and is based on a fallacious premise.

I also believe that having an artifically low interest is generally not good, because savers would not be compensated enough for inflation. And economic activites are not solely dependant on interest rates although too high a rate would choke off many businesses.