When long-time Federal Reserve Chairman Alan Greenspan completed his final term in 2006, his face seemed destined for the Mount Rushmore of central bankers, should one ever be erected. But the stock market collapse of 2008 led to a similar collapse of his reputation and a rethinking of his legacy. Was he a fraud who caused the collapse of the world financial system, or a genius who was simply powerless to prevent it?
We look at three arguments for the position that the financial crisis should ruin Greenspan’s legacy, and three arguments that, in spite of the recession, his overall track record remains strong.
The Case Against Greenspan
His libertarian outlook led to costly deregulation
While Greenspan’s views may have evolved from his years as an Ayn Rand devotee, his faith in the self-regulating power of the markets stayed with him until the end, to the great detriment of the American economy. His support for deregulatory action helped pave the way for out-of-control speculation on Wall Street and, eventually, the financial crisis.
One example of Greenspan’s deregulatory zeal is his role in weakening and eventually scrapping the Glass-Steagall act, which allowed “too big to fail” banks to get even bigger. And for years, he opposed efforts to regulate derivatives, which spun out of control in the leadup to the crisis.
Greenspan himself said after the crisis, “I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders.” Unfortunately, his realization came too late.
He failed to pop the housing bubble
A related but separate criticism comes over Greenspan’s insistence on maintaining low interest rates throughout the 2000s. Greenspan followed conventional wisdom in keeping interest rates low after the dot-com bust and the September 11 attacks, a defensible decision. But he kept cutting rates for the next two years, even as the economy was out of the woods. The Federal Funds Rate dropped to a low of 1 percent in 2003 and did not begin the slow crawl back up until 2004.
He supported the policies that created the deficit
The overheated economy of the 2000s, though headed towards disaster, could have at least helped shore up the government’s balance sheet. The US had a significant budget surplus when President Bush took office in 2001.
But the surplus was squandered on massive tax cuts. Greenspan had previously held that budget surpluses should be used first to pay down the national debt – which, at $5.8 trillion, was still imposing – before being spent on tax cuts. But the chairman shifted his stance to support the Bush plan, saying that there was enough money for both tax cuts and paying down the debt. History would prove that prediction tragically wrong.
In Greenspan’s Defense
He was not an anti-regulation zealot
The caricature of Greenspan as a Randian opposed to any and all regulation is greatly exaggerated. By the time he became Fed chairman, Greenspan was more nuanced in his views and open to reasonable regulations. He supported, for example, raising auditing standards after the Enron scandal, and in the words of successor Ben Bernanke, “rarely resisted regulatory initiatives put forth by the Federal Reserve Board staff.”
His resistance to regulation of derivatizes and other financial innovations stemmed from his belief that they were useful in deconcentrating risk, which at the time was not a radical view. Even today, with the benefit of hindsight, top economic minds are unsure of the right levels of regulation.
While Greenspan admitted his faith in regulation was tested by the crisis, the problem was not his dogmatism. It was the complexity of the challenges faced by the Fed during this period.
He warned against Fannie and Freddie
On one item contributing to the Great Recession, Greenspan’s prescient warnings which could have prevented, or at least mitigated, the crisis were ignored.
Greenspan spent the years before the crisis repeatedly warning that Fannie Mae and Freddie Mac, government sponsored entities created by Congress to facilitate mortgage lending, had overstepped their mandate and were overleveraged, adding systemic risk to the housing market. He called for both GSEs to be more heavily regulated (which, it’s worth adding, goes against the claim that he had an ideological aversion to regulation).
Much ink has been spilt debating whether Fannie and Freddie caused the financial crisis. Without venturing into that debate, it’s safe to say, after the federal takeover of both organizations, that Greenspan was on the right side of history on this item.
His track record over two decades was strong
When Greenspan left the Fed in 2006, two Princeton economists noted that Greenspan “has a legitimate claim to being the greatest central banker that has ever lived.” The financial crisis understandably led to a re-evaluation of this legacy, but what Greenspan accomplished during his term should not be overlooked.
Greenspan saw two recessions during nearly two decades, a rate any central banker would sign off on. These bookended the longest expansion in US history, as the country saw 10 years of GDP growth. From 1992 to 1999, the economy grew an average of 4 percent per year, a rate unseen in the post-Greenspan era. Greenspan was also a steady hand through two Gulf Wars and 9/11.
The financial crisis must be factored into any evaluation of Alan Greenspan’s accomplishments, but should not overshadow all else.
Greenspan’s claim to be the greatest banker to ever live disappeared on Sept. 15, 2008, when Lehman Brothers filed for bankruptcy. In the aftermath of the Great Recession, all talk about Greenspan centered on his role in the leadup to the crisis. But in the past couple years (in part due to the publication of Sebastian Mallaby’s biography of Greenspan, The Man Who Knew) much-needed nuance has been added to the discussion.