Charleston Gazette, January 18, 2004
Knight-Ridder/Tribune Media Services, January 5, 2004
Alan Greenspan used the occasion of his speech to the American Economic Association to defend his legacy. His 16-year record as Chairman of the Federal Reserve is certainly mixed, but there is one mistake he shouldn't be allowed to brush off: the stock market bubble.
But that's exactly what he tried to do, claiming that he did the right thing by allowing the bubble to grow to outlandish proportions, and then trying to clean up the mess afterwards. His argument was that he might have caused unnecessary and unpredictable harm to the economy by raising interest rates in order to contain the stock market bubble.
But Mr. Greenspan sets up a false choice between raising interest rates or letting the bubble grow. There was a much easier solution that did not involve raising interest rates: he could have simply explained the basic arithmetic of the bubble to the financial markets and to the public.
If anyone doubts that this could have prevented this $8 trillion dollar bubble from accumulating, they need only to observe the enormous effect that every Delphic utterance from Greenspan's lips has on financial markets. Indeed, when he first noted the possibility of "irrational exuberance" of the stock market in December of 1996, it sent stock markets falling around the world.
That was enough to scare him from pursuing the matter further. At the time, the S&P 500-stock index was at 745 and the Nasdaq was at 1297. The S & P would more than double over the next three and a quarter years and the Nasdaq nearly quadrupled. But Mr. Greenspan -- who already knew that the market was overvalued before it took off into the stratosphere -- decided to smile and ride the wave of exuberance.
The arithmetic of the stock market's excess is straightforward (see www.cepr.net) and irrefutable. There was a bubble in the stock market -- not just the Nasdaq or technology stocks -- that was inevitably going to burst. And the bigger it grew, the worse would be the consequences when it broke.
Greenspan's defense is that the recession brought on by the collapse of the stock market was "exceptionally mild." That's technically true, but also misleading. The recession officially ended in November of 2001, but the economy lost 768,000 more jobs in the first two years of rebound that followed. This is an unusually terrible recovery: even the "jobless recovery" of 1991-93 generated 1.4 million jobs in its first two years.
Add in the millions of people who lost the bulk of their retirement savings in the bubble's collapse, and it is clear that it was irresponsible for the Chairman of U.S. Federal Reserve to remain silent in the face of history's largest financial bubble. Sure, some people would not have liked to hear the truth at the time -- but the Fed Chairman's job has never been to win a popularity contest.
Indeed, Mr. Greenspan has been more than willing to use his enormous power to raise interest rates, thereby throwing millions of Americans out of work, in order to keep wages from growing "too fast." This is based on the theory, for which the economic evidence is dubious, that low rates of unemployment lead to "excessive" wage demands -- which theoretically can cause inflation to spiral out of control. In 1989 the Fed raised short-term rates (currently at 1 percent) to 10 percent, unnecessarily causing the 1990 recession.
Mr. Greenspan's negligence regarding the stock market bubble is, unfortunately, more than a question of his legacy. There is currently a $3 trillion dollar bubble in the housing market, which when it breaks could have an effect similar to the bursting of the stock market bubble. Mr. Greenspan has encouraged the growth of this bubble by publicly denying its existence.
But this unprecedented run-up in home prices -- more than 40 percentage points above the overall rate of inflation over the last 8 and a half years -- has no plausible explanation other than being the result of a speculative bubble. Mr. Greenspan should tell the truth about this bubble -- this time before, rather than after, it has done its damage.