NYU Stern

Mauling the Maestro

By Thomas Cooley

There was a time, not long ago, when former Federal Reserve Bank Chairman Alan Greenspan was almost universally regarded as the Magus of the Markets. His elliptical statements seemed to be the expression of a deep and arcane knowledge that, with subtle and almost imperceptible gestures, moved the world financial markets towards ever-increasing prosperity.

"In the Wizard of Oz," Bob Woodward wrote in Maestro, his 2000 study of Greenspan at the Fed, "when the man behind the curtain emerges, we are let down. With Greenspan we find comfort."

But the Maestro's reputation has taken a beating of late. Author Charles R. Morris recently said of the current credit crisis that, "the story has no single villain, but Alan Greenspan comes close." An editorial in the New York Times (December 19, 2007) criticized Greenspan for brushing aside warnings about subprime lending practices starting in 2007. That failure, it suggests, will ultimately place Greenspan's Fed "in the hall of shame."

John Cassidy in the New Yorker (February 4, 2008) puts the blame for the subprime credit crisis squarely on Greenspan's shoulders: "If anybody is at fault it is Greenspan, who kept interest rates too low for too long and ignored warnings, some from his own colleagues, about what was happening in the mortgage market." And Jeffrey Sachs, writing in the Miami Herald (March 25, 2008, describes Alan Greenspan as the "main culprit" for the crisis in the US financial markets, leaving his successor, Ben Bernanke "with a terrible situation."

In good times, central bankers are the magicians of national wealth. In bad times, they are the Rasputins of the market. The truth is far more subtle.

Greenspan was neither as important as he has been given credit for when times were good, nor is he the goat that he is made out to be now.

The fact is, monetary policy is pretty boring when times are good. You want it to stay boring for as long as possible, and Greenspan did a good job of that—his Delphic utterances notwithstanding. He didn't create the prosperity, he just got out of the way and let strong productivity growth drive the economy. His particular insight was in recognizing just how strong productivity growth was in the 1990s.

Central bankers have their mettle tested, however, when they operate in a climate without precedent-when business ceases to be business-as-usual. Greenspan weathered many tests-the market crash of 1987, the Asian financial crisis, the Russian Bond defaults, the LTCM meltdown, 9/11—and came through his reputation not merely intact, but enhanced. Greenspan and the Fed kept the markets functioning with adequate liquidity in the face of such unforeseen and unprecedented events. Exceptional circumstances did not define the new normal.

At the root of the current crisis in our financial system is the housing market bubble. Did Fed policies cause the bubble? Greenspan argues in his own defense that the rapid growth of securitization and leverage and the apparent absence of risk premiums came not from low interest rates but from the abundance of global savings flowing into the U.S. market. He is right about that: just look at the path of the U.S. Current Account Deficit for the past 15 years. This was a movement of global investment driven by long-term demographic changes combined with the widely perceived stability of the U.S. financial system.

Alan Greenspan certainly wielded a great deal of power during his tenure at the Fed. But his power had limits. He didn't and couldn't magically create an economy that was immune to shocks and crises. He did not lead some people to make bad loans or others to take on too much debt. He didn't encourage people to believe that the market could only move in one direction-up. To view it otherwise suggests that central bankers are more in the order of nannies or governesses, slapping the hands of their infant charges when they make unwise choices.

Ben Bernanke, currently facing the same kinds of unprecedented challenges, understands the Greenspan playbook and is trying to keep the markets functioning by acting decisively when the regular rule book doesn't apply. The results are as yet hard to evaluate, but economic historians will have plenty to chew over in the future. Let's hope that that monetary policy gets boring again, and soon.