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Volcker stands tall, Greenspan shrinks
By Caroline Baum
Article Last Updated: 04/12/2008 03:14:29 AM CDT
Former Federal Reserve Chairmen Paul Volcker and Alan Greenspan
present an interesting study in contrasts.
Volcker is tall; Greenspan isn't. Volcker is a man of few words;
Greenspan won't shut up. Volcker retired as Fed chair and avoided the
limelight; Greenspan is doing everything possible to make sure the
light ****nes on him.
The problem for Greenspan is that the spotlight on him also is
illuminating detritus on the economy's shoreline now that the tide of
easy money has gone out. (Wait, easy money is back!) Greenspan's
curriculum vitae includes two asset bubbles (one in Internet and
technology stocks in the late 1990s, another in residential real
estate), a pair of banking crises, a boatload of fraudulent lending he
chose to ignore and a household savings rate of zero.
What really separates the two men, however, is the legacy issue.
Volcker is content to let his record speak for itself: He inherited
inflation of almost 15 percent and bequeathed a rate of 4 percent to
posterity. It took two recessions to get there, but he did the heavy
lifting on inflation.
Greenspan is desperate to deflect the blame for a credit crisis he
called "the most wrenching" in 50 years. He can write his
autobiography, which he did last year, but he can't write his epitaph.
We, the public, will do that.
He's doing his best to help. The "greatest central banker who ever
lived," in the estimation of Princeton University economist Alan
Blinder -- who, as a Fed governor in
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the mid-1990s, chafed under Greenspan's leader****p -- is being
subjected to almost daily criticism from a jury of his peers. It's
coming quicker than he can produce rebuttals, although he's doing
yeoman's work.
He wrote an op-ed for the Financial Times on March 18 ("We will never
have a perfect model of risk") that generated such an outpouring of
criticism he had to write a follow-up.
Alice Rivlin, who served as a Fed governor under Greenspan, was one of
those who responded to Greenspan's misplaced assertion that
econometric and risk models were to blame.
"We will never have a perfect model of risk in a complex economy," she
wrote. "But the culprit was not imperfect models. It was a failure to
ask common sense questions," such as "will housing prices keep going
up forever?"
Nothing Greenspan says can alter the obvious: The Fed kept short-term
rates too low for too long. No matter what metric you use, a
reasonable person could not possibly come to any other conclusion.
Let's look at what some of those metrics were screaming at mid-year
2004, when the funds rate was still at 1 percent and Greenspan was
concerned about deflation:
The yield curve was vertical. The spread between the funds rate and 10-
year Treasury topped out at 380 basis points, a sign of a highly
stimulative monetary policy.
The real federal funds rate was negative for almost three years in
2002 to 2005. The last time the inflation-adjusted overnight rate was
negative for such an extended period of time was the mid-1970s. 'Nuf
said.
The spread between the nominal funds rate (a proxy for the cost of
borrowing) and nominal gross domestic product (a proxy for the
economy's return) reached 600 basis points, a gap last seen in those
fabulous '70s.
Commodity prices were soaring; the dollar was sinking. Neither is
consistent with deflation.
Elsewhere, Greenspan has argued that the housing bubble was a global,
not a U.S., phenomenon, driven by low long-term rates, the result of a
global savings glut.
"If he thought long rates were too low, why not try to push them up by
raising short rates?" asked Paul Kasriel, chief economist at the
Northern Trust Corp. in Chicago. Bond yields may "dance to a different
drummer," he said, "but they are affected to some degree by fed funds
rate expectations."
If Kasriel agrees with Greenspan on anything, it's in his rejection of
the notion that free markets are inherently unstable and in need of
regulation.
"We don't have a true free market," he said. "The Fed sets an
im****tant price" -- the interbank lending rate -- providing all the
reserves the banking system demands at that price. "It would be an
accident if the Fed were to set that price at a market-clearing
level," Kasriel said.
Just as in the aftermath of the Great Depression, Congress is gearing
up to pass new regulations to prevent the current credit crisis from
happening again.
"That will be Greenspan's legacy," Kasriel said.
As legacies go, that would be Greenspan's worst nightmare.
Caroline Baum is a Bloomberg News columnist.
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