copied from http://www.dailycamera.com/bdc/insight/article/0,1713,BDC_2494_1330583,00.html
Greenspan's irrational exuberance
What caused the current economic debacle? Give the Fed and its chairman a share of the blame
By William Greider, Washington Post With New Economy icons falling all around, the next one may be the Federal Reserve and its hallowed chairman, Alan Greenspan.
When anxieties subside and people examine what caused this debacle, they may grasp that the Fed's policies and proclamations are centrally implicated. Notwithstanding his opaque manner, Greenspan became a cheerleader for the financial-market optimism and implicitly ratified its excesses. The chairman failed to take the timely actions that would have instilled more caution in investors, believing as he does that markets can work things out on their own. Well, they have.
This is exactly what you don't want from a Federal Reserve chairman. Central bankers are not supposed to be either optimistic or popular. They are supposed to be the national scold — the economic regulators who worry constantly over what might go wrong and impose restraints before public opinion or the markets see any problem. In that sense, the Federal Reserve went off the rails in the bubbling '90s. Though still celebrated for wise stewardship, the Fed failed its core function as the disinterested governor.
How does Greenspan feel, for instance, about the mega-conglomerates in banking that he helped midwife, now that Citigroup and J.P. Morgan Chase are in the cross-hairs of criminal investigations? The Fed chairman personally approved Citigroup's creation even before Congress made it legal by repealing the Glass-Steagall Act. He approved the "firewalls" that were supposed to prevent the kind of scandalous conflicts of interest recently revealed. And did the Fed's own bank examiners not notice the funny-money lending to Enron?
A more fundamental critique is that Federal Reserve policy has been a contributing force in producing deep imbalances in the American economy — the growing inequalities of incomes and wealth and other disorders, such as the burgeoning debts of families and business. The Fed helped induce these injurious shifts by essentially favoring the financial system over the real economy of production.
For most of the past 20 years, the central bank continued to fight the last war — inflation — and did so by restraining economic growth artificially. Its brake produced many years of higher unemployment than was necessary, thus ensuring stagnant or falling real wages for ordinary working people.
We will be a long time digging out of the Fed's triumph. The task of reform should begin with a less deferential Congress and media, daring to question the Fed's performance more rigorously. That requires prompt — and more candid — policy disclosure from the Fed.
In the run-up to the current debacle, Greenspan's first pivotal error occurred back in 1996, when he and other Fed governors first recognized a price bubble forming ominously in stock markets. Then-governor Lawrence Lindsey (now the president's economic adviser) urged the chairman to act promptly. Raising margin rates would tighten stock-market borrowing — the easy credit investors use in a speculative binge — and ring a loud warning bell for giddy investors. But Greenspan waved off Lindsey's prescient plea. A few months later, the chairman did speak once of "irrational exuberance," but the markets reacted badly. He dropped the subject.
Taking decisive action would have required courage. The chairman would have needed to set aside his neo-libertarian ideology, which abhors regulatory interventions in the economy. And he would have been compelled to take on the Fed's foremost constituency — Wall Street banks and brokerages — where he is most loved.
Instead, Greenspan's popularity soared with the booming economy. He backed off the Fed's longstanding anti-inflation policy of restraining economic growth and allowed unemployment to fall below the Fed's self-imposed floor. This made everyone feel good, especially the workers whose wages had been depressed for years by the Fed's stringency.
But Greenspan's second great error was joining the celebration himself. He suggested that rising productivity had opened a glorious new era of ever-upward prosperity. His ebullient remarks sounded very similar to the self-congratulations expressed by the Federal Reserve in the late 1920s. Then and now, the Fed's happy talk excited stock-market plungers, large and small.
The third error was the Fed's belated attempt in early 2000 to get some control over frenzied events — an error because it did so by hammering the real economy with interest-rate increases, rather than restraining the financial system directly. Greenspan claimed to detect a phantom price inflation in goods and services. Actually, the only price inflation was in the stock market. The obvious injustice was punishing the many for the excesses of a relative few, driving the broad economy into recession to calm down the out-of-control financial system.
Greenspan overdid it and was compelled to reverse himself abruptly, cutting interest rates dramatically to revive economic activity. Having cut rates so deeply, the Fed is now dangerously close to zero — that is, to running out of arrows. Yet Wall Street once again is clamoring for a big rate cut to salvage the deflating stock market. The Fed declined to cut interest rates last week; Greenspan should continue to ignore the bankers and brokers and allow the stock market to find the "bottom" on its own. The Fed and the White House should prepare a substantial, well-timed package of monetary and fiscal stimulus designed to kick-start the real economy of goods and services. Financial markets will follow.
The point is, the nation pays a terrible price for allowing this cloistered governing institution to evade serious public scrutiny and tougher questioning. Financial markets always matter, but finance is supposed to serve the real economy, not the other way around. Until the Fed's distorted priorities are corrected, the U.S. economy will continue to experience deep troubles.
William Greider writes for the Nation and is author of "Secrets of the Temple: How the Federal Reserve Runs the Country."
August 18, 2002
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