Greenspan attempts to shore up legacy at Fed, but some blame him for credit crisis

By Stephen Foley in New York
Published: 14 September 2007

Alan Greenspan is preparing to hit the publicity trail to promote his eagerly awaited memoirs, just as the feted former chairman's tenure at the US Federal Reserve is facing a revisionist onslaught. Economists and commentators blame him for the current turmoil in the credit markets – and for the ominous signs of an economic slowdown to come.

Rather than being the victory lap of television studios he once envisaged, the interviews Mr Greenspan has planned to coincide with publication on Monday of his book, The Age Of Turbulence, will see him trying to shore up the legacy of his 18 years in charge of US monetary policy, which ended in January last year.

The timing of the book launch could hardly be more symbolic, coming just a day before the most important test of Mr Greenspan's successor, Ben Bernanke. On Tuesday, the Fed will consider an interest rate cut which may be needed to prevent the bursting of a bubble in the housing and credit markets from wrecking the rest of the US economy.

Mr Greenspan stands accused of allowing these bubbles to inflate by holding US interest rates too low for too long – a bad habit his critics say stretches back over his whole tenure, from the first few months where he cut rates sharply in the wake of the stock market crash of 1987.

"With hindsight, it is possible to see that his modus operandi was to blow one bubble after another," said Tom Schlesinger, the executive director of the Virginia-based Financial Markets Center, which analyses the Fed. "Mr Greenspan consistently argued that central banks have no legitimacy to intervene to prevent asset price bubbles, and to substitute their judgement for that of millions of market participants. But central banks have no problem whatsoever intervening when they think that product prices are inflating, or when labour markets are overheating."

Aggressive moves to cut interest rates in 1987 were credited with preventing the stock market crash from affecting the rest of the US economy, which kept on growing, but a similar move to restore confidence after the collapse of the hedge fund Long-Term Capital Management in 1998 has been blamed for having the side effect of inflating the dot.com bubble, which burst in 2000.

It was at this point that financial market traders began to talk about the "Greenspan put" – a notion that the Fed would always act to protect the markets from losses. Mr Bernanke is still having to dispel that idea, insisting that he will not cut interest rates to bail out irresponsible lenders, only to protect the real economy.

A vitriolic profile in the new business magazine Portfolio is just the latest contribution to prompt an impassioned debate over Mr Greenspan's approach to interest rate policy.

Economists are debating the extent to which his final period of interest rate cuts at the start of the decade – including a full percentage point cut after the September 11 attacks of 2001, and further reductions that took the main Fed funds rate down to just 1 per cent – was a factor in the cheap credit explosion. Wall Street's invention of exotic new debt products was another factor, as was a wall of new money coming in from emerging markets. But low interest rates certainly helped to generate not just an economic resurgence but also a speculative house price bubble and a whole industry offering mortgages to borrowers who were previously deemed uncreditworthy – and are now proving themselves so.

The discussion at this month's central banking symposium in Jackson Hole, Wyoming, was in many ways a coded assessment of Mr Greenspan's tenure, concerned as it was with the overheating and subsequent cooling of the US housing market and its relationship to monetary policy.

In his speech, John Taylor, an economist at Stanford University, suggested that the Fed Funds rate should never have been taken lower than 1.75 per cent in 2001, when the US economy began to emerge from recession, since it encouraged markets to believe that the Fed had de-emphasised its perennial fight against inflation because of fears of deflation.

"A higher funds path would have avoided much of the housing boom," Mr Taylor said.

"The reversal of the boom and thereby the resulting market turmoil would not have been as sharp."