Alan Greenspan’s Legacy to Central Banking: ‘The Guru Can Punch Back’
Alan Greenspan 'knew the dark arts of politics better even than the politicians did,' says biographer Sebastian Mallaby
By Greg Ip
Alan Greenspan stepped down from the Federal Reserve in 2006 a hero, but in the financial crisis that followed, became a goat. Was either reputation justified? No, says Sebastian Mallaby, a fellow at the Council on Foreign Relations. His exhaustive new biography, “The Man Who Knew: The Life and Times of Alan Greenspan,” portrays a man who both shaped and was shaped by the U.S. financial system from the 1940s to the present.
I sat down with Mr. Mallaby to talk about Greenspan and his book. An edited transcript follows. You can also hear the entire interview as a podcast. (Disclosure: Mr. Mallaby provided an endorsement for my last book.)
GREG IP: Before the crisis, Alan Greenspan was “the maestro,” the man who could do no wrong, and yet after the crisis he became the man whose easy money and deregulatory inclinations gave us a financial crisis. Are these portrayals wrong?
MR. MALLABY: He went from hero to zero faster than anybody else in modern American memory. To some extent that’s justified: You cannot be the most powerful economist in the world, which Greenspan was for a long time as chairman of the Fed, then have the global financial system blow up and say, “It wasn’t my fault.” You have that much power, you have to have influence and responsibility.
But in my view, the mistake he made is not the conventional narrative. The conventional narrative would say, look, in the 2000s, inflation was around target, so interest rates must have been right. On the other hand, we had a financial crisis, so the regulation must have been wrong.
What I discovered in my five years of research was that the Fed tried more than we realized to do things about subprime mortgages, about Fannie and Freddie, the GSE lenders. The New York Fed tried a bit on excess leverage at the banks. And these regulatory efforts were stymied by the fact that the U.S. regulatory system is extremely balkanized, very political, and it’s extremely hard to really drive down risk through regulation. Therefore, I think, the real mistake was not to push with interest rates.
MR. IP: There’s also a view out that Greenspan was somehow blind to the possibility of bubbles, that he thought markets were hyperefficient. But you’ve found that that he actually had a much more sophisticated view about how markets worked.
MR. MALLABY: This is one of the incredibly exciting things about my research—discovering that Greenspan was not the guy we thought we knew. I was in his office repeatedly, talking to him at length, and whenever I asked about his early intellectual development, his eyes would drift up to a particular shelf above my shoulder. And as I looked up there, I saw this fat binder, the kind that might contain a Ph.D. thesis. I [said] Alan, it would be great if I had your Ph.D. thesis, which had been so-called lost, disappeared from the library at New York University, which was supposed to have it. When he gave it to me, I found its central portion was about bubbles, about the threat of financial instability to economic growth and therefore that central banks had to address that asset-price instability. So the idea that he was a naïve believer in the self-policing efficiency of markets is just 180 degrees wrong.
MR. IP: He was also an acolyte of Ayn Rand, the high priestess of the libertarian free-market vision of humanity. Reading your book, it appears he had a very austere and simplistic vision when he was young, but it changed.
MR. MALLABY: Greenspan had given these speeches under the auspices of Ayn Rand’s institute when he was in his late 30s. It was 1963, ’64, and he’d given these talks on the economics of a free society, which I thought must contain the kind of pristine expression of his libertarian faith. And one day I was going to see Ayn Rand people from that time, trying to get the transcript of these lectures, and I found a person in a cabin, isolated in the woods of rural Virginia, and in his basement there were the 300 pages, the whole transcript, the complete map of my subject’s mind in that period.
When I read it, I came across this quote saying, get this: “The creation of the Federal Reserve was an historic disaster.”
So the man who later embodied the Fed didn’t think the Fed should have been created. And that shows you how extreme he was in his belief that there should be a gold standard, there should be no monetary accommodation of asset price run-ups whatsoever. And he did change, so the later Greenspan, the pragmatic Greenspan, the person who rescued the financial system repeatedly, was diametrically opposed.
MR. IP: Is that a way of saying that he was politically expedient, willing to subvert his true beliefs in order to get along or to achieve more influence? Or is that a too uncharitable?
MR. MALLABY: You have this principled libertarian. He goes into government, and progressively he becomes the opposite of libertarian. He’s the man who used to believe in the gold standard, and now he’s the embodiment of fiat currency. Is that expediency, or is that just recognizing reality? I think you can take your pick.
MR. IP: There are terrific passages about how, for example, the Nixon White House used Greenspan to control Arthur Burns, chairman of the Federal Reserve at the time, how Greenspan bested Henry Kissinger in White House infighting. A picture emerges of a very political person. And yet central bankers today, including Greenspan, would hold themselves out as above politics. Is that wrong? Is Donald Trump right that central bankers are political people, trying to keep the president of the day in power?
MR. MALLABY: This is a common view, which I think is very wrong. When you look in detail at monetary history, the central bank can’t escape politics. It’s always either the victim of politics, as Arthur Burns was, where the people who were later jailed for Watergate did this dirty trick against the chairman of the Fed to force him into cutting interest rates. So either the Fed is the victim of politics or it can choose to be political itself and fight back. We live in this culture right now of the backlash against the technocrat, the expert. Alan Greenspan’s career shows how the expert can be empowered, the guru can punch back.
The way that Greenspan protected and established the independence, authority and prestige of the central bank was by being more political than the politicians who criticized him. If they wanted to leak bad stories about him, he would leak three bad stories about them. If they wanted to try and entrap him in politics, you know what? He had contacts in the Senate. He would go over there and so and so, who was his enemy, suddenly would not get confirmed to a big administration position. So he knew the dark arts of politics better even than the politicians did.
MR. IP: Your bottom line is, “He was a man who knew; he was not the man who acted.” You say he knew about the dangers of bubbles, but he chose not to act against a housing bubble that ended in our financial crisis for political reasons. I covered Greenspan a lot in those years, and the argument he and those around him advanced went like this: Bubbles are hard to detect. If you detect them, they’re hard to burst. And if you burst them, you might end up doing more harm than if you allowed them to burst on their own. That assessment seems to have stood the test of time. It’s shared by his successors, Ben Bernanke and Janet Yellen. Do you disagree? Do you think that he should have acted?
MR. MALLABY: I do disagree, with some trepidation, because very serious people like Ben Bernanke and Janet Yellen are on the other side. I believe you’re on the other side, and you’re pretty serious as well. All parts of that three-part thesis you just laid out are open to question.
[Can you] detect bubbles in advance? You don’t know for sure, but you do see danger signs. In the transcripts of the Federal Open Market Committee, Greenspan’s repeatedly pointing to danger signs. Second, that you couldn’t necessarily raise the Fed’s interest rate enough to pop the bubble. I just don’t believe it. In 2013, when there was the so-called taper tantrum, the Fed did effect a repricing of asset market, and the amount of tightening needed was 0%. It has more power than it thinks.
There’s one last part, which is maybe you can just clean up after the bubble. I mean, clearly that was not true after 2008. When you look at the aftermath of the tech bubble, for example, the Fed did clean up after that, but it did so by cutting interest rates so much that it inflated the real-estate bubble.
MR. IP: If Greenspan were still chairman of the Fed, how would Fed policy be different today?
MR. MALLABY: I suspect it would not be all that different. Greenspan as a commentator occasionally comes out these days and says he’s worried about QE [quantitative easing]. The truth is that if you look at his record, he was always risk-averse, always ready to support growth. He was an activist, and therefore I don’t think it would be that different.
MR. IP: You’ve spent five years on this book. How is the Greenspan that you got to know different from the Greenspan that you knew before?
MR. MALLABY: One of the nice things is that he is in private a very humorous person. I discovered things which really don’t fit with the image of the dour, besuited, sober Fed chairman. In 1959, this is a man who bought the Buick Electra 225 convertible with red leather seats on the inside, one of those double-hoop steering wheels, which had leather on the outside and gleaming chrome on the inside. It had chrome all over the outside of the car. There was one of those radiator grilles in the front, snarling at you angrily, enormous tail fins. It was irrational exuberance incarnate.
MR. IP: There was also quite a parade of women in his life. What’s up with that?
MR. MALLABY: He was not against marriage—he did it twice. But he was single between the age of 27 and 71. That’s an unusual formula. And in between 27 and 71, as he told me, he dated senators, news anchors, beauty queens and much in between—and, I would add, not always sequentially. He was on the one hand extremely private, very shy, and therefore not really suited to sharing his life with a partner. That’s why he was single for the bulk of it. At the same time, because he was shy, he wanted to go to A-list parties with a beautiful woman on his arm.
It was important to his self-image. A lot of his life can be explained by the story of an introverted, shy person with extraordinary mental ability who wanted to convert that geekish facility with numbers into worldly recognition. And he did it first by making a lot of money, very young. He did it by dating glamorous women. And then he did it by attaining more power than any other economist has managed in the postwar era.
MR. IP: Did Alan Greenspan leave a permanent mark on the U.S.? And if so, what is it?
MR. MALLABY: He created something which we didn’t have before, namely a central bank which represented a combination of economic expertise and political clout. We think of Paul Volcker, his predecessor, as the giant who slayed inflation. But we forget that in the last part of his tenure, Volcker was surrounded by the Reagan administration, who put Reaganites onto the Fed’s board, who voted against Volcker, both on interest rates and twice on regulation. Volcker, by the end of his tenure, was a diminished shadow of his former self.
Greenspan comes in, and for the first four or five years he faces enormous political pressure. You know, the budget director in the George H.W. Bush White House, Richard Darman, was whispering in Washington that Greenspan was this creepy guy, 65 years old, calls his mother every day—doesn’t he remind you of the creepy guy in “Psycho,” the Alfred Hitchcock movie? There was really nasty political pressure on the Fed in the first few years.
But then Greenspan establishes his authority. He shows he won’t cave to the pressure. He shows that he can fight back by being as good at the political dark arts as his tormenters. And then the Fed enters this golden period of prestige from the advent of Bill Clinton in 1993 to the end of Greenspan’s tenure in 2006.
This model of the empowered expert, the political guru, is now in retreat in the era of Donald Trump, but it isn’t totally gone. I would say that’s the central legacy that Alan Greenspan has left to the United States.