190) Greenspan: Revered to reviled?

Warned about the after effects of a house price collapse, Mr Greenspan’s response was that asset bubbles were not the business of central banks.

He was hailed as the greatest central banker of all time (This writer thought so too). But former US Fed Chairman Mr Alan Greenspan’s reputation is heading towards tatters.

Never in history or hereafter will a central banker have as sharp or quick a fall.

The problem was the phenomenon of an asset price boom — specifically the boom in house prices.

This took place in the environment of sharp falls in US interest rates engineered by the Greenspan Fed, following the collapse of the dot com bubble and 9/11. From 5.5 per cent, as we entered 2000, the Fed cut to 1 per cent and kept it there for as long as three years.

In the meanwhile and as a result, housing prospered as did the stock market. Economic growth was tepid compared to the Clinton years (and might have been far worse but for the housing investment stimulant). Early warning

Sane advice was not in short supply. Mr Greenspan was warned — not once but several times, not by an odd economist, but many — about the after effects of a house price collapse.

His response was that asset bubbles were not the business of central banks and they should not influence monetary policy.

The most he would concede was that central banks might have a lot of cleaning up to do if asset prices crashed — in essence, no action on the way up but rate cuts and adequate liquidity provisioning on the way down.

Mr Greenspan did not see a housing collapse in his tenure but did successfully tackle the 1987 stock market fall, the Mexican and Asian crises and hedge fund LTCM’s implosion with his recommended medicine.

In fact, he was busy fighting a different war — one against deflation, strange as it sounds today. In this, he was on the same wavelength as the present Fed Chairman, Mr Ben Bernanke, who too missed the significance of asset bubbles. By the time Mr Greenspan decided to start raising interest rates, it was too late to check the boom, which, sooner or later, was bound to end in tears.Regulation laxity

More than failure to recognise the risk of asset bubbles, Mr Greenspan must be faulted for the laxity in bank regulation, which enabled the financial system to create millions of (now) worthless mortgages and Collateral Debt Obligations backed by these weak assets.

The crowning glory was the rush to insure them with Credit Default Swaps, which were written for trillions of dollars by institutions like the late unlamented AIG on the strength of dubious credit ratings awarded by conniving rating agencies.

It will remain a tragedy that the first rate mind of Mr Alan Greenspan did not see all this coming.

S. Balakrishnan