Alan Greenspan and the Crash

Alan Greenspan was from 1987 to 2006 the Chairman of the Federal Reserve of the United States. Basically he set Federal Reserve interest rates, performed oversight on the Federal Open Market committee (FOMC) and set reserve requirements for banks. The first function grabs all the headlines in the press. And deservedly so since this operation affects home loans, credit card rates and what banks can borrow from other banks. But it was the second function that created as much of the financial mess as the first one. But let’s start off with the first function specifically the federal funds (FF) rate.

Alan Greenspan did an incredible job for many years. Many economists were in awe of his ability to anticipate 3 months to a year down the road what the economy would be doing. This is referred to as “lag” effect on the economy. Simply put what Mr. Greenspan did in March would not have an effect for months. It takes a real master and a little luck to get monetary policy right looking so far in the future but give Mr. Greenspan credit. He did it for years under Reagan, Bush I and Clinton.

In 1987 when Black Monday occurred and the stock market crashed 22% (the equivalent of a 3,000 point drop in the 2008 market) Mr. Greenspan was masterful in restoring confidence in markets. The Federal Reserve pumped money into the markets and restored confidence. By the end of the year the stock market was in the black by going from 1.897 in January to 1,939 in December. A textbook example of how to handle a crash. Alan Greenspan’s reputation as the master of the Federal Reserve was born.

So what happened under Bush II? A good insight comes from following Mr. Greenspan’s corrections of the FF rate.

In 1987 the FF rate was 6% to 7.3%. Played like a master through the crash. 1989 as the Savings and Loan debacle was coming unhinged Greenspan raised the rate to 9.8%. A master stroke that caused a lot of silly loans that would have been made to become expensive even to the most blinded speculators. Now keep in mind the Savings and Loan disaster didn’t play itself out fully until 1990-91. Mr. Greenspan was ahead of the curve, saw what was coming and reacted properly. He made money more expensive for speculators saving the America public billions of dollars in bail out money. A masterful job of running the Federal Reserve.

As Mr. Greenspan saw the negative impact of the Savings and Loan disaster on the economy and the slowdown in economic activity he dropped the FF rate to 4.49%. Once again brilliant use of monetary policy. Everyone with inside business knowledge griped here and there but there was no disputing Mr. Greenspan was keenly aware of what was going on in the economy and was moving monetary policy in the right direction.

In the early 90’s as the economy tanked and Clinton came to power and raised taxes. The FF rate was lowered to 2.91%. As the 90’s went on Clinton cut capital gains taxes and signed the NAFTA free trade agreement with Canada and Mexico the economy began to heat up again. The FF rate climbed to 4.5% to 5.5%. Steady and calm as it should be for a steady and calm economic growth period. Well done, we all enjoyed the 90’s.

As the 90’s closed and the Internet stock exploded and went crazy huge amounts of wealth were being created. Mr. Greenspan gave his famous speech in 1996 about the stock market and irrational exuberance.

Mr. Greenspan 12-05-1996 “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

Clearly Mr. Greenspan was way ahead of the curve since the National Association of Securities Dealers Automated Quotations (NASDAQ) didn’t crash until April 2000. And as this new wealth flooded Americas markets creating the specter of overpriced assets and inflation what did Mr. Greenspan do? Raised the FF rate to 6.85% putting a damper on inflation. Brilliant once again.

So what happened under Bush II? As money came into Fannie Mae and Freddie Mac flooding the home mortgage markets Mr. Greenspan didn’t notice? No! Mr. Greenspan did notice. He is recorded several times warning congress that more oversight and tighter financial restrictions need to be placed on Fannie Mae and Freddie Mac. Every chance he got from 2003 he mentioned the for coming crisis to congress until he retired in 2006. He was not ignorant. He just failed to act.

Why? Only Mr. Greenspan knows. What we do know is by 2002 the FF rate was 1.23%. Justifiable since the economy was recovering from 9-11 and a recession. As the sub prime loans began to dominate the markets starting in 2003 driving up real estate cost faster than inflation what happened? Mr. Greenspan LOWERED the rate to .97%. The exact opposite of his earlier actions under similar circumstances. The FF rate stayed at 1% through much of 2004 as foreign funds flooded US market in search of stable sure returns and sheer speculation. In essence Mr. Greenspan opened the floodgates of plentiful cheap money. Why?

Was he a saboteur? Did he want democrats to gain power? A financial collapse so well timed for the 2008 election certainly would not be beyond the capabilities of Mr. Greenspan and others with access to trillions in funds. We will never know the story for years but what is certain is Mr. Greenspan had a history of doing the right thing and he went against everything he had accomplished in the past to facilitate the destruction of the economy.

Eventually the FF rate was raised to 5.27% in 2007 as the housing markets were crashing all around everyone. The opposite of what should have happened. This intentional or unintentional destruction of markets by the Federal Reserve and it’s manipulation of interest rates is a text book example of why many economist think this power should be taken away from the Federal Reserve. Many economist feel interest rates should be set by market forces alone. Currently the FF rate is 0.13%. Yes 0.13%. The Federal Reserve is scrambling to restore credibility and facilitate money growth. Similar to closing the barn door after the horses have all escaped.

The FOMC actions are more complex but basically Mr. Greenspan was increasing money stock (MZM) during this period of 2003 to 2006. This while foreign investment was flooding our markets. Mr. Greenspan should have been stabilizing or even shrinking the money sock by selling treasury bonds and taking the money off the market and into the treasury. Coupled with raising interest rates and the housing bubble would have at the very least been mitigated if not eradicated.

Now the Federal Reserve is increasing stocks of money faster than ever. What is the next housing bubble? Most likely our currency. Our monetary base has gone up from $824 billion to $1,435 billion in 2008! Normally this change is from 0% to at the most 15% from year to year. This year it has grown an astonishing 80%! We are in very serious times.

If the congress fails to cut taxes or better yet scrap the current tax code and adopt the fair tax we will have a dollar collapse similar to third world countries like Argentina, Venezuela and the former USSR. Congress needs to cut taxes now; Congress needs to take away the power of the Federal Reserve to set interest rates. The Federal Reserve needs to quit increasing the money supply. Congress needs to quit baling out everyone. But none of this will happen. When it all collapses we will once again need to rely on each other to get through this. As we have for centuries.

History repeats itself. I wrote about him in my first post on this web site. And here is more evidence of Keynesian economics and the democrats seizing power for the foreseeable future. Another example of the people having their trust betrayed by selfish and political motives. Mr. Greenspan will go down as one of the worst Federal Charimans along with Eugene I. Meyer (September 16, 1930 – May 10, 1933), Eugene R. Black (May 19, 1933 – August 15, 1934), Marriner S. Eccles¹ (November 15, 1934 – February 3, 1948).