The former Fed chairman discusses the possible fallout from Greece, the shortcomings of stimulus programs, and his role in the financial crisis
Let me begin with the question of Greece, the likelihood of default, and the potential ramifications.
The chances of Greece not defaulting are very small. It's extremely unlikely that the political system will work in such a manner as to create the type of finances which will solve this problem. What you have to do is get [Europe-wide] fiscal consolidation, meaning that all of the affairs that relate to budgets are governed by some central council. Once you do that, you're very close to political integration. And I think that the possibilities of that are virtually nil. Right now, Greece has got interest rates on its two-year notes of over 30 percent. That's almost the equivalent of the market saying the chances of this country making it approach zero. So I think that we have to be prepared to take the consequences. The reason that is so important to the U.S. is that the sovereign debt of these peripheral countries is held very heavily by the European banks, which will be up against the wall. The U.S. has very few liabilities against Greece. It's got huge liabilities against Europe.
Could Greece have the same impact as Lehman Brothers in 2008?
I doubt that, largely because the Lehman Brothers issue came up in a startling way. After Bear Stearns defaulted in March of 2008, there was a very considerable perception that if you are going to be bailed out, as Bear Stearns was, that all investment banks or all financial institutions which were larger than Bear Stearns would be bailed out. So when Lehman Brothers wasn't, the shock to the market was overwhelming. I don't think that this particular issue at this stage can be a shock.
What's wrong with the American recovery?
I don't think we're about to move into a double dip, so to speak, but we're certainly growing at a subnormal rate. And statistically the reason is very simple. Construction, which in every other recovery since 1949 has been extraordinary, positive, and very supportive of the economy, has barely moved.
This is because of weakness in the housing market? Commercial construction?
If you dig down into the numbers and try to look at what's causing it, there is an extraordinary degree of apprehension about the longer term. And if the environment of your economy is highly unstable—especially with the activism that is involved in trying to stimulate the economy—people are not sure what to make of the longer term, and that means that they are very reluctant.
You mentioned stimulus, but what about debt?
Definitely, that is a major part of it. But the data show that a significant proportion of those stimuli create degrees of uncertainty which very much, possibly even wholly, offset the positive effects that occur as a consequence of the stimulus programs. I think, for example, the $787 billion stimulus program that was initiated in February 2009 hasn't had much of an effect, and the reason is that you can demonstrate from the data that the negatives that are created, as a consequence of this very extraordinary uncertainty, largely are offsetting.
What's the most important thing you've learned about markets in the last four years?
They work. In the sense that when you have imbalances, people withdraw and the markets collapse.
My impression was that you had realized that markets aren't perfect.
One of the things that I had been almost taking as a given was that corporate executives, specifically bank executives, knew enough about their organizations and cared enough to act in the support of the solvency of their institutions. I was wrong. They did not.
You spent a long time watching rates and inflation. Do you worry about inflation in today's circumstances?
Very much so, yes. History tells us that when you go through a period such as this with huge amounts of liquidity in the system, which at the moment is not being used at all, that eventually it takes hold and it begins to move in the price level. So I don't know a single economist, or certainly any member in government that deals in this area, who isn't worried about that issue.
Do you think any of the decisions you made as Chairman of the Federal Reserve contributed to the financial crisis?
The '08 crisis? The answer is no. And I wrote a long part of a paper for the Brookings Institution [on this]. If anybody wants to take the paper and tell me where I am wrong, I will listen.
Excerpted from an onstage Q&A at Bloomberg Headliners, held in New York.