By Robert Kuttner
We will be hearing a lot about Alan Greenspan's legacy as the final year of his Fed tenure winds down. Here is a dissenting view: Greenspan has been a genius -- at sparing the economy the worst consequences of problems partly of his own making. These achievements have stabilized the economy for now. But the delayed damage will surely haunt his successor.
First, however, let's give credit where it's due. Greenspan grasped early on that the New Economy could accommodate more growth than many of his colleagues thought prudent. In the mid-1990s he calculated that higher productivity rates, resulting from new technology and competition, made moot old assumptions about growth and inflation. It was no longer true that inflation would result if growth exceeded about 2.5% or if unemployment fell below the 6% range. So Greenspan let the economy rip, growth took off, joblessness sank to 4%, and inflation stayed tame. He was the rare Fed chairman who didn't take away the punch bowl too early in the party.
Greenspan also boldly flooded the system with credit and jawboned banks to keep lending at moments such as the 1987 crash, just two months into his tenure, when financial panic threatened to paralyze credit flows and collapse the economy. He also did it in the 2000-01 market crash and at times when major banks were under water, as with Citibank (C ) in the early 1990s. In that crisis, he and then-New York Fed President E. Gerald Corrigan personally helped find Citibank new sources of capital. Greenspan also made sure the U.S. banking system survived the Mexican and South Asian collapses of the 1990s and that of wayward hedge fund Long Term Capital Management. So the activist Greenspan stretched the Fed's legal mandate for the greater good.
I RECENTLY INTERVIEWED NOBEL laureate Milton Friedman, who has long argued that the Fed should be largely passive, let markets work, and confine itself to a "strict monetary rule" of targeting price stability. Friedman, at 93, will soon publish a study comparing central bank performance in the U.S. crashes of 1929-33 and 2000-01 and the Japanese deflation of the 1990s. Friedman concludes that the Greenspan Fed, unlike the others, intervened effectively. Although Friedman is averse to praising any government agency, he concedes that the Fed, as an institution, learned a lot in 70 years.
So why isn't Alan Greenspan a candidate for economic sainthood? The big reason is that Greenspan, in his other role as free-market ideologue, helped push the economy into the same perilous waters that required central banker Greenspan's miracle rescues. As a Republican conservative, Greenspan used his prestige to lend political cover to the fiscally outrageous tax cuts of President George W. Bush. For the moment, low interest rates coexist with high deficits and rising debt. But that won't continue indefinitely, and we will pay the piper dearly as long-term rates rise and the dollar comes under international pressure.
Greenspan has been a champion of the excessive deregulation of financial markets that in turn set the economy up for bubble and crash. He famously warned that markets were succumbing to irrational exuberance, but refused to wield the appropriate cooling instrument -- raising margin requirements. (He couldn't use the blunter instrument of higher interest rates because he needed cheap money to bail out sundry financial calamities created by too much deregulation.)
For two decades, under both former Chairman Paul A. Volcker and more extensively under Greenspan, the Federal Reserve dismantled the Glass-Steagall Act by administrative stealth, widening loopholes through (de)regulatory actions. The breaching of the supposed Glass-Steagall wall separating commercial banking and investment banking produced conflicts between the interests of insiders and those of the investing public; this, in turn, helped overheat the market. Greenspan also bent regulatory rules to ease bank mega-mergers that had little economic purpose other than to enrich insiders and pump up stock prices -- again feeding the bubble mentality.
In sum, Alan Greenspan favored dismantling too much regulation and taxation -- and then compensated for the damage by deftly leading a hyperactive Fed. Historians will one day conclude that the ultralibertarian Greenspan was a bit like the arsonist who then plays the role of valiant firefighter. It's better not to set the fires.
Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale