When I was a young economist in the Irish Central Bank, Alan Greenspan was the king of central bankers. Greenspan, who died this week at the age of 100, seemed to me to be exactly what a prominent economist should be: brilliant, mercurial but possessing an emotional depth than many of the other buttoned-up technocrats lacked. He had a Renaissance Man’s appreciation of music, art and history, yet my concern, even then, was his commitment to an extreme ideology. For a person who appeared to understand the human condition, his attachment to the libertarian teachings of Alice O’Connor (better known Ayn Rand and born as Aliza Rosenbaum), was a bit disappointing.
Libertarianism believes in low or no taxes, minimal government spending and unfettered free markets. Be a libertarian all you want, but then don’t become the most interventionist central banker the world has ever seen – which Greenspan became.
Surely what is good for the goose is good for the gander? The paradox of Greenspan revolved around him extolling the virtues of capitalism, playing down the risks in financial markets, eschewing regulation of all forms, yet when things went pear shaped he was always ready to intervene to bail out Wall Street. How could a true believer in free markets espouse socialism for the rich and capitalism only for the poor? In a Greenspan crisis, the wealthy could be assured of a dig out, while austerity was reserved for the downtrodden.
And yet despite these glaring contradictions, his tenure in the US Federal Reserve saw the US economy – and American incomes – grow rapidly and permanently.
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Can this positive macro result make up for the fact that, also under his watch, the financial system in the US took on ever-increasing risk, which he cheerled, leading ultimately to the collapse of the US financial system in 2008 – a calamity he never saw coming? It is hard to be generous, but rather than apportion blame, why don’t we explore why Greenspan was so able and yet so blind? And why did so many of America’s leading economists believe such nonsense for so long? And how did such monetary myopia spread throughout the world so quickly in the early 2000s?
[ Alan Greenspan’s deregulation agenda set the scene for Ireland’s financial crashOpens in new window ]
Official Ireland also suffered from Greenspan-ism and its fairytale about the soft landing. Every single economist and adviser, all the official, public-financed economic institutes, those in a positions of influence in Ireland, believed in the soft landing, which was peddled every time anyone shouted stop. Hibernian Greenspan-ism, embraced from the Galway tent to the Central Bank’s bulletins, was celebrated as the country became increasingly indebted and senior officials believed that we could get rich selling bits of Ireland to each other with other people’s money. Obviously the whole thing came crashing down. But that was only obvious if you were listening to another story rather than the one being flogged by Alan Greenspan.
Greenspan believed in something called the “efficient market hypothesis”, which postulates that markets are always right, there can’t be any way that markets can be wrong, because information is free and ubiquitous and market prices, always and everywhere, reflect fundamentals. If prices are sky high, it is because demand is sky-high, itself driven by fundamentals; similarly, if prices are at rock bottom, it is because demand has collapsed. Faith in this type of thinking means that, if left to their own devices, markets always right themselves.
Luckily, there were other, far more plausible but unpopular theories being kept on life support by some unfashionable economics lecturers. The observations of two economists, Hyman Minsky and Charles Kindleberger, summed up a different world view which argued that markets are inherently unstable. And the longer they are stable or appear to be stable, the more risk will be taken, thus rendering them unstable. These economists warned that human nature plays a pivotal role and as we get excited together, we egg each other on, creating conditions for bubbles, where prices go way above what can be justified by fundamentals. And once the crash comes, the associated debt and bankruptcies mean that the economy can become trapped in a long recession.
[ The Irish Times view on Alan Greenspan: from boom time to the crashOpens in new window ]
Even as a student, this struck me as a more accurate picture of the real world than Greenspan’s mathematical fantasy world. What Greenspan’s mathematic models acquired in precision, they lost in relevance because not only did these models not accord to reality, they corrupted reality and led to false conclusions, which had deleterious real-world impacts.
In short, when economists like Greenspan saw a price they saw a number; when normal people see a price, we get a feeling and that feeling leads to euphoria, giddiness and optimism. These very human emotions cause us to act irrationally, excitedly getting caught up in the frenzy. When we look back at 2008 we can’t quite believe that we did what we did. Buying that second house in Bulgaria, apartment in Sandyford or piece of unzoned land outside Portarlington. But this happened because we are human and we make mistakes, particularly when we are swept up in the euphoria.
By taking the messy human being out of his economic analysis, replacing real-life behaviour with “assumptions” about how humans should behave, rather than how we actually behave, Greenspan and his disciples waltzed themselves up a financial cul-de-sac. Despite the global catastrophe of 2008, Greenspan remained defiant. At one of the many enquiries following the crash, Greenspan was asked if he was mistaken. And his response:
“Partially ... I made a mistake in presuming that the self-interest of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms ... I discovered a flaw in the model that I perceived is the critical functioning structure that defines how the world works. I had been going for 40 years with considerable evidence that it was working exceptionally well.”
With his passing, it is quite clear that such an unrepentant attitude in the face of a financial calamity from the man who was running the show has damaged the economics profession, undermined its credibility and has led, to some extent, to the widespread notion that the experts shouldn’t be listened to. After all, Greenspan was the experts’ expert, which is why his legacy is so ambiguous.
