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Flawed titan of the Fed

And so begins The Flaw, David Sington’s new documentary about the origins of the financial crisis. The movie, which opened in London recently, makes a compelling argument that the nature of American capitalism has changed in recent decades, giving rise to unstable levels of inequality and a mistaken belief in the self-correcting power of free markets. ‘The Flaw’ focuses largely on the housing market and offers a far less blistering critique of Wall Street than Inside Job¸ Charles Ferguson’s 2010 Oscar-winning documentary. Yet in both films, Greenspan, who spoke with Newsweek at his office in Washington, D.C., is cast in a similar role — as someone who personifies much of what went wrong with the economy.

Since the housing bubble burst, and Wall Street teetered on the brink of collapse, Greenspan — once widely hailed as the oracle of the American economy — has seen his standing plummet. Most recently, Paul Krugman, the Nobel Prize – winning economist and columnist for The New York Times, wrote that Greenspan is continuing “to cement his reputation as the worst ex–Fed chairman in history” — a searing statement even for someone on the left.

And yet what continues to drive much of the criticism of Greenspan is not so much his record at the Fed but his recent political commentary. Despite his 2008 mea culpa, Greenspan has largely remained steadfast in his faith in laissez faire, arguing against the government’s stimulus package and recent financial regulation. As Congress continues to fight over long-term spending and the future of entitlements, it is precisely this sort of stubborn libertarianism that has enraged Greenspan’s critics and once again cast a spotlight on his legacy.

When Greenspan retired five years ago, his reputation seemed unimpeachable. Despite fears that he would govern the central bank as a conservative ideologue — he was once a disciple of the radical libertarian writer Ayn Rand — during the early ’90s, Greenspan proved to be a pragmatist and a highly successful technocrat, according to Brad DeLong, an economist at the University of California, Berkeley. One of the central bank’s two primary jobs is to keep prices stable and employment high. On both fronts, Greenspan’s record, from 1987 to 2000, was strong, according to friends, former colleagues, and even critics. “The years that Alan Greenspan was chair were years of unprecedented growth and price stability,” says Larry Summers, the former Treasury secretary.

Greenspan’s first decade or so in office was also marked by a series of potential disasters. Yet from the stock-market crash of 1987 to the Asian financial crisis in the late 1990s, Greenspan — with a combination of luck and skill — helped steer the US economy away from catastrophe. “He deserves tremendous credit,” says John Taylor, a senior fellow at the Hoover Institution and one of Greenspan’s most prominent critics.

Some of the more serious criticism borders on unfair. Many critics have argued that the Federal Reserve’s low-interest-rate policies in the early 2000s encouraged investors to take excessive risks. And to some extent, that’s true. Yet at the time, deflation was a legitimate concern. And to assign much of the blame for the financial meltdown on the central bank’s easy-money policies — rather than holding Wall Street accountable for its excessive greed — is a bit like jailing the person who accidentally left the back door open and then pardoning the thief who came in and robbed everyone blind. For all hoopla about Greenspan — and on this, ‘Inside Job’ strikes a resonant note — what’s remarkable about the financial crisis is how few Wall Street malefactors have been prosecuted, despite considerable evidence of fraud.

Where Greenspan deserves considerable blame, however, is on the regulatory front — something that The Flaw, for all its sharp analysis of economic history, mentions largely in passing. The central bank is among the main federal agencies in charge of policing the financial system. All dropped the ball at some point, yet when it came to the economy, Greenspan was perhaps the country’s most influential figure.

As the government’s Financial Crisis Commission concluded several months ago, the Fed had heard warnings of widespread fraud in the mortgage market yet did not act to curb it, which was well within its power. In fact, more than a decade before the crisis, Congress made the Fed the primary watchdog of the growing subprime-mortgage market.

Despite this regulatory failure, many economists say that Greenspan’s legacy is still relatively positive, thanks to the success of his early years. And some, such as Kohn and Blinder, praise his overall record on monetary policy. In fact, some of the most scathing words have more to do with Greenspan’s criticism of the Dodd-Frank financial regulation than his actual stewardship of the economy. “What next?” John Cassidy wrote in a blog post for The New Yorker. “Donald Rumsfeld attacking the notion of postwar planning?”

In an interview, Greenspan — his voice raspy, his eyes looking weary behind his dark-framed glasses — was reluctant to talk about his legacy. Instead, speaking in long, careful sentences, the former Fed chairman tried to appear unfazed by his critics. “Mistakes are essential, and I have made my share,” he said. “But they don’t weigh heavily on me. I don’t have any interest in dwelling on the past.”

Yet as the interview neared its end, his tone belied his agitation. “I am as sensitive as anybody. But criticism doesn’t bother me that much. I know with certainty that two plus two equals four, and I don’t need help to make that judgment.”

Perhaps, but it is this defiance — as much as any flaw in his ideology — that will continue to obscure his actual legacy, which shouldn’t exclusively be defined by the crisis.

© Newsweek