Greenspan's bubble? Lessons for next time

In 1996, when Alan Greenspan asked in a speech whether "irrational exuberance" was causing a stock-price bubble, some Wall Street pundits worried that the Federal Reserve chairman might intervene in a booming stock market. They said it was none of his business.

In hindsight, some experts now wish he had intervened. By making it harder for stocks to be bought "on margin" – with borrowed funds – the Fed might have slowed the torrid rise of share prices, and perhaps forestalled what is still proving to be an economically damaging collapse of Wall Street share prices.

The debate, while partly Monday-morning quarterbacking, will affect the way Mr. Greenspan is remembered, and to what degree he retains his reputation as a deft handler of the world's biggest economy. It could also teach lessons that affect how the nation's central bank deals with the next nascent stock bubble.

Recent criticism of Greenspan has clearly dimmed his halo – but not removed it altogether.

Thinking back on the prosperity of the 1990s, investors, most economists, and the public in general regard Mr. Greenspan's nearly 16-year tenure as chairman of the Fed as a huge success. Yes, a few cartoonists even portrayed the lanky Fed leader as a saint with a halo.

But the bursting of the stock exchange bubble has clearly damaged his reputation.

"A lot of people have lost a lot of money," notes Lyle Gramley, a Washington consulting economist and former Fed governor. At least a few are "are quite sure the drop in the stock market is his fault."

The criticism was sufficient for Greenspan to defend his views on the bubble issue at some length at a conference of central bankers in Jackson Hole, Wyo., Aug. 30.

Transcripts of a September 1996 meeting of Fed policymakers have Greenspan saying he could "guarantee" that a hike in margin requirements would get rid of the bubble. "My concern is that I am not sure what else [it] will do."

In Jackson Hole, Greenspan claimed that "it was very difficult to definitively identify a bubble until after the fact."

Tom Schlesinger, executive director of the Financial Markets Center in Philomont, Va., holds that the Fed should do its duty to tame wild enthusiasm on Wall Street just as it brakes the economy when necessary. He says his research shows that in the past, boosting margin requirements for investors has curbed stock prices without requiring a hike in interest rates to brake the economy.

Greenspan's critics say the stock-market bubble misdirected hundreds of billions of dollars into telecom and Internet enterprises, which subsequently faced financial troubles that still weigh on the economy today.

Many experts continue to believe Greenspan deserves praise, not censure, considering his guidance of the world's most important monetary system during such events as the 1987 stock-market crash, the 1997 financial crises in Asia, the debt default of Russia in 1998, and the post-9/11 stock plunge.

But the job of Fed chairman invites criticism. One charge against Greenspan is that he has not used his great prestige to lead Washington toward a more effective method for conducting monetary policy at a time when the role of commercial banks in the economy has shrunk.

A more immediate issue: With the economy still struggling after two slow years, should the Fed have lowered interest rates last month to give it another jolt? Economist Lawrence Kudlow, among others, calls for faster money-supply growth.

At its last meeting of policymakers Sept. 22, two members of the Open Market Committee argued for a rate cut and took the unusual step of registering that disagreement publicly. The votes were the first such registered dissents since 1995.

The debate over Greenspan comes amid speculation about his possible retirement. At 76, he is the oldest Fed chair in history.

Possibly Greenspan's greatest achievement was the almost inflation-free boom of the 1990s.

He was "the one person in the whole world" who saw a new dynamism in the American economy, says Mr. Gramley, a former Fed governor. Greenspan let unemployment slip below 6 percent after 1995, though many economists believed that tight labor markets would stir up inflation again. Rising productivity, however, kept inflation down.

Jeffrey Frankel, a Harvard University economist, holds that one Greenspan mistake was his support for President Bush's tax cuts in 2001. Greenspan saw the move as preferable to a huge paydown of federal debt. But now the reverse is happening: Washington has returned to red ink, which Mr. Frankel sees as a major reason for the faltering economy.