From Sideman to Conductor of the Global Economic Orchestra
Sebastian Mallaby has written a magnificent well-written book about Alan Greenspan and the times that shaped him. (Full Disclosure: I am mentioned in the book.) It is a story about a musically talented Jewish kid from Washington Heights who became a sideman playing the saxophone in a 1940s jazz band and who by the dint of his intelligence rises to become chairman of the Federal Reserve Board. We follow Greenspan through his undergraduate days at NYU where is math geekiness shines through to his stint in an economics graduate program at Columbia. There he meets future Fed Chairman Arthur Burns and learns the importance of knowing every number in the economic data set. By doing this he sees the economy from the ground up rather from the top down approaches of grand theory. His knowledge of the data will become most useful as his career progresses.
After a brief interlude he forms the economic consultancy of Townsend-Greenspan and garners a host of industrial and Wall Street accounts. He becomes the man who knew. About the same time he falls into the ultra-libertarian cult of Ayn Rand. Somehow he managed to keep the practicalities of his work separate from the extremes of the cult. In 1959 he authors a paper describing how share prices influence corporate capital expenditures. It is a precursor to Tobin’s Q for which Charles Tobin wins the Nobel Prize in economics. Simply put when share prices exceed replacement cost there is an incentive to expand and vice versa. Forty years later Larry Summers jokes that Tobin owes Greenspan a share of Nobel cash.
By the late 1960s Greenspan catches the political bug and works as an insider on Nixon’s presidential campaign. It is from that beginning he has an involvement in every Republican administration that came later. He learns how to wield power and bests Henry Kissinger in a bureaucratic fight over an Iran oil deal that never came to pass. By 1980 he was one of the key negotiators in the aborted attempt to have Jerry Ford become Reagan’s 1980 running mate. Far from being a sideman he was inside in the thick of it.
In 1987 Reagan appoints him to chair the Federal Reserve and of a sudden the stock market crashes. He with others work to prevent a repetition of 1929 and he comes out of it with an enhanced reputation. He has an icy relationship with the Bush Administration but gets along famously with the Clintons. It is then when the late 1990s economy takes off that he becomes the conductor of the global economic orchestra and is practically deified for a sustained period of high growth, low unemployment and low inflation. He rightly diagnoses well ahead of the data that productivity was surging. That was brilliant, but all those factors lead to “irrational exuberance” in the stock market.
But herein lies the problem that would haunt his reputation 10 years later. By targeting inflation and employment he necessarily ignored the asset markets and their potential to trigger instability. He ignored the warning of Hyman Minsky who noted that “stability leads to instability” as investors anticipate that the good times will last forever. When they don’t the financial system is undermined and with that the safety and soundness of the banking system.
Greenspan’s critics argue that he should have stopped the housing bubble of the mid-2000s through increased regulation. Mallaby rightly argues that getting the regulations right is a difficult task and in the midst of a bubble it is hard to do politically. Greenspan was unwilling to spend his political capital on this. Where Greenspan failed was that he believed that bankers in their own self-interest would prevent risk from getting out of control. They didn’t. I made a similar mistake in thinking that the Wall Street investment banks would not end up eating their own cooking by keeping so much bad paper on their balance sheet. They did. On the other hand Mallaby supports the critics in thinking that Greenspan should have been more aggressive in raising rates in 2004-06. To be sure bubbles are hard to detect and there was belief that the authorities could clean up a mess after the fact, but as it turned out the cleanup costs in 2008-2010 and still ongoing were enormous.
Mallaby also discusses Greenspan’s private life. After a failed marriage in the 1950s Greenspan becomes a serial monogamist dating staff members at Townsend-Greenspan, a speech writer in the Ford Administration, television personality Barbara Walters, and a host of others until he marries NBC newswoman Andrea Mitchell.
My few quibbles with the book is that in Mallaby’s discussion of the economic history he leaves out the importance of the Garn-St.Germain Depository Institutions Act of 1982 which enabled savings and loan associations to diversify their asset portfolios. That in combination with the new Reagan depreciation schedules created a marriage made in hell between the S&L’s and the tax syndicators that helped overbuild America in the 1980s. He doesn’t discuss the 1985 Plaza Accord whose effect was to flood the global economy with money setting up the 1987 crash and the final surge of the commercial real estate boom. He also fails to note that the Fed missed the rolling recession in commercial real estate that began in Texas, went to Phoenix and finally the Fed woke up when it reached New England. But New England was a weigh station on the road to Southern California and the New York City metropolitan area. Leaving these points aside I would highly recommend this book for readers interested in the life of a very interesting man and how economic policy is really made.
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