Greenspan fiddled while the economy burned

Greenspan previously had assured Congress that there was no need to oversee funds like Long Term Capital Management; now Greenspan's own Federal Reserve staff concluded that, if LTCM failed, there was a significant potential for a once-in-a-lifetime capital market meltdown: A bailout was arranged, but it is reported that Greenspan was unhappy with the Fed's role in the solution. He felt that the probability that the world financial system would collapse was less than 50%, and the Fed should not have lent its name or offices to the bailout. Yet, even if the odds of a collapse were less than half, why would one with the power to prevent the collapse run the risk? The answer can provide an insight into Greenspan's thinking and his tolerance for others to be hurt.

As the prosperity of the 1990s progressed, Greenspan's celebrity increased. The cable channel A&E called him the most fascinating person of 1999. Paeans to him were written. Friends from his early life, who never saw such celebrity coming, were surprised. Greenspan clearly relished his status. As one of the most powerful men in the world, he certainly could have been driven to the Fed meetings, but he chose to walk. Television networks chronicled these strolls. Commentators speculated on the future of rates based upon the size of his briefcase. Greenspan spoke in ambiguous terms, which allowed him an easy way out of any position because no one could understand what he was saying, giving rise to the term "Fed speak." It is said that he had to propose three times to Andrea Mitchell before she understood that he wanted to marry her.

Greenspan will be remembered for many things, but perhaps none more than a speech he gave on Dec. 5, 1996, at a reception in his honor at the American Enterprise Institute. It was over 4,000 words long. About halfway through, Greenspan did something that only two other Fed chairmen had done before: he addressed the market directly.

He asked, "How do we know when irrational exuberance has unduly escalated asset values?" His dramatic phrase was unprecedented. Greenspan's predecessor at the Council of Economic Advisors, Herbert Stein, observed it was a good thing the U.S. markets were closed. International markets, however, remained open and tumbled immediately. The Nikkei had its biggest loss of the year. The sell-off continued around the world. At the New York Stock Exchange opening the morning after his speech, the Dow was down 145 points. His comments cemented his status as an oracle. He began to have a clerk monitor his congressional testimony for market movements.

His comments further established his record as a terrible forecaster. In 1959, he had made similar comments to Fortune when he warned of "overexuberance." The market was up 43% the ensuing year. The day following his comments to the AEI, the Dow closed at 6,448. The Dow would continue to climb, not reaching its peak for four more years.

Greenspan and the Fed never have been able to appreciate fully the effects of productivity increases and advancing technology on those improvements. In the 1990s, the American economy (minus technology) grew at about the same rate as Germany's very slowly. The difference between the U.S. and the rest of the world was the effect of technology and the efficiencies it provided.