September 17, 2007, 12:01 am
Q&A: Greenspan on Bubbles, Saddam, Cheney and Bernanke
By Greg Ip
In an interview in conjunction with the release of his memoir, Alan Greenspan discussed a wide range of subjects: the increased role of bubbles in business cycles; the global roots of what he now acknowledges was a housing bubble; his advice to the Bush Administration that Saddam Hussein should be removed before he gained too much control over the world oil supply; Dick Cheney; and the benefits of introverted Fed Chairmen. “The Age of Turbulence: Adventures in a New World,” published by Penguin Press, is to be released officially today. (See related story.)
At the Brookings recently, you talked about the role of psychology in business cycles. The book doesn’t get into that much.
It’s inferred. Sort of post-book. What strikes me about the current period is it’s wholly consistent with my generalized view of how important innate human characteristics are in sustaining the business cycle. I’ve always been concerned that in setting up an econometric model you take history irrespective of whether it’s up or down, and there’s an implicit judgment that the coefficients work symmetrically on the upside and downside. There is a general belief for example that capital gains on homes has a buoyant effect on consumption going up and precisely the same on the other side. I’m beginning to question whether that premise is true.
For example, the academic literature seems to have established that for most of us, the pain of a dollar of loss is far greater than the pleasure of a dollar of profit.
Yes. Fear is the driving force on the downside. Elements of wishful thinking and euphoria form the upside. When we look at the external world it’s very obvious. Fear is a far more dominant projector of action than is euphoria or anything like that. The division of labor … essentially creates competition and specialization and hence rising productivity and growth. Fear invariably and universally induces disengagement and disengagement is negative division of labor.
So a bubble is the inevitable end of every business cycle?
It comes to an end under two conditions. One is a bubble, or some variation of a bubble, in which capital investment is projected with expectations which are not realistic. The other is … you get an inventory cycle. [At the bottom of the cycle] inventories are liquidating .. and consumption is above production and as it goes up, production goes above consumption until [inventories need to be liquidated again]. There is no irrational euphoria, it’s just misjudgments.
At the Fed you said housing was in a froth, but you avoided calling it a bubble. From the vantage point of 2007, can you say now that it was in a bubble? Oh yeah. Lots of froths are equal to a bubble… What was driving prices higher was essentially the aftermath of the decline of the Soviet Union and the fall in real long term interest rates which drove up residential prices all over the world. And indeed, the U.S. was not at the top of the list by any means. It drove them up sooner in Britain and Australia as I recall. I find this issue that the Federal Reserve created the housing bubble just utterly devoid of any awareness of who created all the other bubbles. And they all look alike. Long-term real interest rates moved [in] parallel all over the world and the results were what you always get: a fall in equity [risk] premiums, a rise in price:earnings ratios, huge increases in liquidity, and large increases in the market values of assets.
Many people, including some former colleagues of yours from that period, believe the Fed kept interest rates too low for too long, thereby contributing to the housing bubble and problems in subprime mortgages. Do you agree?
We kept them too low for too long because we were effectively creating an insurance against [deflation]. The problem in making choices is that you recognize that if you miss, you can end up with interest rates too low, too long. The question is, what did that have to do with the housing boom? Remember that long term Treasury rates and mortgage rates stayed flat from early 2004 through the summer of 2005 [while the Fed raised the federal-funds rate from 1% to 3.5% in 0.25 percentage-point steps]. We tried effectively to get mortgage rates up as part of our incremental 25 basis point operation and we failed… If we were dealing with an inflationary environment, we would have had no trouble getting the 10-year [Treasury yield] up… Had we [raised rates] earlier, do you think we wouldn’t have gone through exactly the same phenomenon?
Your book criticizes the Republican Congress and the Administration for abandoning small government principles. Is Dick Cheney part of the problem or part of the solution?
I don’t really know. I mean you have to understand how profoundly impressed I was with Dick Cheney during the Ford Administration. And he and I remain very close in the years subsequent. Indeed, he was the only person who showed up at both my 50th and 70th birthday parties. And I still hold him in high regard. There’s an extraordinary intelligence there. He has very good judgment on issues… I do know that other than the issue that we had on the deficit [whose importance Cheney downplayed] that he had very much the same ideas as I had. I have no reason to believe his views from the Ford administration have changed.
His popularity ratings are quite low and he’s sometimes portrayed as sinister. Is that an accurate characterization?
Not in the slightest. He has strong views but manipulator, that he’s not. He’s been very straight with me. Clearly we don’t hold the same views we did back in the Ford administration and don’t have similar objectives. As I point out in the book, it’s unrealistic to believe that people in public office and public life will not have their views changed as indeed mine were between, say, 1977, when I left the Ford Administration, and [now].
Tell me about your views on the importance of deposing Saddam.
My view of the second Gulf War was that getting Saddam out of there was very important, but had nothing to do with weapons of mass destruction, it had to do with oil. My view of Saddam over the 20 years … was that he was very critically moving towards control of the Strait of Hormuz and as a consequence of that, control of the oil market. His purpose would be very much similar to [Venezuelan President Hugo] Chavez’s actions and I think it would be very dangerous for us. So getting him out to me seemed a very important priority.
Did you share this view with Cheney and Defense Secretary Donald Rumsfeld?
Do you think it influenced the Administration’s decision to invade Iraq?Their decision had been made prior to my discussions with them. My recollection is that someone said, ‘We can’t deal with oil because it’s a major political problem’ [because both Bush and Cheney came from the oil industry]. But it was not Cheney or Rumsfeld.
Isn’t it ironic that you, a Republican, seem to have respected, Bill Clinton, a Democrat, most of all the presidents you knew?
Look, the Clinton Administration was a pretty centrist party. Pro-international trade. I could see myself fairly close to [Robert] Rubin and [Lawrence] Summers and Clinton and Roger Altman and a number of the other people there, but they’re not governing again. The Democratic party has moved away, I fear very significantly in the wrong direction.
And I’m saddened by the whole political process. It’s not an accident that Republicans deserved to lose in 2006, and I said it wasn’t that the Democrats deserved to win and they proved they didn’t deserve to win by having been very effective on the negative side. But when it came time to rule all of sudden their ratings collapsed, and the reason they collapsed is they’re just as negative as the Republicans. I mean, we have some very fundamental problems that require action.
Now it turns out politics is less important , domestically , than it was, because globalization is taking over an ever increasing part of the decision making process with the exception of national security.
How is your successor, Ben Bernanke, doing?
He’s doing excellent. I think he’s handling policy quite sensibly. And not of a small matter, his regulatory views are very close to mine in virtually every aspect I’ve seen. What he’s essentially doing is carrying forward the major regulatory issues I developed with staff, like on [government-sponsored mortgage companies] Fannie [Mae] and Freddie [Mac] and numbers of other questions that have emerged. I really appreciate that.
He’s an extraordinarily intelligent guy. I had previous contact with him at Jackson Hole [in 1999]. He was one of the very few people who supported us on the issue of not targeting asset prices. And very many of his views were consonant with things that I believe. The trouble is he’s as introverted as I am.
At least Bernanke eats lunch with the staff in the cafeteria. You never did that.
He’s more gregarious than I.
In your book, you refer to Paul Volcker as “introverted and withdrawn.” Isn’t that like the pot calling the kettle black?
He’s worse than I am. I think though … where the issue of policy is really complex and not just a survey of other people’s opinions, you want somebody who is comfortable with his own judgment. Volcker … may not have been open and jovial and outward-going but he had strong convictions. And that’s not inconsistent with introversion. I would be uncomfortable with a “hail fellow well met” central banker.
Because he might be too anxious to please?
Do you aspire to a job in public life again? I don’t think so. There’s no other job in public life that is like chairman of the Fed. [This] gets around to a question of whether I should just be shutting my mouth and going fishing. I confronted the issue. Since 1948 I have spent every single day thinking how the economic and political worlds have changed. If somebody had said to me in June or July of 1987, ‘We’d like you to become chairman of the Federal Reserve, but you’re never allowed to discuss any economics after you leave,’ I’d have said, ‘Forget it.’ What do they want me to do? Become an anthropologist? The best thing I can do is try to stay away from the sensitive issues where it gets me second guessing what Ben is doing… I understand and am very much sensitive to my talking and what for example, my friends at the Fed may think … and I try as hard as I can to stay away from that.