Greenspan, Bush and Obama: Who’s Responsible For The Financial Crisis? – Peter Hartcher

Issue 2 | 15 April 2009

Peter Hartcher has worked in Washington DC for the Australian Financial Review, and was a visiting fellow at The Lowy Institute in 2003. He is currently Chair Editor of The Diplomat and is the international and political editor for the Sydney Morning Herald. He has written widely on Australian politics and foreign affairs and was prescient in his judgement of Alan Greenspan in Bubble Man (2005). Peter Hartcher addressed The Sydney Institute on Wednesday 15 April 2009 to reflect on the Global Financial Crisis and its causes.

GREENSPAN, BUSH AND OBAMA: WHO’S RESPONSIBLE FOR THE FINANCIAL CRISIS?

PETER HARTCHER

I was surprised to see when I came into the room tonight a pile of my book, Bubble Man, because the book is now three or four years old. I haven’t seen that many of them together in years; it’s like a family reunion of familiar faces you haven’t seen. And it’s very enterprising of you, Janet, to find so many copies – it’s out of print. I didn’t think you could find so many, I didn’t think they existed.

Everything is a fashion business, I suppose. It is funny how the cycle turns. There are more people here tonight to hear about the book three or four years on than there were at the launch when the book first came out. It was a very unfashionable thing to do at the time, to criticise a living god, which is what Alan Greenspan was.

The title of the book as you know is Bubble Man, and the subtitle is “Alan Greenspan and the missing seven trillion dollars”. The seven trillion dollars that is in the subtitle was the amount of wealth destroyed in the stock market crash in the US in 2000. That was the end of the technology bubble. I had a feeling of deja vu when, on the last trading day of 2008, I was reading an American newspaper and they calculated that the US stock market last year lost $7 trillion. All those years apart, the same amount of wealth destroyed on the stock market. I’m going to put it to you that the cause was the same man, and broadly the same phenomenon.

But of course it wasn’t just the $7 trillion in US equity wealth that was destroyed in that crisis, in the current great recession. If you add up the losses in asset values around the world, the Asian Development Bank has estimated total losses in the last year and a half at $50 trillion US – global GDP is about $55 trillion. So, according to the Asian Development Bank, the asset wealth destruction that has occurred in the last year and a half is equivalent to about one year of global economic output. That is a stunning amount of money and even Alan Greenspan didn’t think he could destroy that much wealth.

But it was tricky because he was revered. And I remember some of the difficulties. I even had threats, believe it or not. Can you imagine writing a book about a central banker and getting threats from a number of people? One of them was Australia’s favourite son, Jim Wolfensohn.

Jim Wolfensohn was the President of the World Bank at the time, and he and Greenspan were thick as thieves. They’d been good friends for years. Greenspan visited Jim Wolfensohn every year. They’d hang out at Wolfensohn’s (he has not so much a log cabin as a log mansion) at Jackson Hole, Wyoming. The two of them holidayed there, together, every year.

Knowing this, and collecting material on Greenspan, I rang Jim Wolfensohn and said, “Jim, I’m writing a book about Greenspan, I have most of the technical stuff but I’m lacking some colour about the guy, he seems like a pretty dry character. Can you give me some details to bring him to life a bit for readers?” And Jim told me a good story. He said, “Look, here’s something about Alan you have to understand. You wouldn’t guess this but Alan Greenspan has a fantastic sense of humour.” Well he’s right, you wouldn’t guess that. So I said, “Give me an example.” He said, “At the house in Jackson Hole, I keep a guest book. I like people to sign it and put a comment. I was looking through it a couple of years ago and I was astonished to see that Alan Greenspan the previous year had visited me at Jackson Hole and had written in my guestbook: he had correctly forecast the exact closing level of the Dow Jones index for the year still in progress. He’d correctly picked the closing price of the US dollar. And he’d predicted a big fire in Chicago. I thought to myself, “This is amazing! The guy is supposed to be a guru but he got it down to the decimal point! How does he do it?”

Then Wolfensohn added, “I was ranting to my family about the man’s prescience when my son said, rolling his eyes as only sons and daughters can to their parents, ‘Look Dad, it’s simple. All he does is he comes every year, he leaves the comment space blank, and when he comes the next year he fills it in.'”

So even Alan Greenspan had a sense of humour. But, as I was finishing up the call and thanking Jim Wolfensohn for his time, he said, “I have to ask you, what are you writing?” I said, “It’s a book on Greenspan. It’s essentially a critical book.” He said, “What’s your core thesis?” I said, “My core thesis is that Alan Greenspan is a better politician than a central banker.” Jim paused for a minute and then he said, “Alan has a lot of very influential friends in this town. And you want to be very careful what you write.” He added, “And one of those influential friends is me.” It was like dealing with the mafia, not central banking. But it was sensitive, it was unfashionable, but now I think the reckoning has occurred.

So let’s talk about who is to blame. There is certainly plenty of blame to go around: $50 trillion lost and to date at least 30 million people thrown out of work as a result of the current crisis. But before we talk about who is to blame, we need to talk about what is to blame. What happened and what are the causes?

What was to blame

The way I tell the story, these are the causes: first, is the root cause of every financial crisis in four centuries of financial capitalism, and that’s easy money. When there is plenty of money in circulation, it is easy to get, interest rates are low, it brings down the perception of risk in the markets, it increases people’s sense of confidence, it makes people lax with the way they use money. I suggest it is the same with anything you give people for free. Give people free water: they waste it. Free air: what have we done with it? Same thing with money: make it free, or very cheap, and it gets abused and misused. That was at the root of the problem. That easy money fed into the financial crisis of the decade which was the US housing boom.

You will remember, at the beginning of this, there had to be something actually collapsing and it was US housing prices. It didn’t just turn out one day that derivatives were worthless. Those derivates were tied to an asset and that asset was real estate, residential real estate in the US. So, money was running freely and we know that when there’s excess money it always does something nasty. It either turns up in inflation, ordinary inflation as we understand it, with products, or it turns up in asset inflation like stocks, and you get a stock market boom and bust, or it turns up in real estate, or you get some other nasty phenomenon.

Over the last four centuries, easy money has flowed into all sorts of phenomena and all sorts of objects have become the object of speculation: tulips, most famously, but also canals in the nineteenth century, Japanese golf course memberships in the 1980s. It doesn’t matter what the object is. If there is loose money it will find its way to something, it will become a pernicious problem and it will bust. So in this case it flowed into US residential housing, which took off with a huge run up in US housing prices.

So, you have to have easy money, and then you have lax banking regulation. Now this is where most of the popular commentary and understanding of the current crisis kicks in. Most of the commentary only picks up the story at this point, the regulatory point. If it had just been a regulatory problem, we would not have had the crisis we had. There would not have been a giant bubble to break, and that in turn would not have fed on loose money. So you need to have those two critical preconditions before the regulation question even becomes relevant. You had to have lax banking regulation.

We all know that mortgage lenders were lending to whomever they chose; janitors earning $20,000 a year were able to borrow $700,000. On that level it is a well known, well rehearsed story, and I won’t go over it again. There’s a slightly less well known part of the lax banking regulatory story though, and that is that after the Great Depression the US Congress separated banks from investment banks. This was to stop contagion spreading from one sector to the other – specifically from risky investment banks into what are supposed to be less risky commercial banks, the ones that do the credit that makes the economy tick.

The Glass-Steagall Act was repealed in the early 2000s, so that investment banks and banks were allowed to merge. That dividing wall that existed for 70 years was dissolved, that is part of the lax banking regulatory story. Then you had lax derivatives regulation. So, you had bank loans that went bad, but the size of those was magnified many times by the fact that derivatives were priced according to those, but with much more leverage. So, for example, for every $1 movement in the price of the asset you’d get a $10 price movement of the derivative.

The final point I would nominate as one of the contributing causes of this crisis was the slow, fumbling response that we saw from government authorities and regulators in the US. That allowed what was essentially a domestic real estate and financial crisis to become a global credit freeze.

Who was to blame

Now that we know what’s to blame, here’s the fun part: who’s to blame? Well, who was in control of money supply? Who was the guy at the spigot controlling loose money? Who was the guy that decided that, in an effort to pump the economy back up again after the 2001 recession, that interest rates in the US should go to 1 per cent, and be held at 1 per cent for a year? Of course it was Alan Greenspan. And it was that decision of Greenspan in 2000-2001 that created the tsunami of liquidity that then fed into the housing boom.

So, Alan Greenspan was in charge of monetary policy; he was in charge of the easy money. Therefore, as the progenitor of the liquidity, he was also the guy who allowed the easy credit to flow into the housing boom. Who was the guy in charge of bank regulation? Well that would be Alan Greenspan too. One of the critical differences, it has turned out in this cycle, between Australia and the US, is that in Australia, Peter Costello made the decision to split bank supervision out of the Reserve Bank and put it in a separate agency, APRA. In the US that idea was occasionally mooted, but the Fed, Alan Greenspan’s Federal Reserve, were not interested in that idea. So, Greenspan himself at the Fed kept control of banking regulation and prudential policing of the banking system.

So let’s see; that’s easy money, the housing boom, banking and derivates – lax regulation of derivatives was a contributor to the cause. Now if you look at a flow chart of responsibility for the American financial markets, you will not see Alan Greenspan’s name on the name of the organisation that is responsible for derivatives trading. That organisation is the CFTC: Commodities Futures Trading Commission.

In the normal course of events, you wouldn’t hear the name of the CFTC, you wouldn’t know about it, but it just so happens that this time it has been a contributor to the biggest financial crisis we have seen since the Great Depression. Now, although Alan Greenspan’s name isn’t on the CFTC, let me tell you a little story from 1998.

The woman who ran the CFTC at that time, a woman called Brooksley Born, was very worried about the derivatives market. She could see that it was growing like topsy; she could see that it was unregulated; and she could see that it was spreading risk in unpredictable ways, potentially threatening the entire credit system. So what would you do if you were a responsible regulator? Sensibly enough, she went to the Congress and said we need to regulate derivatives.

At this point Alan Greenspan and his friend – then US Treasury Secretary Bob Rubin, in the Clinton Administration – went into a concerted attempt to lobby Congress. First, they attempted to talk Born out of her idea. Then they lobbied Congress directly, when she wouldn’t change her mind, and managed to defeat that proposal. Not content with that, however, Greenspan and Rubin were so determined that derivatives should not be regulated, not only did they block the CFTC’s attempt to regulate it, even to the extent of lobbying Congress in person, they then went further.

Greenspan and Rubin successfully appealed to the Congress to legislate the CFTC Act to prevent it permanently having the power to regulate the derivatives market. So these were people, from other agencies, asking Congress to limit the power, permanently, of the agency that was responsible for derivatives trading. Naturally enough, Brooksley Born resigned the following year.

So now we have Alan Greenspan’s name together with Bob Rubin, and I should add Rubin’s deputy at the time, Larry Summers, who is today Chairman of the President’s Council of Economic Advisers in the Obama White House. All have their names on this decision. That was a decision by the way that you find a bit puzzling. If there’s a clear systemic risk, if something is being traded unregulated, why not do something about it? In brief, Wall Street didn’t want it, so there were powerful vested interests against it, and Greenspan’s ideology didn’t allow it: a potent combination.

Now, the derivatives are just an interesting postscript on this story, really. The US was going to have a recession anyway. In fact, even the banking regulatory story is an amplifier rather than a causal event. With a big run-up in the housing boom the way the US had in house prices, that was going to bust, the US was always going to have an ugly bust in residential real estate. And that was going to lead to a recession.

That was so plain that even a punk amateur from a far distant country could see that, and hence I predicted it in the book, Bubble Man. I thought it was entirely obvious. What magnified the scale of that underlying act, the bursting of the housing bubble, was the lax banking regulation and the lax regulation of derivatives. So they amplified what was already going to be an unhappy story in the United States.

So Alan Greenspan, I think, you have to say, had his name on all the fundamental contributors to this crisis. But he doesn’t have his name on the final point which I argue was a contributing cause to the crisis, and that is the slow and fumbling response.

It had been running for a year and a half, infecting financial markets and mortgage lenders, real estate companies, smaller banks and larger banks for a year and a half before it really hit in September 2008. The event that crystallised it, the moment when it became an international virus, was the collapse of Lehman Brothers, the US investment bank, in September 2008, and then it just continued to burn out of control.

Greenspan had already retired – so I can’t pin this one on him. But we can pin it on a couple of people. We can pin it on the Bush administration and, although at first blush this may seem a little unfair and unreasonable, we can even pin the very last phase of it on the Obama Administration.

The Bush Administration allowed that percolating crisis to reach a crescendo. The Obama Administration then inherited that problem, on 20 January 2009, and its first responses were failed responses. If I can be more specific, and since we’re talking about who to blame here, let me get very specific. In the Obama Administration, the official with responsibility for this and the official who fumbled the response is a fellow called Tim Geithner.

Tim Geithner is now US Treasury Secretary. And while we’re on the subject of Tim Geithner, he was also the guy who decided (even though he was not yet in the administration and even though it was during the Bush years) that Lehman Brothers should be allowed to collapse. Before Obama hired him in his administration, Tim Geithner was the President of the Federal Reserve Bank of New York, which is one of the twelve regional banks in the Fed. It is the one traditionally known as the front line crisis manager for Wall Street. So it was Geithner’s misjudgement to allow Lehman Brothers to collapse which then allowed what had been a fairly well contained domestic US crisis to become the truly world class crisis that it has become.

Once Obama made Geithner his Treasury Secretary, Geithner’s judgment didn’t get any better. Geithner’s pedigree was with Rubin and Summers, and he is part of a dominant Democrat Party policy clique in economic and financial circles. When he took the job in the Obama Administration as US Treasury Secretary, markets thought that was terrific – the Dow rose 7 per cent and the reviews were gushing.

Then Geithner then came up with his first response to the banking crisis, with his iteration of the so-called TARP (Troubled Asset Relief) program to bail out the banking system. The markets were in dismay, the Dow fell 4 per cent, the press turned savage, Geithner’s judgment was suddenly in question. And that sent us into the last couple of months of what was, who knows, but probably an unnecessary further round of pessimism, confusion and fear in capital markets.

What is not to blame

Having said who is to blame, now that I’ve fingered Alan Greenspan, Bush, Obama and Geithner, it’s also important to consider what’s not to blame. In something as big as a crisis like this, a lot of finger-pointing goes on, and there are a lot of agendas running.

Let me tell you about three things that I don’t think are to blame for this crisis. One is capitalism, the doctrine itself and the system. We’ve heard our Prime Minister tell us that “extreme capitalism” was the cause of this crisis. I have said that that is like accusing the captain of the Titanic of “extreme navigating”. The doctrine of capitalism did not form Greenspan’s judgment in allowing monetary policy to run too long too low, nor did it necessitate any of the other conditions for this crisis.

Here’s a quick common sense test: is Australia a capitalist country? Yes, absolutely. We’re not as red in tooth and claw as the US, but our system is very similar to theirs in terms of the role of capital in the system. Did we have a great collapse in our credit and banking system, endogenously? No, we imported it from the US. Other capitalist countries like our own did not have this so-called crisis of capitalism.

Therefore it is not capitalism; it is bad policy. It is bad policy in the US that occurred within the system of capitalism, just as you can have good policy within capitalism. So I let capitalism off the hook, just as I let the skills of navigation off the hook for the crash of the Titanic. You can’t blame the doctrine of navigation for that.

Also I don’t blame globalisation, which is another one of the key reputational victims of this crisis. You hear it said often that it was globalisation that allowed the transmission of this crisis to whiz around the world. Of course, it did. It was a system of globalisation and interconnected capital markets, banking systems and companies that allowed this crisis to transmit itself. But it doesn’t take globalisation as we currently understand it to bring us this international transmission.

In the literature, the first acknowledged really big global financial crisis was in 1873. You don’t need the internet, you don’t need investment banks; you don’t need any of the modern apparatus to allow a financial crisis to transmit itself from country to country. It was after the 1873 crisis, in 1875 actually, that the then Baron Rothschild said “the whole world has become one city”. So even in 1873 people were marvelling at the ability of financial crises to skip easily from one country to another.

Likewise globalisation, while it does permit the crisis to transmit, is not responsible for the crisis itself. Globalisation did not trigger that fundamental epicentre of this crisis. If you want a real crisis, of course, you would shut globalisation down, and you would have North Korea and their successful policy of Chuch’e, which is their peculiar doctrine of self reliance. North Korea, having cut itself off to the rest of the world is demonstrating what a real crisis looks like, with a third of its population undernourished, according to the UN Food Program, and an unspeakable state of affairs in a country which has the potential to be one of the world’s most successful economies, just look across the border to South Korea and contrast and compare.

Finally, I let China off the hook for this. You sometimes hear it said, particularly in the US, that the Chinese contributed to this crisis, in fact were one of the main points of origin of this crisis. How so? The argument runs that the trade imbalance between the US and China has built up huge trade surpluses in China (true) that those surpluses China has hoarded as foreign exchange reserves (true, $2 trillion worth), that China then reinvested most of those reserves back into the US, particularly into Treasury bonds and other debt markets – also true.

Based on this chain of events the Chinese are blamed for fuelling cheap capital into the US system, which then allowed the absence of an awareness of risk, excessive risk taking, excessive house prices and everything that followed from that.

I would argue that the global imbalances between the US and China were neither necessary nor sufficient for this crisis to occur. Just as we’ve seen recurrent financial crises around the world in the absence of this or other imbalances, it was not necessary for that state of affairs to obtain. If Alan Greenspan was determined that official interest rates go to 1 per cent, he was going to take them to 1 per cent, regardless of whether the US was borrowing the money from China, from Japan or from Mickey Mouse. It’s a nice way of blame-shifting, and indeed it would be nice to redress that imbalance in consumption and investment that we see between the US and China that produces that imbalance. It’s not a healthy phenomenon for the world economy. But it’s not the cause of the great recession.

Let me just finish up by offering you a prediction of my own. As Yogi Berra said, “Predictions are tricky, especially when they involve the future.” There is a book that has been out for a couple of years called Black Swans, which has got a lot of publicity and its author has become quite a celebrity. Black Swans title refers to events that are very unlikely and very hard to predict, and that nobody really foresees, but that have huge consequences. These events are named “black swans” because it was always assumed in the world that all swans were white, until the discovery of Australia, when the early settlers were of course astonished to find black swans.

The collapse in the US housing market and the recession that followed was not a black swan. I was only one of a number of people that could see that coming. Years in advance, it stuck out like a sore thumb – the prediction is in Bubbleman. I didn’t see the full consequences of it. The derivatives market didn’t exist in the way it was going to come to exist. So the size and scale of it took me by surprise, although apparently less than it took Alan Greenspan by surprise – he said he was watching the crisis unfold with “shocked disbelief”.

This was not entirely unpredictable. The core event, the housing bubble and the collapse and the recession that followed was predictable. Now based on that credential let me offer you another prediction, which I think is equally obvious and equally unsurprising should policy not change, and that is this.

To defeat this crisis, we have seen central banks around the world do what Alan Greenspan did to defeat the previous crisis in 2001, and that is cut interest dramatically, flood the world with liquidity. Except this time it has happened on a much bigger scale and it has happened everywhere at once. At the same time, we have seen governments prime the pump with fiscal stimulus, which has magnified the scale of the response.

Now, just as excess money always leads to some nasty pernicious event, just as it was excess money at the root of this crisis, my fearless prediction is this. At the moment, money in the US is cheaper than free – if you want to borrow money from the central bank you can get it for below the rate of inflation, so in real terms you are being subsidised to borrow money. Unless that excess money is retracted, and quickly, and these liquidity conditions are changed as soon as recovery gets under way, then I don’t know exactly how or where that excess liquidity will manifest itself or exactly how and where the next crisis will emerge, but unless that happens we are already building, in fact we have already started, the next crisis.