Green Span

Williams 1 Rhett Williams Daniel Gibbons Intentional Finance March 2, 2009 ALAN GREENSPAN Introduction Alan Greenspan is an economist and served as Chairman of Federal Reserve Bank of the United States (Martin 5). He was first appointed to this position in August 1987 by then President Ronald Reagan. After that, he was reappointed to that position by successive presidents until January 2006, when he retired. During his tenure as Chairman of Federal Reserve Bank, he was responsible to set interest rates and entrusted with the task of directing U.S. national monetary policy (Canterbery 45). In the initial period of his career, he incorporated a consulting firm, Townsend, Greenspan, & Company in association with a bond trader William Townsend. The company had major clients such as US Steel and J.P. Morgan. Later on, he decided to leave the company to join as Director of Policy Research for Richard M. Nixon's presidential campaign in 1968 (Jones 13). Thereafter, he became Chairman of President Gerald Ford's Council of Economic Advisers. He received his PhD from New York University in 1977 (“NNDB”). Interestingly, the university did not require him to submit dissertation for his doctorate degree. The United States witnessed tremendous affluent during his tenure. From 1993 to 2000, the country reported creation of around 21 million new jobs. This substantial growth rate in new jobs creation dented unemployment rate below 4 percent during 2001. Further, the economy grew by around 4% a year and this strong growth rate translated into the addition of $2 trillion to real GDP. (“Business Publications”) Major policies

Williams 2 It is only during his tenure, the Federal Reserve Bank explicitly announced inter-bank interest rates of the previous night, when it amended commercial banks (Martin, 2000). So, it is believed that the federal bank achieved very much transparency under his chairmanship. Apart from announcing interest rates, the reserve bank also provides a slight indication on near-term policy trends. When he served as Chairman of Federal Bank, he emphasized the policy of keeping lower interest rates and thereby stimulating growth of the economy. Movement of Inflation during His Tenure When Greenspan assumed his position as Chairman of Federal Reserve Bank, inflation rate hovered around 4% a year. Thereafter, trend of inflation started declining and achieved its lowest level of 1.5% during 1998, according to IMF data. It was observed that inflation rate breached only one time 5% level during his career as Chairman of Federal Reserve Bank. Chart 1: Trend in inflation 16 14 12 10 8 6 4 2

1 0 8 9 8 9 1 2 8 9 1 3 8 9 1 4 8 9 1 5 8 9 1 6 8 9 1 7 8 9 1 8 9 1 8 9 1 0 9 1 9 1 2 9 1 3 9 1 4 9 1 5 9 1 6 9 1 7 9 1 8 9 1 9 1 0 2 1 0 2 0 2 3 0 2 4 0 2 5 0 2 6 0 2

0

Inflation

Source: International Monetary Fund, Note: Inflation data are average for the year Although, more than 80% of the drop in inflation witnessed during Paul Volcker Chairmanship, it remained at a manageable level for a longer time only during Greenspan’s term. Implication of his policies

Williams 3 Under his guidance, interest rates were slashed between 2001 and 2002. This drop in interest rates influenced consumers to pull equity out of their homes and invest in room additions. These actions of home owners increased home building and modernization of existing homes in the country. Later on, Federal Bank decided to increase interest rates in a bid to rein in rising inflation. Chart 2: Trend in mortgage loan amount 250.00

$000

200.00 150.00 100.00 50.00 0.00

New home

Previously occupied home

Source: Federal Reserve Bank This rise in interest rate increased delinquency rates in the country and subsequently resulted in real estate bubble. Greenspan, thus, paved the way for subprime crisis and resultant fallout of global capital markets. Chart 2: Trend in interest rate

Williams 4

10

%

9 8 7 6 5 4 3 2 1

19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

0

Interest rate

Source: Federal Reserve Bank Note: Federal funds effective rate is taken During low interest rates regime, most of the lenders in the country opted to lend to consumers, who did not have good credit history, primarily to earn higher profits. It was manifested from the increased proportion of sub-prime loans to all home loans. This increased capital flow towards high risk assets are believed to be the prime cause for today’s global financial crisis and the root cause for this crisis was lower interest rate policy adopted by Greenspan. Hence, Greenspan was blamed for increased capital flow towards sub-prime loans that led to current global financial crisis. Further, it was argued that Greenspan’s low interest policy fuelled the cheap capital flow into China and caused overheating of Chinese economy. Conclusion Greenspan committed the mistake of increasing interest rate from its lower level, it can be seen from chart 2. He resolved the subsequent damage by decreasing it again, resulted in lower interest rates. Because of this, the country experienced two huge bubbles during his tenure. In contrast, the country was free from any such bubbles for more than 50 years, prior to his arrival. Greenspan blamed securitizes for current global crisis as the demand from them

Williams 5 influenced subprime mortgage originations. Moreover, tremendous demand from investor community across the world prompted subprime mortgages pooled and sold as securities. Strong demand for U.S. subprime related securities by banks, hedge, and pension funds, which was supported by quixotically positive rating designations by credit agencies also the reason for the financial crisis. Despite the fact that, securitization seems to be the major reason behind the current crisis. One thing we need to remember that it is his low interest policy which had given fillip to lending activities towards high risk assets. This surge in capital flows towards sub-prime loans gave an opportunity for securitizes and the country witnessed robust growth in securitization process. In order to tap the high interest rate offered by mortgage backed securities, investors across the world invested in these securities. Hence, it is appropriate to state that Greenspan’s policies are the principal reason for the current financial turmoil.

Williams 6

Work Cited “Business Publications.” 28 Feb., 2009 “NNDB.” 28 Feb., 2009 Canterbery, Ray. Alan Greenspan. City: World Scientific Publishing Company, 2006. Federal Reserve Bank. 28 Feb., 2009 International Monetary Fund. 28 Feb., 2009 http://www.imf.org/external/pubs/ft/survey/1999/012599.pdf Martin, Justin. Greenspan. Cambridge: Perseus Pub, 2000.