When Alan Greenspan ran the US Federal Reserve, he allowed M3—the broadest measure of money in an economy—to grow at an 8.3% annual rate in the 11 years to February 2006. That’s almost 3 percentage points faster then the growth in nominal gross domestic product. Other central bankers copied him, producing a flood of global liquidity.
He allowed US banks to build networks of interbank obligations in derivatives and credit derivatives whose nominal value was a multiple of the US gross domestic product (GDP). In other words, he provided too much money to the financial system and didn’t exert enough control over its excesses.
Greenspan doesn’t accept responsibility. In an article in the Financial Times, he blames exceptionally low global real interest rates for housing bubbles in the US and elsewhere. “The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent,” he wrote. He added: “The core of the subprime problem lies with the misjudgements of the investment community.”
That won’t quite do. He can hardly claim Fed policy has no effect on real interest rates, either in the US or globally. With the world’s largest economy pursuing an easy money policy, it would have been difficult for other central banks not to follow suit. Reflecting global liquidity, foreign currency reserves worldwide more than quadrupled between 1997 and 2007 according to the International Monetary Fund—a growth rate of 16.2% a year, double the nominal increase in global GDP.
Thus the coincidence of US stock market and housing bubbles with similar bubbles in other countries does not absolve the Fed, as Greenspan claims, even if it does spread the blame somewhat to other monetary authorities.
On the regulatory side, Greenspan knew that non-traditional obligations of US banks were ballooning—and they didn’t always appear on their balance sheets. Credit derivatives, for instance, were largely untried in recession but represented a fundamental alteration in credit market dynamics. The Fed could have tightened up capital and/or reporting requirements on such activities years ago.
Greenspan argues that the Fed cannot “lean against” bubbles while they are in progress. But as chief regulator of the US banking system, it has the best access to information and should be able to spot excesses—in fact, its own people regularly spoke about high leverage and inadequate stress testing by banks. A responsible Fed in such circumstances could have tightened both monetary policy and regulation. The Greenspan Fed failed on both counts. That makes him a prime suspect in the current mess.