Greenspan's lack of foresight - then and now

Man who made credit cheap now wonders what happened

If the current financial crisis seems like a bad dream that won’t end, come back with me to a less-painful time, when the leaders of U.S. economic policy faced problems so much more benign that it’s hard to see them as problems at all.

As investment banks disappear along with investors’ retirement portfolios, this age might seem like a lifetime ago, before the appearance of THE GLOBAL UNSTOPPABLE CREDIT MONSTER THAT’S EATING THE WORLD ECONOMY.

Yet in fact our story takes place just seven-and-a-half years ago. That was a time when Alan Greenspan’s comments on economic troubles were a lot more influential – but just as full of hogwash as those he made last week, when he expressed surprise that Wall Street banks had failed to act more prudently.

The U.S. was flirting with a recession in January 2001, but that wasn’t the main thing on Greenspan’s mind that month when he went to Congress to testify on behalf of the new administration of George W. Bush.

Back then, Greenspan and others with their hands on the economic levers were struggling over what to do with a painful (to them) legacy of the Clinton years -- federal budget surpluses.

That’s right. It may be hard to believe now, as the Federal deficit for this year climbs to more than 6% of GDP and Congress is set to fork over $1 trillion in bailouts and stimulus. But back then, the U.S. government was actually taking in more money than it was spending.

The phenomenon, created by booming tax receipts on capital gains, corporate profits, rising incomes and fiscal discipline, should have caused joy in Washington, where the Republicans had taken control of Congress in 1994 promising to impose that very thing.

Yet the surpluses were greeted like a hayseed cousin or an obnoxious party guest that everyone seemed desperate to be rid of. 

North of Washington, and just north of Wall Street, the surpluses were messing with one of the most visible cultural icons of unchecked government spending: the federal debt clock in New York’s Times Square. Two straight years of surpluses had the damn thing going BACKWARD, and economists were taking guesses as to when the amount might disappear altogether.

The new President, George W. Bush, made no secret of his disdain for the idea that the government should possess money without having to borrow it.

During a debate the previous summer against Al Gore, who kept promising to put the money in “a lock box,” to make sure social security would still be around for Baby Boomers to collect on, Bush was adamant in arguing that it wasn’t really the government’s money.

“It’s the people’s money,” Bush said, and he intended to give it back in the form of trillion-dollar tax cuts.

But Congress back then still had enough sitting members to wonder whether it might be better to use the money to either pay down the debt or save it for some future crisis (like the current one).

That’s where Greenspan comes in. In early 2001, the man was at the height of his influence, getting credit for both good times and bad. His steady hand on the spigot of the U.S. money supply , it was said, helped preserve the good times through default and evaluation crises in Mexico, Argentina, Asia, Russia and elsewhere.

And once the dotcom boom went bust and recession threatened, his “irrational exuberance” comment seemed downright prescient. Especially to those who forgot he made it in 1996, three years before his Fed finally began hiking rates to make things more rational.

When Greenspan endorsed Bush’s tax cuts in January, 2001, this is what he said: “It is far better that the surpluses be lowered by tax reductions than by spending increases,” Greenspan said in January, 2001. Translation: Congress shouldn’t trust itself to be the keeper of any surplus. Opposition in said Congress withered, and surpluses soon became a distant memory.

While Bush’s Treasury Department started handing out checks, Greenspan’s Fed kept cutting rates until U.S. consumers and businesses finally got the message: the best way to bounce back from the tech stock bust and the recession that followed the 9/11 terrorist attacks was to borrow and spend our way back to prosperity.

That worked really well, as all pyramid schemes do for a while, as Americans bought bigger houses, bigger cars and more of everything. The pain that should have been felt in the wake of the dotcom bust was alleviated by replacing stock portfolio wealth with real estate wealth. The home equity line of credit became everyone’s ATM machine.

Yes, it worked well, until the economy finally ran out of people who could afford four-bedroom homes and giant SUV’s even with no money down.

Meanwhile, the best minds of Wall Street found ways to repackage the risk and spread it around, which is why the crisis is now affecting economies around the world.

All of this has surprised Greenspan, who perhaps more than anyone else on the planet had a chance to force some fiscal discipline onto the financial services industry --  and the U.S. economy -- rather than encouraging them to abandon it.

That, of course, would have taken an immense amount of foresight, not to mention will. Too bad we had to wait more than seven years to find out he had neither.