During the end of the first quarter of 2001, there was a virtual chorus of individuals across the country blaming Alan Greenspan for the economic downturn that followed the DotCom Bust. The chiming got louder as the stock market continued to crumble and economy softened. While Greenspan may have been a culprit in the downturn, it was not because of his actions or inactions during the economic and stock market declines. On the contrary, it was because of what he did not do during the speculative boom. Thus, the complaints were great examples of how little most individuals knew about the bull market of the 1990s and the bear market of the early 21st century.
If Greenspan was going to do anything to keep what happened to the market from happening, then he should have raised margin requirements in the stock market and raised interest rates to slow the speculative booming economy some before the giant market top of March, 2000. The fact that a U.S. bubble in both the market and the economy was allowed to occur were problems that Greenspan helped to create.
Then, when the market and economy declined, as a result of the bubble collapsing, many became obsessed with blaming Greenspan because his actions after. Where were those same individuals when the market and economy were advancing at a rate that created an environment where junk companies could come to the market and anything with a “.com” went up? Worse yet, the length of the expansion allowed competition to increase to a point where saturation and over-capacity existed in many industries from steel to chips. A condition that JP Morgan once used to refer to as an environment of “gutter markets.”
What most of the people who were screaming about Greenspan, was his hesitancy to reduce rates more quickly after the bust. In short, this choir was essentially saying that we needed more and cheaper borrowing to keep the boat afloat. However, what got us into the mess was a classic over-speculative bull market which in part was fueled by excessive private individual and corporate debt accumulation, and a serious drawdown in private savings (the savings rate at that time was the lowest point since 1932). The DotCom bull market was a classic speculative bubble; high exposure to paper, low savings and a heavy debt load.
On the other hand, there were a handful of folks who preached back then about the “moral hazards” that helped to get the market where it was. “Moral hazard” is the reference to the late middle and late 1990s unbridled borrowing and speculation that had gone on from Japan and Southeast Asia, to creation and failure of the hedge fund Long-Term Capital. The negative effects of Long-Term Capital was met with heavy U.S. Government intervention and thus sent signals to others that excessive speculation by influential financial institutions would be met with government intervention.
This borrowing and excessive speculation occurred with equity (stock & real estate) prices on the rise. When the deterioration occurred in equity values, the balance sheets of those borrowers looked even worse. This was also classic to the “unwinding” process of a speculative bubble.
My suspicion is that the folks who badgered Greenspan, were either in the denial stage or simply didn’t understand the nature of a speculative boom and bust. Giving more people easier and cheaper access to borrowed money at that time was not the answer. The answer was not to let the boom get too big in the first place. And that is where Greenspan and a whole host of others went wrong.
In Bill Fleckenstien’s widely acclaimed book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve writes, “Down through financial history, markets have intermittently gone to excess. Prices go to the sky and then fall through the ﬂoor. Human beings can’t help themselves. But the bubbles in U.S. stocks and real estate didn’t just happen. To a degree that the American public has not yet fully realized, these costly distortions were instigated and financed by the Federal Reserve—Alan Greenspan’s Federal Reserve.”
Quote of the Week: “If you are not learning, no one will ever let you down.”—Robert Anthony
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.