Back during the Great Buying Panic of the 1990s, when making money in stocks was as easy as putting in a buy order for QQQ, Federal Reserve Chairman Alan Greenspan was called, “The Maestro.” Greenspan was considered to be a magician in his nearly 19 years at the helm of the Fed, guiding the U.S. to untold prosperity with low unemployment, stable prices and low inflation. Not even the bear market of 2000 to 2003 seemed to damage his reputation.
But now that the credit bubble has burst, bringing down housing prices, some are reevaluating Greenspan's monetary policy. William Fleckenstein, a veteran short-only hedge-fund manager, is (and has been) a vocal critic of Greenspan & Co. In addition to his hedge fund, Fleckenstein is a frequent guest on CNBC, and a columnist — first at Silicon Investor in the 1990s, then at TheStreet.com — and now publishes a daily commentary, Market Rap, on his own site: Fleckensteincapital.com. He also writes the popular column “Contrarian Chronicles” for MSN Money.
His book, Greenspan's Bubbles: The Age of Ignorance At The Federal Reserve, was recently published by McGraw-Hill. (The book was co-authored by Frederick Sheehan, a former director of Asset Allocation Services at John Hancock Financial Services.)
Registered Rep.: In your book, you place two bubbles — the tech wreck of 2000, and the current credit/housing bubble — directly at the feet of former Fed Chairman Alan Greenspan.
Bill Fleckenstein: I think the evidence is incontrovertible.
RR: Of course, Greenspan's mucking up monetary policy wouldn't have surprised Sen. William Proxmire (D-Wis.), who, as your book points out, called him a lousy economist to his face when he grilled him during Greenspan's confirmation hearings in 1987.
BF: He wasn't the only one. People who have been around know that Greenspan had a “dismal record,” as Proxmire put it, on the president's Council of Economic Advisers from 1976 to 1986. I've only been running money since 1982. But I know some guys who are 10, 12, 15 years older than I am, and they had known of Greenspan and his record as an economist. They concluded that he was really, really average — or even below average.
One of the staggering things to me is that in the case of Greenspan, he had been allowed to make a string of errors with no apparent self-introspection. And, in fact, if you read what he said, he has gone out of his way to say, well after the fact, “No, no, no. I didn't have any part in that problem. We did the right thing.” I mean, well, if you're in denial about mistakes that were made on your watch, or mistakes you made with your own portfolio, you're never going to get better.
RR: What are some other errors, the ones that your friends and Sen. Proxmire saw?
BF: Well, he pointed out how the S&L's were making record profits right before they blew up. The 15 of the 17 thrifts he cited would close, and would eventually cost taxpayers $3 billion. He wrote in a letter to a thrift supervisor in 1985 — admittedly four years before it blew up — that the Charles Keating-run Lincoln Savings and Loan “presents no foreseeable risk to the Federal Savings and Loan Insurance Corporation.” Of course, Keating was thrown in jail, and the cleanup of his mess would end up costing $2.5 billion. In some ways, the S&L crisis was a precursor to the undisciplined, runaway lending that led to the housing crisis that started last year.
Before all that, as an economist in 1973, Greenspan told The New York Times: “It is very rare that you can be as unqualifiedly bullish as you can be now.” He was spectacularly wrong. Four days later, the Dow Jones Industrial Average peaked, and then went on to decline by 46 percent. There are other examples in his career, both at Townsend-Greenspan and at the CEA, that led Proxmire to say at the confirmation hearings in 1987, Greenspan's bad economic calls “broke all records for the entire period.”
RR: He must have been right sometimes.
BF: He was right about the bottoming of the economy in the 1990 to 1991 recession, but then he kept interest rates too low for too long. He kept rates at 3 percent for another 15 months, from September 1992, when he stopped cutting.
RR: So, Greenspan's legacy, even after the stock blow up of 2000 to 2003, was still pretty strong. Of course, people are rethinking his talent.
BF: Well, again, he's responsible for two bubbles. And, according to Jeremy Grantham [chairman of GMO, a money manager known for his bearish tendencies], there were only 27 other bubbles dating back to the Dutch tulip craze of 17th century. Grantham's definition of a bubble is: Events where the price action is two standard deviations from a long-term trend. Of course, for many, bubbles are hardest to see during them. Back in the late 1990s, I was one of the few people — I wasn't alone — but one of the few people who was willing to say, “This is a bubble; this is going to end badly. Right?” And back then, people laughed. People just thought that was crazy; the Fed was doing everything right.
Investment bubbles occur infrequently, and they are an example of herd mentality gone wild. In modern times, they tend to be a function of central bankers gone wild simultaneously. The bubble of the 1920s that ended in 1929 was a function of (A) the crowd, and (B) the Federal Reserve at the time. You can go back and read about them. Ben Strong, the then Fed chairman, said they were going to give the market a shot of whiskey because they thought it needed a little perking up. The Japanese stock and real-estate bubble was a function of Central Bank's stupidity in addition to the madness of crowds. And so, the equity bubble that we had was a function of Greenspan continually administering interest rates that were too low. We had a problem with the misallocation of capital. You know, they'd come in and cut rates again, and so what I tried to do in the book was use the actual minutes from the FOMC [Federal Open-Market Committee] meetings to find out what the Fed was saying about the situation, and contrast that with what he is saying now — or said in subsequent years — about that period. And what you'll find is that the Fed paid some lip service to a bubble in 1994, and Greenspan gave his irrational exuberance speech in 1996. But there was no real discussion at the FOMC about a bubble and what to do about it. It just didn't happen. Every time they cut rates, they never worried, “Oh, geez. Might we overdo it?”
The arrogant fallacy of the Fed and Greenspan — and all the folks that believe in him — is that the Federal Reserve can pick the right interest rate to run the world. That is not possible — any more than you can centrally plan an economy. That always ends in disaster. And a group of economists can't pick the right interest rate, either. You're going to make mistakes. As we learned, what happens when you pick one that's too low, and you have some sort of a crackup, whether it's in Asia or Long-Term Capital, and then you go to try to solve it with more of the same, you are going to have another problem again at some point. And so what I did was carefully examine what they were saying about what they were doing, and Greenspan was so blinded by productivity that he didn't think anything was a problem. That's my quick and dirty analysis of going through all that.
RR: Why even have a Federal Reserve at all?
BF: Well, that's a pretty good question.
RR: You don't think we need a Central Bank?
BF: I think the concept of the Fed when it was established in 1913 was to prevent a run on banks, back when they temporarily got liquid; that's not a dumb idea. The problem is that the Fed has these twin mandates: full employment and price stability. Greenspan and [current Fed chief Ben] Bernanke seem to think, and of course every politician believes, full employment first, stable prices second. If you pursue full employment, you will not have stable prices, and, in the end, you will not have full employment either. The only way you can ever attempt to get the full employment — without misallocation of capital and bubbles, and problems of excesses — is if you attempt to have price stability above all else.
RR: Can the Federal Reserve really prevent a mania?
BF: No, the madness of crowds can do what it wants. But a central bank that is reckless in its administration of monetary policy, unintentionally or intentionally, can certainly make it far, far worse. And if the bankers misread the situation, and get the pompoms out and start cheerleading for productivity and sort of the new era kind of stuff, they can certainly make matters worse.
RR: And Greenspan made matters worse? He in essence created a real-estate bubble?
BF: Greenspan made speeches in 2005 and 2006 talking about how there wasn't a real-estate bubble. In 2004, he specifically spoke to Congress, and said real estate couldn't become a bubble, because there were all these reasons: There weren't enough transactions, transactions costs were too high, it wasn't arbitrage-able. He listed his reasons specifically why real estate could not even enter into a bubble.
RR: How about Ben Bernanke? Is he just more of the same?
BF: Absolutely. But I think that he might be inclined to learn from his mistakes, which I don't feel like Greenspan ever did. But let's face it. The poor guy is an academic. You know, I don't think he's ever run 15 cents. So, if you've never been involved in the market, and you don't know what they're like, and you haven't had the experience of it, how are you ever going to try to do this job? Again, they are on a fool's errand. You cannot pick the right interest rate and try to make it work without winding up having it end up in tears at some point. This has been a failed experiment that's gone on for better than 20 years, and I think it's coming to an end. I don't know what's going to come out of this crisis — recession, bear market, or what. I can only hope on the other side we abandon interest-rate targeting once and for all here in America.