Greenspan and the curse of counterfactual

April 9, 2010

Laurence_Copeland-150x150Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. –

Suppose that, instead of appeasing Nazi dictator Adolf Hitler at Munich in 1938, Neville Chamberlain had taken Britain to war, what would today’s history books say about the episode?

It is of course impossible to know. Perhaps something along the lines: “the British prime minister’s stubborn refusal to compromise resulted in a war which dragged on for 6 months at a cost of over 300,000 lives…..” Make up your own scenario.

We can never know. But we can be 100 percent certain the history books would NOT now say anything like: “by refusing to appease the dictators, Neville Chamberlain saved more than 30 million lives, prevented the division of Europe and saved the world from 40 years of Cold War”.

In the same way, we can be absolutely sure that, if former Federal Reserve Chairman Alan Greenspan had raised interest rates and tightened credit in 2005 or 2006, putting a stop to the lending boom before it could become a risk to the banking system as a whole, he would not today be feted as the man who saved the world from the worst financial crisis in 60 years.

More likely, opinion would be divided over whether the ensuing recession, with the loss of maybe 1 percent of GDP and 100,000 jobs, was at all necessary.

Critics would have called for Greenspan’s head and possibly even for the Fed to lose its independence, while the defence would have been left lamely quoting the famous dictum of a previous chairman that it is the job of the Fed to take away the punchbowl just as the party gets going.

At least that is how I rationalise Greenspan’s post-crisis position. After all, this is the man who coined the phrase “irrational exuberance” to characterise market sentiment in 1996 during the tech stock boom, yet failed to act at that time and let the bull market run on for another three years, and who has argued ever since that it is impossible to identify a bubble.

The truth is, I suspect, that his nerve failed him then, and failed him again, with catastrophic results, in the last year or two of his tenure, as the mortgage-backed securities market and the rest of the shadow banking system ballooned.

Having been greeted in some quarters as the greatest central banker of all time, he was simply unable to face the prospect of leaving office reviled as the man who tipped the US into recession, however mild the dip might have turned out, compared to what we are now suffering.

A chairman of the Federal Reserve has to be single-mindedly committed to public service, otherwise he would never take on the job at a salary of barely $200,000, so the idea of an ignominious departure from office would be hard to bear – unlike the commercial bankers content to run away from the wreckage they create with sackloads of loot to comfort them.

(By the way, note that Mervyn King, governor of the Bank of England is paid less than 300,000 pounds – more than the Fed chairman, but nonetheless a figure to bear in mind next time you hear somebody say: “banks have to pay multimillion-pound salaries, otherwise they could never get high-calibre people”.  Since they paid millions in salaries before the financial crisis for their supposedly high-calibre management teams, experience suggests that what we really need now is to pay lower salaries in order to recruit lower-calibre managers.)


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why could we not draw a similar scenario for our then Chancellor of the Exchequer Rt. Hon. Mr. Gordon Brown.

Posted by Pankaj Patel | Report as abusive

The saying goes if you pay peanuts you get monkeys, the bank paid out billions and still got idiots.

Posted by jeff | Report as abusive

All we need is Banker’s salary/bonus should be consistent to other sectors. Huge bonus makes them greedy and force them doing creative accounting to boost bonus. We need to stop all bonuses, if they want to go away, they are most welcome. There will be no shortages of bankers in this job market.
Actually government and we the general public are responsible for their activities. We made them too greedy. In developing countries bankers doesn’t have those benefits,yet doing their job.
So I’m agree with Laurence and want lower payments for bankers. If they need more money, they are most welcome to leave job and do their own business. Only then they will realize life is not a bed of roses.

Posted by M.M.Islam | Report as abusive

Greenspan was the spokesman and figurehead of various committees, let’s be fair.

By the same token, the salary might be ‘low’, but the fringe benefits are usually high, as is the pension fund, which is usually VERY high, which all-in-all leads to a high standard of living over life expectancy.

Posted by Gandhiolfini | Report as abusive

I agreed with the last comment ,moreover, because greedy would make people lose their mind ,the market would become manupulating ones. The more regulation the gov. make for the giant companies , the more money involving with , it means that the comercial activities won’t leave the policy away,otherwise, the regulator would have been connecting with the benefit with for a long time .

Posted by Max | Report as abusive

Just make sure that people who stand to make enormous equity-type returns with no personal commitment stand to share in the losses that they create, again in front of others.
The case is similar as regards improper financial conduct – if the rewards for those who did right matched the rewards for those who did wrong; then at least this symmetry could allow us better to assess whether man is a rational economic animal.

Posted by EdMartin | Report as abusive