Greenspan and the curse of counterfactual
- Laurence 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.)