Former Fed Reserve chairman strikes back

For 18 years as Federal Reserve chairman, he was celebrated for helping drive a robust US economy. Yet in the years after he stepped down in 2006, he was engulfed by accusations that he helped cause the 2008 financial crisis - the worst since the 1930s.

Now, Alan Greenspan has struck back at any notion that he, or anyone, could have known how or when to defuse the threats that triggered the crisis.

He argues in a new book, The Map and the Territory, that traditional economic forecasting is no match for the irrational risk-taking that can inflate catastrophic price bubbles in assets like homes or tech stocks.

In an interview, Greenspan reflected on his book, his Fed tenure and the risks that still endanger the financial system. Relaxed and looking fit at 87, he spoke for an hour in the sunroom of his house overlooking a wooded hillside of northwest Washington.

Surrounded by books of presidential and financial history, Greenspan acknowledged some errors of judgment as Fed chair. But he said he saw no reason to downgrade his own assessment of his tenure.

"Our record was fairly good," he said.

Reaching back nostalgically to the Republican administration of Gerald Ford, when he led the president's Council of Economic Advisers, Greenspan remembers a different Washington. He recalls it as a time when political leaders dared to trust their opponents and collaborated to reach common goals.

It didn't hurt, Greenspan said, that the Democratic speaker of the House, Thomas "Tip" O'Neill, would drop by the West Wing of the White House some nights "and have a bourbon with Jerry".

Here are excerpts of the Greenspan interview:

You write that you were shaken by the 2008 financial crisis because of the failure of one of the pillars of a stable financial market, "rational financial risk management". What did you discover in your research for the book about this issue?

Fear and euphoria are dominant forces, and fear is many multiples the size of euphoria. Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply. When I started to look at that, I was sort of intellectually shocked.

When you published your last book, Age of Turbulence, in 2007, you were being hailed as a "maestro" of the global economy. Then the worst financial crisis since the 1930s erupted. Your policies as Fed chair were blamed for sowing the seeds for that crisis. How did the criticism affect you personally?

I've been around long enough to know that a good deal of the praise heaped on me I had nothing to do with. The only thing I did object to was ... where the criticism was actually wrong. Did it bother me? Of course it bothered me. But I've been around long enough to have ups and down. So you get over it.

With the knowledge you gained from the financial crisis, has it changed your own assessment of how well you performed as Fed chairman?

The real question is, should I have done something different? And the answer to that question is no. Did we make mistakes? You bet we made mistakes. But I thought our record was fairly good. Remember, we stepped in, probably at just the right time after October 19, 1987, when the market went down 22 per cent. It was pretty rocky for a while, but I thought we manoeuvred that better than I expected we would be able to do.

A lot of criticism centres around the failure of the Fed and other regulators to deal with the explosion of subprime mortgages, which were packaged into securities that then turned bad and were at the centre of the troubles. Should the Fed have handled subprime mortgage regulation differently?

The problem is that we didn't know about it. It was a big surprise to me how big the subprime market had gotten by 2005. I was told very little of the problems were under Fed supervision. But still, if we had seen something big, we would have made a big fuss about it. But we didn't. We were wrong. Could we have caught it? I don't know.

Should the Fed start reducing its US$85 billion a month in bond purchases?

I've tried to stay away from specific comments on Fed policy, for one good reason. Paul Volcker [his predecessor as Fed chairman] was very thoughtful. He never commented on Fed policy. I don't comment. They have got enough problems.

What advice would you give Janet Yellen, who has served the Fed as a board member, president of the San Francisco regional bank, and since 2010 as vice-chair?

I had a learning curve on a lot of different aspects of how the Fed operates. Janet clearly doesn't need that.

The size of the Federal Reserve's balance sheet stands at a record US$3.7 trillion. You have expressed concerns about this size, which is more than four times where the balance sheet stood before the start of the financial crisis. What are your worries?

My basic concern is that we have to rein this thing in well before the demand for funds picks up and makes it very difficult to rein in. [Inflation] is not immediate. It is down the road. But historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn't hit [with higher inflation].

You write that our highest priority should be to fix our broken political system. How?

Unless you are willing to compromise, society cannot live together. What is happening now is an increasing proportion of positions are getting beyond the point where the system can effectively hold together. I am concerned about it.

- AP