HIS CONTRIBUTION
It was not just Alan Greenspan’s model that failed. There were many parties at fault. The erosion started long before Greenspan’s chairmanship. He ignited a keg of dynamite under a financial system that was already wobbling. When the economy faltered, Greenspan drove the Fed funds rate below the rate of inflation. Annual borrowing, by all parties in the United States, rose from $1 trillion in 1988 to $4.1 trillion in 2006.12 During Greenspan’s time at the Fed, the nation’s debt rose from $10.8 trillion to $41.0 trillion.13 He was the Federal Reserve chairman who increased the money supply from $233 billion to $792 billion.14
Greenspan was not wholly at fault. Banks did not have to lend the money. Debtors did not have to borrow. Bankers and brokerage houses are to blame for reckless lending and reckless leveraging.
He took orders as well as issued them. Congress bullied Greenspan, but that had been true of all Federal Reserve chairmen. New during Greenspan’s chairmanship was the path of former politicians to hedge funds, privateequity funds, and banks. Greenspan spurred the financial economy, and those who interrogated him took advantage of it.
12 Federal Reserve, Flow-of-Funds Accounts, Z-1.
13Figures from year end of years he entered and left office. “Beginning of office” is December 31, 1987: “End of office” is December 31, 2005; From Federal Reserve, Flow of Funds Accounts, Z-1
14Federal Reserve Publication, Aggregate Reserves of Depository Institutions and Monetary Base, Table 1.
The United States has been devaluing its currency for the past century. What one could buy with $1 in 1913 (the year the Federal Reserve Act was passed) costs about $20 today. William McChesney Martin’s battles against Congress and influential economists, chronicled in the early chapters, were losing efforts. Congress was not entirely at fault for pestering the Fed. The American people lived inflationary lives. They bargained for wages and benefits that could not be paid in constant dollars. They worked fewer hours. Americans were buying more from abroad than they were selling. The government was spending more than its revenues by the 1960s.
The economists kept revising their theories to rationalize these practices. The theories were new and beguiling. The imbalances were as old as civilization. These contradictions have always ended in tears.
By the 1970s, the gold standard had to go. Economists offered new theories. The influential academics bolted to the head of the class. Barely mentioned was the immense liberation of a paper-currency world. Imbalances no longer had to be settled in gold. Governments found deficit financing to be an opium to the masses. Government programs abounded. The masses grew accustomed to inflation and borrowing in currencies that tended toward depreciation. Thus, debtors paid back less real money than they had borrowed. Bankers could lend more after the link to gold was severed, since no final settlement of claims existed. This was also a platform to launch speculative derivative products.
Other central banks decided to degrade their currencies in coordination with dollar devaluations. The bonfire of the paper currencies is a matter of time. Then, the institution of central banking will wear no clothes. Nobody contributed more to the denouement than Alan Greenspan.
HIS SUCCESSOR
Ben S. Bernanke succeeded Alan Greenspan as Federal Reserve chairman. When Bernanke is evaluated, the wreckage he inherited should be a consideration. If Bernanke had followed Paul Volcker, his Fed would still have possessed a substantial degree of influence over the nation’s credit system and over the large financial institutions.
Nevertheless, his influence in the economy and markets has amplified the United States’ problems. The “Greenspan put” has become the “Bernanke put.” Its consequences are far more pervasive than Greenspan’s. (It might be argued that Greenspan would have done much of the same, but such a debate is unfruitful It is acts that count.)
Bernanke did not just cut interest rates to ward off a recession. He lent money to brokers, bought the largest insurance company in the world (AIG), allowed overleveraged investment banks to convert themselves into commercial banks, thus permitting them to snuggle underneath the Fed’s too-big-to-fail umbrella.
When the commercial paper market floundered, the Federal Reserve decided it would lend to corporations. (Commercial paper is used by large corporations to fund short term obligations.) Thus, General Electric, General Motors Acceptance Corporation, and American Express were among the companies fortunate enough to sell their paper to the Fed.
Bernanke opened more borrowing facilities (at last count there were 16). Even when the credit markets heal, the precedent has been established, just as Continental Illinois was the precursor, in 1984, to too-big-to-fail-banks.
General Electric Chairman Jeffrey Immelt wrote in his company’s 2009 annual report: “The interaction between government and business will change forever… [T]he government will be an industrial policy champion, a financier, a key partner.”15
The Mortgage Machine (see Chapter 22) showed what can happen when government plays a role similar to what Immelt envisioned. The other troubling aspect is what happens to companies that are not one of the government’s champions? In a very different context, President George W. Bush said: “You are either with us or against us.”
Consequences of the “Bernanke put” will be interesting to watch. 15 General Electric, 2008 Annual Report, Letters to Shareowners; released early March 2009.
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The Great Distortion
2006
[I]ncreases in home values, together with a stock-market recovery that began in 2003, have [aided] … [t]he expansion of U.S. housing wealth, much of it easily accessible to households through cashout refinancing and home-equity lines of credit[.]1
—Federal Reserve Governor Ben S. Bernanke, 2005
What did Alan Greenspan bequeath to his successor?
Foremost was a recovery that distorted the American economy more than ever. Americans borrowed from abroad and spent at home. In 2000, the U.S. imported about $400 billion more than it exported. By 2004, this had risen above $600 billion, and was close to $800 billion by 2006.2
Personal consumption drove the economy. Between 2001 and 2006, Asha Bangalore, economist at Northern Trust, estimated that 40 percent of new jobs were related to housing.3 This was not sustainable.
The manufacturing economy kept shrinking. From the end of 2000 to 2004, manufacturing wages and salaries fell from $819 billion to
1 Ben S. Bernanke, “The Global Savings Glut and the U.S. Current Account Deficit,” Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, March 10, 2005.
2 OECD.StatExtracts. Dataset: balance of payments, United States. Annual data. Actual numbers: $417 billion in 2000, $624 billion in 2004, and $788 billion in 2006.
3 William A. Fleckenstein with Frederick Sheehan, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve (New York: McGraw-Hill, 2008), pp. 193–194; information from Grant’s Interest Rate Observer, April 21, 2006.
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$683 billion.4 Manufacturing profits fell from $144 billion in 2000 to $96 billion in 2003.5 The attenuation of manufacturing was a reason that Americans were falling behind. In 2008, goods-producing jobs (manufacturing, mining, and construction) paid an average of $21.54 an hour while service workers earned $11.22 an hour.6
From March 2001, the official starting date of the recession, through the end of 2004, employment fell by about 500,000. There were 1.2 million jobs lost in the private economy. (The government had gone on a hiring splurge; 700,000 additional public servants contributed to the deceivingly low half-million job losses.7)
Official voices implored Americans to buy: “I encourage you to all go shopping more,” was President Bush’s advice five days before Christmas in 2006.8
In sum, the U.S. economy was spending (consuming) much more than it earned. This was financed by foreigners purchasing American securities and by the appreciation of U.S. assets. Foreign buying supported the dollar. The appreciation
of U.S. house prices provided the cash to spend, through refinancing and home-equity loans. Financial services never had it so good.
How this arrangement worked as an economic system is a story in itself. The Seventies, Again
The process over this past decade is similar to that in the 1970s, when Volkswagen shipped the dollars it had received (from sales in the United States) to the Bundesbank. (The Chinese central bank has received the most excess dollars in the current decade, but the process is the same, so the original example is continued.)
Volkswagen sold a car in the United States. It received dollars from the buyer. The German central bank issued deutschmarks to Volkswagen in return for the dollars. In the post-2000 decade, the Bundesbank made the decision that its excess dollars would be allocated to investment in U.S. Treasury securities. Thus, by buying the U.S. debt, the German central bank funded American shoppers. When the Bundesbank bought U.S. securities, the German central bank also controlled the slide of the U.S. dollar in relation to the deutschmark.
4 From the month of December 2000 to the month of September 2004; Richebächer Letter, December 2004, p. 2.
5 Richebächer Letter, July 2004, p. 11; NIPA data.
6 Bureau of Labor Statistics, “Employer Costs for Employee Compensation–December 2008,” Table 1, released March 12, 2009.
7 Richebächer Letter, December 2004, p. 2.
8“Should Bush Tell America to Go Shopping Again?” WSJ.com, October 7, 2008.
A central bank may be influenced by its government. The German government had a motivation to prop up the dollar. If the dollar fell too far, Volkswagens would be unaffordable to Americans.
This same pattern of currency circulation anchored the world trade and financing system when Bernanke became Fed chairman. China was most often cited, but there were many countries exporting more goods to the United States than they received in return. Americans were buying from foreign industries, but foreigners did not buy as much from American manufacturers and service providers. This shortfall meant that American companies did not participate in these international flows. As a result, U.S. companies sold fewer goods. Domestic companies had fewer revenues, since workers were not spending their money on U.S. goods. Lower revenues of U.S. companies reduced profits and salaries. American corporations were forced to restructure in order to compete with foreign competition. Layoffs followed, and companies outsourced jobs overseas. This had been true since the 1970s.
The dollars that bought toys from the Chinese were sent by the toy manufacturer to the Chinese central bank. The toy manufacturer received Chinese currency (the yuan) from the central bank. The yuan entered the Chinese economy: the “real” economy as opposed to the financial economy.
The Chinese central bank then shipped the Chinese toy manufacturer’s dollars back to the United States. Earlier in this decade, foreign central banks recycled dollars into U.S. Treasury securities. As the current account deficit rose further, they bought agency securities (from Fannie Mae and Freddie Mac), believing the U.S. government would back these bonds should the underlying assets in the securities default (mortgage payments in San Diego, for instance). Between 2002 and 2007, almost 40 percent of the increase in Fannie Mae, Freddie Mac and other U.S. government agency securities were bought by foreign central banks.9
9 Russell Napier, “Nationalizing America,” CLSA Asia-Pacific Markets, March 2008, p. 12.
When the Chinese central banks sent dollars back to the United States, investment banks and brokerage houses were on the receiving end. The banks and brokerages manufactured the securities. The dollars did not return to the “real” economy but to the financial economy. Goldman Sachs or Lehman Brothers received the dollars; the Chinese paid for securities produced by Goldman Sachs. Financial company revenues and profits rose. Securities firms hired more workers. This overseas bond trade shifted significant amounts of corporate profits in the United States toward financial institutions.
These distortions caused malignancies in the U.S. economy. From 1950 to 1980, about $1.40 or $1.45 of debt was required to produce each dollar of GDP. From 2001 through 2005, the ratio was $4.30 of debt to every dollar of nominal growth.10 Finance, rather than capital investment, generated growth.
Bernanke’s World
Ben Bernanke seemed to think that all was well. He was not concerned about the trade and finance imbalances. He was a leading missionary of a hot phrase: the “global savings glut.” He chided foreigners for saving too much. In Bernanke’s world, Americans were consuming as they should. His statement at the head of the chapter is from a “global savings glut” speech delivered in March 2005. In April, with time to revise his insight, he showed no better grasp of home economics: “[T]he recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things.”11 Even today, Bernanke’s economics remain uncluttered with the possibility of too much debt. He is still a gung-ho apostle of renewing economic growth through consumer borrowing and spending.
10 Richebächer Letter, March 2006, p. 10.
11 Ben S. Bernanke, “Global Savings Glut and the U.S. Current Account Deficit,” Homer Jones Lecture, St. Louis, Missouri, April 14, 2005.
Before his chairmanship, he gave a speech entitled “The Great Moderation.” In that 2004 address, Bernanke offered interpretations of the “remarkable decline in the variability of both output and inflation” over the past two decades. He permitted the possibility that structural changes to the economy and luck may have played their role, but left no doubt that “improved performance of macroeconomic policies, particularly monetary policy” should receive the Nobel Prize.12 [Bernanke’s italics].
Bernanke’s “great moderation” has since exploded, leaving this speech as a testament to the accumulated wisdom of central bankers. He was blind to the financial mayhem that accompanied his economic moderation. In 2008, researchers at the International Monetary Fund (IMF) identified 124 international banking crises since 1970. Four were in the 1970s, 39 were in the 1980s, 74 were in the 1990s, and 7 were after the millennium.13 The current worldwide banking crisis is not included. It would be premature to quantify it.
The Great Moderation was, in fact, the Great Distortion. The Peak
We now know that the housing bubble peaked sometime in 2005 or early 2006. Ben S. Bernanke was sworn in as Federal Reserve chairman on February 1, 2006. The brightest guys in the room thought that the excesses were about to collapse. Sam Zell, owner of Equity Office Properties, offered his opinion: “The enormous monetization of hard assets has created a massive amount of liquidity.… Together with [the rising demand for income in the developed world], these factors … are reducing the relative expectations on equity.”14
Another who saw the sun setting was Stephen Schwartzman, head of Blackstone Group, perhaps the premier buyout firm over the past two decades. He told an audience: “We have low [interest] rates, tons of money in both the private equity and debt markets.… But when it ends, it always ends badly. One of those signs is when the dummies can get money and that’s where we are now.”15
12 Ben Bernanke, “The Great Moderation,” speech at the meetings of the Eastern Economic Association, Washington, D.C., February 20, 2004.
13Luc Laeven and Fabian Valencia, “Systemic Banking Crises: A New Database,” IMF, October 2008, p. 56.
14From Sam Zell’s 2005 electronic Christmas card, “The Theory of Relativity,” www. yieldsz.com; quoted in Ted Pincus, “Zell Remains Relaxed about Economy as Others Fret,” Chicago Sun-Times, September 12, 2006.
However, Zell and Schwartzman misestimated. Even though the housing splurge was over, the financial economy’s credit machinery was speeding up. The nominal value of derivative contracts held by U.S. commercial banks (those over which the Fed has direct regulatory authority) leapt from $33 trillion a
t the end of 1998 to $101 trillion at the end of 2005, about the time Greenspan left office. This was roughly a 17 percent annual increase. By the second quarter of 2007, 18 months later, the nominal value had risen by 50 percent—to $153 trillion in derivatives.16 Did the credit creators take advantage of the novice? Whatever the case, Bernanke seemed unaware of the ruckus.
Finance was called upon to prevent the direst threat to Washington: a recession. Funds were directed at the most egregious commercial propositions. Wall Street funded the builders. Finding bodies to occupy the new developments would be the greatest challenge, but not now. The investment banks financed developers to increase the flow of mortgage securitization. The banks wound up owning half-finished developments in the desert, abandoned by bankrupt builders.
Likewise, banks were not, as was generally believed, selling all the mortgages they wrote. In early 2007, they held $3.4 trillion worth of direct mortgages, land development, and construction loans on their books. This was about 33 percent of commercial bank assets. Adding mortgage securities increased real estate exposure to 43 percent of assets.17
The United States was not the only economy that was vulnerable to financial excesses. In 2005, McKinsey Global Institute calculated that the ratio of global financial assets to annual world output had risen from 109 percent in 1980 to 316 percent in 2005.18
Financing fed on itself. Increasing leverage was important. The brokers and dealers had doubled their trading assets since 2000. This growth was not to help companies finance new inventions, but to leverage their balance sheets. Broker/dealers expanded their assets by $282 billion in 2005 (the largest increase in a single year), then added $615 billion in 2006.19 The carry trade was estimated in trillions of dollars.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 34