TETT: OK, well, good morning, everybody, and
welcome to this morning's breakfast debate
with Chairman Greenspan.
My name is Gillian Tett.
I'm the U.S. managing editor of the Financial
Times, so I hope you've all got your free
copy of the FT out in the lobby.
And Chairman Greenspan is obviously a man
who needs absolutely no introduction, least
of all to this audience.
I was looking at his new paperback version
of his book, which again I hope you've all
seen.
It's called "The Map and the Territory 2.0."
This is Chairman Greenspan getting into the
digital age with 2.0.
And at the back of it, it says, "After reading
this book, you will understand why five American
presidents turned to Chairman Greenspan and
made him one of the great economic policymakers
of our time," which I think is a very good
explanation as to why so many of you have
come to breakfast this morning for this sellout
event to hear his thoughts about the global
economy and where it's going.
And it is a terrific time to be talking about
this, because quite apart from the fact that
the book is out yesterday, I think, with the
paperback version with updated chapters on
very topical issues, like China and like gold
-- and we'll discuss that in a minute -- we're
also at a very interesting juncture for the
global economy.
Not only are we all sitting here with baited
breath to see what the Federal Reserve does
next, or rather doesn't do or stops doing,
but we've also had a fascinating development
overnight in Europe, not just in terms of
the European bank stress tests, but the fact
that Sweden's central bank has just cut interest
rates in recognition of the deflation and
stagnation that's very much gripping the Western
world at the moment.
So we're going to talk for about half an hour,
and then I'll open it up to questions.
This is a session which is on the record.
But I'd like to start by asking you, Chairman
Greenspan, when you look at the Western world
today, do you agree with Christine Lagarde's
assessment that today we're living in a time
of the new mediocre, in terms of economic
performance?
Is the Western world currently doomed to secular
stagnation, to use another phrase chaired
by your former colleague, Larry Summers?
GREENSPAN: Well, I'm always, always in agreement
with the famous member of the IMF.
I think this is essentially what we've seen
before.
The best way I would put it is this.
If you're looking at the stagnation, so to
speak -- incidentally, remember that Alvin
Hansen coined that phrase back in 1938.
And what they were looking at was an economy
which, remember, during the Great Depression,
the unemployment rate in the United States
never got below double-digit numbers.
And the system required somebody to come out
and say, "There's something fundamental different
here."
And he did, in a very famous 1938 opus.
I remember it well, because it was one of
the very first books that I read when I was
becoming an economist, and I was very impressed
with it.
Essentially, we're looking at a period like
1940.
This is very similar in many respects, because
what is missing here is -- or I should say
what is (inaudible) -- is a very high level
of uncertainty.
And the best way to measure that, the way
I do, in fact, and I do it and describe it
in some detail in the book, is I set up the
gross domestic product not in the usual personal
consumption expenditures and investment and
that type.
I look at it and taking the whole array of
outlays in terms of what is their unit -- what
is their life expectancy?
Software is three to five years.
Nonresidential buildings may be thirty-five
to forty years.
Haircuts, one month.
I invented that on the basis of a personal
sample.
(LAUGHTER)
TETT: Male or female.
GREENSPAN: In any event, if you basically
weight the GDP, what you find is that there's
an extraordinary collapse in the average duration.
Then if you look more deeply into the numbers,
it's all in buildings and construction and
things where the income flows from income-earning
assets is to a very significant extent in
far distant years.
So that when you array the numbers in that
form, and then you look at, for example, the
yield spread between the U.S. Treasury five-year
note and the thirty-year bond, that spread
a couple of years ago was the widest spread
in American history, which is another way
of saying, as you go farther and farther into
the future, you're discounting those incomes
more and more.
Now, the reason I raise this issue is when
you look at the rest of the world, this is
exactly the same problem that exists everywhere.
You -- I have -- in the book, I show charts
which show this significant decline that's
measured in a number of different ways.
The easiest way, when you don't have the data,
is just construction or capital investment
as a percent of GDP.
You look at the euro area, you look at the
United States, you look at Great Britain,
they all look the same.
In fact, I've done it for pretty much every
country in the world, and I even took a fling
at Ukraine, and lo and behold, same pattern.
In other words, the discounting of far-distant
assets is extraordinary, in the sense unprecedented
since the 1930s, and that statistically explains
all of the stagnation.
TETT: Right.
GREENSPAN: So it is not some new conceptual
framework.
It's the same, old thing, just not been properly
measured.
TETT: But I think telling people we're basically
back to the future and back to 1938 or 1940
is not exactly reassuring, because what's
got the world...
GREENSPAN: It didn't reassure me, I'll tell
you.
TETT: But what got the world out of that funk
last time, that stagnation, of course, was
World War II and a lot of government spending.
GREENSPAN: Uh-huh.
TETT: When you look across five to ten years,
how do you see the Western economy evolving
now?
Do you think that this stagnation, this sense
of...
GREENSPAN: Well, there needn't be, in the
sense that we can restore the same sort of
average level of discounting for the very
distant future that we had before.
Those discount rates are derivative of human
nature.
And I go into it in some detail in which when
I talk about time preference and some of the
stabilities in human nature, you know, I go
back to 5th Century B.C. Greece, where interest
rates were very similar to where they are
today.
Ancient Rome, the same thing.
In other words, there's something about how
human species discounts the future which is
unchanged, as best we can judge, and we're
looking at the same thing today.
I think what we've got to do is to recognize
where the uncertainty is coming from and get
rid of it.
I mean, obviously, when you're looking at
very distant investments, which have gotten
shoved aside, you've got basically very uncertain
tax rates out there.
Tax rates are a very critical factor in the
estimation of discounted rate of return on
the new investments.
And I don't know how we're going to get around
this, but the real problem that I find very
disturbing is the fact that we are not touching
entitlements when we're looking at our fiscal
situation, and that's basically where the
data show the problem is.
And as I point out in the book, this is not
a partisan issue.
In fact, the actual rate of increase in entitlements
under Republican administrations has been
greater than under Democrat.
So it's the so-called political third rail
for everybody.
Unless we get to grips with that thing, I
don't see how we come to grips with this problem.
TETT: So if you were sitting in the White
House today trying to draw up a plan to revitalize
America, what would be your top three or four
campaigning points?
I mean, reform entitlements, change the tax
code.
Would you change the tax code?
Would you...
GREENSPAN: All I have to say about tax rates
is the lower, the better, but if you're going
to have commitments of entitlements, pay for
them.
In other words, you cannot expect just to
print money or do what we're doing now.
We're not printing money; we're just expanding
the federal bank's balance sheet.
But eventually, that will turn into printed
money.
It hasn't yet, and that's what the real fascinating
issue of the current period is.
It's always easier to take a larger deficit,
because inflation is dead in the water, and
the reason for that is, effective demand is
dead in the water.
If you have a situation where you've got very
significant potential liquidity or actual
liquidity, and prices are falling, the only
explanation for that is that there's a huge
deficiency of demand, and this where we're
seeing a long-lived assets.
You take -- you can knock out -- say, construction
takes -- is about historically was about 8
percent of the GDP.
You knock out half of that, that's four percentage
points.
That's all of the increase -- major increase
in the unemployment rate.
So you don't have to look in a lot of different
places.
It's right there, and it's right in the very
long-lived assets, which we know are a function
of how people discount the future.
TETT: Right.
If any of you in the room haven't seen the
book, I would urge you to have a look at it,
because quite apart from being a fascinating
recognition of the limitations of models and
the problems of using purely orthodox economic
approaches to look at financial markets, which
I as an anthropologist love, because I love
the recognition that human nature matters,
has also got a plethora of fascinating and
verily quite alarming charts about where we
are.
But just to come back to the issue that if
you think the current sense of gloom, stagnation,
call it what you will, is due to a lack of
demand in the Western economy, do you think
that actually engaging in quantitative easing
or all these other unprecedented monetary
experiments has been the right path?
Has that just be a distraction and red herring,
because it takes away from any need to address
the fundamental lack of demand?
GREENSPAN: Well, let's look -- there's been
two aspects to quantitative easing.
One is to galvanize effective demand by creating
credit in the marketplace.
That has not worked.
But what has worked is the second prong of
the issue that originated, quantitative easing
-- getting the real rate of return on long-term
assets down, and that will have a major effect
on price-to-earnings ratios, on cap ratio
in real estate, on all income-earning assets.
And, indeed, in that respect, it's been a
terrific success.
But it hasn't been a success in the demand
side for one fundamental reason, namely that
as of now, if you look at the Federal Reserve,
Bank of England, ECB, what you basically see
is an explosion of assets, an explosion of
reserve balances, and that's the only two
statistics that are moving.
And what that essentially is, is the fact
that the Federal Reserve, it is paying twenty-five
basis points to the -- say, Wells Fargo, which
we'll say holds deposits at the San Francisco
Fed, it has got a sovereign guarantee, virtually
no capital requirements, and a reasonably
good rate of return for that type of security.
So what do they do?
They just sit there and let it sit.
And the result is they get a nice return,
but they do not relend it into the markets.
In other words, you don't get Wells Fargo,
say, relending it to, say, IBM or to U.S.
Steel or the usual borrowers of funds, and
unless and until that happens, you don't galvanize
the level of economic activity.
And if you just look at countries or central
bank after central bank, it is not really
pushed beyond the levels of just the two major
accounts.
When that starts -- and it will eventually
start -- all things can happen.
TETT: And what is going to happen?
GREENSPAN: Not all of them are good.
But, for example, we are seeing the first
sign -- commercial and industrial loans is
not a big category, but it is -- from my judgment,
it's the canary in the coal mine.
After being -- after extensions (inaudible)
extensions -- being relatively flat, it took
off earlier this year and hasn't gone up hugely,
and I cannot say to you that other aspects
of loan demand have increased.
Certainly, mortgage demand has not, and that's
the bigger -- much bigger item.
And so we're not getting that secondary effect,
but when we start to get it, for whatever
reason, then you begin to get real interest
rates rising.
And because -- remember, in this process that
drove the stock prices higher, it is basically
a very significant decline from an extraordinarily
elevated equity premium.
JPMorgan has got, I think, the best measure
of that that I've seen, and what they showed
is that at the -- the peak of the problem,
their equity premium, which is the rate of
discount -- or the rate of earnings required
on an equity investment to become viable,
their figures showed that we were at the highest
equity premium in fifty years.
And I think, probably going back earlier,
that series didn't go back beyond that.
But what that basically means is that there's
huge discounting.
And, you know, putting it in psychological
terms, it is fear at its maximum, and basically
there is a limit to human fear, and that's
where we got, and then that kicked the market
all the way up.
We are still in areas which are sort of average,
no longer very high, but we're not at very
low levels, either, yet.
TETT: So essentially what you're saying is
that we've got the makings -- we have a lot
of trapped cash in the system, a lot of trapped
money the banks aren't using that are just
piling up at the central bank, we have equity
markets being elevated, we have demand low.
It sounds like a very bubbly territory.
Do you think it's time for the Federal Reserve
to raise interest rates and get back to a
more normal system or normal financial market?
GREENSPAN: It's one of those questions that
I cannot answer.
Or I should say, I can answer but won't.
But overall, let's -- you know, look at what
really is moving markets.
There's a presumption that the Federal Reserve
can control intermediate interest rates.
It can control overnight rates by -- basically
it controls the supply side.
But the critical rate is no longer the federal
funds rate.
It's the interest rate being paid by the Federal
Reserve banks to hold reserve balances, and
should, for example, they decide to relend
them, then remember what happens, is that
basically the reserve balances go down, and
that is technically a tightening of monetary
policy.
So the Federal Reserve doesn't want to do
that or allow that to happen.
It has got to raise rates to attract the funds
to keep the reserve balances where they are.
And so I think that the real pressure is going
to occur not by an initiation by the Federal
Reserve, but by the markets themselves beginning
to require ever higher rates of interest paid
by the Federal Reserve to hold the funds that
the Federal Reserve deems where they want
monetary policy to be.
TETT: So, essentially, what you're saying
is the real risk now is that the Federal Reserve
is going to lose control of the process.
GREENSPAN: I'm sorry.
I don't follow what you mean.
TETT: Well, essentially what you're saying
is that we're all talking as if the Federal
Reserve can very gradually and smoothly control
this return to normality.
The image that some of your former colleagues
have used to me is a bit like a plane coming
into land and very slowly and smoothly, gradually
descending as they put interest rates up or
they stop -- stop the asset purchases.
What you're essentially saying is what's going
to really drive this return to normalization
is something that the Federal Reserve cannot
control, which is what the market demands
as the price of keeping money with central
banks.
I mean, the Federal Reserve is not in control
in this case.
GREENSPAN: Remember, we've never had any experience
of anything like this.
So I'm not going to sit here and tell you
I know exactly how it's going to come out,
nor an economist term, what the elasticity
of demand is and what prices will do.
I know almost for sure one thing -- that real
long-term interest rates are below where human
time preference is.
And I use the experience of a long multi-century,
millennia, of remarkably stable interest rates,
which is the best reflection we have of how
the human species essentially discounts the
future.
It's what tells them how much seed corn to
put aside from a crop.
It makes all of those decisions about how
much production you hold back from consumption
and invests, whether it's in axes or hatchets
or whatever, or it's in transistors, you know?
It's all the same species.
TETT: Right.
GREENSPAN: I think periodically you have to
look at that, when you're at -- are at sea,
your profession becomes more relevant than
mine.
TETT: This is Chairman Greenspan celebrating
the power of anthropology, which I love.
But...
GREENSPAN: So I just want to say, one of the
things about this book -- for those of you
who are interested -- this is a combination
of classical economics and behavioral economics
with Keynes' animal spirits all the way through
it.
TETT: That's a great elevator pitch.
GREENSPAN: Thank you.
TETT: A quick question, though.
I mean, or two questions.
One is, given what you're saying about the
magnitude of the task currently facing the
Federal Reserve, and given that this has never
been seen before, if you were a betting man
today, and you have been trading the markets
in the early parts of your career, what probability
would you give to the Federal Reserve being
able to exit these challenges without creating
another financial crisis?
GREENSPAN: Well, let's leave the word "crisis"
out.
TETT: OK, extreme instability or volatility.
GREENSPAN: May I -- if I can use the substitute
term "turmoil"...
TETT: Turmoil.
Yeah, turmoil will be good.
We like turmoil.
GREENSPAN: ...I don't think it's possible.
TETT: You don't think it's possible?
GREENSPAN: No, I think that -- remember, we
had that first tapering discussion, we got
a very strong market response.
And then we reassured everybody to have no
-- remember, tapering is still slowing the
rate of increase -- we're still increasing
the balance sheets.
And the ECB is starting anew -- the ECB's
got far greater problems than the Fed has.
The Fed is in reasonably good shape in that
regard.
TETT: Well, that's not reassuring.
(LAUGHTER)
TETT: I'm going to turn to the audience for
questions in one minute, but before I do though,
I just want to ask though, one of the really
interesting chapters in your book is about
gold.
And there's been a lot of media debate in
the past about your views on gold.
You yourself oppose a question as to why would
anyone want to buy this barbarous relic -- I
don't know whether John Paulson is in the
audience -- but it's an interesting question.
But do you think that gold is currently a
good investment given what you're saying about
the potential for turmoil?
GREENSPAN: Yes.
(LAUGHTER)
TETT: Do you put...
GREENSPAN: Economists are usually perfect
in equivocating.
In this case I didn't equivocate.
Look, remember what we're looking at.
Gold is a currency.
It is still by all evidences the premier currency
where no fiat currency, including the dollar,
can match it.
And so that the issue is, if you're looking
at a question of turmoil, you will find, as
we always have in the past, it moves into
the gold price.
But the gold price is actually sort of half
a commodity price, so when the economy is
weakening, it goes down like copper.
But it's also got a monetary characteristic
which is instrinsic.
It's not inbred into human beings -- I cannot
conceive -- of any mechanism by which you
could say that, but it behaves as though it
is.
Intrinsic currencies like gold and silver,
for example, are acceptable about a third
party guarantee.
And, I mean, for example at the end of World
War II, or just at the end of it, Germany
could not import goods without payment in
gold.
The person who shipped the goods in would
accept the gold, and didn't care whether there
was any credit standing -- associated with
it.
That is a very rare phenomenon.
It's -- it's the reason why, for example,
in a renewal of an agreement that the central
banks have made -- European central banks,
I believe -- about allocating their gold sales
which occurred when gold prices were falling
down, that has been renewed this year with
a statement that gold serves a very important
place in monetary reserves.
And the question is, why do central banks
put money into an asset which has no rate
of return, but cost of storage and insurance
and everything else like that, why are they
doing that?
If you look at the data with a very few exceptions,
all of the developed countries have gold reserves.
Why?
TETT: I imagine right now, it's because of
a question mark hanging over the value of
fiat currency, the credibility going forward.
GREENSPAN: Well, that's what I'm getting at.
Every time you get some really serious questions,
the 50 percent of the gold price determination
begins to move.
TETT: Right.
GREENSPAN: And I think it is fascinating and
-- I don't know, is Benn Steil in the audience?
TETT: Yes.
GREENSPAN: There he is, OK.
Before you read my book, go read Benn's book.
The reason is, you'll find it fascinating
on exactly this issue, because here you have
the ultimate test at the Mount Washington
Hotel in 1944 of the real intellectual debate
between the -- those who wanted to an international
fiat currency which was embodied in John Maynard
Keynes' construct of a banker, and he was
there in 1944, holding forth with all of his
prestige, but couldn't counter the fact that
the United States dollar was convertible into
gold and that was the major draw.
Everyone wanted America's gold.
And I think that Benn really described that
in extraordinarily useful terms, as far as
I can see.
Anyway, thank you.
TETT: Right.
Well, I'm sure with comments like that, that
will be turning you into a rock star amongst
the gold bug community.
In fact, you're probably trending on Twitter
today.
But we do have time for half an hour for questions
now.
I'm sure what Chairman Greenspan has said
has been very provocative and controversial,
so I'm sure there will be a lot of comments
and questions.
Please, please, please keep them very short
and brief, and it will be courteous, but not
compulsory, to identify yourself.
So -- and there are some microphones coming.
QUESTION: Hamid Biglari, TGG Group.
Chairman Greenspan, in light of your observation
about the low likelihood that markets would
escape turmoil as QE is tapered off, I'm wondering
if you could comment on the impact on the
-- the relative impact on emerging markets
in light of the fact that they're far more
financially leveraged now than they were fifteen
years ago, when we had the last round of significant
crisis there, and the potential for capital
outflows as the dollar depreciates.
GREENSPAN: Yeah, it's difficult to make generalized
judgments about emerging markets, because
too many of them have very warped political
systems.
I mean, take Brazil.
With Rousseff coming in, I mean, it is remarkable
what she has done in a negative way to Brazil,
yet those are in the GDP figures.
I mean, take Venezuela.
Same problem, same cause.
And you have an awful lot which creates problems
with the data.
So getting a clean -- clean shot at, so to
speak, full evaluation of emerging markets,
you got to, first, take that consideration
and then take China out and put it aside and
examine that separately.
That, of course, is the 800-pound gorilla
in the emerging markets, and it's a fascinating
history that they've developed.
So it's so difficult to generalize on this,
but clearly, to the extent that you get developed
countries in some difficulty, it invariably
impacts the emerging nations, especially those
who are commodity producers.
TETT: Right, we go to another -- two more
questions here, and then we'll go over here,
so...
GREENSPAN: This is all murderer's row up in
the first row.
(LAUGHTER)
QUESTION: I wonder if we could turn to Europe
-- Byron Wien from Blackstone -- I wonder
if we could turn to Europe for a moment.
Germany has slowed down, perhaps because of
the impact of Ukraine, and Germany is the
engine of growth for Europe.
Europe is in danger of slipping back into
recession.
What should Mario Draghi do to avert an economic
catastrophe in Europe?
GREENSPAN: Well, I'm always been, in effect
-- in the original edition of this book, which
goes back to '13, 2013, I raised some serious
question about the viability of the euro generally.
And, indeed, I had the privilege of sitting
in with the G-10 governors which -- there
are eleven of them, and almost all are European.
The whole emergence of what ultimately became
the euro was thoroughly discussed in that
period amongst that group, and it was very
interesting to see what they had in mind.
They were struggling with the question of
two world wars on European territory in a
very short period of time.
And they were looking for ways to integrate
politically the euro area.
And they came up with -- as they put it -- we
would like to replicate a currency which was
the fifty states of the United States.
And they came up with this, fully understanding
that it meant cultures had to be become pro-European
and not individual, and that eventually, say,
Italians would behave like Germans.
Well, on January 1, 1999, when the euro came
into place, and everything was locked in place
-- and I must admit, extraordinarily smooth
-- and I think basically was over -- and the
beginning of a very heavy international boom,
where there was no competitive disadvantage.
If you could produce it, you could sell it.
And so what was happening is that, with the
lower euro interest rates for -- for example,
Italy -- I mean, they came down 500 basis
points as they moved into the euro.
That meant they could borrow, and did, very
heavily -- Greece, Portugal, Spain, Italy
borrowed heavily.
There is no evidence that the notion that
many of the European central banks believed
that when in the euro all of the -- all of
the peripheral Southern European countries
would behave like Germans.
From day one, they didn't.
They -- instead of devaluing, they always
did when they were in trouble, they borrowed
from Northern Europe.
Today, what we really need is the ability
of a lot of these countries to devalue.
And this is the ultimate -- there's no -- I
mean, you know, like you're asking, where
do we go from here?
Well, the only place we go from here is to
free the currencies to readjust, because they're
now extraordinarily imbalanced with respect
to (inaudible) and all you need to do is,
there's a facility in Europe called TARGET2,
which reflects the intra-central banks lending
to each other.
And lo and behold, you've got the Bundesbank
lending very large net balances to Italy and
Spain.
And very recently, as Draghi went towards
expansion, it shows up -- it showed up immediately
in the TARGET2, whereas the German Bundesbank
lending net to other members of the TARGET2
group was going down steadily.
And then in the last three or four weeks,
it's turned back up.
That is telling you that this is not a solution
to this.
The only solution, as I've put it in the book
originally, is actually a full political integration
of Europe, because if that occurs, then the
currency problem disappears.
TETT: And if it doesn't occur, you think it
breaks up?
GREENSPAN: I'm sorry?
TETT: If it doesn't occur, if political integration
doesn't occur, do you think the euro breaks
up eventually?
GREENSPAN: Yeah.
TETT: So yet more turmoil, if not crisis.
GREENSPAN: Yeah, this is -- I mean, when you've
got pressures pushing and pushing and pushing,
you -- there's no end to that until it cracks.
TETT: Right.
Well, I'll ask you later for reasons to be
cheerful, but...
GREENSPAN: I mean, look, the problem is, I
can't -- if somebody can figure out a way
beyond this, I'd be delighted to embrace it
and I'd even be delighted to embrace the fact
that I was wrong, but I can't find any evidence
of that.
TETT: Right, well, next question.
Then we'll come to the side.
QUESTION: Gregg Feinstein from Houlihan Lokey.
Earlier, you acknowledged that the Fed's impact
on the economy has been muted.
Certainly, though, people acknowledge that
the Fed's effect on actually the market has
been enormous.
And it seems as if the Fed is able to influence
asset prices easier than the underlying economy.
And each time that the market seems to tremble,
as a result of the interrelationship and the
leverage in the world financial system, it
seems as if the Fed simply comes to the rescue.
And they make some statement about how long
they're going to wait to raise interest rates
and things sort of head back up again.
So is there -- is there a complacency on the
part of investors that has developed that
any time that the market shakes -- because
it's all they can do -- that the Fed is going
to come to its rescue, and then interrelated
to that and going back to your gold question,
is it then that an elected government will
always choose inflation over austerity, because
you're going to lose your job if you do austerity,
that is causing some of the confidence in
gold, because it's the only way out of this,
is to inflate our way out of it?
GREENSPAN: That's what history tells us.
But, remember, there's a deeper question here.
This -- you're making that statement, for
example, in, let's say, 1880 or 1890.
I'm being -- I'm trying to trace where we
are.
Those statements never arose back in that
period, because the big debate was between
whether you had gold or silver.
But the fact the fiat currency expansion got
very tarnished with -- you know, in 1775,
we printed a whole bushel full of continentals.
And one of the fascinating things about that
period is the fact, for the first year or
two, there was very little evidence that that
had any effect on prices, meaning that that
paper currency circulated with the same value
as specie.
And there is an extraordinary -- there's an
extraordinary lag which exists between actions
of that type and consequences.
Now, eventually the continental was not worth
a continental.
But it took a long while.
And I think that we're looking at very similar
things now.
This, again, is a human propensity.
One of the things that I really used this
book to write was to develop a concept of,
how do you shift from a system where everybody
is acting rationally, which is what all of
our models basically said, to one which is
-- where reality is, where peoples are acting
intuitively, in various different types of
forms.
Irrationality is, in many respects, systematic.
You can model it.
And, indeed, I show in many cases why, for
example, fear is demonstrably a much stronger
force than euphoria.
And so that -- you know, you look at the unemployment
figures, the unemployment figures go up sharply
and down very slowly.
This is -- types of things which I think we've
got to understand and -- one of the reasons
I say, as a conclusion in this book, that
the non-financial parts of our economy behave
very well.
They're highly capitalized.
And essentially, it is the financial system
which is wholly divorced -- it's a different
function than the type of things we do in
the non-financial area -- one, it has to do
wholly with allocation of savings into investment.
That is where animal spirits really run wild.
And we have to understand that better than
we do now.
And this is the reason why everybody knew
there was a bubble in 2008, but to my knowledge,
nobody -- even when we knew on a Monday morning
that Lehman was going to go into -- was going
to default, did we get the reactions right
away.
It took several days before the whole system
broke down.
And if you can't forecast something like that,
what good is forecasting?
TETT: Do you regret not having pricked the
bubble in, say, 2005?
GREENSPAN: No, because by then, I think it
was -- you can't -- well, one of the things
I've concluded in the book is that pricking
the bubble short of collapsing the economy
doesn't do anything.
We tried at the Fed, for example, in 1993
to -- actually, 1994 -- we raised the federal
funds rate by 300 basis points, which is a
huge amount in a short period of time with
-- we went up 50 basis points, 75 basis points,
and we did slow what was an -- call it incipient
rise in the Dow, for example.
It stabilized.
And we got what we thought was a previously
unachieved safe landing, and so we started
patting ourselves on the back, and lo and
behold, as soon as we stopped tightening,
the Dow took off again.
And the reason is that markets are very complex.
The markets observing the fact that 300 basis
points did not disrupt the economy changed
the equilibrium level of the Dow Jones Industrial
Average from here to there, and the markets
just took off.
There is no evidence, which I'm aware, where
central banks have incrementally tightened.
The only occasion where we actually saw something
is when Paul Volcker's Fed hit late 1979 and
early 1980, put a clamp on the economy, and
it's only by bringing the economy down that
you could burst the bubble.
And that is very bad news, in the sense that
this is not -- the only place where incremental
tightening actually defuses bubbles is in
econometric models.
And that's because they're misspecified.
TETT: Right, well, that's not very reassuring,
either.
But we have some questions over here.
The woman there.
QUESTION: Jeff Schafer, JRShafer Insight.
It's always very interesting, Chairman Greenspan,
to hear what you have to say about the economy.
My sense -- I think you share it -- is that
if you look back over the last 100 years,
whenever we had financial turmoil, housing
has been at or very near the center of it.
And we're now looking at a trend in Washington
towards re-legitimatizing subprime mortgages
and their financing by Fannie Mae, putting
off the holding requirements for mortgages,
and the general looks like willingness to
reconstruct the mortgage system we had before
the crisis.
I'm wondering what you think of that and where
you think we're headed with housing finance
in this country.
GREENSPAN: Question one, not much.
Question two, territory we'd just as soon
not be in.
It's -- we have got a tendency to do that
over and over.
You can -- quite right, looking back 100 -- you
go back 200 years, you'll find it, too, so
don't worry about it.
TETT: So are we creating a new subprime...
GREENSPAN: What?
TETT: Are we creating more subprime mortgage
problems?
GREENSPAN: I think at this stage that -- it's
too soon to tell, but we're not -- see, remember
what's happened.
TETT: Or is it the case that we have so many
other problems to worry about first, this
is...
GREENSPAN: Here's the issue, that -- remember
that one of the consequences, as essentially
the way we dealt with the mortgage crisis
is we made the mortgage market henceforth
non-recourse loans.
So what happens is that if you can't foreclose
on the property and get it back, your down
payments tend to be much higher.
And, indeed, that is exactly what happened.
And so we do have 30 percent down payments
on standard prime mortgages.
And that's enough of a suppression.
But I will grant you that if you put government
subsidized funds into the marketplace to create,
quote, affordable housing without a full recognition
of the fact that we've been exactly down that
road before -- and what was wrong previously
is there's nothing wrong with subprime mortgages.
We had a protracted period where this very
small segment of homeowners who could not
afford the huge down payments, the 20 percent
down payments, but could meet the monthly
payments of a fixed-rate loan, that market
was actually functioning profitably for banks.
The problem happened when we decided that
we wanted to expand the whole market, and
the only way to do that was essentially with
securitized loans.
TETT: And adjustable, yes.
GREENSPAN: And adjustable rate securitized
loans, and that was the doom.
TETT: That was the problem.
GREENSPAN: As soon as we -- as soon as we
see adjustable rate loans of the type we're
talking about, look out.
TETT: Right.
Any more questions?
Jacob and then Zach and then -- very brief,
because we're almost out of time.
QUESTION: Thank you.
Jacob Frenkel, JPMorgan.
You spoke naturally about the Fed and also
the ECB, about the challenges and about the
fact that it will not end easily or nicely.
The question is, is there any role of governments
and other policy instruments that should come
in so that the burden will not be fully on
the Fed and the ECB?
And a bigger question is, is it possible that
in the past few years, some of the central
banks have actually entered into a territory
that typically would have had to be addressed
by governments?
GREENSPAN: He usually knows the answers to
the questions he asks.
(LAUGHTER)
One of the statements I make categorically
in the book, which is crucial, is I argue
that there wasn't a single problem in the
structure of intermediary finance, so to speak,
that led up to the 2008 crisis that could
not have been forestalled or contained with
adequate capital, and that I go on further
to demonstrate that we have a long history
of capital requirements going up and going
down for technical market reasons and then
in more recent periods, regulatory areas.
But the fundamental question is, is that it
appears that with the data we have -- remember,
the National Bank Act was enacted in 1863.
We've got homogenous records for commercial
national banks going all the way back, and
you can see net income as a share of equity,
capital equity, and despite the fact that
that -- that the ratio of capital -- equity
capital to assets in the banking system was
going straight down after the Civil War.
The rate of return on equity was stable.
The only way that can algebraically happen
is the rate of return on assets went straight
down.
The argument I hear about -- from -- mainly
from my old banker friends -- Jacob excluded,
needless to say -- is that if you raise capital
requirements, you reduce net return, and that's
dangerous to the system.
You don't.
The history of financial markets from my point
of view suggests that the markets are continuously
adjusting so that what the firm basic statistic
which is consistent with human nature, if
I may generalize it, that statistic is the
net income relative to equity, because that's
where the competitiveness in a global capitalist
market functions.
And if you -- if that is where the markets
operate, and you raise regulatory capital
requirements, you are going to raise the rate
of return on assets.
You're going to find very quickly that banks
start to open up their spreads on lending
of these types of assets.
Why?
Because they can do it and the markets force
them to do it.
And you're going to find that if we get a
significant capital increase, I think you're
going to find the spreads on individual lending
-- from a cost of capital to the actual interest
rate that the banks are charging -- that is
going to open up in precisely the symmetrical
way that it did during the 19th century when
we were going in the -- wholly in the other
direction.
And if that is the case, then we're saying
that all we need to do to maintain a stable
financial system is to get capital requirements
to the level that in the event of default
you don't get contagious defaults, which upends
the non-financial system.
TETT: Right.
GREENSPAN: I argue in the book that the non-financial
system operates very effectively, until it
gets polluted by the distortions that occur
when animal spirits take over the financial
system.
And that to me means that we're overdoing
it.
I've argued that Dodd-Frank is a mistake.
It's going in the wrong direction.
And I've argued that we don't need that much
regulation, provided you get banks to put
up capital.
If there are going to be losses, that the
shareholders of the banks do this.
I go into a long analysis where this is also
related to productivity, the standards of
living, to the inequality of incomes that
occur as a consequence.
It's a story which will go way beyond what
she's going to allow me to talk.
TETT: Well, we are actually coming up to the
end.
I'm going to say, in an otherwise gloomy hour,
that we have a point of cheer, which is that
Chairman Greenspan has a simple solution to
fix the banking crisis.
Probably not one the banks want to take.
I think it's been a fascinating discussion.
I take away three keys points, firstly, that
the current state of the world is very unhealthy
and unbalanced; secondly, that we're not going
to be able to exit this without some form
of turmoil or crisis, let's call it turmoil;
and, thirdly, that Chairman Greenspan is trying
to engage with these fundamental problems
in a very refreshingly frank manner.
And for that, I think we can all be very grateful,
indeed.
So thank you very much, indeed, for a fascinating
debate.
END
