Roach: Greenspan Blinded by ‘Ideology’

Former Fed Chairman Alan Greenspan's fingerprints are all over what is "fast becoming the worst financial calamity since the Great Depression,” says Morgan Stanley’s Stephen Roach.

"Greenspan’s blend of politics and ideology led to bad economics and a succession of policy blunders whose severity is only now becoming clear,” he asserts in a recent op-ed in Foreign Policy magazine.

"His handling of the housing bubble was the smoking gun.”

Roach says he couldn’t agree more with Greenspan’s view that it is critical that we learn the lessons of the current crisis. He just doesn’t believe Greenspan himself knows what those lessons are.

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"Just saying no to asset bubbles was always an option,” Roach says. "Too bad Greenspan couldn’t bring himself to take away the punch bowl just when the party was getting good.”

Roach points out that the fastest-rising home prices since the end of World War II combined with innovative financing techniques to let U.S. homeowners live on the inflated values of their homes.

And it all happened under Greenspan’s 18-year tenure at the Fed.

But it was Greenspan’s "markets know best” philosophy that ultimately prevented him from acknowledging the twin housing and credit bubbles that brought on the economic crisis — let alone act to contain them.

In fact, Greenspan’s policies helped pushed residential net-equity extraction from 3 percent to nearly 9 percent of disposable personal income by 2005, leading U.S. consumers to spend well beyond their means.

"Personal consumption climbed to an unheard-of 72 percent of real GDP in 2007, a record for any leading economy in modern history,” he observes. "Household debt soared to a record 134 percent of disposable personal income.”

As an increasingly asset-dependent U.S. economy began borrowing surplus funds from other countries to keep growing, it also began running massive current account and trade deficits to attract foreign capital.

Roach says Greenspan and his disciple, current Fed chief Ben Bernanke, saw the situation precisely backwards.

They saw America "doing the rest of the world a huge favor by absorbing its surplus savings” and believed serious dollar risks were a problem for another day.

"Suddenly, that day doesn't seem so distant,” he notes.

Roach says growth under Greenspan was "increasingly based on fumes” and led to cleanup costs that will likely be "a good deal larger than any growth that might have been foregone” had Greenspan’s Fed intervened.

For one thing, a tighter monetary policy would have made investors less eager to buy what Roach calls "opaque and increasingly toxic financial products.” Roach adds that rating agencies, regulators, Wall Street, loan sharks, property speculators and subprime homeowners will all pay a steep price for Greenspan’s lack of action.

"I suspect the Federal Reserve will also pay a steep price, losing some autonomy as Congress adds financial stability to the Fed’s responsibilities,” Roach says.

"The central bank’s stewardship of the U.S. economy is far too important to be left to politics and ideology.”

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