Greenspan's Impact: From Irrational Exuberance to the 2008 Financial Collapse -

Following the early Monday announcement of the passing of former Federal Reserve chair Alan Greenspan, tributes began pouring in, especially from former colleagues and market experts who closely observed his 18-year tenure at the US central bank.

Many hailed him as a transformative figure at the Fed, offering unique insights to investors, although his legacy is somewhat complicated by the global financial crisis of 2008-09.

Collaborators noted that his time in office coincided with significant economic changes, moving from a high-inflation era to a tech-driven economy. Greenspan led the Fed from 1987 to 2006 and died at his home in Washington.

His contemporaries attribute much of the Fed’s steadfast commitment to fighting inflation to him, as he recognized the impact of a productivity surge in the 1990s and modernized the Fed’s communication strategies.

Read: Alan Greenspan, who steered the Fed during growth before the 2008 downturn, passes at 100

“He was an exceptional central banker,” stated former chair Ben Bernanke in an email. “We continue to gain insights from him, even in his absence.”

Greenspan made an early impact by emphasizing inflation control, reinforcing the bold strategies initiated by his predecessor, Paul Volcker.

“When Paul Volcker tamed double-digit inflation in the early 1980s, he handed Alan Greenspan a 4% inflation rate,” noted Charles Evans, president of the Chicago Fed from 2007 to 2023. “Under Greenspan, inflation was systematically and opportunistically reduced to 2%, and even lower into the early 2000s.”

Others recognized Greenspan for transforming the Fed’s communication approach. In February 1994, the Fed’s rate-setting committee released a statement after its policy meeting for the first time, clarifying its decision.

The Greenspan Put

Among professional investors, Greenspan is fondly remembered for the flourishing financial markets during his leadership. The S&P 500 Index of US stocks nearly quadrupled, achieving an annual return exceeding 10%.

“Jokes circulated on Wall Street in the 1990s and early 2000s that if he were to pass while still at the Fed, they would need to prop up a dummy in his chair to maintain market confidence,” remarked Jeremy Siegel, emeritus finance professor at the University of Pennsylvania.

Beginning with the October 1987 stock market crash, Greenspan showed his willingness to intervene by providing liquidity, which led investors to coin the phrase “the Greenspan put.”

“In response to the 1987 stock market crisis, his actions were appropriate,” stated Ed Yardeni of Yardeni Research. “However, he set a precedent of the Fed coming to Wall Street’s aid in times of trouble.”

Irrational Exuberance

Greenspan also occasionally took steps to temper financial markets, leading to one of his most memorable statements.

In a speech in December 1996, he asked: “How do we know when irrational exuberance has unduly escalated asset values?”

A Fed staff member who shared the speech with the media later informed reporters that it contained nothing particularly noteworthy, causing many to overlook that key line. Those who did report it triggered a swift reaction in Asian markets.

“He faced considerable criticism from market participants who felt he overstepped,” said Charles Lieberman, co-founder and chief investment officer at Advisors Capital Management, during an interview on Bloomberg Surveillance.

Today, that phrase is often evoked as a nod to Greenspan whenever markets exhibit excessive optimism.

“‘How do we know when irrational exuberance has unduly escalated asset values?’ It turns out, we didn’t, and his question remains valuable advice for today’s markets,” noted Bill Gross, co-founder and former chief investment officer of Pacific Investment Management Co.

Productivity Call

During the 1990s, as companies embraced new technology with the advent of the Internet era, Greenspan encountered another significant moment in his career. As the economy expanded, he argued that an ensuing surge in productivity would alleviate inflationary pressures, prompting him to avoid tightening interest rates.

“It’s remarkable how Greenspan perceived that a looser monetary policy was possible,” commented David Wilcox of Bloomberg Economics, who served as an economist under Greenspan. “Acknowledging that the productivity data of that time was questionable, he worked with senior staff to produce the empirical evidence demonstrating that productivity growth was stronger than the official figures indicated.”

Greenspan often sourced insights about the economy from unexpected places, noted renowned investor Stanley Druckenmiller, who served on the Treasury Borrowing Advisory Committee alongside the former central banker.

“The remarkable aspect of Greenspan was his fascination with models and his intellectual rigor – he could engage anyone on detailed topics,” explained Druckenmiller. “At the same time, he appreciated conversations with business leaders about real-time insights and market conditions that models didn’t capture.”

The Shadow of Crisis

Nonetheless, the emergence of the credit crisis in 2007, which ultimately led to a near-global financial collapse in 2008, has cast a long shadow over Greenspan’s legacy.

While he received accolades upon leaving office in 2006, critics contend that he failed to identify the growth of a housing bubble that sparked the worst economic downturn since the Great Depression.

A key point of contention is Greenspan’s belief in allowing markets to self-regulate, with the Fed intervening only when necessary.

“He made a calculated choice to prioritize years of economic growth over potential risks,” noted Randall Kroszner, an economics professor at the University of Chicago and a Fed Governor from 2006 to 2009, during an interview with Bloomberg TV. “We tried to minimize some of that fallout, but the costs were likely greater than he anticipated.”

While some criticism is warranted, it’s crucial to view Greenspan as just one component of a broader regulatory and policy landscape, emphasized Don Kohn, a former vice chair at the central bank.

“It’s accurate that he didn’t wave a warning flag saying ‘something is wrong, we need to take action,’ but even if he had sounded that alarm, his authority to act would have been limited,” Kohn remarked.

Others remember him for his mastery of economic data and his ability, despite his meticulousness, to grasp the broader economic picture.

“I recall him during board briefings – he would engage with our experts on the most intricate details,” said James Clouse, an economist at the Andersen Institute who served at the Fed for over 30 years. “He had an extraordinary grasp of data and could discuss those intricate details with board staff while also maintaining a comprehensive view.”