Greenspan's Bubbles

Before I begin my book review, you should know that I have a strong positive bias toward smart money managers that rely on fundamentals to formulate their investment theses. I enjoy reading the intellectual rigor of Doug Kass, general partner of Seabreeze Partners Management, Inc. and commentator for The Edge Column on RealMoney Silver (subscription required—part of TheStreet.com family), Jim Rogers (see his The Millennium Adventure website), and Bill Fleckenstein. While these managers will not always voice the same opinions, I know that when I read their opinions, they have been well thought out. Having stated my bias, I will now move on to the book review.

I heartily and enthusiastically recommend Bill Fleckenstein's book Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve. Those of you who read Bill Fleckenstein's articles know that he was critical of the Fed for having created the excessive high technology bubble and is critical of the Fed for having created the housing bubble. In his book, Bill chronicles, by reviewing Greenspan's speeches and FOMC transcripts, how the Fed created both bubbles. FOMC (Federal Open Market Committee) transcripts are released after a five year lag, so not all of the relevant transcripts are yet available. Bill Fleckenstein's comprehensive analysis provides an interesting examination of Greenspan's record as Fed Chairman.

Some might be inclined to believe that it is always easy to find fault in hindsight when everything is laid bare. However, as Bill and others demonstrated by their articles throughout the period, astute observers could and did recognize the problems in real time.

Once again Greenspan was able to rationalize the maniacal behavior that took place daily. Productivity explained it all. Companies felt good, analysts felt good—all was well because productivity was powering a new era. His predecessor at the Fed, Paul Volker, the man who had successfully broken the back of inflation in the early 1980s, didn't quite see it that way. He had too much respect for his former office and was too much of a gentleman to be direct, yet on May 14, 1979, he made the following point in a commencement address to the American University, School of Public Affairs/Kogod School of Business: "The fate of the world economy is now totally dependent on the growth of the U.S. economy, which is dependent on the stock market, whose growth is dependent on about 50 stocks, half of which have never reported any earnings."

Obviously the prior quote relates back to the dot com era. Just after the dot com era passed, Bill Fleckenstein and others chronicled in real time the problems with the housing market, all of which leads us to today. The housing and mortgage situation is dire with the final outcome yet to be determined.

Throughout both periods, Greenspan's overwhelming belief in technological and productivity gains led him astray. He often confused cause and effect. It was not the technological and productivity gains in the technology as well as housing and mortgages industries that led to super rich valuations. Rather, it was the low cost of money that encouraged averaged citizens to reach beyond their means, both intellectually and financially, that created the super rich valuations. Because of a proliferation of media sources, both cable networks and internet sites, citizens became overly confident of their abilities to judge the worthiness of securities. With everyone else enjoying the party and no one even threatening to remove the punch bowl, people were enjoying themselves then and were content to worry about the hangover tomorrow.

During Greenspan's tenure, the creative destruction component of capitalism was routinely suppressed. The main consequence of this suppression was a loss of fear. Thus, the normal risk reduction response to periodic financial pain never occurred, as Greenspan wouldn't even allow small crises to run their course. Instead, as people lost respect for the idea that they might lose money, risk taking continually escalated until the situation reached a point where it is now: the United States, individually and collectively, is swimming in an ocean of debt that has been rapidly ratcheting higher. At the same time, the country is experiencing a declining real estate market that supports much of that debt, a sinking economy that has been dependent on an unsustainable real estate bubble, and a weak currency. Plus, there are over $500 trillion worth of derivatives that Warren Buffett has described as "financial instruments of mass destruction." You couldn't have created a more precarious environment if had tried.

Many people today are having to contend with their financial hangover. Tomorrow has finally arrived. Bill Fleckenstein's book provides an excellent chronicle of the events that led to our current difficulties. We are perhaps right in the midst of the housing troubles. After reading Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve, you will have a better appreciation as to why and how we got here.