Book Review: 'Greenspan's Bubbles' by Bill Fleckenstein

Originally posted at:http://seekingalpha.com/article/89073-book-review-greenspan-s-bubbles-by-bill-fleckenstein


Much of the public who are aware of Alan Greenspan have only heard positive things about the former governor of the Federal Reserve board. Political pundits, when commenting on Greenspan, offer nothing but effusive praise. Wall Street has deified the ex-jazz musician.

Then there are a small band of critics who charge that Greenspan has been recklessly incompetent and has imperiled the US economy.

One of those critics is short seller and hedge fund manager Bill Fleckenstein. "Fleck," as he is known, has been an unrelenting critic of Greenspan since I first stumbled across his writings over a decade ago. A witty writer, Fleck has penned a short book entitled Greenspan's Bubbles where he lays out the case against The Maestro.

According to Fleckenstein, much of the prosperity of the past 20 years has been due to Greenspan's penchant for bailing out financial markets when they have gotten into trouble. Rather than allowing markets to clear naturally, Greenspan sought to cut interest rates and increase the money supply whenever asset markets fell hard. This encouraged risk taking and the development of the "Greenspan put" whereby investors felt they could take on more risk than they otherwise would have had they not believed that Greenspan would bail them out.

Each crisis was met with more action by the central bank, which meant more stimulus and more problems down the road as problems where pushed into the future. The excess monetary creation fed its way into the real economy, artificially inflating economic growth and encouraging the misallocation of resources and excess supply - think tech stocks and homes. Eventually, Fleckenstein argues, we will have an enormous bill to pay, one that we may be paying right now.

Greenspan's claim that bubbles could only be identified in hindsight and the proper duty of the central bank was only to deal with the after-math of the popped bubble contributed to the creation of bubbles. If an asset bubble was being fed by the central bank, yet the central bank was unable to recognize the results of its actions, and then used the power of the printing press to flood the system with money to ease the asset market's descent. The seed's of the next bubble were being sown if the bank did not embark on a policy of cleaning out the excess monetary creation. This, Fleckenstein argues, occurred under Greenspan.

Fleckenstein argues that many adjustments to the economic statistics (not necessarily the fault of the Federal Reserve or Greenspan) have skewed the true health of the economy, leading to poor policy decisions. For example, hedonic adjustments to the calculation of inflation have understated inflation. Adjustments have always lowered the official rate of inflation because of quality improvements - think computers - but never once have inflation rates been adjusted upwards because of deteriorating products and services - think airline flights.

Fleck also takes issue with the notion that productivity rapidly improved during the latter half of the 1990s, which Greenspan inferred through the increase of investments in technology, even though official growth rates in productivity had not yet shown a dramatic increase. Greenspan believed that productivity was being understated by official figures since all the investments in computers and servers and software must have lead to an acceleration in productivity, even though there was little empirical evidence that this was so.

A former protégé of Ayn Rand, Greenspan had an enduring faith in markets. By buying into the notion that markets were almost always efficient, there was no reason for the central bank to intervene when asset markets went nuts, valuing companies in the billions of dollars when a company barely had $10 million in sales. If the collective action of millions of investors valued such a Talking Sock Puppet company at that level, who was the central bank to doubt them?

Today, nearly a half a trillion dollars worth of losses have been recorded by banks as home prices have fallen nearly 20% from their peak according to the Case-Shiller home price index, all on top of the collapse of the Tech Bubble, which erased $7 trillion of shareholders' wealth.

I generally agree with the central premise of the book - Greenspan was complicit in the creation of the never-ending asset bubbles. I would also concur that Greenspan's stock, like the stocks of the Talking Sock Puppet companies of The Tech Bubble, is vastly over-rated. Whether or not he is the worst central banker of all time, I have no idea for I don't even know the name of the Fed governor in 1929 and am too lazy to Google it.

Fleckenstein acknowledges that Greenspan is not solely to blame for the asset bubbles. However, I think that though Greenspan may be the single greatest contributor to the bubbles, I tend to believe that he is not as responsible as his arch critics and the perma-bears contend. The support to keep the party going was intense, not only from the politicians in Washington, but from Wall Street and investors themselves. Remember, the emotions were so incredible; analysts who downgraded stocks would sometimes receive death threats. M guess is that it wasn't Alan Greenspan making them.

Greenspan's faith in technology investments driving an acceleration in productivity gains is almost certainly over-done. However, the lesson I take away is that so much power should not be in the hands of one man. Greenspan was the overwhelming force on the Federal Open Market Committee. It was Greenspan who determined the setting of the interest rates, and not the FOMC.

Greenspan used the committee primarily to legitimize his decisions on the rate that should be set. If Greenspan - that one man - was wrong, for example, about the productivity gains arising from technology investments, then the fall-out from the Fed's policies could be disastrous. Thus, Ben Bernanke's decision to democratize the FOMC is a very welcome decision.

Fleckenstein wrote the book with Fred Sheehan. Greenspan's Bubbles is short. It does not take long to read. In an interview with Kate Welling, the authors said that the length of the book was due to the tight deadline set by the publishers. Sheehan will publish a more extensive volume in the future.