Greenspan’s lasting legacy

Federal Reserve Chairman Alan Greenspan leaves office this week with a glowing legacy, having presided for 18 years over an extraordinary period of economic progress and stability in the United States.

But his sterling reputation — he often is hailed as the best Fed chief in history — may be tarnished by growing concerns about a bubble in housing markets on the East and West coasts that many economists believe was nurtured by the extremely low interest rates engineered by the Fed from 2000 to 2004.

Under Mr. Greenspan’s stewardship, the Fed cut rates below the rate of inflation through a series of moves in response to the stock market crash of 2000, the September 11, 2001, terrorist attacks, the corporate scandals of 2002 and an emerging threat of deflation in 2003.

While the moves bolstered the economy and prevented the 2001 recession from being deep and painful, they unexpectedly spawned a unprecedented binge of buying and speculation in housing.

Home sales and prices hit records every year at an accelerating pace. By the middle of last year, when the market finally started settling down, prices had doubled or tripled in coastal cities and resort areas.

One result is that American households are saddled with record levels of debt and have driven up U.S. debt to the outside world to levels that pose dangers for the economy.John Makin, a visiting scholar at the American Enterprise Institute, said he knew Mr. Greenspan was dealing with a bubble of his own making when he saw condo prices double in Key West in one year. Units under construction in the Florida resort last year sold four times over before they were even occupied, he said.

It was the second bubble under Mr. Greenspan’s tenure after the tech-stock bubble of the late 1990s.

“The current U.S. housing bubble is the result of two aspects of Fed policy,” Mr. Makin said.

Fed to the rescue

One is the series of rate cuts the Fed carried out in response to various economic shocks. Between 2001 and 2003, the Fed lowered its main lending rate from 6 percent to 1 percent, before beginning to raise rates in June 2004.

The other is the widespread impression the Fed’s actions left on investors that the central bank will do whatever is necessary to prevent a meltdown in asset markets out of concern that it would damage the economy.

The Fed-engineered rescue of the Long Term Capital Management hedge fund during the financial crisis of 1998 added to the conviction that Mr. Greenspan would “spike the punchbowl” to cushion market falls, even if they are fueled by reckless speculation gone awry, Mr. Makin said.

The idea that investors could count on the Fed for a bailout was encouraged by Mr. Greenspan’s own statements that the Fed cannot stop or prevent a bubble, and the Fed’s only role is to intervene in the aftermath of a bubble to prevent the collapse from hurting the economy.

Hopes that the Fed will come to the rescue of hapless housing investors if the overheated market collapses “rightly or wrongly made the housing bubble intensify,” Mr. Makin said.

Another economist, John R. Talbott, author of “Sell Now: The End of the Housing Bubble,” said Mr. Greenspan intentionally fed the housing boom by offering “possibly the worst financial advice ever given to the American people” in February 2004.

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