Greenspan: Market Bubbles are Human Nature

From Staff Reports

Commenting that “the human race has never found a way to confront bubbles,” former Federal Reserve Chairman Alan Greenspan said the whipsawing financial markets are enduring today are in many ways "identical" to those he had to deal with in 1987 and 1998, while he was still head of the central bank.

Greenspan spoke last Thursday night to a group of academic economists in Washington, D.C.,  at an event organized by an academic journal, The Brookings Papers on Economic Activity.
"The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock-market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907," Greenspan said.

Greenspan was the Fed chairman from 1987 to 2005 and is now a private consultant. He was referring to the stock market crash of 1987, and the ensuing fallout, and the implosion of Long-Term Capital Management, a hedge fund operated by a group of Novel laureates who apparently didn’t know as much about the capital markets and about financial derivatives as they thought. [To see what Contributing Edtior Keith Fitz-Gerald has to say about the Fed’s role in the subprime-mortgage debacle, click here].

According to Greenspan, business expansions are driven by euphoria and contractions by fear. While economists tend to think the same factors drive expansions and contractions, "the expansion phase of the economy is quite different, and fear as a driver, which is going on today, is far more potent than euphoria."

In human nature, Greenspan said, euphoria takes over when the economy has been on the rise for a couple of years, fostering bubbles – and “these bubbles cannot be defused until the fever breaks.”

Bubbles can't be broken through incremental adjustments in interest rates, Greespan said. The Fed doubled interest rates from 1994 and 1995 and “stopped the nascent stock-market boom.” But when the rate-hike campaign was halted, and the central bank," but when the Fed stopped, reversed course, and cut interest rates to try and keep the LTCM meltdown and the Asian contagion from speading and wrecking the U.S. economy, stocks took off again. Indeed, many experts believe that these rate reductions ultimately fueled the dot-com bubble that, also, imploded.

Said Greenspan: "The human race has never found a way to confront bubbles.”

Related News and Story Links:

  • The Wall Street Journal: Greenspan Likens Market Turmoil to 1987.