Wednesday, December 14, 2016

Book Review: “The Man Who Knew: The Life and Times of Alan Greenspan” by Sebastian Mallaby

I read this excellent biography with a great deal of interest since I worked with (and debated) Federal Reserve officials on a variety of issues when I worked at the Treasury Department and Alan Greenspan was Chairman of the Federal Reserve Board. While long, the book is well written and exhaustively researched. It does deal with some contentious economic issues, but does so in an accessible way. It also discusses the political situation and Greenspan’s political maneuverings during key points in his career, and goes into some detail about his personal life. It is a well-rounded portrait of a very strange man who became one of the most powerful economic players in the world.

There are two issues I was particularly interested in because of my involvement with them during my Treasury career. The first is Greenspan’s public advocacy that Treasury issue five-year gold-backed notes in a September 1981 Wall Street Journal article, and, as I recall, in a submission before the Reagan Administration’s Gold Commission. I was early in my Treasury career working on Treasury debt management issues among other domestic finance policy issues, and I was tasked to write internal memos rebutting Greenspan’s arguments for gold-backed notes. I did not find Greenspan’s argument that the Treasury would save money convincing as an analytical matter, and, as a practical matter, I pointed to the disastrous French experience with gold-backed bonds under President Giscard d’Estaing. 

What I did not know and learned from this book is that one of the reasons that Greenspan proposed this was as a ruse to stop the Gold Commission from advocating a return to the gold standard. At Treasury, we did not think this was a real possibility because of the presence of Administration officials on the Commission who would follow Treasury’s lead on this, even if the new President was intrigued with the idea. Any decision to return to the gold standard would involve Treasury as well as the Fed. Treasury owns the U.S Government’s gold, not the Fed, and an issue this important would have to be an Administration initiative.

While Mallaby does not conclude how wedded Greenspan was to the idea of Treasury issuing gold-backed notes, I was and am under the impression that he thought it was a good idea. He would later propose a more realistic alternative, inflation-indexed notes and bonds, which Treasury resisted for years but finally decided to start issuing in 1997 during the Clinton Administration. (I was involved in these discussions over the years and was delegated to formulate and write the key terms and conditions of these securities once the decision was made to issue them.)

The other issue that I was particularly interested in was Mallaby’s description of the dispute over the regulation of over-the-counter (OTC) derivatives in the President’s Working Group on Financial Markets in 1998. Brooksley Born, the Chair of the Commodity Futures Trading Commission (CFTC) wanted to claw back some of the exemptions that the CFTC had made pursuant to legislation from CFTC regulation for many OTC derivatives (without making a determination whether the instruments in question were subject to the Commodity Exchange Act, the statute the CFTC administers and enforces). Because of the 2008 financial crisis in which credit default swaps played a role, Born has been lionized for advocating for regulation of OTC derivatives.

I have argued on this blog that what happened at the PWG meeting has been misrepresented by a PBS Frontline documentary and elsewhere. (See here, here, here, and here.) Mallaby’s account of what happened at the key PWG meeting generally agrees with what I have written. He talked to Pat Parkinson, who worked at the Federal Reserve Board at the time and was present at the PWG meeting, as was I. In an endnote, Mallaby quotes Parkinson remarking that Born “snatched defeat from the jaws of victory.” Here is what I wrote about this:

“…One of the reasons for her [Born’s] failure is that she stubbornly maintained that OTC derivatives were subject to the Commodity Exchange Act (“CEA”), an argument, which, for technical reasons, put into question the legality of certain outstanding derivatives, such as total return swaps based on equity securities. It also seemed by her insensitivity to this issue that she was motivated too much by turf considerations. That guaranteed that others, especially the bank regulators, would oppose the CFTC on this.

“Secretary Rubin was, in fact, concerned about OTC derivatives because he felt that they might be increasing systemic risk. (It should be kept in mind that the Treasury had little turf to be concerned about with regard to this issue, except that of the Office of the Comptroller of the Currency, which is fairly independent from the Departmental Offices and, consequently, is often left to fend for itself.) Because Rubin had sympathy with Born’s policy concerns, though not her legal arguments or apparent turf grabbing, he proposed that the President’s Working Group on Financial Markets ask a series of questions to the public about OTC derivatives, similar to the questions the CFTC had prepared for a concept release on the subject. Born refused, and despite pleas from the other members of the PWG, went ahead with the concept release in May 1998.

“Her intransigence on this subject drove Rubin into Chairman Greenspan’s corner, much to the relief of the major OTC derivatives dealers who were not unaware that the Secretary was not entirely comfortable with their business. There is a chance that, if Born had approached Rubin and SEC chairman Arthur Levitt with her policy concerns rather than with her legal arguments, she might have been able to get their support for some greater oversight of the derivatives industry. It is possible that some of the discussion would have focused on how to do it and who should do it, though Greenspan and others would have continued to argue that any government interference in the form of regulation of this market would be harmful. In any case, that would have been a healthier and more productive debate than the endless, and ultimately boring, legal debate over whether swaps are futures.”
I was happy to see that this major book provides an account of what happened at the PWG meeting on derivatives that is more accurate than that which is generally believed. Mallaby, though, does not mention that Rubin proposed that the CFTC’s proposed Concept Release be issued by the PWG as a way of reducing the legal uncertainty for certain OTC derivatives and that Born flatly refused to consider this. Her intransigence, which I ascribe to political incompetence, was key to her failure to achieve greater regulation of OTC derivatives.

Also, Mallaby does not discuss that regulating the OTC derivatives market could be accomplished in a different way than that proposed by the CFTC. Financial regulation can hinge on the regulation of certain types of instruments or on certain types of financial entities. While many OTC derivatives could be viewed as not subject to regulation as instruments at the time of the PWG meeting, many of the market makers and key market participants for these instruments were subject to regulation by the various bank regulators, the SEC, and, in some cases, the CFTC. The big players were the commercial and investment banks, and Treasury staff, including me, thought that the bank regulators and the SEC would do an adequate job in this area. We were mistaken, but that was not the only area where there was a failure of the regulators to use their existing authority to head off, or at least mitigate, the 2008 financial crisis. It is also not clear, though, what the relatively small CFTC would have been able to do if they clearly had the authority to regulate this market, which they did not.

There are other areas where Mallaby debunks the accepted story, such as in his discussion of Fed Governor Edward Gramlich, Greenspan, and what the Fed did or did not do with respect to subprime mortgages. Mallaby’s account is more favorable to Greenspan than what is commonly believed. It would be interesting if people with direct knowledge of this were to weigh in with their account of what happened and whether they support Mallaby’s account. (I have no reason to doubt Mallaby’s account, but this is a contentious issue.)

At the conclusion of the book, I think Mallaby is perhaps a bit too generous in his assessment of Greenspan. He writes: “Greenspan’s passivity as a political actor exacerbated his single error as an analyst—his underestimation of the potential costs from financial fragility.” However, one could argue that another failure was that monetary policy was too loose at the end of Greenspan’s tenure, leading to stock market and real estate bubbles, though not consumer price inflation, and that this was an error. To be fair, Mallaby does discuss these issues elsewhere. (In an amusing 2008 article, the satirical website The Onion wrote: “A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.” See “Recession-Plagued Nation Demands New Bubble To Invest In.”)

While one I could go through the book and mention other points of disagreement, mostly minor, and some not terribly significant errors and omissions, which the author may correct in subsequent editions, this book is a very impressive biography and highly readable. If you are interested in Alan Greenspan or generally interested in U.S. economic developments from the 1970s on, this book is well worth reading. Because Mallaby did an incredible amount of research, including numerous interviews with many people, even those who were directly involved in some aspects of the story can likely learn things they did not know. Mallaby set out a very ambitious goal when he started this project, and he succeeded.   

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