Myths of the Greenspan Era

Myth 2: Greenspan's Flexibile Approach Met All Challenges

Flexible? Hardly. The Greenspan's response to nearly every economic challenge has been the same: inject more liquidity into the system. That's why money supply has risen so dramatically over the past 18 years. (Why the Fed is no longer reporting M3 is beyond my comprehension, so save your emails.) It's also why rates are down to unnaturally low levels.

To be considered flexible, one would think you need more than a single trick in your bag of economic magic. Where Greenspan has shown a large degree of "flexibility" has been in his skillful political maneuvering. That has been an enormous asset to the Fed.

Consider how he handled the Long Term Capital Management blowup: Gathering the major Wall Street banks together, he strong-armed them into rescuing the derivative-laden hedge fund before it became a full-blown disaster.

This was less the act of an economist and more the workings of a master politician. Sure, all the firms involved made a lot of money from the rescue operation -- but they put lots of capital at risk, and did so when the outcome was far from certain.

Myth 3: The Plunge Protection Team

The concept of the so-called Plunge Protection Team (PPT) comes from President Reagan's executive order #12,631 (March 18, 1988) for the formation of "The Working Group on Financial Markets."

The stated goal of the order was to "enhance the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets" as well as "maintaining investor confidence." It's a short hop from that mission statement to the creation of a PPT.

The markets themselves contributed to the conspiracy. During the 1987 crash, traders claimed that equities "mysteriously" managed to stop their stomach-churning collapse. The most common explanation has been that large purchases of index futures stemmed the bloodletting.

While others have laid this myth to rest previously (for example, John Mauldin's discussion here), the best way to resolve this fallacy is to look at the market during the month of the correction.

Plunge Protection? The chart from October 1987 says otherwise

Click here for larger image.

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