On the day of Jimmy Carter’s inauguration, January 20, 1977, Greenspan took the noon shuttle back to New York and proceeded to his office.1 Townsend-Greenspan was still located at One New York Plaza, scene of the dramatic fire in 1970; and the business was still prospering, despite the boss’s two-and-a-half-year absence. Kathryn Eickhoff and the three other women vice presidents had kept the data flowing and the clients contented, churning out austere analyses on manufacturing profits, steel output, and so on. But although Greenspan was happy to be reunited with his ersatz family, he allowed himself one modest grumble. Eickhoff had been telling clients that a hot housing market was driving consumer spending: people were taking out second mortgages on their homes and using the proceeds to remodel their kitchens or purchase new cars, turbocharging the economy. Eickhoff’s observation had a sting in its tail. If the housing market turned cold, consumer spending could nose-dive. The economy could turn out to be more fragile than anybody realized.
“Where are your data on this?” Greenspan demanded once he had settled back into his job.
“Well, we don’t have any data exactly,” Eickhoff answered. “But every meeting that we go to, we can find somebody at the table to explain how you do this mortgage extraction in that particular community.”
Greenspan did not like this answer. He was not impressed with anecdotal evidence. The Townsend-Greenspan brand was based on dealing strictly with facts.
“Why didn’t you get the data then and find out whether you were right?” he pressed Eickhoff.
Eickhoff pleaded lack of time. Everybody at the firm had been paddling hard to stay afloat with Greenspan not there.
“Well, if you’re right, it’s in the data,” Greenspan insisted.
“Fine,” Eickhoff retorted. “I’m right; we’re right; you go find it.”
Over the next weeks, Greenspan spent hours sequestered in the library.
“Kathryn, you were wrong,” he announced eventually. “You had absolutely no idea of the size of this phenomenon.”2
It was not the most gracious way to concede that Eickhoff had been onto something. But over the next year Greenspan made the most of her insight about mortgages and consumption. It was the sort of idea that appealed to him deeply, not least because it harkened back to his magisterial 1959 paper. Eickhoff’s point was an example of how a change in the value of an asset—in this case, housing—could have powerful effects on spending by individuals. Likewise, Greenspan’s 1959 paper had emphasized that a change in the value of a different type of asset, corporate stock, could determine spending by companies on new plant and machinery. Moreover, Eickhoff’s insight appealed to Greenspan because it was overlooked by his rivals. Most economic forecasters focused on the national accounts, the data set that presents output by companies, households, and the government, which adds up to the gross domestic product (GDP). But capital gains are nowhere to be found in these accounts. If the value of a home increased by $100,000, and the homeowner took out a second mortgage for 80 percent of that amount, that extra $80,000 of spending power did not show up in the national accounts—not in the personal disposable income number, not anywhere.3 The impact of changing asset prices was occurring under the radar.
Greenspan set his team to work quantifying the home-price effect in detail. He wanted to know how much mortgage lending was being channeled to families who already owned homes—and who were therefore likely to spend the proceeds on things other than housing. No data existed on this “home-equity extraction,” as it later came to be known. But Greenspan estimated how much new mortgage debt might have been created as a result of the construction of new homes, and he calculated how much debt existing mortgage holders would normally repay in any given period. By taking his estimate for new mortgages and subtracting repayments on old mortgages, Greenspan arrived at the expected change in the total amount of mortgage debt in the economy. Now he was just one step away from the statistic he wanted. If the expected increase in mortgage debt was smaller than the actual change, the difference must represent additional mortgage lending to existing homeowners—home-equity extraction. Thirty years after his undergraduate vacation job at Brown Brothers Harriman, Greenspan had lost none of his taste for statistical sleuthing.4
By August 1977, Greenspan was ready to lay out his results in detail to his clients. When home values had gone up in the early 1970s, he reported, less than a third of the increase had been extracted to support spending. By contrast, during the second quarter of 1977, virtually the entire increase in the market value of existing homes had been monetized. This was a remarkable finding. Thanks to the financial industry’s eagerness to hand out new mortgages, consumer purchasing power had expanded by almost 5 percent during the quarter; and although Greenspan did not drive home this point, total spending in the economy (counting in spending by government and companies as well as consumers) might have been boosted by almost 3 percent.5 The implication was that GDP growth in the second quarter, which had come in at an annualized rate of 8.1 percent, might have come in nearer to 5 percent without the miraculous boost from housing. The flip side was that if the housing boom came to an end, the economy would slow. There was a “danger that the rise in home prices could take on a speculative hue,” Greenspan observed. “The assumption of ever rising prices for new homes is not valid.”6
The clients on the receiving end of these data did not always know what to make of them. They paid Greenspan as much as $30,000 annually to receive his economic letters and hear from him in person once every quarter—the retainer matched the entire salary of the average in-house analyst who listened to his presentations.7 In return for this princely compensation, Greenspan would show up at his clients’ offices with the outsized leather briefcase full of data that he carried with him at all times, like the presidential football; some clients suspected he had one arm longer than the other. His manner of speaking was both impressive and mysterious: “It suggested he was stewing a vast amount of data in his head, and letting out only a little of the steam for his public to sniff at,” a client recalled years later.8 Most of his audiences were money managers at mutual-fund houses, pension funds, or banks, and they were in the business of making yes/no, buy/sell decisions on specific stocks and bonds. But Greenspan floated above this dull binary game, forcing his listeners to consider multiple scenarios. If the dollar fell a little, three knock-on trends might develop; if it rose, there could be two consequences. Meanwhile, if inflation ticked up, there were four possible versions of the future. Greenspan would speak on and on, his expression seldom altering, his heavy-lidded eyes hidden behind thick glasses. The clients paid top dollar for his ruminations because there was no doubt about his mastery of data. But after he departed they would huddle together anxiously at post-Greenspan meetings. What had he really said? What did it mean for their portfolios?9
Greenspan traveled relentlessly, visiting clients across the country. His staff joked that he could only keep up with his schedule because he had learned to live out of a suitcase as an itinerant jazz player.10 But as he crisscrossed the country, Greenspan was deepening his grasp of economics, too. His experience at the Council of Economic Advisers had expanded his intellectual ambitions: for the first time, he had been surrounded by colleagues who were more formally qualified than he was. When he returned to his firm, he resolved to ramp up the sophistication of its macroeconomic forecasting, and to this end he retained the consulting services of a young ex-CEA economist named John Taylor, later to become a renowned Stanford professor and insistent Greenspan critic. Although he was now past the age of fifty, Greenspan himself returned to New York University to take courses in econometrics.11 Twenty-seven years after enrolling in the graduate program at Columbia, he completed his doctorate.
Greenspan’s PhD thesis, submitted in late 1977, was not a conventional dissertation. It was a strange mixture of articles written over many years, including the 1959 paper on asset prices; it ranged from math-heavy technical submissions to a layman-friendly article published in the Economist. But although the style was eclectic, the thesis served to capture the central strands in Greenspan’s thought, distinguishing him sharply from the dominant camps in late 1970s economics. Unlike Milton Friedman and his fellow monetarists, Greenspan never put stock in stripped-down models that forecast the future path of the economy by tracking a favored measure of the money supply; he was far too interested in the workings of industry and government budgets to zone out all those details.12 Unlike both monetarists and Keynesians, Greenspan emphasized the key role of financial markets in driving the economy, and he was leery of the intellectual hubris that underpinned Keynesian fine-tuning. Finally, unlike many conservative economists in the late 1970s, Greenspan never fell in love with “rational expectations.” In its earliest versions, the rational expectations school argued that both fiscal and monetary policy could be powerless to affect growth and jobs, because citizens offset it. For example, if the government ran a budget deficit in the hopes of stimulating growth, rational individuals would expect the government to have to increase taxes later to pay the interest on the debt—and they would prepare for the higher taxes by saving more in the present, thus negating the intended stimulus. Greenspan agreed that fine-tuning was counterproductive, but he did not agree that it was impotent. Indeed, he had doubted the power of the expectations channel in his correspondence with Friedman about Nixon’s price controls, and in his ridiculing of Franklin Roosevelt’s conceit that fear alone caused the Depression.
Greenspan opened his PhD submission with an argument that drew directly from his 1959 paper. By ignoring the impact of asset prices on spending, Greenspan contended, the reigning forecasting models were “abstracting from reality in a somewhat unrealistic manner.” The mistake was understandable: capital gains and losses were not part of the national income accounts, and their absence had “tended to bias model builders away from data which are not readily available.” But still, Greenspan continued, economists ought to do better; and he cited the impact of home-equity extraction, which was “largely missed in the standard models.”13 Moreover, Greenspan insisted, it was not just that rising home prices could boost spending; the effect also worked the other way around, with higher spending tending to boost home prices. Because of such feedback loops between finance and the “real” economy, unsustainable trends could appear sustainable for a long time, as higher asset prices boosted spending, which boosted asset prices, which boosted spending. Eventually, the feedback loops would drive prices to completely unsustainable levels, and the bubble would burst, landing the economy in serious trouble. Although he was writing in the heyday of efficient-market faith, Greenspan did not believe that markets were always rational and stable any more than he had done as a commodity trader in the 1950s.14
With the unfair benefit of hindsight, Greenspan’s position was both impressive and ironic. Years before his critics charged that the Fed during his tenure had been blind to wealth effects and bubbles, Greenspan was at the cutting edge of thinking on these questions. And he was ahead of his time in another sense, too. Both in the 1970s and later, most forecasting models essentially left finance out. They assumed that the channeling of capital from savers to spenders was a utility-like function that would not alter growth; they did not reckon with the fact that shifts in the financial sector, such as a greater willingness to facilitate home-equity extraction, could change the path of the economy.15 In the wake of the 2008 crisis, this underestimation of finance was held up as one of the economics profession’s cardinal errors. But Greenspan was never guilty of this mistake. Ever since his study of John Gurley and Edward Shaw in the 1950s, he had emphasized the significance of shifts within finance, and by the 1970s he was all the more convinced that economic forecasters had to factor finance into their thinking. “Our financial institutions are more flexible and complex than we had supposed a couple of decades ago,” he observed in his thesis. “Certain elements of the financial system are sometimes dominant; sometimes quiescent.” Such shifts from dominance to quiescence—from bullish risk taking to a bearish desperation for safety—could change spending and output dramatically; and Greenspan strove to build this observation into the forecasting model at his firm, tracking bond issuance and money-market funds as well as plain-vanilla banking. The approach harkened back to Greenspan’s mentor and partner, Bill Townsend. But it was also “ahead of the game,” as John Taylor remembered years later, in 2011.
Greenspan was awarded his PhD in late 1977, and Barbara Walters held a small dinner in his honor. Arthur Burns and his wife Helen attended, as did Greenspan’s old NYU undergraduate friend, Bob Kavesh, and a very proud Rose Greenspan. At the end of the evening, Barbara passed out cigars that she had brought back from Cuba after interviewing Fidel Castro.16
• • •
Even as he lived an ambitious private life, Greenspan remained engaged in public policy. He joined Time magazine’s board of economists and the Brookings Panel on Economic Activity. He taught the receptionists at his firm to pay special attention to phone calls from the press—they were to inquire about the reporter’s deadline and make sure that Greenspan responded fast enough to have his quotes included in the article. Journalists, for their part, repaid Greenspan’s attention with flattering profiles. Soon after his return to his consulting firm, a prominent New York Times commentator reflected that Greenspan had forged “probably the most intimate and influential relationship an economist has ever enjoyed with a president.”17 Somehow Greenspan managed to convince journalists that he was virtuously indifferent to power and status, even as his courtship of journalists suggested otherwise. “If power interests you, you would miss the change,” Greenspan mused to the Times, reflecting on his shift from the White House back to private life. “I wouldn’t say I was unaware of power—or didn’t even like it—but my professional work interests me more.”18
Greenspan’s media appearances delighted his mother. Whenever he was due to appear on TV, one of his assistants would call Rose and tell her the time and channel.19 But Greenspan’s hunger for the spotlight was less welcome to some of his colleagues. Kathryn Eickhoff accused him of suffering from “Potomac fever”: halfway through a discussion about some delicate statistical question, the boss would break off abruptly because a journalist or congressman was on the telephone. “There were times when I could have killed him, because we were in the middle of something important for the firm,” Eickhoff recalled; and his public shtick about how his “professional work” mattered more to him than fame only added insult to injury.20 Even so, Eickhoff could never be cross with Greenspan for long. “It’s really difficult not to get along with Alan,” she reflected years later. “He doesn’t give off enough emotional content for you to be offended.”
Greenspan’s place in the spotlight obliged him to comment on the new economic ideas stirring in the Republican Party. These contrasted sharply with his own public opposition to budget deficits.21 In June 1978, the voters of California passed a referendum known as Proposition 13, which imposed an immediate cut in property taxes. When the leader of the Prop 13 movement was accused of dangerously expanding California’s budget deficit, he retorted that his tax cut would compel legislators to hack “the barrels of lard out of the government budget.” The idea that preemptive cuts in revenue would somehow elicit responsible spending cuts seemed wishful, and research later showed it to be wrong.22 But recognizing the political attraction of tax cuts, Greenspan gave Proposition 13 a qualified endorsement: “Such brutal sledge-hammer techniques turn out to be necessary to prevent government from continuing to increase its share of overall economic activity,” he ventured.23 Greenspan had recently told Fortune that “it would be a mistake to enact a general tax cut,” and that “economists ought to recommend what they think is right and let the politicians make the political judgments.”24 Now he was violating his own injunction.
A fortnight later, on July 14, 1978, Greenspan testified before a Senate subcommittee. The hearing had been called to study a tax bill introduced by a Republican duo—Representative Jack Kemp of New York and Senator William Roth of Delaware. The Kemp-Roth bill relied on a new type of tax logic, more radical even than the approach embraced in California. Lower tax rates would stimulate growth and therefore extra tax revenue, the bill’s proponents claimed; tax cuts would pay for themselves. Some three months earlier, the Congressional Budget Office had debunked this so-called supply-side theory—the 1964 tax cut, a favorite precedent for supply-siders, had generated enough growth to offset only a quarter to a third of the lost income.25 But Kemp and Roth were undeterred—either by research or by ridicule. “Sound the trumpets and hear the heralds,” Walter Heller, the former Kennedy CEA chairman, sneered in the Wall Street Journal.26 “Lunch is not only free, we get a bonus for eating it. P.T. Barnum, move over.”
As the Senate hearing convened, Senator Roth began by presenting a birthday cake to his counterpart, Representative Kemp, in honor of the one-year anniversary of the introduction of their bill. “I might say that this is one of the few times that the American people may not only have their cake, but eat it too,” he said, parrying ridicule with self-parody. Roth then proceeded to congratulate himself and his Republican colleagues on their budget conservatism even as he peddled his tax cut—to his way of thinking, there was no contradiction. Back in the 1960s, the Democrats had been the ones to champion tax cuts, justifying their policy with the mistaken idea that inflationary budget deficits could lastingly boost employment. Now the Republicans had seized upon the equally misguided fallacy that tax cuts were self-financing.
Rather than denouncing the fallacy of Kemp-Roth, Greenspan tiptoed around it. He ventured that the economy was in such dire need of sharper incentives that tax cuts, particularly on corporations, were imperative—even if they involved a larger deficit. Without improved incentives, what Greenspan termed “the British disease” of industrial stagnation beckoned. “Since the cost of stagnation politically, socially, and economically is so large, we have to lean over backward to avoid it.”
Naturally, Roth was delighted. “I think you set forth the facts for substantial, across-the-board tax cuts as well as I have heard them set out,” he said, enthusiastically. But then he demanded to hear more. One of the most quoted economists in the nation was sitting there in front of him. The senator was determined to nail down his support as explicitly as possible.
“Mr. Greenspan, looking at the Wall Street Journal article that appeared on July 12, 1978, titled ‘The Kemp-Roth Free Lunch,’ I’m sure you’ve seen the article?”
Roth was referring to Walter Heller’s P. T. Barnum taunt. Greenspan signaled that he had indeed read it.
“I wonder if you agree with the thrust of it?” Roth asked. He was fishing for the Republican former CEA chairman to neutralize the Democratic former CEA chairman.
“My good friend, Professor Heller, is fighting a strawman,” Greenspan obliged. “The problem he raises is not the issue.” Contrary to Heller’s article, tax cuts would not widen the budget gap, Greenspan maintained. The reason was that they would be followed by spending cuts.
Greenspan was not about to endorse the supply-side fantasy of self-financing tax cuts in its entirety. But he was willing to give Republican leaders what they wanted anyway by embracing the Prop 13 faith that tax cuts would create pressure for spending cuts. For more than a decade, Greenspan had insisted that there was a ratchet effect in government spending, with each new program whetting the public’s appetite for the next one. Now he was happy to imply that cutting Leviathan would be simple.27
• • •
Three months after his tax testimony, in October 1978, Greenspan extended his arguments on housing finance in the unlikely setting of Utah State University.28 He had been invited to this remote outpost, perched on a flat bank in a mountainside eighty miles north of Salt Lake City, to deliver a speech, and he used the occasion to address the question implicit in his writings on home-equity extraction. Something had changed in the financial sector, triggering a deluge of new mortgage loans. What was it?
Greenspan began by noting a collapse in the relationship between interest rates and the housing market. Until the start of the 1970s, rising interest rates had caused mortgage finance to dry up: housing demand fell and so did house prices. But by the mid-1970s, Greenspan noted, rising interest rates were no longer having that effect. At the time of Greenspan’s speech in Utah, the Fed had just increased the short-term interest rate to 9 percent, but mortgages were still easy to come by and house prices were booming.29
The reason, Greenspan told his audience, was that the rules of the game had been changed by the government. The construction industry, furious at periodic real estate busts imposed by high interest rates, had lobbied Washington for relief. Washington had duly responded; but, Greenspan said sourly, “as is typical with any political endeavor in this country, we inevitably overdid it.” In 1970, Fannie Mae, a government-sponsored enterprise (GSE) set up during the Depression, had been allowed for the first time to buy private mortgages, and in the same year Congress created a second GSE called Freddie Mac to compete with Fannie. Goading each other on, Fannie and Freddie stood ready to buy mortgages from banks and S&Ls, with the result that these lenders gained a huge new source of funds—there were “massive expansions of mortgage credit availability.” One decade earlier, new mortgage creation had seldom exceeded $15 billion per year. Now six times that quantity was normal.
This revolution, Greenspan went on, had consequences beyond housing. “The mortgage market has basically exploded into a major new financial vehicle that dwarfs the federal deficit, dwarfs corporate borrowing, and dwarfs state and local borrowing,” Greenspan declared. “It has become the most dominant element in the whole financial system.” The government-sponsored enterprises had driven up house prices, boosting the wealth of families and so boosting consumption; a politically conceived change in the financial plumbing was effectively driving spending on vacations, education, large automobiles—everything. The upshot was that the mortgage explosion had not merely delinked the housing sector from interest rates; it had delinked the whole economy from interest rates, at least temporarily. Thanks to Fannie and Freddie, lending was cheap and plentiful even though the Fed had raised the short-term interest rate to its highest level in almost four years. Monetary policy was apparently tight, but financial conditions were in practice loose.30 The economy was growing at a heady rate, and the trend was not sustainable.31
Greenspan was describing a version of what he would later call the conundrum.32 In testimony before Congress in February 2005, he famously noted that the Fed’s efforts to raise interest rates were not having their usual effect, possibly because a flood of foreign purchases was pushing down interest rates on long-term bonds, so higher short-term interest rates did not translate into higher long-term interest rates. The implication, which Greenspan emphasized repeatedly after the crisis of 2008, was that the Fed had been nearly powerless to defuse the housing bubble—rates for long-term mortgages were barely responding to the short rates that the Fed guided. But this breakdown in the relationship between long rates and short rates was in fact less novel than Greenspan implied. As he had written in his PhD thesis, shifts within finance were constantly altering the economy’s behavior. Foreign bond purchases in the 2000s provided one example of this truth. The advent of Fannie and Freddie in the 1970s provided another.
Having shown how economic growth had been temporarily delinked from interest rates, Greenspan gave warning that trouble was looming. Years later it would be argued that the opening up of a new credit hose—huge lending from foreign countries, especially China—caused asset-price inflation. In 1978, Greenspan explained that the opening up of the mortgage hose was causing consumer price inflation. Fannie and Freddie were creating spending power that had already pushed CPI inflation back above 8 percent a year, and the effect was all the more powerful because the Federal Reserve was too weak willed to counter it. With a clarity that is ironic in hindsight, Greenspan described how the Fed was falling down on the job. Rather than pushing back against the stimulus from financial innovation by raising short-term interest rates more, the Fed was letting the financial system have its way, with the result that there was “a huge excess of credit in the system.”33 When the Fed finally got tough, the party would stop. But the longer it delayed, the more the bursting of the housing bubble would be painful.
“A recession is almost surely going to occur,” Greenspan concluded in his Utah speech of October 1978. “Any attempt to find a way to somehow push under the rug the imbalances that have been created, especially in the financial markets of recent years, is likely to fail.” Precisely the same warning might have been addressed to Greenspan himself in January 2006, on the day of his retirement as Federal Reserve chairman.
• • •
Whatever the prospects for America’s economy, Townsend-Greenspan was thriving. In 1979, the firm hired David Rowe, the first PhD economist to sign on for a full-time staff position. Rowe had been trained by Professor Lawrence Klein of Wharton, the father of Keynesian macroeconometric modeling who would win the Nobel Prize the following year, and by Klein’s colleague Albert Ando, who would eventually help to create the Fed’s macromodel. Studying under these two masters, Rowe had come to see the difference in their styles: Ando was a perfectionist, spending months crafting each equation that went into his model; Klein was an ambitious visionary, at one point launching an effort to combine disparate national forecasts into an econometric model of the entire world economy. When Rowe moved into his new office at One New York Plaza, he wondered which pattern Greenspan would follow—Ando-style craftsman or Klein-type visionary. He quickly discovered that the answer was neither.
Rowe eventually labeled Greenspan the “street-smart economist.” Unlike Albert Ando, he was not about to spend months tweaking a single equation, for he doubted that real-world relationships remained stable long enough to justify such effort. In Greenspan’s opinion, each part of the economy reflected multiple influences that were constantly in flux: for example, household spending might be driven by house prices or job prospects or fears of inflation or any number of factors, and the drivers that most mattered would vary from one period to another. Likewise, unlike Lawrence Klein, Greenspan mistrusted grand hypotheses about how the economy functioned. He was not interested in what ought to happen according to some elegant theory; he was interested only in what would happen as a result of messy reality. Consequently, he set about building his forecast on discreet insights. Greenspan knew that rising metal prices often signaled an industrial revival; that rising inventories might portend a slowdown; that planned growth in government spending usually signaled good times for the defense industry. Even if none of these relationships was fixed or certain, each contained a useful hint. If you collected enough canaries, you got a sense of what might happen in the coal mine.
Greenspan would not have been upset by Rowe’s description of him. He was after all a business economist, with roots among the empiricists at Columbia University and the National Bureau for Economic Research. He remained more interested in measurement than in theory; he was not so much a modeler as an empiricist with a big computer. Exposure to more orthodox economists at the Brookings Institution or the Council of Economic Advisers did nothing to shake his confidence in his eclectic approach. And because he was not dazzled by theory, he felt free to focus on data—on ferreting out information that others did not have rather than obsessing about the mathematical assumptions that linked the data points together. If Greenspan discovered a correlation that seemed to have a good record of predicting the future, he would embrace it happily—and never mind the fact that it might seem orthogonal to a more conventional economist. “Which single indicator do you find most useful?” people would frequently ask. “Scrap steel prices,” he would say, relishing the bemused looks that greeted him.
Rowe came to appreciate his street-smart boss, both intellectually and personally. He knew that introverted intellectuals could be hell on wheels to work for—they refused to take the time to explain what they wanted, then blamed you for not doing it. Greenspan was not like that at all: he was happy to have Rowe into his office to discuss statistical issues, provided that no journalist or congressman was demanding his attention. He had a sense of humor, too. One day Rowe remarked to Greenspan that whenever their discussions went on for longer than a few minutes, Rowe would end up seated while Greenspan paced about the office, often in his socks.
“I guess that’s because my brains are in my feet,” Greenspan said. “Yours must be someplace else,” he added.
Around this time, Greenspan got a call from the storied brokerage firm Merrill Lynch: Don Regan, the profane ex–marine colonel who ran Merrill, was asking to meet him. Greenspan went over to Regan’s office at Merrill’s hulking steel-fronted headquarters and was confronted with an offer that he was not supposed to refuse: Merrill would buy Townsend-Greenspan and Greenspan would become Merrill’s chief economist. Regan had a number on a piece of paper, and Greenspan took a look. “That’s a big bundle of cash!” he told himself. Keeping his composure, he told Regan he needed time to think. It was a Friday, and Regan asked him to respond by Monday morning.
Greenspan went home and thought to himself, “You know, if this were a shoe factory this would be one hell of a price-earnings ratio. Of course I would sell it.” The next day, Saturday, Regan’s unbelievable offer kept crowding his mind, paralyzing him with indecision. When he awoke on Sunday morning, he was still heavy with anxiety. But then, in the shower, the weight suddenly lifted.
“I said to myself ‘Oh my God, now I know what was bothering me,’” Greenspan recalled. “‘It’s my independence.’” His head knew that the offer was compelling; his heart rebelled against the prospect of being folded into someone else’s organization chart. After that epiphany, Greenspan turned down Don Regan—an act that came back to haunt him when Regan became Ronald Reagan’s Treasury secretary.
If Greenspan’s choice of freedom over money revealed something of his character, the way he arrived at his decision was even more illuminating. Faced with a life-altering choice, he had been uncharacteristically rattled; but over the course of thirty-six hours, he had consulted precisely nobody. He was still seeing Barbara Walters, who had leaned on him heavily as she had pondered her own career move from breakfast to evening TV, but he had not felt inclined to ask Barbara to reciprocate. “There was nothing to consult anyone about,” he said, years later. “There was no factual information I didn’t have. . . . A fact is a fact. Once you know it is a fact, there is nothing more to be discussed.”34
Perhaps Greenspan’s solitary decision making said something about his relationship with Walters; after all, he was also seeing other people. Around this period, Greenspan was invited to spend the weekend at a home in New Jersey, where he would play tennis with Brendan Byrne, the governor of the state, and Peter Benchley, the author of Jaws. Greenspan accepted the invitation and asked if he could bring a date, a woman from his office. But Greenspan’s solitary decision making also spoke volumes about him. His most vivid experiences played out within the confines of his head. The solitary boy lived on inside the famous adult.
• • •
Greenspan’s pessimistic Utah speech soon proved to be prescient. As he predicted, the delinking of interest rates from mortgage lending was not absolute; in the end, the Fed hiked interest rates enough to make an impact on the housing market. The tipping point came soon after he spoke. At the start of 1979, with the Fed’s short-term policy rate now up at 10 percent, mortgage lending started to fall, silencing the engine that had propelled consumption. In the first three months of the year, annualized growth came in at 0.8 percent, down from 5.5 percent in the previous quarter.
Greenspan’s warnings about New Frontier economics were coming true also. As growth slowed, inflation paradoxically sped up: price controls and other regulatory meddling had succeeded in suppressing investment and productivity gains, dampening growth; meanwhile, they also created bottlenecks, fueling inflation. The resulting stagflation left policy makers wondering whether to stimulate the economy or apply brakes to it. Money-supply data were not much help in resolving this dispute; financial innovation rendered the numbers hard to interpret. Spending power concealed itself in places that the familiar monetary measures missed: in money-market funds; in instant credit provided by department stores; or in a truly futuristic innovation known as the automated teller machine, which facilitated shopping sprees at all times of the night or weekend. In the face of these uncertainties, Greenspan sided with the hawks who prioritized fighting inflation. “A recession is unavoidable. The sooner we have it, the better off the economy will be,” Greenspan told Time in April 1979. The overhang from the long mortgage binge had to be purged out of the system.35
Greenspan gave the Carter administration credit for its conservative stance on the budget and deregulation. “I find remarkably little difference anymore between the liberal left and the conservative right on general economic issues,” he told the New York Times. “Now everybody’s looking to restrain inflation, improve production, and increase investment.”36 In keeping with this bipartisan pronouncement, Greenspan offered some informal help to Senator Edward Kennedy as he readied his presidential bid, and he did the same for Jerry Brown, the California governor whom he had met with Barbara Walters and Diane von Furstenberg. But even as Greenspan the intellectual shifted toward the middle ground, the travails of the economy caused a collapse in Jimmy Carter’s popularity ratings, encouraging Greenspan the politician to position himself for a top job in a future Republican administration.37 In August 1979, 84 percent of Americans told Gallup that they thought the country was on the wrong track. Many appeared to sympathize with the writer Tom Wolfe, who had called Carter an “unknown down-home matronly-voiced Sunday-school soft-shelled watery-eyed sponge-backed Millennial lulu.”38
Since leaving the White House, Greenspan had remained in touch with Gerald Ford, who was mulling a political comeback. On his trips out to California, Greenspan would visit Ford in Palm Springs, where the former president had installed himself in a ranch house overlooking a golf course; the two would play a round and Greenspan would keep his old boss up to date with the latest goings-on in the economy. But if Ford chose not to plunge back into politics, Greenspan had a backup plan. Marty Anderson, his old Randian friend who had brought him into the Nixon campaign, was now hard at work for California’s former governor.
In the first days of May 1979, Anderson visited Greenspan to ask whether he would help Ronald Reagan, even if his allegiance to Ford might make things awkward. “I’m not asking for your political support,” Anderson told his friend. “I just want to know if you can advise him on what he should do if he is elected.”39
Greenspan accepted readily. He would be happy to begin advising Reagan straightaway, provided it was understood that this was not an exclusive commitment.40
Anderson duly arranged for Greenspan to meet Reagan at Stanford University, where Anderson and other influential Republican thinkers congregated. The encounter went well, and afterward Reagan instructed Anderson to involve Greenspan in the campaign as much as possible.41 At the start of September, Greenspan duly flew out to Marina del Rey, an affluent corner of Los Angeles wedged between the bohemia of Venice Beach and the brutish utilitarianism of the city’s international airport. A handful of other Reagan advisers were there, too: George Shultz, Nixon’s former Treasury secretary; Caspar Weinberger, the future defense secretary; and Edwin Meese, who would serve as a top White House counselor and later as attorney general. At 9:30 a.m., after a quick breakfast of coffee, juice, and rolls at the Marina City Club, the men settled into a discussion of the themes that might animate Reagan’s candidacy.42
Greenspan kicked off the proceedings with a forecast for 1980. He had settled into his familiar role, commanding the attention of colleagues because he had more facts than they did.
“Next year will be an unmitigated disaster,” Shultz said, summing up Greenspan’s somewhat technical remarks for the group’s noneconomists. “Continuing high inflation, economic instability, demands for wage and price controls. It will be a chance to shift the debate in a conservative direction.”
The discussion continued until lunch, dwelling in detail on the arcana of the federal budget. After the break, the group reconvened, and this time Reagan himself joined the proceedings. Greenspan was struck by his manner: the candidate projected ease and warmth; there was an attractive roundness to his voice, perhaps learned long ago from acting.43 But Reagan could also disengage, like a daydreaming child. As they settled in for the afternoon session, the actor became the audience.
The discussion moved on to the case for deeper deregulation and the need to move spending programs out of Washington to state and local government. At one point Reagan intervened to clarify the proper pronunciation for the name of that apparatus he aimed to control: Was it “gov-ERN-ment” or “GUV-mint?” Otherwise, he was silent.
Marty Anderson emphasized that Reagan’s cabinet must be forceful enough to get Reagan’s economic priorities accomplished.
“On those priorities,” Shultz said. “I recommend you read Alan Greenspan’s paper.” The former Treasury secretary evidently viewed the aspiring Treasury secretary as something of a guru.
“New issue,” came a voice that had been silent for a while. “Money. No nation can survive under fiat money.”
It could have been Greenspan, circa 1964, delivering his Randian lectures on the economics of freedom. But the speaker was Ronald Reagan.
“Could we reestablish a monetary standard or discipline?” the candidate asked in his mellow voice. “For instance, could we coin $200 gold pieces from the Fort Knox reserves?” Reagan evidently associated Nixon’s break with the gold standard with ruinous inflation. He wanted to go back to the old verities.
“You are reversing cause and effect,” Greenspan told the candidate, displaying a greater bluntness than he sometimes did with politicians. “We went off the gold standard because the printing of money increased and inflation developed.” Inflation had forced the country off the gold standard, not the other way around. And that led Greenspan to a surprising conclusion.
“We must resolve the fiscal and inflation problems,” Greenspan said. “If we can do that, there is no need to return to the gold standard.”
• • •
The small group around Reagan cannot have guessed the full significance of Greenspan’s statement. But he had summarized a fundamental change in his worldview—one that would set the stage for the two decades of his Fed tenure. For more than a generation, conservative economists had believed in monetary rules, just as conservative social-policy experts emphasized the rule of law. The monetary rules came in assorted guises: one camp favored a gold standard to preserve domestic price stability, often combined with fixed exchange rates to preserve the dollar’s international value; a second camp favored Milton Friedman’s proposed autopilot, whereby the rate of money expansion would be fixed according to a rule so that politicians could not tinker with it. Whichever camp conservatives favored, they preferred rules to discretion. Rules would prevent inflation, avoid exchange-rate fluctuations, and forestall bubbles. But now Greenspan was breaking with this intellectual tradition. He still feared inflation and asset bubbles as keenly as ever—witness his writings on home-equity extraction—but he no longer viewed rules as the right antidote. He would still be willing to humor Reagan by paying occasional lip service to the virtues of the gold standard. But he no longer believed this message.
In one sense, Greenspan’s new stance was only logical. It would clearly be futile to go back onto the gold standard so long as inflation raged, because inflation would undermine the credibility of the gold peg and the Nixon shock would be repeated. Equally clearly, if raging inflation could in fact be contained, then going back to gold would have been proved unnecessary. Yet in another, deeper way, Greenspan’s new stance reflected a changed understanding of democracy. Modern pluralistic systems, Greenspan was saying, were messy and willful; after witnessing government up close, he knew this conclusively. It was idle to expect such systems to submit to rules—political pressures would destroy them. Technocrats who hoped for enlightened economic policy would have to roll their sleeves up and wage political battles.