Outlook: All is vanity as Alan Greenspan bubbles in Jackson Hole

Lloyd's of London

Does Alan Greenspan, soon to receive an honorary knighthood for services to global economic stability, need to be quite so defensive? If monetary bigwigs had expected to hear something new and insightful from the veteran Federal Reserve chairman when they gathered for the annual symposium of the Kansas City Fed at Jackson Hole, Wyoming, late last week, they would have been sadly disappointed. Instead they got what amounted to a litany of self justification.

Broadly summarised, Mr Greenspan said that there was no way of knowing for sure that the tech bubble of the late 1990s was a bubble until after the event, and that even if it had been possible unambiguously to identify it as a bubble, there would have been no way of addressing it other than by plunging the economy into recession, the very outcome the Fed is trying to avoid. Did not Mr Greenspan feel just a little humbled by the Fed's failure to control the bubble? Not a bit of it. There is perhaps a lot more research that needs to be done on the nature of bubbles and their implications for interest rate policy, he suggested, but as for the last one, he was certainly not to blame.

As it happens, Mr Greenspan was largely repeating himself. He said most of it on several occasions as the bubble was reaching its zenith. But like a rabbit held in the headlamps, he seemed to have no idea what to do about it. He knew a road crash was coming, but either was or believed himself powerless to act. As the boom times roll, investors grow progressively more oblivious to risk. Mr Greenspan is right to say there is little central bankers can do about this phenomenon, for human optimism doesn't respond easily to calming medication. Mr Greenspan would have been thought a spoil sport and worse if he had attempted to quash the exuberance. The longer the boom persists, the more reckless investors and bankers become until eventually they start to believe that the old rules no longer apply. A new paradigm comes into existence that fully justifies the heady heights that stocks have risen to and all the other excesses of a boom.

Despite his wisdom and his responsibility, Mr Greenspan is no more immune to these forces than anyone else. What's more, he was at the time being subjected to a veritable barrage of rhetoric and advice that told him to stay out of the stock market. Steve Forbes used to write it in his magazine virtually every week. The Fed's job was to look after inflation, he repeatedly said, not to worry about asset bubbles. By running too tight a policy, Mr Greenspan was stifling growth and innovation. In an extraordinary analysis of why America led the world in the New Economy stakes, Business Week said something similar. Only by having a loose bias in interest rate policy could you hope to generate the levels of investment necessary to succeed in the new industries, the magazine triumphantly announced. America had it; Europe and the rest of the world largely didn't.

Mr Greenspan's mistake is that he took all this "advice" too much to heart, and as the greed inspired frenzy of Wall Street and the over investment of the technology industries first took hold and then ran riot, Mr Greenspan did nothing. Rather the reverse, in fact. Every time the stock market threatened to fall from its high wire act, Mr Greenspan would wheel out the safety net. Like the fifth cavalry, he would come riding to the rescue, further underpinning the belief that the stock market had become a one way bet. Mr Greenspan became a kind of demi-god, whose brilliance as a policy maker had abolished risk for ever.

By cutting interest rates and easing credit conditions in the aftermath first of the emerging markets crisis, and then again the Long Term Capital Management collapse of 1998, Mr Greenspan arguably helped prompt the final, mad speculative dash for technology investment. He may not have been 100 per cent sure it was a bubble that was going on - who was he to pit his judgment against hundreds of thousands of informed investors, he once famously asked - but it appears he was 99 per cent sure - Mr Greenspan originally referred to irrational exuberance in stock markets as far back as 1996. Yet still he did nothing about it.

It is presumably vanity that makes him refuse to admit the mistake. What he should have said was that there was no appetite for the necessary medicine, or for the corrective mechanism of a stock market crash. That's no excuse, perhaps, but it's probably quite close to the truth. Modesty is not, however, an attribute of great men and Mr Greenspan wants to be remembered as the greatest central banker in history. To end his career in policy failure was very definitely not in the script.

Mr Greenspan still hopes to be proved ultimately right. Central banks cannot do anything about bubbles, he contends, but they can do something about the aftermath. On this front, he's doing pretty well. OK, so there's already been a mild recession in the US, but even that might have been avoided but for 11 September, which pole-axed what otherwise was beginning to look like a textbook example of how to deal with the aftermath of a prolonged boom. Only trouble is that to the extent that Mr Greenspan is succeeding in saving the US economy from the worst excesses of the past, he's only doing so by inspiring a separate, debt fuelled, consumer spending spree, which in time will bring its own problems.

Worryingly, Mr Greenspan is now as sanguine about the house price bubble, which is just as bad in the US as here, as he was about the stock market. The stock market is turned over 100 times a year, he pointed out in testimony to Congress earlier this year. Housing is less than 10 per cent, which he thought "scarcely tinder for a speculative conflagration". Mmm. Perhaps it's time to sell that house after all.

Lloyd's of London

Lloyd's of London has become such a byword for catastrophic loss, scandal, antiquated practice and brinkmanship that it is sometimes hard to take the institution seriously at all. Yet take it seriously we must, since it is still one of the world's largest insurers and therefore a big contributor to Britain's balance of payments. One thing seems certain. It won't long remain so unless it pushes through with dispatch the modernising reforms proposed by its chairman, Sax Riley.

In opposing the reforms, the Association of Lloyd's Members, the largest of the organisations representing individual Lloyd's names, says that it broadly supports the changes but believes names are being discriminated against. One complaint is that they are required to contribute disproportionately more capital. Another is that they are disadvantaged by removal of the central compliance function. But the biggest is the fear that eventually the reforms will result in them being frozen out altogether by depriving them of their voting power. As it happens, that's not the present intention, but the concern is understandable, since the purpose of most of the reforms is to make the market as conducive to large corporates as possible.

The original intention was to phase out unlimited liability names entirely, but Lloyd's was eventually forced to back down. Names would be ill advised to obstruct the market's further attempts to modernise itself, but their rights and traditions are none the less worth something. They are like sitting tenants, and if the rest of the market wants to dilute their rights, then it must compensate them. There's no money for compensation, claim the corporate members. Nonsense, say the names, and they are right. Lloyd's is still a powerful name and brand, despite its troubles.

jeremy.warner@independent.co.uk