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Greenspan, term ending, returns to Randian roots

In the autumn of his life as Federal Reserve chairman, Alan Greenspan is thinking about his legacy.

He's not alone. Last month, at the Kansas City Fed's annual Jackson Hole symposium, Greenspan was toasted as ``the greatest central banker who ever lived'' by Princeton University's Alan Blinder and other notables who trekked to the Grand Tetons in the hope some of his greatness would rub off on them.

Greenspan surely wants to have some say in how he'll be remembered. Perhaps that's why, with one burst bubble under his belt and a potential one still inflating, he returned to his philosophical roots in a speech last week to the National Association of Business Economics annual meeting in Chicago.

You wouldn't have seen any reference to it in the media coverage. And understandably so. There was no market-moving news in the first two-thirds of his speech.

Instead, Greenspan provided a brief history of the changing attitudes toward the government's role in the economy: the free- market capitalism of Adam Smith that prevailed in the 19th and early 20th centuries; the attempt at interventionist, demand-side management advocated by John Maynard Keynes during the 1930s Depression, when the market system seemed to fail to restore the economy to full employment; the resultant stifling of competition and economic stagnation of the 1970s; the failure of wage and price controls and eventual disillusion with regulation; and the ultimate triumph of free markets when "the collapse of the Berlin Wall in 1989 exposed the economic ruin behind the Iron Curtain,'' Greenspan said.

Commanding heights

It was "Atlas Shrugged'' without Dagny Taggart and Hank Reardon to lead us through the struggle.

Greenspan was present at the creation of Ayn Rand's masterpiece as part of the free-market philosopher's inner circle in the 1950s. It makes perfect sense that as he gets ready to retire from the Fed on Jan. 31, Greenspan would create an idealized image of himself, even if it differs from reality.

The last third of Greenspan's speech last week -- the one that got media attention -- was less impressive and much less noble. He left Ms. Rand to fend for herself as he stepped into his role of government bureaucrat.

Greenspan's thesis, if you could call it that, was that successful economic policy, including the monetary management to which he is entrusted, leads to nutty behavior on the part of investors.

Good is bad?

Yes, that's right. If the Fed does its job in providing an environment of low inflation, the economic stability it engenders leads to "market exuberance,'' Greenspan said, implying the behavior is rational even if it's frivolous.

"Why would a better economic environment cause investors to be more careless?'' asked Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. "A true Randian would have total trust in individual judgments.''

Perhaps investors are induced to be more careless by the presence of a safety net. Greenspan's risk-management approach to policy-making implies acting to offset the biggest risks and protect the biggest risk-takers. Like the doctrine of "too big to fail,'' it suggests that if you are going to roll the dice in a big way, make sure any failure creates a systemic risk to ensure government intervention.

Greenspan's 18-year tenure at the Fed has been characterized by multiple such interventions, the kind his mentor would have despised.

The 'Greenspan Put'

Consider that the "Greenspan put'' has become as much as part of the lexicon as the maestro's own popularized inventions, such as "irrational exuberance'' and ``economic headwinds.''

A put option gives the buyer the right to sell a security, index or futures contract at a specific price by a specific date. Buying a put protects the holder against a decline in prices.

After multiple rescue efforts -- Greenspan cut rates in 1995 following the Mexican peso crisis and Orange County blowup and again in 1998 in response to the near-collapse of hedge fund Long-Term Capital Management -- investors began to refer to, and rely on, the Greenspan put as an implicit guarantee that the Fed would cut rates if things got too dicey for the stock market.

"He has been willing to ease, and ease aggressively, thereby creating the right financial conditions for a mania,'' said Bill Fleckenstein, president of Fleckenstein Capital in Seattle, who has painstakingly documented Greenspan's bad forecasts over the years. (Think ``Whip Inflation Now'' in 1974.)

Proud parent

While Greenspan's topic last week was ostensibly how greater flexibility has enabled the U.S. economy to handle shocks, the speech was really "an attempt to rewrite history and can only be titled, 'Damn, I'm Good,''' Fleckenstein said. For example, Greenspan went out of his way to remind us that the Fed was uncomfortable "with a stock market that appeared as early as 1996 to disconnect from its moorings.''

The Fed chief has been spending more time of late on the possibly unmoored housing market than on any irrational pricing in the equity market. (Last week, the Fed published a working paper co-written by Greenspan on home equity extraction.) He must know "the stock market is not valued any differently now than it was in 1996,'' Glassman said.

The price-to-earnings ratio of the Standard & Poor's 500 Index averaged 19.21 in 1996 compared with 19.59 in the first nine months of 2005. In other words, if it was disconnected then, it's disconnected now.

Does that mean that both home and equity prices are detached from the fundamentals?

Rand believed that individuals, including investors, act in their own self-interest. Greenspan is certainly acting in his. On that score, at least, his mentor would be proud.

Baum is a columnist for Bloomberg News

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