Former Federal Reserve Chairman Alan Greenspan on Interest Rates, Bush Economic Policy, Personal Legacy

Published September 18, 2007

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This is a rush transcript from "Your World with Neil Cavuto," September 18, 2007. This copy may not be in its final form and may be updated.

NEIL CAVUTO, HOST: We are breaking from our usual format to devote a lot of time to this next guest.

The Federal Reserve hinting its move today was as much meant to calm markets as us. But if even the title of my guest's book is right, a mere cut in rates won't do that in and of itself.

The book is "The Age of Turbulence." That age is now. And that author is Alan Greenspan. And that book of his is number one on all book lists right now, handily besting a fellow you might have heard mentioned once or twice on this network, O.J. Simpson.

Dr. Greenspan, good to have you.

ALAN GREENSPAN, FORMER FEDERAL RESERVE CHAIRMAN: Pleasure to be here.

Video: Former Federal Reserve Chairman Alan Greenspan discusses Fed's interest rate decision

Video: Greenspan defends rate cuts from critics

Video: Greenspan assesses President Bush's handling of economy

Video: Greenspan reflects on professional legacy

CAVUTO: You're ahead of O.J. Congratulations.

GREENSPAN: I find that very unusual.

(LAUGHTER)

GREENSPAN: But I appreciate it.

CAVUTO: All right, let's talk. I know you don't want to necessarily comment on what the Fed did today. That is your purview and right.

Nevertheless, by cutting rates a half-a-point, the signal the markets got is that, hey, those guys maybe see some bad stuff going on, and that they're doing something fast.

What do you think?

GREENSPAN: I think everybody makes interpretations of what everyone thinks by looking at what the prices did. I used to do that. I have ceased doing it, because I don't have a clue, because, unless you go out there and get everybody's vote, so to speak, as to why they did or did not move in a market, you are hypothesizing.

And there are actually lots of other alternative explanations. But everyone — I guess it is the nature of the beast — has an opinion of what, you know, several million people's motives were in making a certain move.

CAVUTO: Yes. But, if we were not going anywhere, we're flat, right, and then we're all of a sudden up 330-some-odd points, the markets clearly liked this, right?

(CROSSTALK)

GREENSPAN: Something happened.

CAVUTO: Right. Right.

GREENSPAN: I vouch for that.

CAVUTO: Now, the markets seem to have been sensing that the Federal Reserve risked falling finding behind the proverbial curve, missing what was a slowdown, if not worse.

Do you think, by cutting interest rates, we have averted that?

GREENSPAN: Neil, that is one of the questions I can't answer. I have chosen not to speak about monetary policy or its very specific aspects for short — short run.

As you know, of course, in the book...

CAVUTO: Right.

GREENSPAN: ... I talk about the longer run and the problems that will confront the Federal Reserve, and, indeed, all central banks.

But people at the Federal Reserve Board are terrific. It's a wonderful organization. They are very smart. Let's just let them do what they think is right, because I know how they go about it. And leave them do the work.

CAVUTO: OK. Do you think...

GREENSPAN: I don't — I don't...

(CROSSTALK)

CAVUTO: I understand. I don't want you...

GREENSPAN: People — nobody needs to comment about it...

CAVUTO: I will get you to trash them later.

GREENSPAN: ... especially...

CAVUTO: I will get you to trash them later.

GREENSPAN: OK.

CAVUTO: A quarter-point move is what you were largely known for. When your — when you moved, it was largely in quarter-point increments, not all the time.

But now you have a half-point move, the first move down we have had in more than four years. One could infer from that some worry.

GREENSPAN: Neil, I mean, I don't want to waste any of your time here.

(LAUGHTER)

(CROSSTALK)

GREENSPAN: Look, first of all, there are innumerable occasions when, when I was chairman, we moved 50 basis points and 75 basis points. It depends on the circumstances. It depends on the value — it depends on a detailed analysis, which the Federal Open Market Committee is involved in.

It depends on the staffs' input from the reserve banks and from the board economists. And, remember, the very first thing that goes on in the Federal Open Market Committee, after its usual bookkeeping stuff, is, you go around the table.

And everybody brings to that table a real-time view of where their particular districts are. And it is a new set of information which is not available from government statistics. And the judgments that are made are made on the basis of all of the information at that time.

You know, when I was writing this book, I tried to go back and find areas where I thought I had made a mistake or the board had made a mistake. And, of course, we did make forecasts and took actions which, in retrospect, were clearly off, because our forecast was slightly off.

But I could not find a single example where the process was at fault. In other words, the way in which the Federal Reserve, with the — the banks and the board, make decisions is a very sophisticated, very coordinated operation.

CAVUTO: Well, let me ask you about that operation. How much do volatility in the markets play into your consideration? In other words, if you have had the craziness we have been having over the last few months, does that play into a decision on whether to hike or lower interest rates?

GREENSPAN: Volatility is a signal that there is an unstable set of bid/ask spreads, which move around a great deal. That is telling you something about the financial system and, by implication, the economy as a whole.

And those are inputs, obviously, in any decision the Federal Reserve makes. And I think most every one of us could probably bring out a chart, a VIX or other volatility measures, and hold forth on what they think it's actually telling you. And it is — it's one of the very important statistics that any central bank looks at.

CAVUTO: All right.

So, if you sit on the Federal Reserve, Doctor, and, all of a sudden, you know that, if you don't make a move, the markets are going to go nuts, should that be part of your thinking, that, if we don't, in this case, cut interest rates, the markets are going to go nuts?

GREENSPAN: Well, remember that there are two types of market moves that — or I should say funds rate or interest — or discount rate moves that the Fed makes.

The ones which are consistent with what everyone else believes, and, indeed, the reason for that is, everyone is looking at the same data. However, there do come occasions — they are increasingly rare in recent years — when the markets deviate quite significantly from where the Federal Reserve Open Market Committee believes it should be.

And, in those instances, there is actually a very specific purpose in surprising the markets. You want to wrench expectations back or forth in a certain direction.

Now, I grant you, that is rare. And one of the reasons it's rare is that quality of economic data have improved so enormously and it is so widespread, that the Federal Reserve is essentially reading the same data that the general public is.

The Fed does have a few things which are not available. We — we get — we did when I was there, and I assume it's still the case. We get certain data a little earlier, not a great deal earlier, but enough earlier to make a difference.

We obviously have huge amounts of information on, for example, foreign exchange intervention, which is not publicly — which is not publicly available.

And those types of data do enter into the decision-making process.

CAVUTO: But not the Dow up or down on a given day?

GREENSPAN: No, not the — the Dow going up and down is often noise.

CAVUTO: All right.

So, let's talk about the noise right now. One is that, by cutting interest rates, the — critics, who had said that we had no reason to cut interest rates — I think it was a third of economists surveyed in a recent Wall Street Journal survey — had said that it would be sending the wrong signal. It would be bailing out hedge funds and — and duplicitous lenders, who should not be bailed out, and that the Federal Reserve could, quite accidentally, be sort of appeasing a temper tantrum of a — of a child.

GREENSPAN: Yes.

You know, I have — I have a problem with the — the — just the general concept. If you run a successful monetary policy, you are going to raise asset prices to higher than where they would otherwise be. And those are the asset prices of those who have had very prudent investment policies, but also those who are very egregious speculators, who deserve to be punished.

The problem you have is, this and the overall economic outlook go together. In other words, in order to punish those who are undeserving, you have to punish the whole economy and the deserving. There is no way to make that break and...

(CROSSTALK)

CAVUTO: Or reward both. Or reward both.

GREENSPAN: Or reward. Look...

CAVUTO: Right.

GREENSPAN: ... there were — I mean, Ben Bernanke made a statement in which he said, it is not the job of the Fed to bail out egregious actions.

Correct.

And then he added, but it is really the job of the Federal Reserve, essentially, to make certain that the economy is going on a proper — as...

(CROSSTALK)

CAVUTO: But, when you cut interest rates, Chairman, do you think that you, effectively, do bail out some?

GREENSPAN: It is inevitable that you bail out lots of people all the time whenever you do anything. You — a great number of people benefit on the basis of things they had nothing to do with. Others lose because they ran into a problem they had nothing to do with.

CAVUTO: But some hedge funds and brokerage houses who should have known better were bailed out today, were they not?

GREENSPAN: Yes.

I mean, the problem, you have to — you have to make the choice. How — one, how important is it to punish those people, relative to balancing the economy? And the Federal Open Market Committee obviously made the judgment that they did not want to bail out all of those people, but the question that they had to weigh is that, were punishing those people more important than doing something that they perceive to be...

CAVUTO: In the greater good.

GREENSPAN: In the greater good.

CAVUTO: So, let me ask you this.

When I spoke with President Bush a couple of months ago on this very subject of a bailout for — for the — the housing industry, or, more to the point, even duplicitous lenders, or the folks who took on questionable loans, one of the things he said was: No bailout. I might extend terms. I might make it more flexible to work through the FHA.

But it is not as if we don't have precedents for bailouts. You worked behind the scenes to get long-term credit capital and addressed that. You worked with President Clinton to effectively deal with what was a hemorrhaging in Mexican debt, the devaluation of the peso.

So — so...

GREENSPAN: I agree with you with Mexico, but not LTCM.

CAVUTO: Well, what do you call long term? Wasn't that a bailout?

(CROSSTALK)

GREENSPAN: No, it was not.

What it was, was the Federal Reserve Bank of New York asking the debtors of LTCM to get together themselves and take a look at whether they wanted a fire sale of those assets or they wanted them liquidated in a gradual manner. It was up to them.

And they got in a room. Bill McDonough, who set it off...

CAVUTO: Right.

GREENSPAN: ... went out of the room. He gave them a little coffee. And I'm not sure...

(CROSSTALK)

CAVUTO: Well, that was a more than a come-to-Jesus meeting.

GREENSPAN: Well, now, wait a second.

CAVUTO: What that — if that had not been done, we might have had a whole different history, right?

GREENSPAN: Neil, but wait a second. You know, yes, but supposing I - - I mean, well, let's go — let's go back; 1907, we had an extraordinary crisis.

J.P. Morgan said, these people who are out in the street are very frightened. They could substantially create a far more stable financial and economic system if they realized that, if they made rational decisions, instead of being bound by fear, they jointly could stabilize the financial system. So, what did he do? He gathered them all up...

CAVUTO: Gathered them all in a room.

GREENSPAN: ... in the Morgan Library up on 35th Street, and was a little bit rougher, I might add, than...

CAVUTO: Well, he browbeat them. You're being kind.

(CROSSTALK)

CAVUTO: All right, so, let me ask you — we have to go a quick break.

GREENSPAN: Yes.

CAVUTO: I think your wife knows a thing or two about that.

GREENSPAN: Yes.

CAVUTO: So — so, let me ask you, would you liken what is happening to mortgages today to the situation with long-term credit back then, the situation with Mexico before then? Is this a crisis, or a potential crisis, that, if authorities don't intervene more aggressively, it is a disaster?

GREENSPAN: It's going to be a long answer. Do you want to get your break or do you want me to start the answer now?

CAVUTO: Start your answer.

GREENSPAN: First of all, it's important to analyze what the nature of the problem is.

What the nature of the problem has — and, actually, it is starting to ease a little bit, before the Fed action. We were observing a situation in which innumerable numbers of lenders were frightened — were frightened that their counter parties, the people to whom they lend, would not be able to pay the money back. And, as a consequence, you had a situation where, for example, asset- backed commercial paper, which, as, like all commercial paper, is considered extraordinary liquid, AAA-type paper, began to become — began to look as though it was weak.

And what they saw was that the assets that backed up — which were financed by the commercial paper had some subprime loans in them. And, of course, subprime loans, at the time, all of a sudden, began to be the instruments of default.

CAVUTO: Right.

GREENSPAN: And, so, what we saw is that commercial paper rates, the regular ones, stayed flat. The, say, 30-day asset-backed commercial paper just took off.

What that tells you is a case where there was an extreme stringency. And the way you have to address the extreme stringency is essentially to remove its cause, which is the fear of default.

CAVUTO: Take that out of the equation, and things settle down.

GREENSPAN: Take that — if you can.

CAVUTO: OK. GREENSPAN: It doesn't mean that you are going to be successful.

CAVUTO: All right.

I didn't understand it completely, but you said it so brilliantly, I don't doubt it now.

All right, we are going to take a quick break here, but did want to bring you in on a FOX News Alert that has just come into our newsroom.

President Bush has been responding to Dr. Greenspan's direct and indirect criticism of him. We are going to roll that tape and allow Dr. Greenspan to respond to that right after this.

(COMMERCIAL BREAK)

CAVUTO: All right. This is a FOX News alert and a FOX exclusive. President Bush commenting on Alan Greenspan's criticism of his administration. The president speaking to our own Bret Baier for a special he's preparing on Vice President Dick Cheney to air on October 13. Here's what the president had to say.

(BEGIN VIDEO CLIP)

GEORGE W. BUSH, PRESIDENT OF THE UNITED STATES: I would say that the record, our fiscal record is admirable and good. After all, the deficit percentage to GDP is low, relative to the 30-year average. It's about 1.5 percent of GDP, which is — which is good. And we submitted a budget that shows that we can get it balanced.

I would also argue that cutting taxes made a significant difference, not only in dealing with the recession and the attack in our country, but it made a significant difference in dealing with the deficit, because a growing economy yielded more tax revenues, which allowed us to shrink the deficit.

And so I would respectfully disagree with the characterizations of Chairman Greenspan.

(END VIDEO CLIP)

CAVUTO: All right. With me now, Alan Greenspan, the former Fed chief and the author of the new book, "Age of Turbulence", flying off bookstore shelves right now, No. 1 on Amazon.

What he's saying, essentially, is, "I know Greenspan is worried about deficits but, as a percentage of GDP, they're the best they've been in three decades. I have a good track record on this. The tax cuts triggered the type of growth we had, kept the recession shallow."

What do you think of that?

ALAN GREENSPAN, FORMER FEDERAL RESERVE CHAIRMAN: The issue is really not the short term. The president's numbers are correct. Indeed, the deficit this year is coming in well under expectations.

The concern that I've had is what the potential for the budget deficit is when the Baby Boomers retire. Any evaluation of the period that starts in about 2010-11 forward, especially when you look at Medicare, creates a huge fiscal problem. We have never had a major increase in retirees like we're about to run into.

CAVUTO: By the way, you point out in the book, not only here, everywhere, that it's going to be a global issue.

GREENSPAN: It's a global issue. And if you basically say, for example, look at Medicare, leaving out the issue of whether it's taxes or if you have benefit cuts, it's very clear that, unless there's an extraordinary change in the outlook for either the — demography or the cost of medical care, that tax increases cannot solve the Medicare problem.

CAVUTO: You're — I just — I don't want to, at this point, ask you about what to do about entitlements. You're quite right. You've raised that.

GREENSPAN: Well, that's — but see, that's precisely the issue. Nuance the issue. If we were on a...

CAVUTO: Because by the way, you didn't give this president credit for at least attempting to address it. He was shot down by members of his party and the Democrats.

GREENSPAN: Let me say this. My basic problem is with the Republican Congress. My problem with the president is that he did not use the veto sufficiently. It was not he who essentially created the agriculture policy or, I should say, the agricultural program or the highway bill. He would have — he was coming in much lower.

But, instead of vetoing a lot of that stuff, it came through.

CAVUTO: So you say he needs to start vetoing, right? So now he's got — he's got a big. Well, wait. He's got a big transportation bill, right? It's a $100 billion plus bill. Should he veto?

GREENSPAN: He'd better start vetoing certain stuff, because we are getting into the demographic issues wholly unprepared. We cannot afford to have procedures which lead us into the longer-term period.

Look, Neil, as far as I can see, what we really ought to be thinking of is how our accounts look on an accrual basis, like a regular corporation evaluates things. If you had an accrual basis of accounting, our fiscal situation would be awful.

In other words, we are on a cash accounting basis, so the big commitments we have made don't show up as deficits for many, many years. But you shouldn't do planning on a cash budget. Corporations stopped doing that 150 years ago.

CAVUTO: Well, one of the ideas espoused by, actually, a prominent team of all the major Democratic candidate running for president, is to address some of the issues you talk about by hiking taxes, or rescinding the tax cuts for the well-to-do, the top — the top wage earners.

Will that do it? In other words, if you raise taxes on the upper income that we're on the path that Alan Greenspan wants?

GREENSPAN: Look, the Republican Congress didn't do it. I said, basically, that they swapped policy for power and in the end, got neither.

The Democrats came in. They're doing pretty much the same thing as Republicans are doing. I'm not saying that the Democrats — what I say in the book in effect...

CAVUTO: Hang on.

GREENSPAN: ... that the Democrats didn't win.

CAVUTO: But raising taxes on the upper end, will that go a long way toward addressing what you said?

GREENSPAN: It will not.

CAVUTO: OK, OK. I do — that I do want to pick up on.

More of Alan Greenspan and the book the world is talking about after this. Right after this.

(COMMERCIAL BREAK)

CAVUTO: All right, wrapping up with Alan Greenspan, "The Age of Turbulence" is the book, number one on all best seller lists. And Dr. Greenspan, the one rap against this book, maybe — is that you created the pickle we're in. You kept interest rates so low for so long, we got the housing bubble or froth or whatever you want to call it, how others held it (ph). Are you guilty?

GREENSPAN: No. No, I actually made a statement that we ought to be careful at that point (ph), about allowing interest rates to remain too low too long in the short end of the market because certain things can build up.

Actually, I was wrong. Nothing like that did happen. What did occur, however, was this extraordinary change which I point out is critical with the end of the Cold War and the extraordinary economic room behind the Iron Curtain which effectively told us that central planning didn't work. And it was such a clear-cut victory for market capitalism that much of then Third World very quietly, with no fanfare, moved all of a sudden to markets, China, being the obvious big case.

The effect was, and China is the critical case here, a huge amount of foreign direct investment into China, which went from virtually ...

CAVUTO: No, no doubt, but the end result was you must have seen what was happening in real estate and when you espoused hey, adjustable rate mortgages aren't a bad idea, when fixed rates were already very low ...

GREENSPAN: Look ...

CAVUTO: ...did you feel it?

GREENSPAN: Let me go finish my first part and I will go through (ph) this quickly. The second part is just terrible misreporting.

CAVUTO: You didn't recommend adjustable rate mortgages?

GREENSPAN: Not in — no ...

CAVUTO: ...or say they weren't a bad idea?

GREENSPAN: There are — very — good idea — let me do that first. A very good — I said in early 2004 that adjustable rate mortgages were conforming mortgages for lots of people who plan to live in their home for only a short few years, makes a good deal more sense than a fixed rate mortgage on the basis of the ...

CAVUTO: OK.

GREENSPAN: ...study by the Federal Reserve.

CAVUTO: All right, look, I know you want so much to mention the economist (ph) (INAUDIBLE), all of that. I want to touch on the relationship with the Bush family. Bush senior — I know you want — Bush Senior kind of feels that you were slow to cut rates and cost him re- election. And this president obviously feels that you're kind of bad mouthing him out of office. Do you have a problem with the Bush family?

GREENSPAN: I certainly do not. I admire both the Senior Bush and the Junior Bush who I've gotten along with exceptionally well. My basic problem is my concern about the Republican Party in which I have been brought up. And this is not the fiscal policies of the Republican Party of Goldwater, which I so strongly supported.

CAVUTO: So, they abandoned you, you didn't abandon them?

GREENSPAN: Well, I don't want to say anybody abandoned anybody, I'm just basically saying that I think we've lost our way.

CAVUTO: But you like Bill Clinton?

GREENSPAN: I thought Bill Clinton was the best Republican president we've had in a while.

CAVUTO: You put him up there with Richard Nixon in terms of brilliance, right?

GREENSPAN: Both of them had all sorts of problems ...

CAVUTO: OK, all righty.

GREENSPAN: ...but, as far as IQ is concerned, both are terrific.

CAVUTO: All right, Alan Greenspan, "The Age of Turbulence." It'll get you talking, it'll get you debating, it'll even get you fighting.

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