Recent events in the United States have led to a debate among economists and analysts about the role of Alan Greenspan as chairman of the Federal Reserve in the United States. The increasing magnitude of the crisis in the US and the signals that the effects are fast spreading into Europe are leading to a renewed questioning of the monetary policies that were applied between 2000 and 2006. When Greenspan left the Fed in January of 2006 he was almost unanimously applauded. Many even said that he had been the best chairman the Fed had ever had. At that time the memory of strong growth during the 90’s and of the mildness of the recession of 2001 were strong points that outweighed any potential criticism to his years at the Fed.

But circumstances have changed significantly since then. Even though there were discussions about a possible bubble in the housing market in the US, it was not until August of 2007 that it became apparent that there was a crisis in the subprime market and that this crisis was affecting the financial system in the US, and possibly, in other regions of the world.

With events changing so rapidly, and with general conditions worsening almost every week, the perception among many of the role of Greenspan at the Fed is also changing. In particular, there are two accusations against him now. The first is that the Fed lowered interest rates too fast between 2001 and 2003, but maybe more importantly, that after that it kept a 1% interest rate too long and raised it only in 2004, and slowly, thus fueling the bubble in the housing market by making financing the purchase of a house very cheap. These critics suggest that once it was possible, the Fed should have raised interest rates faster in order to avoid an overheating of the housing market.

The second criticism is that Greenspan was so extreme in his interpretation of free markets that he refused to increase the Fed’s regulation of some high-risk, new financial instruments tied to the subprime market. Thus, critics say, he set the conditions for widespread effects worldwide in financial institutions once these instruments showed their real risk.

The first criticism describes the “lose-lose” situation that central banks sometimes face when bubbles appear. If the central bank reacts by increasing interest rates and the bubble in fact bursts, they will be accused of causing the burst, something, some would claim, that would not have happened if the bank had not increased interest rates so fast. But if central banks do not increase interest rates, or increase them too slowly, as was the case with Greenspan and the Fed, they will be accused of feeding the bubble. You lose in either case. So if you have a bubble there is a great chance that whatever you do will receive criticism.

The second criticism may be more difficult to dismiss. The recent proposals to give more regulatory power to the Fed confirm the concern about inefficient regulation. If the crisis creates ripple effects across the financial system in different areas of the world, even where the subprime market was inexistent, then this may be a sign that there was too little regulation for some financial instruments, so that the risks associated with the subprime market in the United States extended throughout the financial system. Banks accepted sophisticated and non-regulated financial instruments that seemed very secure, but that we now know, were not. As always, the issue is how to achieve a sound balance in regulation, given that there are dangers associated with too much or too little regulation.