Greenspan put
Encyclopedia
The "Greenspan Put" refers to the monetary policy approach that Alan Greenspan
, the former Chairman of the United States Federal Reserve Board, and other Fed
members exercised from the late 1987 to 2000.
The term "Put" refers to a put option
, in which the buyer of the put acquires the right to sell an asset at a particular price to a counterparty; as such it is exercised if prices decline beneath this level. During Greenspan's chairmanship, when a crisis arose and the stock market fell more than about 20%, the Fed would lower the Fed Funds rate, often resulting in a negative real yield. In essence, the Fed added monetary liquidity and encouraged risk taking in the financial markets to avert further deterioration.
The Fed did so after the 1987 stock market crash
, which prompted traders to coin the term Greenspan Put, later termed Moral hazard
. In 2000, Alan Greenspan raised interest rates several times. These actions were believed by some to have caused the bursting of the dot-com bubble. The Fed also injected funds to avert further market declines associated with the Savings and loan crisis
and Gulf War
, the Mexican crisis
, the Asian crisis, the LTCM
crisis, Y2K, the burst of the internet bubble
, the 9/11 attacks and repeatedly from the early stages of the Global Financial Crisis to the present.
The Fed's pattern of providing ample liquidity resulted in the investor perception of put protection on asset prices. Investors increasingly believed that in a crisis or downturn, the Fed would step in and inject liquidity until the problem got better. Invariably, the Fed did so each time, and the perception became firmly embedded in asset pricing in the form of higher valuation, narrower credit spreads, and excess risk taking. Joseph Stiglitz criticized the put as privatizing profits and socializing losses
and implicates it in inflating a speculative bubble in the lead-up to the 2008 financial crisis..
continued the practice of reducing interest rates to fight market falls. The decision by the Fed to lower short-term interest rates to 50 basis points (0.5%) on October 8, 2008, and thereafter a range from 0.00-0.25% rate in December 2008 suggests attempts to create a Bernanke put similar to the Greenspan put. New steps in quantitative easing
further illustrate the Fed's attempt to moderate the business cycle
. Recent (post Mar 2011) declines in measures of velocity and related declines in monetary growth measures suggest there is a limit to market manipulation, though interest rates have not risen and the economy continues to show little sign of serious improvement.
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...
, the former Chairman of the United States Federal Reserve Board, and other Fed
FED
The Fed is the informal name of the Federal Reserve System, the central bank of the United States.Fed or FED may also refer to:...
members exercised from the late 1987 to 2000.
The term "Put" refers to a put option
Put option
A put or put option is a contract between two parties to exchange an asset, the underlying, at a specified price, the strike, by a predetermined date, the expiry or maturity...
, in which the buyer of the put acquires the right to sell an asset at a particular price to a counterparty; as such it is exercised if prices decline beneath this level. During Greenspan's chairmanship, when a crisis arose and the stock market fell more than about 20%, the Fed would lower the Fed Funds rate, often resulting in a negative real yield. In essence, the Fed added monetary liquidity and encouraged risk taking in the financial markets to avert further deterioration.
The Fed did so after the 1987 stock market crash
Black Monday (1987)
In finance, Black Monday refers to Monday October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short time. The crash began in Hong Kong and spread west to Europe, hitting the United States after other markets had already declined by a significant margin...
, which prompted traders to coin the term Greenspan Put, later termed Moral hazard
Moral hazard
In economic theory, moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard...
. In 2000, Alan Greenspan raised interest rates several times. These actions were believed by some to have caused the bursting of the dot-com bubble. The Fed also injected funds to avert further market declines associated with the Savings and loan crisis
Savings and Loan crisis
The savings and loan crisis of the 1980s and 1990s was the failure of about 747 out of the 3,234 savings and loan associations in the United States...
and Gulf War
Gulf War
The Persian Gulf War , commonly referred to as simply the Gulf War, was a war waged by a U.N.-authorized coalition force from 34 nations led by the United States, against Iraq in response to Iraq's invasion and annexation of Kuwait.The war is also known under other names, such as the First Gulf...
, the Mexican crisis
1994 economic crisis in Mexico
The 1994 Economic Crisis in Mexico, widely known as the Mexican peso crisis, was caused by the sudden devaluation of the Mexican peso in December 1994....
, the Asian crisis, the LTCM
Long-Term Capital Management
Long-Term Capital Management L.P. was a speculative hedge fund based in Greenwich, Connecticut that utilized absolute-return trading strategies combined with high leverage...
crisis, Y2K, the burst of the internet bubble
Dot-com bubble
The dot-com bubble was a speculative bubble covering roughly 1995–2000 during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more...
, the 9/11 attacks and repeatedly from the early stages of the Global Financial Crisis to the present.
The Fed's pattern of providing ample liquidity resulted in the investor perception of put protection on asset prices. Investors increasingly believed that in a crisis or downturn, the Fed would step in and inject liquidity until the problem got better. Invariably, the Fed did so each time, and the perception became firmly embedded in asset pricing in the form of higher valuation, narrower credit spreads, and excess risk taking. Joseph Stiglitz criticized the put as privatizing profits and socializing losses
Privatizing profits and socializing losses
In political discourse, the phrase "privatizing profits and socializing losses" refers to any instance of speculators benefitting from profits, but not taking losses, by pushing the losses onto society at large, particularly via the government....
and implicates it in inflating a speculative bubble in the lead-up to the 2008 financial crisis..
Bernanke Put
In 2007 and early 2008, the financial press had begun discussing the Bernanke Put, as new Federal Reserve Board chairman, Ben BernankeBen Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
continued the practice of reducing interest rates to fight market falls. The decision by the Fed to lower short-term interest rates to 50 basis points (0.5%) on October 8, 2008, and thereafter a range from 0.00-0.25% rate in December 2008 suggests attempts to create a Bernanke put similar to the Greenspan put. New steps in quantitative easing
Quantitative easing
Quantitative easing is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank buys financial assets to inject a pre-determined quantity of money into the economy...
further illustrate the Fed's attempt to moderate the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
. Recent (post Mar 2011) declines in measures of velocity and related declines in monetary growth measures suggest there is a limit to market manipulation, though interest rates have not risen and the economy continues to show little sign of serious improvement.
See also
- Credit cycleCredit cycleThe credit cycle is the expansion and contraction of access to credit over the course of the business cycle. Some economists, including Barry Eichengreen, Hyman Minsky, and other Post-Keynesian economists, and some members of the Austrian school, regard credit cycles as the fundamental process...
- Liquidity trapLiquidity trapA liquidity trap is a situation described in Keynesian economics in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as...
- Privatizing profits and socializing lossesPrivatizing profits and socializing lossesIn political discourse, the phrase "privatizing profits and socializing losses" refers to any instance of speculators benefitting from profits, but not taking losses, by pushing the losses onto society at large, particularly via the government....
- Speculative bubble
- Too big to failToo Big to FailToo Big to Fail is a television drama film in the United States broadcast on HBO on May 23, 2011. It is based on the non-fiction book Too Big to Fail by Andrew Ross Sorkin. The TV film was directed by Curtis Hanson...
- ZIRP
External links
- Greenspan Put, Investopedia.