Fed Chief Bids Adieu to ‘80s Excesses

It’s official: As far as Federal Reserve Chairman Alan Greenspan is concerned, the money-mad ‘80s are over.

Just in time, too. Junk bonds, leveraged buyouts, hot real estate markets and excessive borrowing in general are finally being reined in. That may seem painful to those caught in the middle of the credit squeeze, Greenspan believes, but the ultimate gain from wringing out the financial abuses of the 1980s is likely to be a healthier economy in the years ahead.

The current reduction in lending by banks and thrifts, which has hit particularly hard at builders of commercial real estate and housing, “has its roots in part in the excesses of the 1980s,” Greenspan argued in congressional testimony this week. “The weaker credits extended during that decade have come home to roost.”

While he did not come right out and admit it, Greenspan’s remarks represent a kind of mea culpa for him as well.

“As one of those who celebrated the deregulation of the 1980s, Greenspan shares responsibility for some of the disasters, too,” said David Hale, chief economist at Kemper Financial Services in Chicago. “What his testimony amounts to is an implicit criticism of how the private sector behaved and how the public sector failed.”

For months now, home builders, small-business leaders and key lawmakers have been complaining of a widespread “credit crunch” as banks and savings institutions started to curb many of their riskier loans.

Not only did last year’s S&L; cleanup law impose higher standards on thrifts in a bid to avoid a rerun of the costly taxpayer bailout, but federal regulators also moved to discourage banks from making similar loans--particularly to real estate developers--to prevent them from falling into the same trap.

Last week, after resisting pleas to relax its grip on credit, Greenspan conceded that slightly lower interest rates are useful as a counterweight to some of the more restrictive lending practices. And in testimony before the Senate Banking, Housing and Urban Affairs Committee on Wednesday, he hinted that further modest cuts might be needed if the credit squeeze gets worse.

But he devoted much of his statement to explaining why he thinks too much debt was created over the last decade without adequate regard to whether it was going into productive investments. What the nation needs in the early 1990s, he argued, is to curb unnecessary lending today before it sows the seeds tomorrow of another financial collapse even worse than the S&L; disaster.

The borrowing spree of the 1980s, Greenspan admitted, clearly got out of control.

“Many of the loans made during the 1980s should not, by historical standards of credit-worthiness, have been made,” the Fed chairman argued. “As standards reverted closer to normal, those weaker borrowers have been finding it far more difficult to access credit.”

It’s not a pleasant process to watch. Along much of the East Coast, particularly around Boston and New York, local economies are clearly in recession, with many businesses and state governments reeling from the downturn.

Consumer spending, a key engine of growth throughout much of the 1980s boom, has cooled dramatically. The result has been a shakeout among overbuilt retailers and a sharp drop in television and newspaper advertising.

Pursuing a relatively tight money policy, the Fed has discreetly welcomed much of this economic slowdown as needed to prevent a revival of higher inflation.

But recently, Greenspan worried, lending restrictions by banks may have swung too far in the other direction.

“The tightening is beginning to have very real, unwelcome effects,” he said. “It is difficult to discern the dividing line between lending standards that are still healthy and those that are so restrictive as to be inconsistent with the borrower’s status and the best interests of the lender in the long run. In recent weeks, however, we may have slipped over that line.”

Much of what is happening today was foreseeable as an outcome of the long-delayed S&L; cleanup. Back in early 1989, when President Bush first offered his bailout plan, a wide variety of experts predicted that roughly doubling capital requirements for banks and S&Ls; to 6% would force financial institutions to cut back on some lending.

“As we move toward tougher capital requirements,” First Interstate Bank economist Jerry Jordan said then, “the response of most managers will be to shrink their assets to conform with their existing capital base rather than try to raise new funds.”

That’s just what many financial institutions have done. To provide a more substantial cushion of their own funds to cover bad loans, a significant number of banks have curbed new lending while hundreds of thrifts have been taken over by the government.

To most Americans, these changes have imposed little hardship, particularly since deposits up to $100,000 are covered by federal insurance and home mortgages and credit cards are available from a wide variety of sources.

But after nearly a decade-long building boom fueled by easy credit and favorable tax breaks, the tougher new banking rules imposed on top of an overbuilt housing and office building market are producing agonizing withdrawal pains among construction firms and real estate developers.

While today’s cutbacks may be traumatic, they should be less painful than the sharp recessions that have ended every previous decade since the 1950s. “For the nation as a whole,” Greenspan explained, “the tightening of credit standards will leave the financial system on a sounder footing and contribute to economic stability in the long run.”