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 late 1987 to 2000.
Contents
Overview
The term "put" refers to a put option, a contractual obligation giving its holder the right to sell an asset at a particular price to a counterparty. The put option can be exercised if asset prices decline below that put price, protecting the holder from further losses. 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.
Bernanke Put
In 2007 and early 2008, the financial press had begun discussing the Bernanke Put, as new Federal Reserve Board chairman, Ben Bernanke 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 March 2011) declines in measures of velocity and related declines in monetary growth measures suggest there is a limit to market manipulation.