As Economy Thrived Under Greenspan, So Did Debt

· The trade deficit for last year is estimated to have swollen to another record high, above $700 billion, increasing America's indebtedness to foreigners.

"The economy's increasing reliance on unprecedented levels of debt is clearly unsustainable and extremely troubling," said Charles W. McMillion, chief economist with MBG Information Services, a financial analysis firm. "The only serious questions are when and how will current imbalances be addressed and what will be the consequences."

The Fed chairman told Congress in June: "I think we've learned very early on in economic history that debt in modest quantities does enhance the rate of growth of an economy and does create higher standards of living, but in excess, creates very serious problems."

Greenspan didn't define "excess," but economists see troubling possibilities: A sudden reversal in housing prices could trigger a recession if consumers cut back on spending and households have trouble paying their mortgages. The trade gap could swell to a point that forces a sharp fall in the dollar and surge in interest rates, also causing a recession.

Even without a crisis, the debt load will weigh on the economy simply because of the interest to be paid on it, which leaves less money to spend on other things and prevents living standards from rising as fast as they would otherwise, some analysts believe.

The Past Five Years

To understand how all this debt built up, recall how things looked in early 2001.

In January 2001, Beverly and Kevin Wilmore were excitedly overseeing construction of their home, looking forward to moving in with their two children the following year.

But from his office at the Fed's marble headquarters on Constitution Avenue NW, Greenspan saw that the economy was sputtering. Stock prices had been sliding for nearly a year after peaking in early 2000 at the height of the tech boom. Retail sales had soured. Businesses were throttling back on production and investment.

On Jan. 3, 2001, Greenspan convened a conference call meeting of the central bank's top policymakers. They agreed to cut the Fed's benchmark short-term interest rate for the first time in more than two years, to 6 percent from 6.5 percent.

That action marked the beginning of an aggressive campaign by Greenspan and his colleagues to prevent the bursting of the stock market bubble from devastating the U.S. economy.

Greenspan had studied the Great Depression of the 1930s and believed it resulted largely from the Fed's mistakes in tightening credit after the 1929 stock market crash. He also had seen Japan's central bank ease credit too cautiously after that country's property bubble burst in the early 1990s, triggering a decade-long economic slump. He would do the opposite, dramatically easing credit -- by cutting interest rates -- to cushion the economy's landing.

The Greenspan Fed lowered its benchmark rate another 12 times over the next 2 1/2 years as the economy struggled to regain its footing, cutting the rate to 1 percent by June 2003, the lowest level since 1959.