The NASDAQ lost 78% of its value between March 2000 and October 2002. Greenspan cut rates from 6.5% to 1% — the lowest since 1958 — and held them there for an entire year. The cheap money was supposed to prevent a depression. Instead it inflated a housing bubble that would make the dot-com crash look like a practice run. When Bernanke inherited the Fed in February 2006, the bomb was already ticking.
The dot-com bust was Greenspan's belated reckoning. The bubble he had identified with "irrational exuberance" in 1996 but declined to act against had inflated for four more years before bursting spectacularly. The NASDAQ peaked at 5,048 on March 10, 2000, then fell to 1,114 by October 2002 — a 78% decline that wiped out $5 trillion in market value. Pets.com, Webvan, and hundreds of other dot-com darlings went bankrupt. The stock market losses triggered a recession that was mild by historical standards (GDP fell only 0.3% in 2001) but psychologically devastating, compounded by the September 11 attacks that shut down markets for four days and plunged the nation into a war footing.
Greenspan's response was the most aggressive easing campaign since Volcker's emergency cuts of 1982. He slashed the Fed Funds rate from 6.5% to 1% in just two and a half years — eleven rate cuts in 2001 alone. After September 11, the Fed cut by 50 basis points, then again, then again, until by June 2003 the rate stood at 1.00% — the lowest since 1958. And there it stayed for a full year, from June 2003 to June 2004, as Greenspan waited for the recovery to take hold.
The problem with 1%. Greenspan defended the 1% rate as necessary to prevent deflation — a genuine risk in 2003, with CPI inflation at 2% and falling, and Japan's experience with deflation serving as a cautionary tale. But 1% money for a year had consequences he didn't anticipate. With borrowing essentially free in real terms, Americans did what cheap money always encourages: they bought assets. Specifically, they bought houses. Mortgage rates fell to 5.2% — the lowest in forty years. Home prices, which had been rising steadily since the mid-1990s, began accelerating. The Case-Shiller home price index rose 11% in 2004 alone, then 15% in 2005. A house that cost $200,000 in 2000 was worth $320,000 by 2006.
The "measured pace" (2004–06). In June 2004, Greenspan began raising rates in the most methodical tightening cycle in Fed history. He hiked by exactly 25 basis points at every meeting — seventeen consecutive times — from 1% to 5.25% over two years. The phrase "measured pace" was repeated so often it became a punchline. But the predictability that made traders comfortable also made the tightening ineffective at cooling the housing market. Long-term mortgage rates, which depend on bond market expectations rather than the overnight Fed Funds rate, barely budged. The 30-year mortgage rate rose from 5.8% to 6.4% — a trivial increase compared to the 425-basis-point rise in the Fed Funds rate. Greenspan himself called this the "conundrum" — why wasn't the long end of the yield curve responding to higher short-term rates?
Bernanke's inheritance. Alan Greenspan stepped down on January 31, 2006, after eighteen years as chairman, widely celebrated as the greatest central banker of his generation. Ben Bernanke, a Princeton economist who had studied the Great Depression, took over with rates at 4.5% and the housing market at what would prove to be its peak. Within two years, he would face the worst financial crisis since the 1930s — the very event he had spent his academic career studying. The seeds had been planted during Greenspan's 1% era. The harvest would be Bernanke's to reap.
| Date | Fed Funds | CPI YoY | Key Event |
|---|---|---|---|
| Jul 2000 | 6.54% | 3.6% | Rate peak. NASDAQ already falling. |
| Jan 2001 | 5.98% | 3.7% | First cut. 11 cuts will follow this year. |
| Jul 2001 | 3.77% | 2.7% | Pre-9/11. Recession underway. |
| Oct 2001 | 2.49% | 2.1% | Post-9/11 emergency cuts. Markets reopened. |
| Jan 2002 | 1.73% | 1.2% | Enron bankrupt. Corporate scandals. |
| Jul 2002 | 1.73% | 1.5% | WorldCom collapses. NASDAQ at 1,300. |
| Jul 2003 | 1.01% | 2.1% | Rate at 1% — lowest since 1958. Deflation fears. |
| Jan 2004 | 1.00% | 2.0% | Full year at 1%. Housing surging. |
| Jul 2004 | 1.26% | 2.9% | "Measured pace" begins. First hike June 30. |
| Jul 2005 | 3.26% | 3.1% | Housing prices +15% YoY. Bubble inflating. |
| Feb 2006 | 4.49% | 3.6% | Greenspan exits. Bernanke takes the chair. |
| Jul 2006 | 5.24% | 4.1% | 17th and final hike. 5.25%. Housing market peaks. |
The period from 2000 to 2006 demonstrated the fatal flaw in the Fed's "mop up after" doctrine. By cutting rates to 1% after the dot-com bust, Greenspan prevented a deeper recession — but he also provided the fuel for a far larger bubble. The housing market, inflated by cheap money, lax lending standards, and the widespread belief that home prices could only go up, became the largest speculative bubble in American history. By 2006, Americans owed $10 trillion in mortgage debt, much of it in subprime and adjustable-rate loans that would reset to unaffordable levels as rates rose.
Bernanke inherited a Fed that had spent two decades perfecting the art of crisis response — cutting rates, flooding liquidity, rescuing failing institutions — without ever questioning whether these rescues were creating the conditions for the next crisis. The "measured pace" hikes to 5.25% had done nothing to cool the housing market. The bomb was planted. Within eighteen months, it would detonate.