Alan Greenspan’s obituary writers want to credit him with a single, flattering flaw: that he trusted markets too much. That charge is too generous, because Greenspan never left markets to run themselves. He used the power of the Fed to cultivate and reward financial innovation, making the financial system more fragile for it.

Often misunderstood as an Ayn Rand acolyte, Greenspan was not a true libertarian. His creed was not “leave the market alone” as much as it was to use the tools of the government to make the market faster and more inventive—and then stand by to catch it when it falls.

Those actions fueled the soaring inequality and the economic crash of 2008. Greenspan was no bystander watching markets obey some ineffable logic. His obsession with financial innovation set the stage for the crisis.

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Foundational to Greenspan’s outlook was the idea that financial innovation is the engine of the American economy: The easier it is to buy and sell an asset, the truer its price. Risk itself could be sliced up and sold off until, in theory, nobody was holding too much of it. “No market is ever truly unregulated,” he said. “The self-interest of market participants generates private market regulation.”

Perhaps the clearest expression of the Greenspan belief that government must be mobilized to support financial innovation is the case of derivatives.

In the spring of 1998, the heaviest hitters in American economic policy crowded into a conference room at the Treasury to gang up on one woman. Brooksley Born ran the Commodity Futures Trading Commission, and she had committed the sin of noticing that the market in derivatives, custom bets whose value rides on the value of another asset, had swollen from roughly $4.5 trillion to $28 trillion within four years, with essentially no one watching. She didn’t want to ban them, but she did want basic rules to make the market more stable.

Greenspan acted consistently and adroitly to use the full weight of the American state to build a financial system that served finance, then called the result freedom.

Greenspan, Treasury Secretary Robert Rubin, his deputy Larry Summers, and SEC chair Arthur Levitt shut her down. Greenspan played the ideologue: Regulation would smother innovation. “You can’t put the cork back in the bottle,” he told the room. He had once informed Born over lunch that he saw no need even for laws against fraud, since a crook would lose his customers soon enough.

Born left with nothing to show for her concern. Summers later phoned Born, by her account, with a warning: “I have 13 bankers in my office and they say if you go forward with [derivatives rules] you will cause the worst financial crisis since World War II.” She resigned the next year, and Congress promptly passed a law stripping her agency of any authority over the exact instruments that would detonate in 2008.

Five months after the meeting, a hedge fund called Long-Term Capital Management blew up on those very derivatives and needed a Fed-brokered rescue.

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The commitment to step in and save a market in freefall was critical to the Greenspan theory of financial innovation. Starting with the 1987 crash, through the Mexican bailout in 1994 and the collapse of Long-Term Capital Management in 1998, Greenspan used the power of government to cushion market downturns. Heads, Wall Street won. Tails, the central bank was standing by to soften the blow. The biggest firms could take risk for private gain because everyone understood the public would cover the downside. The markets had a name for this: the Greenspan put.

Cultivating financial innovation did not just require preventing new regulation. It also required active policymaking. When in the mid-1990s J.P. Morgan’s bankers cooked up the modern credit default swap, a clever trick for moving risk off the books and freeing up capital, the Fed blessed it, and the market jumped from $40 billion to $300 billion in two years. When banks spun up special purpose vehicles, shell companies that let them borrow short, lend long, and hold almost no cushion, the Fed waved those through too and left them conveniently off the balance sheets where regulators might have seen them.

In 1999, Greenspan’s Fed cut the loss-absorbing capital banks had to hold against top-rated mortgage securities from 8 percent to 1.6 percent—a mere $16 million in reserve for every $1 billion lent. Under Basel II, a financial stability framework which Greenspan helped write, banks got to grade their own risk with models fed on history for products that had little history to speak of. His own biographer called it handing teenagers the keys to the Mercedes.

The result of Greenspan’s public-policy moves became the American shadow banking system: trillions in short-term borrowing propping up long-term bets, run by thinly capitalized firms past the reach of any regulator. Greenspan treated American finance as a strategic asset, too valuable to lose to international competitors, and cultivated it the way other countries cultivate steel or semiconductors. The “freest” market in the world was deliberately crafted.

The boom Greenspan built handed its winnings to people who already had the most. Finance profits exploded, bonuses with them, and asset values increased dramatically while wages effectively sat still. The share of national income going to the top 1 percent climbed from 10.7 percent the year he took office in 1987 to more than 17 percent the year he left. That was the predictable return on two decades of ingenious public effort on behalf of capital and almost none on behalf of the people who work for a living. Greenspan crafted an efficient market for finance, but American workers did not share in the gains.

By the even of the crisis, the finance sector’s assets had nearly doubled in seven years, to just under $73 trillion, and the notional value of outstanding derivatives had reached an almost unsayable $596 trillion. Greenspan went out on a victory lap. Months before he stepped down, he praised the swaps and securities for making the system “more flexible, efficient, and resilient.”

His final appearance as chair at the Fed’s symposium in Jackson Hole, Wyoming, was a coronation, where his old rival Alan Blinder pronounced him, without irony, the greatest central banker who ever lived. One economist, Raghuram Rajan, stood up to suggest all that innovation might have made things more fragile, and Summers rose to slap him down.

Two years later, the resilient system Greenspan described was a smoking crater, and he told Congress he was in a “state of shocked disbelief” that the model he had bet the country on had failed.

Greenspan was not the libertarian who learned, too late, that markets need rules. He acted consistently and adroitly to use the full weight of the American state to build a financial system that served finance, then called the result freedom. He believed that financial markets work best when investors create new products that enable a more liquid and faster trading system. The rest of us have been living with the consequences ever since.

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