Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (22 page)

²⁰
William D. Cohan,
The Last Tycoons: The Secret History of Lazard Frères & Co
. (New York: Doubleday, 2007), pp. 376–377.
²¹
Laurence H. Meyer,
A Term at the Fed: An Insider’s View
(New York: HarperBusiness, 2004), p. 75.
²²
Ibid.
²³
Martin Mayer,
The Fed: The Inside Story of How the World’s Most Powerful Financial Institution Drives the Markets
(New York: Free Press, 2001), p. 304.
²⁴
Beckner,
Back from the Brink
, p. 372.
²⁵
Cassidy, “Fleeing the Fed,” p. 42.

Greenspan Feeds a Frenzy

Greenspan’s decision in July 1995 to cut the funds rate was a mistake. It was made in the midst of a credit and stock market boom. The S&P 500 had risen 20 percent in the year through June; the Nasdaq had risen 24 percent. Between the May 23 and July 6 FOMC meetings, the Nasdaq rose 7.5 percent. Yet, the stock market was barely discussed in July. This was quite a change from recent meetings.

At the March 28, 1995, meeting, Greenspan had warned: “I think the downside risks are basically coming from the possibility of significant increases in stock and bond prices. If you remember, some of our discussions about the necessity of moving in early 1994 recognized that we were beginning to get wealth effects that were unsustainable and potentially creating bubbles. Ironically, the real danger is that things may get too good. When things get too good, human beings behave awfully.”
²⁷

At the May 23, 1995, meeting, Greenspan mused: “The way I put it is that I am more nervous about the asset bubble than I am about product prices.”
²⁸
Earlier in the meeting, he had stated his nervousness regarding an asset bubble in starker terms: “The disequilibrium that is implicit in this forecast is an asset price bubble, and I am not sure at this stage that we know how or by what means we ought to be responding to that, and whether we dare. There is always the question, if we make a preemptive strike against an asset bubble, of whether we could blow the economy out of the water.”
²⁹

²⁶
Meyer,
A Term at the Fed
, p. 219.
²⁷
FOMC meeting transcript, March 28, 1995, pp. 42–43.
²⁸
FOMC meeting transcript, May 23, 1995, p. 34.

Why the aftermath of a bursting bubble scared him at this point is not clear. We would hear such hand-wringing again and again in later years, but the May meeting may have been the first time he expressed such doubts. Yet, at the same meeting, Greenspan patted himself on the back for the Fed’s earlier foresight: “[W]hen we moved in February 1994, one of the reasons was that an asset price bubble was building up. … In retrospect, it was terribly fortunate that that bubble got pricked at the appropriate time.”
³⁰
Was the bubble of 1995 so much bigger than the one in 1994 that popping it now might “blow the economy out of the water”? If so, cutting rates certainly wasn’t the answer. Greenspan did not mention his fear of a bubble at the July meeting—a fear that was clearly present at the May meeting.

Reading sequential FOMC transcripts from the Greenspan years can be most revealing by following topics as they reach a peak, then simply disappear when the danger grows acute.

Two More Fed Fund’s Cuts: For “Insurance”

This was only the beginning of the cuts, but much was happening outside the Federal Reserve headquarters on Constitution Avenue, the Eccles Building (named after former Federal Reserve Chairman Marriner S. Eccles). Jeff Vinik, manager of the Fidelity Magellan Fund, was the June 6, 1995, celebrity attraction at Salvatore Ferragamo on Fifth Avenue.
³¹
It was at about this time that Jean-Marie Eveillard, star stock picker for SoGen mutual funds, could no longer take a leisurely lunchtime stroll in New York without autograph and photograph seekers nipping at his heels.
³²

Inside the Eccles Building, the Fed cut the funds rate 0.25 percent in December 1995 and again in January 1996—to 5¼ percent. Greenspan called the January reduction “insurance” against recession.
³³
It was more an incitement to madness.

²⁹
Ibid., p. 33.
³⁰
Ibid., p. 32.
³¹
Grant’s Interest Rate Observer
, May 26, 1995, p. 2.
³²
Grant’s Interest Rate Observer
, May 10, 1996.

At the December 19, 1995, FOMC meeting, Greenspan answered his own question of the possible risks incurred by cutting the funds rate: “The real danger is that we are at the edge of a bond and stock bubble.”
³⁴
Two weeks before, Molly Baker at the
Wall Street Journal
reported, “every time someone points out the Internet stocks are absurdly overvalued, the stocks seem to double again in a matter of days or weeks.”
³⁵

Cathy Minehan, president of the Boston Federal Reserve, was a voice of reason: “Mr. Chairman, it is hard for me to believe that real interest rates are too high. It is also hard for me to think about easing credit in the face of the kinds of financial markets that we have right now. The costs of being wrong, both in terms of stock and bond market bubbles … clearly are much higher if upside risks are realized as opposed to downside risks.”
³⁶
The vote to cut the funds rate was unanimous.

The S&P 500 index would rise 33 percent in 1995, 23 percent in 1996, and 33 percent in 1997.
³⁷
This was the greatest three-year boom of the twentieth century, or so we thought.

The Internet Runs Amok

Outside of the FOMC conference room, innumeracy and euphoria were running amok. In the January 3, 1994,
New York Times
—the year before the edition discussed earlier—a novelty was mentioned. In an article about the “information superhighway,” the word
Internet
may have crossed readers’ paths for the first time: “[C]ommonly known as the Net, [it] is going mainstream, even trendy … [but] the Net is seen as a nerdy prototype for the information superhighway.”
³⁸

³³
Beckner,
Back from the Brink
, p. 400—July 6, 1995, rate cut from 6 percent to 5¾ percent; p. 411—December 19 rate cut from 5¾ percent to 5½ percent; p. 413—rate cut on January 31, 1996, “what Greenspan called ‘insurance.’”

³⁴
FOMC meeting transcript, December 19, 1995, p. 40.
³⁵
Molly Baker, “Stargazers Abound While Internet Stocks Skyrocket,”
Wall Street Journal
, December 7, 1995, p. C1.
³⁶
FOMC meeting transcript, December 19, 1995, p. 41.
³⁷
Jim Rogers “For Whom the Closing Bell Tolls” October 22, 2002, Jimrogers.com.
³⁸
Steve Lohr, “The Road from Lab to Marketplace,”
New York Times
, January 3, 1994, p. C11.

Yet 20 months later, on August 9, 1995, Netscape went public and set the world ablaze. The Web-browsing company had never produced a profit. It was rare for a reputable underwriter to take a company public without a string of quarterly earnings. Netscape filed for an offering of 3.5 million shares; investors placed orders for 100 million. Expected to go public at $14 a share, it rose to $71, closed the first day at $58, and ended the year at $139. On December 1, Jim Clark, the founder of Netscape, told Bloomberg News: “[Y]ou could argue there’s something of an Internet bubble developing.”
³⁹

This was when “IPO” was introduced to the American vocabulary. Until now, initial public offering was simply a legal term for a security offering.
Speculation chased the rising market. Net inflows to stock, bond, and money market mutual funds rose from $76 billion in 1994 to $242 billion in 1998.
⁴⁰
(For the five years from 1985 through 1989, total inflows were $216 billion.)

Greenspan’s Reelection

Greenspan entered the homestretch of his “reelection” campaign. In his book on Greenspan’s years at the Fed, market analyst Steven Beckner reported: “[Greenspan’s] term as chairman was to expire March 2, but repeated questions from reporters about his fate were greeted with week after week of ambiguity and ambivalence from Clinton and his aides. Nor had they uttered a word of praise for the job Greenspan had done. He was left to twist slowly in the wintry wind.”
⁴¹

The Economic Report of the President, released on February 13, 1996, was presented under the tutelage of Joseph Stiglitz, then chairman of the Council of Economic Advisers. It argued that lower interest rates would not induce inflation.
⁴²

³⁹
From interview with Bloomberg Business News,
San Francisco Chronicle
, November 30, 1995, p. D1.
⁴⁰
Sean Collins, “Mutual Fund Assets and Flows in 2000,”
Perspective
, Investment Company Institute, February 2001.
⁴¹
Beckner,
Back from the Brink
, p. 414.
⁴²
The Clinton Administration, or Stiglitz, had great faith in NAIRU, the nonaccelerating inflation rate of unemployment. NAIRU postulates that there is a point at which the unemployment rate and the inflation rate are in balance. If the unemployment rate

President Clinton followed with a speech on February 15, 1996. He called for a “national debate” on “whether the economy could grow at faster than 2-½% without accelerating inflation.”
⁴³
Treasury Secretary Robert Rubin followed Clinton. He told the National Press Club that he welcomed a “vibrant debate” at the Fed on the economy’s ability to grow.
⁴⁴
Larry Summers, Rubin’s deputy secretary of the treasury, gave a speech that steamrolled Greenspan. Only an accredited economist could think it made sense: “We cannot and will not accept any ‘speed limit’ on American growth.”
⁴⁵
No speed limit was applied to either the stock market or to the house mortgage market, the engines for growth over the next decade. The MIT-and Harvard-trained Summers, nephew of Nobel Prize–winning economist Paul Samuelson, leads the Obama administration’s brain trust.

Beckner continued: “Fed officials deny these election-year attempts to pressure them had any impact, but thereafter Greenspan and others went to great lengths to deny they wanted to restrain growth.”
⁴⁶
Magnifying glass in hand, Beckner sniffs the trail: “In his February 20, 1996 … testimony, Greenspan … said the Fed would ‘welcome’ faster growth.”
⁴⁷
Beckner spoke to a “former Fed official” shortly before Clinton blessed Greenspan’s third term as chairman: “Alan Greenspan is so dedicated to trying to get himself reappointed that he is willing to compromise some of his independence in order to do so. He desperately wants to be reappointed.”
⁴⁸

“Thank God for Alan Greenspan”

“Thank God for Alan Greenspan” proclaimed the March 18, 1996, issue of
Fortune
: “No recession. No inflation. No voodoo.”
⁴⁹
Robert Ferrell, then senior investment officer at Merrill Lynch, offered a more downto-earth assessment: “If this is the biggest bull market of the century, or maybe the biggest bull market we have ever seen, then maybe the speculation is bigger than we have ever seen.”
⁵⁰
Reader’s Digest
published an article with the title “You Can Make a Million.” According to the author: “[I]t can be done on a modest salary, even on retirement income.”
⁵¹

goes below this level, inflation will rise, and vice versa. The Stiglitz team proposed that NAIRU was lower than believed; thus, the Fed could cut rates, which would (in the CEA’s mind) reduce unemployment without risking higher inflation.

⁴³
Beckner, p. 414.
⁴⁴
Ibid., pp. 416–417.
⁴⁵
Ibid., p. 417.
⁴⁶
Ibid., p. 414.
⁴⁷
Ibid., p. 439.
⁴⁸
Ibid., p. 415.
⁴⁹
Grant’s Interest Rate Observer
, March 15, 1996.

Comparator Systems. Presstek. Diana Corporation. Iomega. These rocket ships were headed straight to the moon but ran out of fuel. For those who were there, the flesh may crawl. For those who weren’t, it was just beginning. The Great Garbage Market of 1968 was invoked as comparison. But the garbage grew more expensive from 1996 to 2000. There were boosters other than Greenspan. Professor Jeremy Siegel had written a best seller:
Stocks for the Long Run
. He theorized that stocks are always the best-performing asset if you wait long enough. Or something like that. It didn’t matter. They bought the book and bought stocks.

In
The Autumn of the Middle Ages
, Johan Huizinga wrote: “[T]he whole of intellectual life [of the late Middle Ages] sought concrete expression, as if the notion of gold was immediately minted into coin. There is an unlimited desire to bestow form on everything. … This tendency towards pictorial expression is constantly in jeopardy of becoming petrified.”
⁵²

In the autumn of the current age, the mind sought and found a new symbol: Alan Greenspan. Next, he would mint gold by bestowing form on an abstract concept: productivity.

⁵⁰
Grant’s Interest Rate Observer
, May 10, 1996, p. 1.
⁵¹
Grant’s Interest Rate Observer
, July 19, 1996, p. 4.
⁵²
Johan Huizinga,
The Autumn of the Middle Ages
, trans. Rodney J. Payton and Ulrich Mamnitzsche (Chicago: The University of Chicago Press, Chicago, 1996), p. 173. (Orig. pub. in 1919 as
Herfsttij der Middeleewen
).

1995–1997

[T]he concept of the general price level is extremely vague and we cannot even speak of a very approximate determination of the average price level. Every index number is to a certain extent arbitrary: the selection of the commodities that are to be included, the choice of the weighting, the base from which the index starts, and, lastly, the mathematical processes applied, are all arbitrary.”
¹