Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (27 page)

In his February 24 testimony before Congress, Greenspan linked productivity to the extremely ambitious IPO and stock market: “Critical to this process has been the rapidly increasing efficiency of our financial markets. … Capital now flows with relatively little friction to projects embodying new ideas. Silicon Valley is a tribute both to American ingenuity and to the financial system’s ever-increasing ability to supply venture capital to the entrepreneurs who are such a dynamic force in our economy.”
¹⁶

Wall Street firms that had opened offices in Silicon Valley during the IPO mania could not have hired a better public relations representative. Their behavior was often scandalous (that, we knew at the time) and criminal (as the courts would decide, in due course). Greenspan capped off his ode to the venture capitalists who lined Sand Hill Road in Menlo Park, California, in a stellar summation: “More recent evidence remains consistent with the view that this capital spending has contributed to a noticeable pickup in productivity.”
¹⁷
Within weeks, Michael Wolff, an entrepreneur who had taken full advantage of the pickup in productivity, published his memoir. He described Silicon Valley companies that had nothing to sell, other than common stock. In
Burn Rate: How I Survived the Gold Rush Years on the Internet
, Wolff admitted: “Optimism is our bank account; fantasy is our product; press releases are our good name.” His book was intended as “a sort of anti-press release.”
¹⁸
Wolff, applying his American ingenuity, diverted capital flows, or “dumb money” (his words), from the rich.
¹⁹
This was the most prominent dynamic force in Silicon Valley.

¹⁵
Seth Mydans, “Vote Places Habibie in Firm Control of Indonesian Politics,”
New York Times
, July 12, 1998.
¹⁶
House Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, “The Federal Reserve’s Semiannual Monetary Policy Report,” February 24, 1998.
¹⁷
Ibid.

Greenspan was not as innocent as he might seem. He had shown some knowledge of how markets work three years earlier, at the December 19, 1995, FOMC meeting: “The sharp decline in longterm yields has struck me as quite extraordinary. … [W]e are getting issues of 100-year bonds. … The fact that some borrowers are issuing these bonds is terrific. Until you get somebody dumb enough to buy them.”
²⁰
By 1998, Greenspan’s productivity circumlocutions were drawing ever dumber money into the chairman’s efficiently priced stock market.

Dot-com IPOs exited Silicon Valley at a rate comparable to the speed at which they went out of business. A few of the forgettable gimmicks for raising $100 million to $1 billion from the summer and fall of 1998 include NetGravity, Broadcast.com, GeoCities, Fatbrain.com, NBCi, and uBid. They couldn’t even spell, how were they going to sell? In fact, they didn’t; these companies either burned through their cash or had been acquired by late 2001.
²¹

Such exuberance might have frightened the investing public. However, Abby Joseph Cohen, market strategist at Goldman Sachs, was second only to Greenspan in relieving market anxieties. When Cohen spoke, it was widely and immediately reported. She referred to her model quite often; it was a happy model, happy with the world and the stock market alike. She spent much of her time on television and, like Greenspan, was invariably courteous, pleasant, and vague. It was often said she reassured investors because she looked like a middle-class housewife. This became a cliché, yet the cliché itself was reassuring.

¹⁸
Michael Wolff,
Burn Rate: How I Survived the Gold Rush Years on the Internet
(New York: Simon and Schuster, 1998), pp. 11–12. “Burn rate” means the need to continually raise more money before a company burns through its earlier funding.

¹⁹
Ibid., p. 51.
²⁰
FOMC meeting transcript, December 19, 1995, p. 38.
²¹
John Cassidy,
Dot.con: The Greatest Story Ever Sold
(New York: HarperCollins, 2002), pp. 350–351

She rebranded American affluence as Supertanker America.
²²
The United States was a flagship of such unsinkable construction that the world’s problems were, well, the world’s problems. Ms. Cohen, earnest to the core, could not have understood the irony of designing such a label in the same year that the movie
Titanic
won 11 Oscar awards. This is not a singular characteristic of Cohen’s: if Wall Street was long on irony, the stock market would be short on exuberance.

Greenspan vs. the FOMC

The FOMC next met on March 31, 1998. Federal Reserve staff economist Michael Prell reviewed current conditions: “[T]he gravitational pull of valuation may no longer be operating. The PE ratio for the S&P 500 recently reached 27 … even as companies were issuing warnings and analysts were lowering their 1998 profit forecast.”
²³
At the same meeting, Fed Governor Jerry Jordan reminded Greenspan: “I also continue to be concerned that we may never see the effects of monetary excesses in output prices, but rather we will see them in asset prices.”
²⁴

Cathy Minehan, president of the Boston Fed, was also worried: “This speculation is fed by financial markets, which are extremely accommodative. From every perspective that we can see in our region and nationally, monetary policy is not tight; it is not even neutral. It is accommodative to an increasingly speculative environment.”
²⁵
Nor was board member Susan Phillips attuned to the productivity miracle: “The situation is starting to feel a bit surreal, perhaps even unbelievable. …”
²⁶

A case for raising the fed funds rate—or margin requirements—was clear. The S&P 500 had risen 46 percent for the 12-month period ending on March 31, 1998. Greenspan’s response to these comments was mixed. He seemed to understand that the economy was now driven by the stock market: “We have an economic policy that is essentially unsustainable. … There is no credible model of which I am aware that embodies all of this.”
²⁷
Since the stock market was beyond his ability to model, the logic of his productivity boom is suspect. Greenspan had hung his hat on stock prices always reflecting correct prices. The variables on the other side of the equation, particularly productivity, changed as need be. Of course, he complained that productivity was not measured properly. In any event, Greenspan did not raise the funds rate.
²⁸

²²
Patricia Lamiell, “Is the Stock Market a Supertanker or the
Titanic
?” Associated Press, March 31,1998.
²³
FOMC meeting transcript, March 31, 1998, p. 14.
²⁴
Ibid., p. 30.
²⁵
Ibid., p. 46.

Two months later, at the May 1998 meeting, the FOMC was rebellious, or as rebellious as this period piece from the Age of Etiquette dared to be. Jerry Jordan weighed in again by reporting what was happening in his district, in Cleveland: “Bankers complain a lot that pension funds and insurance companies are doing deals that no sensible banker would be willing to consider.”
²⁹

Several other members grumbled, to no effect. Greenspan carried the vote, although he felt compelled to say: “I have been giving a lot of thought to the question of whether we are experiencing a stock market bubble, and if we are, what we should do about it. If the market were to fall 40 to 50 percent, I would be willing to stipulate that there had been a bubble!”
³⁰
Was this a new model? After the market did fall 50 percent, in 2000–2001, Greenspan did not admit to a bubble—he wouldn’t even discuss it.

At the May 1998 meeting, he gingerly tested the waters for his “can’t see a bubble” act: “[T]he stock market is significantly overvalued. … But”—there had to be a but—“do I really know significantly more than the money managers who effectively determine the prices of these individual stocks? I must say that I, too, feel a degree of humility about my present ability to make such a forecast.” Others would substitute another word for humility. Taking a step back, if he was too humble to venture a stock market forecast, how could he sit at a table where his committee fixed the world’s short-term borrowing rate?

Greenspan closed the argument on whether the Fed would act on Jerry Jordan’s long-running warning when he declared: “I have concluded that in the broader sense we have to stay with our fundamental central bank goal, namely, to stabilize product price levels.”
³¹
This was only four months after he had told the American Economic Association (in January 1998): “The severe economic contraction of the early 1930s, and the associated persistent declines in product prices, could probably not have occurred apart from the steep asset price deflation that started in 1929.”
³²

²⁷
Ibid., p. 78.
²⁸
He did not think it was “appropriate to move at this stage. Were we to do so, I believe we would create too large a shock for the system, which it would not be able to absorb quickly.” Ibid., p. 79.
²⁹
FOMC meeting transcript, May 19, 1998, p. 58. Ibid., p. 64.

Greenspan’s malleable model, which had broken down at the March 1998 meeting, was once again in tip-top shape. The stock market once again knew all. To justify productivity as the missing variable, Greenspan kept jettisoning unseemly measures. He first ignored his favored price/ book ratio (which he had extolled three years earlier, at the August 1995 FOMC meeting). After such warnings as Michael Prell’s at the March 1998 meeting, the chairman steered clear of price/earnings ratios. His speeches became more emphatic in their propositions—for example, in July 1998: “The implications of today’s
relentless
technological changes are my subject matter this afternoon”
³³
[author’s italics]. It seems a good bet that Greenspan was not calculating productivity as much as he was watching the Nasdaq Composite Index, which is heavily weighted with technology darlings. It had risen 21 percent between these two statements, 30 percent over the past year, and 99 percent over the last three years. In July, the Nasdaq burst through the 2,000 level—only three years after first piercing 1,000. More than 50 percent of the Nasdaq 1000-point rise was due to only three stocks: Microsoft, Cisco Systems, and Intel.
³⁴

Productivity Gains a Crew Member: Stock

Market Analysts

The chairman’s latest brainstorm was to cite stock analysts’ earnings to justify the stock market. The unveiling was at the FOMC meeting of June 30 and July 1, 1998. At the top of the midyear meeting, Michael Prell presented two profit forecasts: both Wall Street’s and the internal (Federal Reserve) projected rate of earnings growth. Both predicted a profit decline.
³⁵
(Prell did not help the chairman by stating, “I won’t take up your time with the umpteenth restatement of our skepticism regarding the sustainability of these valuation levels.”
³⁶
) Greenspan, in a bubble of his own, thought that “the crucial error in our forecast models has been the productivity numbers.”
³⁷
This humble central banker further asserted: “Everyone has been wrong by underestimating domestic demand and wrong in the other direction by overestimating inflation.” Having been wrong, “[t]his has created a major increase in stock prices and a virtuous circle wealth effect.”
³⁸

³¹
Ibid., p. 85.
³²
Alan Greenspan, “Problems of Price Measurement,” speech at the Annual Meeting of the American Economic Association and American Finance Association, Chicago, Illinois, January 3, 1998.
³³
Alan Greenspan, “The Implications of Technological Changes,” speech at the Charlotte Chamber of Commerce, Charlotte, North Carolina, July 10, 1998.
³⁴
Andrew Bary,
Barron’s
, July 20, 1998, p. mw 4.

This is quite a list of insights, each contingent on either a previous insight (by Greenspan) or a previous flaw by “everyone.” It was the prior meeting when he admitted his humility.

After Prell’s introductory discussion of poor projected earnings growth, this would not seem the time for Greenspan to mention profit forecasts to justify the current level of the stock market. He introduced his new diversion by discussing five-year earnings expectations by analysts.
³⁹
Prell told the committee projected earnings growth was expected to slow by the end of 1998. So, the chairman discussed only analysts’ predictions for 2003, five years later.

Although the public generally took Wall Street “buy” recommendations at face value, and would pay dearly for its innocence, anyone with the slightest experience knew that the raison d’etre of these ratings was to hock stocks for their employers. Fed Governor Ned Gramlich alluded to their deficiency at the September 1998 meeting by labeling them “socalled stock market analysts.”
⁴⁰
He thought that their forecasts were still “on the high side by all measures”—specifically mentioning their overindulgent longer-term projections.
⁴¹
Greenspan did not take the bait.

³⁵
FOMC meeting transcript, June 30–July 1, 1998, pp. 13–15. Wall Street earnings are I/B/E/S operating earnings per share; Federal Reserve earnings are NIPA after-tax book profits.

³⁶
Ibid., p. 14.
³⁷
Ibid., p. 35.
³⁸
Ibid.
³⁹
Ibid.
⁴⁰
FOMC meeting transcript, September 29, 1998, p. 69.

The chairman’s mind may have been elsewhere. LongTerm Capital Management had failed and threatened the financial system.
⁴¹
Ibid.
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1998

It is one thing for one bank to have failed to appreciate what was happening to [LongTerm Capital Management], but this list of institutions is just mind boggling.
¹