Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (31 page)

Here his confidence in the amazing American economy is checked by disclaimers—“presumably are knowledgeable,” “apparently conveying”—and then he states that his cadre of informants and the companies they relied upon for information might know nothing at all. Reading FOMC transcripts, there is no record of companies expressing a view on productivity, accelerating or not. In summation, the speech was a catalog of platitudes: claims were disclaimed; absolutes were qualified; enthusiasm was contingent; veritable armies of technicians may be wrong or right. The speech was a smash hit.

Coincident with the chairman’s remarks was the Royal Society for the Arts publication of
Opening Minds: Education for the 21st Century
. It quoted science historian James Burke. The author prophesied: “Instead of judging people by their ability to memorize, to think sequentially and to write good prose, we might measure intelligence by the ability to pinball around through [
sic
] knowledge and make imaginative patterns on the web.”
³³
Burke’s view of the future was speaking at the Federal Reserve Bank of Chicago on May 6, 1999. Greenspan’s mental pinging was not lost on his critics, one of whom referred to the Federal Reserve chairman as “Pinball Al” in his weekly commentary.
³⁴

³²
Ibid.
³³
Royal Society for the Arts,
Opening Minds: Education for the 21st Century
(London: Royal Society for the Arts, 1999), p. 7. The study quoted from James Burke,
The Pinball Effect
, (Boston: Back Bay Books, 1997), Introduction, no page numbers.

It is unimaginable that Messrs. Volcker, Burns, and Martin would consider such hypotheses about the future of technology a suitable topic for the Federal Reserve chairman. It is both inappropriate and beyond the Federal Reserve’s brief. Yet, he spoke as the expert. Greenspan styled his mental doodling as hypotheses, knowing that the public accepted them as dogma.

His admission that analysts’ projections were biased upward with “scant evidence to suggest the bias has changed” is divorced from historical evidence (analysts grow more optimistic the longer a boom booms
³⁵
). Making five-year guesses is an impossible task. Most important, though, this is a very strange train of thought by which to set central bank policy. (It is also a very strange reason to buy stocks.)

Volcker Expresses Skepticism

One who differed on the interpretation of corporate profits was Paul Volcker. On May 14, 1999, the former Federal Reserve chairman spoke at American University. His message resonates and contrasts for its succinct and timely qualities: “The fate of the world is dependent on the stock market, whose growth is dependent on about 50 stocks, half of which have never reported any earnings.”
³⁶

To borrow from Volcker and expand on his summary: Productivity is the lifeblood of the economy. It is productivity, more exactly, the belief in rising productivity, that prevents an otherwise manic stock market from collapsing. It is the stock market that now runs the economy, rather than the market functioning as a mechanism to finance business.

³⁴
Christopher Wood, author of
Greed&fear
, his weekly market commentary to clients of CLSA (Credit Lyonnais Southeast Asia).
³⁵
At the end of the eighties’ boom—in September 1990—analysts predicted 22 percent earnings growth for the following year; instead, profits
fell
11 percent over that period.
Gloom, Boom & Doom Report
, February 1, 2008, p. 1.
³⁶
Fleckenstein and Sheehan,
Greenspan’s Bubbles
, p. 67. Volcker’s speech was the commencement address at American University, School of Public Affairs/Kogod School of Business.

It is the accelerated tendencies of the enriched American consumer and their outsized spending that keeps a downsized Asia working. It is the upwardly biased Wall Street forecasts—that we have decided are no more upwardly biased than in the past—that validates productivity, the U.S. stock market, the U.S. economy, provokes U.S. consumption, and which feeds and shelters most of humanity.

June–December 1999

I’m not saying [security analyst] forecasts are any good as far as earnings projections are concerned. Indeed, they’re awful. They are biased on the upside, as they are made by people who are getting paid largely to project rising earnings in order to sell stocks, which is the business of the people who employ them.
¹

—Federal Reserve Chairman Alan Greenspan, October 5, 1999, FOMC meeting

The chairman had not told the public or Congress about the Federal Reserve’s bubble trouble. His contention of Federal Reserve impotence still snoozed at the FOMC conference table. Until Chairman Greenspan took his central bank vision public (i.e., we can’t see a crash before the carcass has fallen off a cliff ), this academic constraint brayed through Ivy League common rooms. As for Wall Street, this was to be a gift from God, the god who hypothesized in the Eccles Building.

June 17, 1999, was the day that Greenspan disclosed his doctrine to Congress: “The 1990s have witnessed one of the great bull stock markets in American history. Whether that means an unstable bubble has developed in its wake is difficult to assess. A large number of analysts have judged the level of equity prices to be excessive, even taking into account

¹
FOMC meeting transcript, October 5, 1999, p. 48.

203

the rise in ‘fair value’ resulting from the acceleration of productivity and the associated longterm corporate earnings outlook.”
²

Assuming that he was speaking logically (and not just pinballing), Greenspan was acknowledging that the stock market was now accelerating at a faster pace than analysts’ five-year projections. Apparently, Greenspan’s equation—stock market price gains are justified by productivity—was breaking down. Had reality run ahead of his ability to dissemble? No, Greenspan was on top of his game. He next advanced his case for impotency: “But bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”
³

The claim was ridiculous—but it worked. Betting against markets may be precarious, but that is exactly what an investor does with each portfolio decision. Just as he had sprung “can’t see a bubble” on the FOMC in December 1998, Greenspan now announced this central bank restriction to Congress. The next day, a
New York Times
editorial expressed its tentative acceptance of Greenspan’s most outlandish claim: “The new Greenspan is brimming with self-assurance. Let us hope the market does not test his new confidence.”
⁴
If only the
New York Times
had brimmed with enough self-confidence to state that the Federal Reserve chairman was abandoning the Federal Reserve’s responsibility.

Maybe the
Times
was too stunned for such a response. In one gulp, it learned that the Fed did not, and could not, see the hot-air balloon it had so generously expanded—mostly with Greenspan’s hot air. The editors had long trusted the chairman. When Greenspan had issued his stock market warning in February 1997, the
Times
stood by Greenspan in an editorial with the title: “Wise Warnings to Giddy Investors.” (This was when Congress reprimanded Greenspan for jawboning the stock market down.
⁵
) In the editors’ words: “To ward off the bad outcome, Mr. Greenspan gently reminded investors that stock prices fall as well as rise. . . . He also reminded them that the Fed will not shrink from raising interest rates—which will draw money out of stocks.” The 1997 editorial went on to remind readers that those on Wall Street who “contend that the American economy is heading toward unprecedented prosperity” lack perspective: “like any story that says the future will be unlike the past, the predictions are probably wrong.”
⁶

²
Joint Economic Committee, “Monetary Policy and the Economic Outlook,” June 17, 1999.
³
Ibid.
⁴
Editorial, “Hints of a Mild Fed Action,”
New York Times
, June 18, 1999.
⁵
Jawboning
is giving a verbal warning or threat.

The
Times
did not know that between 1997 and 1999 Greenspan would echo the giddy cheerleaders on Wall Street—that this
was
an unprecedented moment in history. Once Greenspan declared our good fortune, he had no reason to monitor the stock market. The June 1999 speech simply informed the public of the chairman’s decision to do nothing.

Greenspan’s brimming nonchalance was evident throughout his “don’t worry, be happy” testimony on June 17, 1999: “While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy.” He told the (presumably) puzzled congressmen: “[W]hile the stock market crash of 1929 was destabilizing, most analysts attribute the Great Depression to
ensuing
failures of policy” [author’s italics].
⁷

This directly contradicted what he had written in 1966. In his essay “Gold and Economic Freedom,” Greenspan had placed the blame entirely on Fed policy
before
the crash. (From his 1966 article: “The excess credit which the Fed pumped into the economy [in 1927] spilled over into the stock market—triggering a fantastic speculative boom.”)

The detachment of the FOMC from reality grew worse. Between May 29 and June 29, 1999 (the month leading up to the June 29–30, 1999, FOMC meeting), the
New York Times
discussed the stock market bubble in 10 separate articles. (A headline on May 30: “Pop! Goes the Bubble.”
⁸
) The word
bubble
was used only once at the June 29–30 conclave. The stock market was mentioned 21 times at this meeting.

⁶
Editorial, “Wise Warnings to Giddy Investors,”
New York Times
, February 28, 1999.
⁷
Alan Greenspan, “Monetary Policy and the Economic Outlook,” Joint Economic Committee, June 17, 1999.
⁸
Gretchen Morgenson, “Pop! Goes the Bubble,” “Market Watch,”
New York Times
, May 30, 1999.

The FOMC raised the fed funds rate from 4.75 percent to 5.00 percent—the first change since the three interest rates cuts following the LTCM troubles in late 1998 (described in Chapter 15). If the stock market was the reason the FOMC tightened, it was well disguised. Forty pages of the transcript prattle on about the FOMC communiqué: should it be of a symmetric or an asymmetric nature? A Fed staffer then read the draft statement. This had been handed out before the meeting started. It passed with a single dissent (Dallas President Robert McTeer).
⁹

The chairman’s sole contribution to stock market analysis at this meeting lifted the bar of either banality or understatement to a new level: “We are observing market capitalizations that are telling us something very interesting even as we simultaneously argue that stock market prices are overvalued. We are seeing a very dramatic shift in the changing capitalizations of hightech versus low-tech companies.”
¹⁰
Whatever argument he referred to was not made at this meeting. In the past 10 years of transcripts, there had never been an FOMC argument.

On August 27, 1999, in Jackson Hole, Wyoming, Greenspan talked about assets. Greenspan’s talk confirms that he still understood markets are not always efficiently priced and that the consequences of market crashes are substantial. In his speech, the Federal Reserve chairman explained: “[W]hen events are unexpected, more complex, and move more rapidly than is the norm, human beings become less able to cope.” The failure “to be able to comprehend external events almost invariably induces fear.” This induces “disengagement from an activity.” The “attempts to disengage from markets … means bids are hit and prices fall.”
¹¹
In his roundabout way, Greenspan had described a market crash.

Such waves of emotional instability beg the question of how derivative models can successfully anticipate fear that causes bids to be hit and prices to fall. Greenspan told his audience that models fail in unusual circumstances: “Probability distributions that are estimated largely, or exclusively, over cycles excluding periods of panic will underestimate the probability of extreme price movements because they fail to capture a secondary peak at the extreme negative tail that reflects the probability of occurrence of a panic.”
¹²
Yet, he seemed content to let bank models monitor risk.

⁹
FOMC meeting transcript, June 29–30, 1999, p. 113.
¹⁰
Ibid., pp. 84–85.
¹¹
Alan Greenspan, “New Challenges for Monetary Policy,” speech at a symposium

sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 27, 1999.

At about the same time Greenspan delivered his speech, Fred Hickey was preparing the September 1999 edition of his monthly
HighTech Strategist
, a highly regarded newsletter devoted to technology investing. The probability of a rising “secondary peak at the extreme negative tail” grew more obvious upon reading Hickey’s letter.

Hickey noted that the Philadelphia semiconductor index tripled from October 1998 through August 1999. Yet, semiconductor sales had peaked at $150 billion in 1995. Money poured into the fastest-rising mutual funds, which then funneled the flows into the largest stocks. Hickey wrote: “The six biggest capitalization tech stocks (Microsoft, Intel, IBM, Cisco, Lucent, Dell) are now valued at $1.65 trillion, up $460 billion this year.… [T]here’s been no revenue growth in the world P.C. [personal computer] industry in 2
¹
⁄
₂
years.” Hickey went on: “Just today, on September 3, 1999, the melt up caused by the ‘favorable’ unemployment report added $63 billion to the market valuations of the ‘Big 6.’
One
day’s gain. At their lows in late 1990, all of the stocks in [Hickey’s top-10 model technology portfolio: IBM, Hewlett-Packard, Intel, Microsoft, Motorola, Cisco, Sun Microsystems, Texas Instruments, Oracle, and Micron Tech] could have been purchased for a grand total of $52 billion. Essentially, most of the technology industry in 1990 is an even swap for one day’s gain of 6 stocks today. This is insane!!”
¹³