Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (38 page)

Within a few days of its announcement, it was clear that Enron’s activities were either juvenile or diabolical. As it turned out, they were both. Foresight was lacking, as is true in every boom. While expansion endures, there is no end to the accounting and financial tricks that companies employ. The list of transgressors was soon better known than the top Nasdaq performers: Global Crossing, Tyco International, WorldCom, Adelphi Communications, Arthur Andersen.

The Enron Prize

On November 13, 2001, Alan Greenspan accepted the Enron Prize for Distinguished Public Service in Dallas. This was a few days after Enron announced that it had filed five years of fictional financial reports.
⁴⁴
Ta c t and political acumen being Greenspan’s specialties, he talked about oil, not integrity.

The day after Greenspan’s oil forecast, Henry Blodget resigned from his distinguished seat in Internet hokum. Greg Smith had resigned from Prudential Securities a week before, where he had been equity strategist for nearly two decades. Smith, interviewed by
Barron’s
, captured the essence of success in the new era—both Greenspan’s and Blodget’s: “ ‘During the 1990s, the stock market became a media phenomenon.’ Television … all too predictably, decided to ‘personalize what was happening in the market.… [T]elevison created the idea that people moved markets, and it covered Abby Joseph Cohen as though her outlook was a news event.’ ” Smith lamented the securities firms that unleashed their “marketing dogs, who turned strategists’ projections into promotional fare.… ‘This was always meant to be a cottage industry, not part of a multi-billion-dollar enterprise.’ ”
⁴⁵
The analyst TV stars and Greenspan (also a TV star) owed their reputations to the fascination with celebrities. They were failures, but few noticed.

⁴²
Chris Gaither, “Market Place,”
New York Times
, November 6, 2001, p. C6; Fred Hickey,
HighTech Strategist
, November 2, 2001.
⁴³
Losses are not adjusted for share repurchases, share dilution, and so on.
⁴⁴
Richard A. Oppel Jr. and Andrew Ross Sorkin, “Enron Admits to Overstating Profits by About $600 Million,”
New York Times
, November 9, 2001, p. C1.

Greenspan came to the December 11, 2001, FOMC meeting full of news: “It may be … not an overvaluation but possibly a new way of looking at the market.… [I]t may be that the markets stay overvalued or undervalued for protracted periods of time.”
⁴⁶
It might also be a superabundance of cheap credit that continued to speculate in the stock market. Whatever the answer, the chairman did not propose that the stock market was accurately assessing the economy.

The FOMC cut the funds rate another 0.50 percent in December 2001. The Fed had now cut rates 11 times in 2001 to 1.75 percent by the end of the year. This was a 76 percent cut from 6.5 percent at the beginning of 2001.
⁴⁷
Short-term rates were lower than the inflation rate. The Federal Reserve Chairman was doing his best to restore the vitality of the “Greenspan put.”

The FOMC was taking more interest in houses than in productivity.
Mortgage
was mentioned 40 times at the December meeting.
⁴⁸
This was anticipated by the chairman on a September 13 conference call. Prior to September 11, “[t]he general level of consumer expenditures seemed to be holding up, I suspect in large part because of capital gains in homes.”
⁴⁹

Technology and productivity were yesterday’s obsessions. In January 2002, the Federal Reserve chairman squashed the new era when he spoke in San Francisco: “[A]las, technology has not allowed us to see into the future any more clearly than we could previously.”
⁵⁰

⁴⁵
Alan Abelson, “Fun and Games,”
Barron’s
, November 12, 2001.
⁴⁶
FOMC meeting transcript, December 11, 2001, p. 83.
⁴⁷
Fleckenstein and Sheehan,
Greenspan’s Bubbles
, p. 120.
⁴⁸
FOMC meeting transcript, December 11, 2001.
⁴⁹
FOMC conference call transcript, September 13, 2001, p. 1.
⁵⁰
Alan Greenspan, “The Economy,” speech at the Bay Area Council Conference, San Francisco, January 11, 2002.

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1994–2002

Why care? I think there is a longterm social cost we are going to pay from all this… . consumption has expanded more quickly than the income of the great majority of American households.
¹

—Federal Reserve Governor Lawrence Lindsey to the FOMC, 1996

It is time to part with the stock market and to address mortgages—or, more to the point, debt. The increasing burden of consumer debt had been an FOMC topic since the early 1990s. Federal Reserve Governor Larry Lindsey expressed fears about the overindebted American. His lectures occasionally animated another FOMC member (or, more often, a Fed staffer) to respond, but the Federal Reserve spent far more time talking about its “symmetrical” or “asymmetrical” communiqués.

The first half of this chapter steps back to FOMC meetings between 1994 and 1996. Larry Lindsey spoke while the committee sat. Lindsey was not ahead of his time. The danger was present. He was not only ignored but also listened as other FOMC members explained that Americans were not spending enough.

¹
FOMC meeting transcript, July 2–3, 1996, p. 33.

251

The second half of the chapter reviews FOMC meetings in 2002. Greenspan and others dedicated a good part of their time to monitoring the latest data on rising house prices, home-equity withdrawals, and how much Americans contributed to GDP growth by spending their cashouts.

Across the bridge between the earlier and later FOMC meetings, there are two trends worth remembering:

1. U.S. households borrowed $336 billion in 1996; they borrowed $1.1 trillion in 2006.
2. U.S. consumers held $5.2 trillion of debt in 1996; this had risen to $12.9 trillion in 2006.
²

The Lindsey Lectures

Between 1994 and 1996, Federal Reserve Governor Lawrence Lindsey gave several presentations to the FOMC on a single theme. The middle class was not recovering from the recession of the early 1990s, but it continued to spend. Americans were relying on more credit and gains from financial markets. Cash earnings from work were slipping. At the February 1994 FOMC meeting, Lindsey explained that among the “bottom 99 percent . . . what we’re seeing is a big change in the functional distribution of income away from wages.”
³
He compared the period from 1983 to 1988, when “56 percent of all the increase in personal income was paid in the form of wages.”
⁴
In 1992 and 1993 that fell to 47 percent, and “during 1993 that fell to 38 percent.”
⁵
[Lindsey’s second reference to 1993 seems to mean the fourth quarter—author’s note.]

In Lindsey’s conclusion, “the non-rich, non-old live paycheck to paycheck, quite literally. That’s where all their income comes from. Remember, virtually none of the capital income or business income goes to them. They have to live on their wages and that wage share is also declining… . [T]he middle-class, middle-aged people who are borrowing are really getting their income squeezed.”
⁶
At another point in the meeting, Fed staffer Michael Prell noted a developing trend: “[W]e’ve already gotten to a period of high-level housing activity.”
⁷

²
Federal Reserve Flow-of-Funds Accounts, Z-1
³
FOMC meeting transcript, February 3–4, 1994; “the bottom 99 percent,” p. 20; rest of quote, p. 21.
⁴
Ibid., p. 22.
⁵
Ibid.

At the May 1995 FOMC meeting, Lindsey again pestered the committee, warning, “[T]here has been a lot of easing of credit terms. At some point this is going to stop.”
⁸
Lindsey made one of his few errors in prophecy: “This is certainly not the kind of environment that is sustainable.”
⁹
Lindsey warned that the Fed’s own forecasts for 1996 assumed a decline in the saving rate from 1995.

To an economist, a declining savings rate is a good thing; a rising savings rate is bad. Janet Yellen, an academic economist by training, expressed the standard interpretation taught in college classrooms. Her worry was the opposite of Lindsey’s: she was “concerned about the possibility” of the savings rate remaining too high. It had averaged 4.1 percent in 1993 and 1994 and had risen to “5.1 or 5.2 percent” in the first quarter of 1995.
¹⁰

1994: Installment Debt Financed Personal Consumption

Lindsey took the opposing view: that 44 percent of the growth in personal consumption expenditures (PCE) during 1994 “was financed through installment debt, and this can’t go on forever.”
¹¹
Yellen feared that if the Fed’s prediction of a 4.4 percent or 4.5 percent savings rate in 1996 was correct, this could have “significant repercussions for the forecast,”
¹²
meaning that GDP growth would slow down significantly. If individuals saved too much (even though 4 percent or 5 percent was a very low rate by historical standards), a recession might follow.

Lindsey predicted that the high percentage of personal consumption expenditure financed from installment debt would slow because banks were lending recklessly.
¹³
He might have added—although there was no reason to do so, since even the FOMC presumably understood—that the longer it went on, the worse the carnage would be. Since it went on for another 12 years, the bankruptcy of both parties—the lenders and the borrowers—was complete.

⁶
Ibid. Lindsey explains each step of his study on p. 21. Lindsey also discusses what he discovered within each income group in much greater detail than can be covered in this book.

⁷
Ibid., p. 13.
⁸
FOMC meeting transcript, May 23, 1995, p. 25.
⁹
Ibid.
¹⁰
Ibid., p. 27.
¹¹
Ibid., p. 25.
¹²
Ibid., p. 27.

Greenspan also talked about installment debt. Of Governor Lindsey’s concern, “I would only respond by suggesting that part of the problem with this big increase in installment credit, which really is outsized,” is a product of the mortgage market. “[L]arge realized capital gains . . . have been financed in the mortgage market. [Gains from selling houses at a profit.] Those funds are going disproportionately into the financing of consumer durables.”
¹⁴

1995—Greenspan’s Concern: Mortgage Market Slowing Down

Greenspan seemed concerned the mortgage market was slowing. Consumers had switched to credit cards and the like to continue spending at a fast clip, since home equity was apparently receding. It might not be a coincidence that at the FOMC meetings in July 1995, December 1995, and January 1996, the Fed cut the funds rate from 6.00 percent to 5.25 percent. Greenspan wanted to be reappointed Federal Reserve chairman in 1996. Lower mortgage rates would aid his cause.

At the July 1995 meeting, Greenspan expanded on how important mortgages were to the economy: “The home builders data clearly indicate that things are moving. This is important not only because of the importance of the residential construction sector, but also because history suggests that motor vehicle sales and some parts of the residential building industry move together. If there is firmness in the home building area it has to exert, if history is any guide, some upward movement in the motor vehicle area, which would be very useful.”
¹⁵
It would be especially useful to a civil servant whose popularity is measured by GDP growth.

¹³
Another possibility: “all these backward-looking assumptions our examiners make about the quality of the balance sheet begin to go in reverse.”
¹⁴
FOMC meeting transcript, May 23, 1995, p. 32.

Lindsey continued his lecture series, whether it interested the FOMC or not. If one can judge by formality of composition, Lindsey was less interested in Federal Reserve decorum than his compatriots were. For instance, after warning about “asset re-diversification” in 1993, he raised the Boston Chicken IPO as a sign of speculation, then suggested the Fed cook up its own fast-food IPO, asking: “What do you think, Al?”
¹⁶
Nobody at the FOMC ever called Greenspan “Al” and very rarely “Alan.” He was “Mr. Chairman.”

In January 1996, Lindsey was “more pessimistic than the staff about the state of the household sector.”
¹⁷
He thought the debate of rich versus poor was the wrong question. The normal separation of income brackets missed a larger problem. He was not concerned so much with income distribution as he was with the indebtedness of American households, rich, poor, and in-between. All of the income brackets—from rich to poor—received interest income, but it was “highly skewed.” In the $50,000–$100,000 income bracket, the top 8.4 percent of taxpayers received 70 percent of all interest income in that class.
¹⁸
Lindsey calculated that more than half of the “well-to-do” range had more
non
-mortgage debt than financial assets.
¹⁹
“In other words, far more than half of upper income households, not to mention lower income households, do not now have financial assets that exceed their debt.”
²⁰
This was in 1996, when Americans were relatively unburdened with debt (in comparison to the present).

Lindsey’s Warnings

In July 1996, Lindsey grasped the problem of indifferent lenders: “[T]he new computerized underwriting procedures continue to extend ever more credit even as debt levels grow. The traditional warning flags simply are not present for the great majority of people who are taking on new debt.”
²¹

¹⁶
FOMC meeting transcript, December 21, 1993, p. 27.
¹⁷
FOMC meeting transcript, January 30–31, 1996, p. 10.
¹⁸
Ibid., p. 11. Lindsey also discusses the $20,000–$30,000 income class: “[T]he top 4.7 percent got 60 percent and the top 13 percent got 79 percent of the interest income received by that class.”
¹⁹
Ibid. Lindsey had “thrown out the very poor and the very rich income classes because there are problems in interpreting both of those.”
²⁰
Ibid.