by Bob Woodward
The Tennessee Baker sat in while the president and the Texas Baker talked several times about the coming Fed chairmanship decision. Jim Baker wanted to dump Volcker, and he was pushing hard for Greenspan. Howard Baker knew Greenspan pretty well. The two had associated in Republican circles in the 1970s, and they had played tennis a number of times at Greenspan’s private club in the Virginia suburbs.
One day in the spring the Bakers invited Greenspan, who headed a private business consulting firm in New York City, to fly to Washington to meet with them at Jim Baker’s house in Northwest Washington.
They had one question. Would Greenspan be available?
If it’s not going to be Paul, Greenspan replied, I would accept.
The president was weighing his options, Jim Baker said. They wanted just to make sure that if they needed him, he was there.
“If you need me, I will be there,” Greenspan said. He wanted assurances that the very existence of the meeting, and certainly the topic, would not be revealed. It would be devastating if it got out that they were thinking of replacing Volcker. Very damaging, he said. The financial markets were really quite unstable.
Howard Baker said that discussion of the Fed chairmanship was on the president’s agenda during the next several days, but that it might take time to sort it all out. They pledged secrecy.
• • •
Now that was interesting, Greenspan said to himself as he headed home on the shuttle. He was aware of some of the friction between the administration and Volcker, but not that it had reached this point. The circumstance of the meeting with the Bakers was in certain respects almost more important than the content, he thought. They could have picked up the phone and asked, In the remote case Paul leaves, would you be willing to come down? Instead, they had arranged a fairly elaborate get-together—chief of staff in the middle of the day, treasury secretary in the middle of the day at the same place, their visitor flying in from New York. That’s not the way things were done around Washington, Greenspan knew. The White House and Treasury were next to each other, and convenience normally drove such matters. Something unusual was up. He was a math whiz and was always calculating probabilities. The chance that he would get the appointment was not in the low range, 1 out of 10. It was high probability, Greenspan figured, maybe 3 out of 4.
Back in his Washington days in Ford’s White House, Greenspan frequently visited his mentor, Arthur F. Burns, who was Fed chairman from 1970 to 1978. He had studied under Burns as a graduate student at Columbia in the 1950s. As Greenspan learned about the job of Fed chairman, he concluded that it was amorphous, not something he would enjoy doing. It seemed to be an arcane exercise, and there were large elements he frankly didn’t get. Greenspan liked the mechanical, analytical work of basic business economics—inventories, arithmetic, physical reality. Monetary policy, the setting of interest rates, was far more complex. It entailed trying to figure out what the business conditions and inflation were going to be in the future. Interest rates had their impact months or a year or more down the road. Seeing the future was about the most impossible task imaginable.
In monetary policy, Greenspan believed, it was very easy to be wrong even if you had virtually full knowledge. Someone who was right about 60 percent of the time would be very fortunate, he believed.
But now he wanted the job. He had watched what Volcker had done to transform the chairmanship and perhaps save the American economy. It was anything but amorphous.
And it was obvious to him that Baker wanted him in the job. Could Baker deliver Reagan? He had done it once before. In working out the compromise on the Social Security Commission, they had faced one seemingly insurmountable obstacle: Reagan himself. The Democrats were demanding a payroll tax increase as part of the compromise. One of Reagan’s core convictions—it was almost rule one—was opposition to more taxes. But Reagan had supported the plan. Greenspan had been astonished that the most ideological of presidents could be so pragmatic. Baker had been able to deliver the president.
• • •
The next morning, Howard Baker reported to President Reagan. Had the president decided what he wanted to do?
No, Reagan said, he hadn’t really decided yet.
Baker pressed. Have you made up your mind that you want to replace Volcker, that you’re not going to reappoint him?
Reagan waffled and seemed uncomfortable. Baker saw that the president seemed to be of two minds.
“I will set up an appointment to go speak to Paul,” Baker recommended, “and I’m going to try to find out if he wants to be reappointed because, you know, there’s a fair chance, Mr. President, that he doesn’t.” That would take the administration off the hook. “I would not be at all surprised if he read the handwriting on the wall just by the fact that I had asked for the appointment and was over there.”
Reagan agreed.
Over the years, Howard Baker had found that Fed chairmen acted as if they had taken the Orders and were serving as priests—independent to a fault and just a little short of arrogant. Perhaps that’s the way it was supposed to be. His job was to decipher the intentions of both Reagan and Volcker.
In Volcker’s office the next day, Baker said he was there at the president’s request. The president had to make a decision about the Fed chairmanship and wanted to know whether Volcker was interested in being appointed to a third term.
Volcker paused. “If I were,” he said finally, “would the president reappoint me?”
I don’t know, Baker said. Of course, he added, that’s up to the president. If you are interested, you should tell me, and I’ll pass it on to him.
On one level, Volcker realized they might not care about his desire unless they were seriously considering offering him reappointment. On its face, Baker’s inquiry suggested that Reagan might be ready to reappoint him.
Let me think about it, Volcker finally replied. He was going fishing, he said, and he would call when he returned.
Baker left unsure. Part of him thought that if Volcker had said he would be honored to have a third term, the chances were that Reagan would reappoint him. At the same time, Baker knew that Volcker didn’t want to beg. Perhaps the proud Volcker didn’t want to be seen as not having been asked. Perhaps he wanted to know in advance if he had the option to stay. Or, more darkly, it was possible that Volcker wanted to be asked just to turn it down.
After his fishing trip, Volcker called Howard Baker and asked to see Reagan. Baker set up a meeting the next day. He figured it could go either way. The chairman came to the White House living quarters to see them. After brief greetings, Volcker pulled out a letter and gave it to the president. It said that he chose not to be reappointed, and he was there because he wanted to tell the president personally.
For the next 10 minutes, Reagan and Volcker had a pleasant conversation. The president was cordial and solicitous. Volcker’s wife, Barbara, was ill and had remained in New York. Volcker said he wanted to get back to her.
For Volcker, it had been a difficult decision. His wife was living in an apartment the size of a student’s. It did not have air-conditioning. After a life almost exclusively of government service, he had little money. In addition, neither the president, nor the secretary of the treasury nor the chief of staff would offer him reappointment on terms that would ensure his independence and dignity as he defined them. He told colleagues that he had never asked for a job in his life, and he wasn’t going to start now.
He was going to be 60 in several months. When had a person done his job? When was it over? When was it time to leave? High inflation had been driven out, but in some respects, so had Big Paul. The Volcker era was over.
• • •
Howard Baker called Jim Baker to report that Volcker didn’t want to stay. Jim Baker was delighted. “We got the son of a bitch,” he told a New York friend.
It had been about two months since Greenspan had heard anything more about the Fed chairmanship.
Then Jim Baker was on the phone. V
olcker had decided to leave. Was Greenspan still interested?
Yes, he said in milliseconds.
Greenspan and Baker knew each other so well that there was no need for a job interview. There wasn’t really anything to catch up on.
“Then you will be getting a call from the president in a few days,” Baker said.
Greenspan had pulled his back, and later in the week, Monday, June 1, he was at the orthopedist. Someone in the doctor’s office walked in and declared, in a tone that indicated that it surely was a joke, “The president of the United States wants to speak to you.”
Alan, said Reagan, I want you to be my chairman of the Federal Reserve Board.
Thank you, Mr. President, Greenspan replied, I’d be honored to do so.
That night, Greenspan attended a birthday party in Washington that his steady girlfriend, NBC television White House correspondent Andrea Mitchell, was having for a friend. After the guests left, he swore her to secrecy and told her that the next day Reagan was going to nominate him. They stayed up much of the night talking.
How do I fill those shoes? Greenspan asked. Paul had really done some heavy lifting.
The next day the White House press corps went on red alert. The president was making an appearance in 20 minutes with an important surprise announcement. Baker didn’t want word to get out in advance.
Afterward, Baker said to Greenspan, “We were all watching to see if it was going to leak on NBC.”
On August 3, the Senate confirmed Alan Greenspan as chairman of the Federal Reserve by a vote of 91 to 2.
1
* * *
ON THE morning of Tuesday, August 18, 1987, Greenspan walked through the door of his private office and into the adjoining massive conference room at the vast marble Federal Reserve headquarters on Constitution Avenue in downtown Washington, D.C. He had been chairman of the Fed for less than one week. Gathering in the stately meeting room were the members of the Federal Open Market Committee (FOMC), which Greenspan now chaired.
The FOMC is an unusual hybrid consisting of 12 voting members—all 7 Fed governors plus 5 of the 12 presidents from the Federal Reserve district banks around the country.
At its regularly scheduled meetings every six weeks, the FOMC sets the most important interest rate that the Fed controls—the short-term fed funds rate. This is the interest rate that regular banks charge each other for overnight loans, seemingly one of the smallest variables in the economy. Greenspan had come to understand that controlling the fed funds rate was key to the Fed’s power over the American economy.
The law gives the Fed power to trade in the bond market. The FOMC can direct the “easing” of credit by having its trading desk in New York buy U.S. Treasury bonds. This pumps money into the banking system and eventually into the larger economy. With more money out there, the fed funds rate drops, making it easier for businesses or consumers to borrow money. Lowering the fed funds rate is the normal strategy for averting or fighting a recession.
On the other hand, the committee can tighten credit by selling Treasury bonds. This withdraws money from the banking system and the economy. With less money out there, the fed funds rate rises, making it more difficult to borrow. Raising the fed funds rate is the normal strategy for fighting inflation.
This buying or selling of U.S. Treasury bonds, so-called open market operations, gives the Fed a brutal tool. Changes in the fed funds rate usually translate into changes in the long-term interest rates on loans paid by consumers, homeowners and businesses. In other words, the FOMC’s monopoly on the fed funds rate gives the Fed control over credit conditions, the real engine of capitalism. Though the changes in the rate were not announced in 1987, private market watchers in New York closely monitored the Fed’s open market operations and soon figured out the changes. The discount rate was the way that the Fed communicated its intentions publicly; the fed funds rate was the way the Fed actually imposed those intentions.
The FOMC, and now Greenspan, had the full weight of the law and nearly 75 years of history—and myth—behind them. They could work their will if they chose.
• • •
The committee members spent several hours in a roundtable discussion, reviewing economic conditions. Then Greenspan took the floor.
“We spent all morning, and no one even mentioned the stock market, which I find interesting in itself,” Greenspan said casually, looking down the colossal 27-foot-long oval table.
Greenspan’s remark was deeply understated. He meant to convey something significantly stronger: For God’s sake, he was trying to tell them, there are factors other than the old classical forces moving the economy. There was more to all of this than consumer or government spending, more than business inventories and profits, more than interest rates, national economic growth, savings, unemployment statistics and inflation. There was a whole other world out there—a world that included the stock market, which had run up 30 percent since the beginning of the year. Wall Street and the financial markets of New York were creating the underlying thrust for a severely overheated economy, the new chairman was certain. The run-up had created more than $1 trillion in additional wealth during the last year. Most of these gains were only on paper, but some people were undoubtedly cashing in and spending more. In any case, many people felt richer—a powerful psychological force in the economy. On top of that, a stock speculation and corporate takeover frenzy was sweeping Wall Street. And nobody had mentioned it. Was the distance between New York and Washington so great?
None of the committee members seemed interested in Greenspan’s point about the stock market, but the chairman was convinced of it. By many measures, including earnings, profits and dividends, the stock market was really quite overvalued, he felt. Speculative euphoria was gripping the economy, and the standard economic models and statistics weren’t capturing what was happening. Greenspan was concerned about the stability of the entire financial system. During his first week on the job, he had quietly set up a number of crisis management committees, including one on the stock market. The situation, that summer of 1987, had the makings of a potential runaway crisis, he thought.
Greenspan had fully acquainted himself with the law, which requires that the Fed try to maintain stable prices. For practical purposes, that means annual inflation rates—the annual increase in prices—of less than 3 percent. For Greenspan, that rate ideally would be even lower, 2 percent or less. The law also directs the Fed to maintain what is called “sustainable economic growth,” a rate of increase in overall production in the United States that can continue year after year while maintaining maximum possible employment. The problem, as Greenspan knew too well, was that annual economic growth above 3 percent traditionally triggered a rapid rise in wages and prices. The Fed was charged with finding a balance between growth and inflation. For Greenspan, any imbalances were warning signs.
The economy in August of 1987 was going too strong. There were no measurable signs of inflation yet, but the seeds were there. Greenspan was sure of it. He saw from economic data reports that the lead times on deliveries of goods from manufacturers to suppliers or stores were increasing, just starting to go straight up. Rising lead times meant that demand was increasing and goods were growing more scarce. He had seen this happen too many times in past decades, so he felt that he knew exactly what he was looking at. The pattern in economic history was almost invariably that you got a bang as prices headed up, resulting in 8 or 9 percent annual inflation—a disaster that would destroy the purchasing power of the dollar. The question now, for Greenspan, was how hard the Federal Reserve could lean against the economy to slow it down, to avoid a drastic series of imbalances. If they tried to put the clamp on with interest rate increases, the system might be so fragile that it would crack under them. The Fed and its new chairman could trigger a recession, defined technically as two quarters, or six months, of negative economic growth.
To Greenspan’s mind, they were faced with a challenge similar to trying to walk alon
g a log floating in a river. You sense an imbalance and move slightly to adjust; in the process you may lose your balance, but if you regain it, you end up in a better, more stable place. If you don’t, you fall off and crash.
Greenspan contemplated two potential missteps. The first would be to do nothing, which would sanction the overheating. The second would be to take action and raise interest rates. It was quite a bind: acting and not acting each had grave consequences.
The new chairman also felt a mild amount of tension because he didn’t want to screw up the formal operating procedures of the FOMC. Before his official arrival at the Fed, Greenspan had met with senior staff members to learn the ropes, to make sure he got it right. A Fed chairman was a symbol, but he was also the discussion group leader. He had to know his stuff. Greenspan’s only flub so far had been to mispronounce the name of the president of the Philadelphia Federal Reserve Bank, Edward G. Boehne. It is pronounced “Baney,” rhyming with “Janey,” and Greenspan had embarrassingly called him “Boney.”
Despite Greenspan’s apprehension about the economy, he felt confident in his ability to serve as chairman. The key was his private business experience as much as it was his previous government service as chairman of Ford’s Council of Economic Advisers from 1974 to 1976. In 1953, at the age of 27, he had founded an economic consulting business in New York City with William Townsend, a bond trader. With a love of mathematics, data and charts, Greenspan had developed models for forecasting based on detailed measurements of real economic activity—from loans and livestock to mobile home sales, inventories and interest rates. Townsend-Greenspan only had about 35 employees, and Greenspan was a hands-on manager, involved in every facet of the firm’s work. In addition to his consulting work, he had served on the boards of Automatic Data Processing, Alcoa, Mobil, Morgan Guaranty and General Foods, among others. He believed that he understood the backbone of the American economy from this experience—computers, metal, oil, banking and food.