by Bob Woodward
Greenspan thought Darman had some sadly out-of-date notions. The Fed couldn’t even measure the money supply accurately, let alone control it. The Fed’s policy was increasingly set by targeting specific interest rates, though they tried to tinker with money supply numbers.
Darman also argued that Greenspan was mismanaging the psychology of money. A public declaration that rates would be lowered would give the economy a needed boost. As a top White House aide, Darman had seen the political force of Reagan’s optimism. Persistent, repeated declarations of hope by the president had generated incredible popular support and momentum. Darman wanted Greenspan to serve the same function for the economy.
For Greenspan, this verged on silliness. In some respects, Greenspan didn’t want too much uncontrolled hope. It was precisely that psychology that generated the spending and investing sprees—whether by government, business or individuals—that could make reasonable, sustainable economic growth difficult. Greenspan wanted all the players in the economy to feel confidence, and that included a determined sense that the Fed had a tight and consistent rein on inflation.
But Darman was very smart, and he had influence with the president and Jim Baker, now the secretary of state, who retained his portfolio as the new president’s chief political adviser. So Greenspan engaged in cautious debate with Darman. He was never as dismissive as he wanted to be, always willing to continue the seminar, engaging the budget director in a range of technical discussions. The approach was simple—hear him out, wait him out, always be open, make no enemies—and make your own decisions.
For his part, Darman felt that Greenspan was a political animal who would respond to public pressure. Look at the results, he said to others, noting that Greenspan continued to lower the fed funds rate slowly.
• • •
On Friday, October 13, the Dow Jones fell 190 points, nearly 7 percent, the largest drop since the 1987 crash. Johnson, the vice chairman, wanted Greenspan to agree to let it be known that the Fed would supply the necessary liquidity on Monday to head off another stock market crash. In 1987, the Fed had promised liquidity after the Monday crash. This would be a preemptive declaration.
Greenspan wanted to wait.
Johnson was in charge of the crisis management committee at the Fed. Convinced he was right, he took matters into his own hands and leaked to The New York Times and The Washington Post that the Fed would be ready to supply liquidity, as it had during the 1987 crash. Sunday’s papers, put out before the world markets would open, had front-page stories quoting a Fed official who asked not to be identified. “Fed Ready with Cash to Cool Market Fears,” read the Post headline. The Times said, “Federal Reserve Moves to Provide Cash to Markets.”
Greenspan told Johnson that it was a mistake, bad judgment. The stock market decline was not that significant, and they had only a limited amount of ammunition to deploy. Don’t go shooting in the dark, he said. The leak made them look panicky rather than cool. Detached and careful was the way Greenspan wanted to manage the Fed. The markets had to find their own natural level. The reason to supply liquidity was to ensure that the payments system flowed freely. Johnson’s leak made it look as though the Fed were moving to keep the stock market up—precisely what the chairman did not want to do. It was important that the Fed be levelheaded.
At a Monday morning FOMC conference call, Greenspan said that the weekend leaks had not been authorized. Corrigan blasted the leaks as “amateurish.”
Greenspan urged restraint and indicated they might make some technical adjustments of little consequence. “I think any official policy position that we initiate can be held off for a few days until this whole thing simmers down and we know pretty much where we are,” he said.
Nonetheless, because of the leaks, Greenspan and those who managed the open market operations felt forced to supply more money to the system. It was designed to be carried out in such a restrained way as not to signal another rate cut, but the action had the practical effect of cutting rates another 1/4 point.
The Dow Jones ended the day up 90 points.
Greenspan did not say or do anything about Johnson’s unilateral action. The damage was done. A blowup would be contrary to his desire to let the incident just fade away.
As the sluggish economic conditions continued, the FOMC cut rates twice more in 1/4 percent increments before the end of the year, taking the fed funds rate down to 81/4 percent.
The first year of the Bush presidency did not bode well for the economy.
It was also increasingly clear that the collapse of nearly one-third of the savings and loans in the country—due to speculative real estate and high-yield junk bond investments—was delivering yet another jolt to the economy.
Savings and loans (S&Ls), known as “thrifts,” had been established in the 1930s in order to promote home construction during the Depression, and they were federally insured. Initially, thrifts could issue only fixed-rate 30-year mortgages to homeowners within 50 miles of their own offices. Over time, it became clear that if short-term interest rates went up higher than the rate the thrift collected from its investments, the S&Ls were going to start losing money.
In order to make S&Ls more competitive with other types of investments, many of the restrictions on thrifts were slowly pared down during the 1960s, 70s and 80s. S&Ls began to invest in non-residential real estate and junk bonds—and since a deposit with an S&L was federally insured, investors could seek high returns without substantial risk. Extensive fraud ensued, as single investors ran high-risk S&L ventures with enormous amounts of leverage—as much as $100 invested for every $3 that the S&L actually owned in deposits. And large numbers of these bloated, overextended S&Ls began to fail.
William Seidman, the man who chaired the Resolution Trust Corporation (RTC)—the government organization that managed the assets of failed thrifts during the S&L bailout—said of S&Ls, “Crooks and highfliers had found the perfect vehicle for self-enrichment.
“We provided them with such perverse incentives that if I were asked to defend the S&L gang in court, I’d use the defense of entrapment,” he said. The government bailout was going to cost tax-payers some $100 billion.
• • •
Greenspan had a problem. Five years earlier, in 1984, a New York law firm had hired him as a private consultant—to make an assessment for Lincoln Savings and Loan Association and its owner, Charles H. Keating. Keating had since become the poster boy for S&L excesses, fraud and political influence buying. The federal takeover of Keating’s S&L alone was expected to cost $2 billion.
At Townsend-Greenspan in 1985, Greenspan had written a seven-page letter stating that, under Keating’s leadership, Lincoln “had transformed itself into a financially strong institution that presents no foreseeable risk” to federal regulators. He recommended that Lincoln be given an exemption that would allow them “to pursue new and promising direct investments” in ventures that earned higher rates of return. It was consistent with his view that investment restrictions on S&Ls loaded down with 30-year mortgages at fixed rates would eventually fail, because they had to pay depositors short-term rates that fluctuated significantly. Federal regulators had not granted Keating the exemption. John McCain, the Arizona Republican, and four other senators, known as “the Keating five,” were now under investigation for helping Keating, who had given them large campaign contributions. McCain cited Greenspan’s prior endorsement as one of the reasons that he decided to help Keating with federal regulators.
Greenspan was alternately embarrassed, forthright and defensive. He granted unusual on-the-record interviews to The Washington Post and The New York Times. “Of course I’m embarrassed by my failure to foresee what eventually transpired,” he told the Times. “I was wrong about Lincoln. I was wrong about what they would ultimately do and the problems they would ultimately create.” At the same time, he voiced consternation that the senators would cite his 1985 letter as grounds for support lent to Keating in 1987. “How could anyone use an
y evaluation I would have made in early 1985 as justification more than two years later?” Greenspan asked. “No one ever called saying, ‘Do you still hold these views?’ It’s almost as bad as saying, ‘I just read a report written two years ago that Amalgamated Widgets is a good stock to buy.’ It just doesn’t make sense.”
The issue of Greenspan’s involvement with Keating soon died.
Privately, Greenspan believed he would do it the same way again, given the information he had in 1985. When he reviewed Keating’s balance sheets, he found them both quite impressive and fiscally sound. Keating had not done anything wrong at that point, or if he had, it wasn’t detectable. Greenspan just hadn’t anticipated that Keating would turn out to be a scoundrel.
• • •
“Listen, you don’t need to write letters about your concerns,” Greenspan said to Senator Connie Mack, the Florida Republican who had just joined the banking committee. “Just pick up the phone and we’ll talk about it.” Mack, 50, whose grandfather of the same name was the famous owner and manager of the Philadelphia Athletics baseball team, had been a Florida banker. He had recently signed a joint letter to Greenspan from some Republican senators complaining about interest rates. Greenspan made it clear he was available to Mack at any time. When they did talk, Greenspan said, “Why don’t you and I just plan to talk more often.”
Mack was soon speaking to Greenspan whenever he wanted, and the two had breakfast or lunch a couple of times a year. He found Greenspan’s I’m-on-your-side tone reassuring and his willingness to listen and confer about the economy nearly endless.
For Greenspan, this wasn’t just the care and feeding of the banking committee. He made himself available to any member of the House or Senate who seemed interested or whom he found interesting. Such private phone conversations or lunches were a source of important information. He could take small bits he picked up from these sessions or his frequent stops on the Washington social circuit and, almost like a professional intelligence officer, assemble those bits into a mosaic—a picture of which way the political winds might be blowing.
Greenspan went to lunches at the Business Council, an organization of business leaders, and listened to the CEOs of America’s largest corporations. As soon as they saw he wasn’t going to disclose much or press his own conclusions on them but instead wanted to listen, they poured out their anxieties or latest good news. Greenspan insisted that he nearly always learned more from the people who came to hear him speak than they learned from him.
“I know that if you really want to get something done that you go one-on-one privately but never publicly,” he once said—privately, not publicly.
4
* * *
ON AUGUST 2, 1990, Iraqi President Saddam Hussein invaded and took over neighboring Kuwait. President Bush declared, “This will not stand,” and it looked as if the nation were on the verge of war.
Greenspan had done enough work on the economics of the Vietnam War to know it took months or more to build up forces and supplies to fight a war on a far-off continent. He consulted with his longtime friend Secretary of Defense Dick Cheney, who had been the White House chief of staff during the Ford administration. Despite the saber rattling, war was far off in time but likely at some point, Cheney said, essentially giving Greenspan a top-secret summary. The gravest problem was the vulnerability of the initial small wave of U.S. troops who had been sent to the Middle East. They could be crushed by Saddam’s forces.
Greenspan convened the FOMC August 21, 1990, at a time of incredible tension, uncertainty and speculation about military action. The Mideast crisis had also sent oil prices surging.
“The odds of an actual war in the Middle East are 50-50,” Greenspan said, refining the top-secret assessment, one of the best available to anyone at the time. “We are bringing in fairly significant tactical offensive weapons,” he added. The chances that Saddam would back down were low. A serious question was the vulnerability of the vast oil fields in Saudi Arabia, near Kuwait. He then gave a precise account of the geography of the oil region. Some of these Saudi oil fields were vulnerable to “a couple of kamikaze raids, which some Iraqi pilots have already volunteered for,” he said, drawing in part on further sensitive top-secret intelligence.
“It’s extremely unlikely that anything will be triggered until we are in position. We are nowhere near there because of the lead times it takes to move our equipment and troops.”
Turning to the ongoing negotiations between the Bush administration and the Democratic congressional leaders on a possible budget agreement to reduce the federal deficit, Greenspan said, “We are in a sense in economic-political policy turmoil. In that type of environment, it is crucial that there be some stable anchor in the economic system. It’s clearly not going to be on the budget side; it has to be the central bank.” And with grammatical pedantry, he added, “It’s got to be we!”
In those circumstances, he urged a more modest view of what they could accomplish. “I don’t think it is in our power to either create a boom or prevent a recession,” he said. “I would suggest that perhaps the greatest positive force that we could add to this particular state of turmoil is not to be acting but to be perceived as providing a degree of stability,” he added, rounding out his argument against taking any action on interest rates at the present time. He proposed a directive that was asymmetric toward ease, to indicate that though the FOMC wasn’t moving rates down now, they were in all likelihood headed in that direction.
The committee members voiced support for Greenspan’s proposal, but they were all over the lot. Some of the bank presidents wanted to lower interest rates slightly, arguing that it might give a psychological boost and create confidence that they were acting to prevent a recession.
“I don’t think I have asked specifically for support in a large number of meetings going back a number of years,” Greenspan said. “I’m not saying that people should violate what they think are their principles.
“But,” he continued, “if you can find your way clear, this is the type of meeting in which it would be helpful if we had a very substantial consensus.”
He won the vote unanimously.
• • •
By September it looked as if the Bush administration and the Democratic Congress had reached a budget agreement that would lower the deficit by $500 billion over five years.
“There is a lot of ‘real stuff’ in here,” Greenspan told the FOMC approvingly on October 2, 1990, in reference to the pending budget deal. Though there was some inevitable smoke and mirrors in the numbers, he said, the agreement was substantial enough that “we have to find some mechanism to ease.” He proposed “an understanding that if the budget resolution passes we go down 1/4 percent.” It was unusual to tie an interest rate drop to action on the federal budget, though the impact of a real budget agreement could help. Less deficit spending would reduce inflationary expectations, so purchasers of bonds would be willing to accept lower interest rates. Lower long-term interest rates would enable businesses and consumers to borrow for less.
One of the bank presidents thought it would be bad precedent to tie an interest rate move directly to political developments.
“I don’t see how we can get around not responding to a real budget agreement,” Greenspan replied. An agreement would mean that government spending was going to be cut significantly, which would slow the economy.
Some spoke up in support of the chairman’s proposal. Martha Seger, a Fed governor generally known to favor lower rates, advocated an immediate 1/4 percent cut to be followed by another 1/4 percent cut as a “reward to the boys on the Hill for doing the budget.”
Several voiced opposition and surprise, and some outright dissent. “It is not a good precedent to have a linkup with fiscal policy,” said Wayne Angell, a Fed governor from Kansas, in reference to the budget deal. “I cannot support this policy action.” Other members of the committee were uncomfortable that inflationary pressures were too high to ease, w
hile still others demanded that if the Fed moved, they publicly link the move to economic conditions and not to the budget agreement itself.
Greenspan held his ground. “I would recommend,” he said, “asymmetric toward ease, with the presumption that if the budget resolution passes both houses, there would be a 1/4 percent decline in the funds rate on Tuesday morning or Wednesday.” After that, he wanted to remain tilted toward further easing, but nothing other than the initial 1/4 percent drop would be done without consulting the other members of the FOMC on a telephone conference call.
Corrigan cautioned the chairman. “I thought there was a lot of wisdom in the suggestion that several people made about not tying this unduly to the budget resolution in your public statements. The more I think about that, the more I think it would be embarrassing.”
“No,” Greenspan agreed, “I would say that the budget agreement would not be a relevant reason to move were it not for the fact that there was a weak economy.” But he held firm. “If the Congress passes the budget bill, I would intend to implement the easing.”
Greenspan won somewhat narrowly, 7 to 4.
• • •
Later in October, Congress passed a somewhat different version of the $500 billion deficit reduction package after protracted negotiations. This version had more tax increases, including a jump in the top income tax rate from 28 to 31 percent. Signing it would put President Bush in the position of breaking his 1988 campaign pledge, the famous “Read my lips: No new taxes.”