Maestro

by Bob Woodward

A furious debate erupted within the administration. Bush’s more political advisers argued that signing the bill with the visible tax increases would betray the anti-tax conservatives and jeopardize his reelection chances in 1992.

  Dick Darman argued that signing the deal was the only responsible course, with deficits heading up and up.

  Another key player in the Bush administration, Treasury Secretary Nicholas Brady, agreed. Brady, a longtime Bush friend who had succeeded Jim Baker in 1988, liked to remind people that he had once been captain of the Yale squash team—even though he was only the seventh-ranked player on an eight-player team. The team won the national championship, and Brady liked to point toward his captainship as proof that he knew how to get things done.

  As treasury secretary, his performance had been closely scrutinized and criticized. Darman called Brady a “dolt” who couldn’t pass an introductory economics exam at any American university. He thought Brady was probably the weakest treasury secretary in the history of the country. Whatever his stature as treasury secretary, Brady was quite close to Bush.

  The continuing U.S. military buildup for the Kuwait-Iraq crisis in the Persian Gulf required that the government show it could reach agreement, Brady said. The most important argument for signing was that the budget deal would give Brady significant ammunition in persuading Greenspan to lower interest rates. Lower interest rates would mean lower costs for new loans, and would also allow businesses and consumers to refinance debts or mortgages at lower rates. Since homeowners increasingly used refinancing as a source of consumer credit, they would be able to buy more automobiles, appliances, home furnishings and a whole variety of consumer goods. That would help the sluggish economy.

  An improving economy was key to assuring the president’s reelection, Brady argued.

  Bush finally signed the agreement but later said publicly that there were parts that made him “gag.”

  When the budget agreement finally passed, Greenspan ordered the 1/4 percent cut on October 29.

  Two weeks later, at the November 13, 1990, meeting, the FOMC faced clear signs of a still greater downturn in the economy. Greenspan remained focused on inflation, which had been running high during October and had only quite recently begun to falter. “Slowing inflation is now finally becoming credible,” he said. But at the same time, he said, “It’s very clear to me that if we are perceived as responding excessively easily to all the other signs that would induce central bank ease, that the risks of the system cracking on us are much too dangerous.” He recommended only a 1/4 percent drop—and that, he said, would have to be done reluctantly. He won unanimous support.

  • • •

  Greenspan was facing another problem, which was perhaps even bigger, but partly secret. The nation’s banks, the foundation of the credit system, were in big trouble. Bad loans, especially those made in real estate and in Latin America, were taking their toll. Some of the largest commercial banks were on the verge of going under. The depth of the problem was a big secret within the Fed, which had a regulatory role. But it wasn’t just the banks. A number of big securities firms and insurance companies were in trouble as well. Greenspan was so alarmed that he rose at 6 a.m. each morning to check the overnight financial news on TV. He was deeply worried about a collapse in the financial markets. It was very disturbing—“The fall of ’90 was the bottom!” he would later declare.

  Surveying the situation from his paneled office at the New York Fed, Gerald Corrigan could see the making of an economic calamity for the entire financial system and the nation.

  Citibank, which six years earlier had been the biggest, strongest and most powerful bank in the world, was closest to collapse. The Federal Deposit Insurance Corporation (FDIC), which insured deposits, examined Citibank and on their grading scale gave it a 4. A 5 was the lowest grade and indicated complete insolvency. Headed by John S. Reed, a problem-solving manager of some genius, the bank had gone through a vast expansion. Now the stock had fallen to a new low because of bad real estate and foreign loans. Corrigan arranged a come-to-Jesus meeting with Reed and informed Greenspan of his plan.

  Greenspan didn’t second-guess Corrigan and gave his tacit approval.

  The day before Thanksgiving 1990, Corrigan met with Reed. They got into a big argument about Citi’s likely losses. Reed insisted that the bank’s losses would total only $2–$3 billion.

  “Goddammit,” Corrigan shouted, it would be $5–$6 billion and Reed had better get used to it. Corrigan figured that Citi had about six months to raise $5 billion in capital, or else they’d go under. At that time, raising $5 billion was almost unheard-of, virtually impossible.

  Leaving the meeting with Corrigan, Reed seemed to cross a psychological threshold and realize he had to put Humpty-Dumpty back together again. Hey, he said to himself, this is a guy who’s been in the business a long time, and he’s seen a lot of banks in trouble. Maybe he knows more than you do. Reed realized that Corrigan was probably right, and that Citi needed more help than he’d thought.

  Prince Alwaleed bin Talal, a young, flamboyant Saudi Arabian of extreme wealth who already owned a considerable amount of Citibank stock, was willing to invest another $1.2 billion. It would give him about 14 percent of the Citibank stock and make him by far the largest single stockholder.

  Corrigan flew to Saudi Arabia for a secret meeting with the prince. During a two-hour meeting, he laid out the rules. The prince had to understand he was a passive investor. He had to agree to an extraordinary set of restrictions: he would not attempt to influence management, take over the bank or the board or try to influence the dividend, loan or credit decisions of the bank. Corrigan made it clear he would not look kindly on any infringement, and in his role as president of the New York Fed he would learn if there were any.

  Reed wrote a 600-page memorandum of understanding outlining his plans to improve performance and cut costs dramatically. He shared a copy with the Fed, which, along with the FDIC and the comptroller of the currency, acted as Citi’s overseer and de facto board of directors as Reed tried to save the bank. Eventually, Reed turned the bank around.

  • • •

  Central to the bank rescue mission, both Greenspan and Corrigan knew, was bringing the short-term fed funds rate down—which would bring down other short-term rates as well. This would enable many banks to borrow at lower rates, creating a larger spread between short-term rates and the long-term rates at which the banks had already made loans to customers. This would mean more bank profit, the key to saving the banking industry and building bank capital. But it would be a long road back. The bad condition of the banks had created a so-called credit crunch, which meant that banks were either unwilling or unable to extend enough credit to meet demand for loans. Businesses that needed loans in order to grow had a harder and harder time finding them, which resulted in yet another significant drag on the economy.

  On top of the problems with the banks, the separate savings and loan collapse had depressed the real estate market. Greenspan was on the board of the Resolution Trust Corporation, which was the government agency created to dispose of the insolvent S&Ls and their real estate. He applauded and supported the eventual effort to unload a large block of real estate—billions of dollars’ worth from all around the country—to get the real estate market primed. There had to be significant real estate sales to revive the market and get prices up. That meant bargain-basement prices, creating vast fortunes for those who got in on it.

  The largest buyer of RTC assets was Joe Robert, a Washington, D.C.–area entrepreneur. He spent about $8 billion and ended up making a total $3 billion profit. It was a practical application of old-fashioned Ayn Rand capitalism in the money jungle. As Greenspan said in a private meeting, “We endeavored to galvanize on the greed of a number of people in the business, who when seeing their counterparts making big profits, dived in, and they virtually cleaned out our inventory.” The real estate market was recovering.

  • • •

  The bank
and S&L problems, along with the credit crunch, were not going to go away quickly, Greenspan knew. It might take years. So his major focus was the economy, which was now headed toward, if not already in, a recession. By the December 18, 1990, FOMC meeting, Greenspan acknowledged this. Real estate prices were down and retail sales were down.

  “But recessions always end,” he said almost coldly. They would probably have to lower rates some. But only some. His concern: “We’ll succeed beyond our wildest dreams. . . . I think we also have to be prepared for the fact that we may, and probably will, overdo it.” Reluctantly, he recommended another 1/4-point cut to 7 percent, and he won unanimously.

  5

  * * *

  “WE’RE IN a slowdown economically in this country, if not recession,” President Bush said in a television interview on January 2, 1991. “In some areas, we’re clearly in a recession. . . .” It was among the most dreaded pieces of political news a president had to convey and face. The prospect of war in the Gulf only heightened the uncertainty.

  Less than a week later, operating under the asymmetric directive approved by the FOMC to reduce rates on his own, Greenspan on January 8 lowered the fed funds rate by 1/4 percent. At the conference call of the FOMC the next day, he announced his action. The Fed’s technical experts on the call acknowledged that Greenspan had based his decision on partial data, compounded by the difficulties of sorting out seasonal patterns at the end of the year.

  After half a dozen members had spoken, Roger Guffey, president of the Kansas City Fed, said he also had some concern about the data—and then he laid down almost a challenge. “It seems to me that it is pretty soft information to be taking a policy action on. But beyond that, it seems to me that almost everything that was expressed this morning by the various participants was based upon uncertainty. And I don’t think we should be making policy on uncertainty. So, I hope that we hold steady for a period of time in the future.”

  Greenspan merely inquired, “Any further comments or questions?”

  • • •

  Greenspan asked his friend Secretary of Defense Dick Cheney for a heads-up before offensive operations began in the Gulf, because of the potential impact on oil prices and the economy. On January 16, the day the air strikes were to begin, Cheney gave Greenspan a top-secret briefing. The prospects of dislodging Saddam’s forces from Kuwait were excellent, Cheney said, but it would involve weeks of round-the-clock bombing and an inevitable ground offensive some weeks or months down the road. They were entering a period of immense uncertainty and international instability.

  Greenspan stayed in his office the night the bombing began. He wasn’t sure how the financial markets would take it. As the first air strikes appeared on CNN about 7 p.m., he watched oil and other prices gyrate wildly.

  On February 1, two weeks into the air war, Greenspan decided to lower rates by 1/2 percent. The economy, now obviously in recession, needed big help.

  When he convened a conference call later that day to inform FOMC members of the second rate decrease, some of the bank presidents mildly questioned Greenspan’s failure to consult them.

  “I don’t know whether you consider this a technical point or not,” said Tom Melzer, president of the St. Louis Fed. Speaking of the rate cut, he asked, “Should that be an action taken by the FOMC?”

  Greenspan responded by saying that the directive given him left him enough room to do what he’d done.

  Dick Syron, the president of the Boston Fed, agreed with Greenspan’s actions but asked if the chairman might want to conduct a formal vote of the committee, so that it would not appear that Greenspan was acting unilaterally. A story had run in The New York Times on January 11 alleging that Greenspan wanted to ease but the bank presidents, a “dissident faction,” were standing in his way. Syron wanted to give Greenspan a chance to have a vote in which the presidents supported him, so that it would not look as if he were out there on his own.

  Greenspan declined, saying that taking a formal vote might lead the markets to believe that the Fed was trying to make a bigger statement than it actually was. Although the 1/2 percent cut was a big one, a formal FOMC vote—possibly calling for everyone to meet in Washington—would have more of an impact than a quiet unilateral action by the chairman.

  At the February 5 full FOMC meeting in Washington four days later, Greenspan appointed a number of Fed economists to a task force to determine exactly how much authority he had under an asymmetric directive to move without consulting the other members of the FOMC. After a brief discussion, nobody mentioned it again. At the end of the meeting, when he recommended that the committee keep rates where they were but issue another asymmetric directive toward easing—giving him precisely the same latitude he had previously enjoyed—the members voted unanimously to support him.

  On March 26, at the next FOMC meeting, the task force presented its findings. They proposed a method of “enhanced consultation.” Greenspan would provide prior notice to committee members of the action that he was contemplating and include an opportunity, via telephone, for some discussion before the action was taken. A number of members voiced concern that the meaning of “enhanced consultation,” and the precise circumstances that warranted it, were slightly unclear. Despite the ambiguity, the issue of what the chairman could do in between meetings was seemingly put to rest.

  But some of the FOMC insiders carried their complaints to the media. Manuel Johnson, who had left as vice chairman the previous year and had joined a private international consulting firm, heard that The Wall Street Journal had prepared a big front-page story. It was going to show that the hawkish bank presidents had slowed Greenspan down and, on one occasion, had even defeated him, forcing him to hold off on a rate cut.

  Johnson spoke with some of his former colleagues. Several grumbled about Greenspan and voiced more concern than they had to the chairman directly or at FOMC meetings. Johnson believed he had confirmed the story and that his business and international clients were entitled to learn of the scoop in advance of the Wall Street Journal story. Johnson wrote in his newsletter on April 2 that the Fed was “in a unique state of gridlock,” adding, “Much of the current policy stalemate stems from a series of brutal confrontations between the Chairman and members of the FOMC over the Chairman’s discretionary control over the fed funds rate.”

  Greenspan’s style—a patient, almost total willingness to listen respectfully and openly to others—tended to diffuse potential confrontation. Nonetheless, the mild discontent was out there. The Wall Street Journal ran a short article on April 4 titled “Dispute Flares Up at Fed Over Greenspan’s Authority,” which stated that the bank presidents had stood up to Greenspan’s discretionary rate decreases.

  The next day, the Journal ran its long front-page article headlined “The New Fed: Democracy Comes to the Central Bank, Curbing Chief’s Power.” Greenspan was quoted saying that accelerating or delaying rate increases by a matter of weeks as a result of listening to others would have had no meaningful impact. Rather, he said, it was the cumulative direction and thrust of interest rate policy that mattered. “The Fed cannot effectively be run by executive fiat.”

  Greenspan complained privately to the Journal and to Johnson, who eventually concluded he had seriously overstated the intensity of the debate. During the next few days, however, the furor grew. More stories appeared in The New York Times, The Washington Post, and The Wall Street Journal alleging that Greenspan’s authority had been curbed and that he faced a severe internal struggle in his efforts to lower interest rates. Some of the FOMC members clearly felt discomfort, if not discontent, with Greenspan’s agenda.

  • • •

  Wayne Angell, a Fed governor from Kansas who had a regular Sunday afternoon tennis game with Greenspan, was concerned that during the first three months of 1991 Greenspan had pushed hard, maybe too hard, for lower rates. Angell, a small, scrappy, outspoken banker and farmer, was concerned that the rapid interest rate cuts were converging with the question of
whether Greenspan would be reappointed by President Bush to another four-year term as chairman. Greenspan’s term expired on August 11, and in Angell’s view the Bush administration was engaged in a dangerous, unseemly game of dangling the reappointment and suggestively tying it to lower rates.

  On April 10, The Wall Street Journal ran a story quoting the White House spokesman saying that Greenspan had done “a fine job,” but that Bush hadn’t yet made any decisions on reappointment—and, by the way, the president and his economic advisers wanted lower interest rates.

  The day after the Journal story, Angell had a long phone conversation with Greenspan. Angell was a strong supporter of Greenspan’s, but he thought it was important to have more collegial discussions at the FOMC and among the Board of Governors. Even more careful listening and consensus building was essential.

  Greenspan told Angell that they had to decide whether to lower rates even more but insisted that he was unsure and open to hearing what all of the others might think.

  Angell said that he too was open about what to do.

  The next morning, April 12, Greenspan convened an early conference call of the FOMC, sometime before 8:30 a.m.

  Angell was surprised.

  “Good morning, everyone,” Greenspan said. The consumer price index (CPI) for March was going to be released later that morning, and it was down significantly—the first decrease in five years. The drop meant that inflation pressures were easing even more. “That is probably going to cement expectations, which are pretty general at this stage,” he said, “that we are in the process of moving to an easier policy.

  “Twenty-four hours ago,” the chairman said, “I frankly would have preferred not to do anything. But we are potentially in a position at this stage where if we don’t move, the markets could break.” There was some evidence that economic growth might be stalling even further, and the market expected the Fed to move. Failure to move, Greenspan believed, risked a crisis of confidence in the bond and stock markets.