PANDERER
TO
POWER
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PANDERER
TO
POWER
THE UNTOLD STORY OF HOW
ALAN GREENSPAN
ENRICHED WALL STREET AND LEFT A LEGACY OF RECESSION
FREDERICK J. SHEEHAN
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Copyright © 2010 by Frederick J. Sheehan, Jr. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.
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To my father, who helped and encouraged me to write this book, even when it seemed futile. My confidence and stamina often flagged; his never did.
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Contents
Author’s Note ix
Introduction to Part 1—Prelude to Power, 1926–1987 1
1 Early Years: The Education of Alan Greenspan, 1926–1958 9
2 The Dark Side of Prosperity, 1958–1967 19
3 Advising Nixon: “I Could Have a Real Effect,” 1967–1973 31
4 President Ford’s Council of Economic Advisers, 1973–1976 47
5 The 1980 Presidential Election: Boosting Carter,
Reagan, and Kennedy, 1976–1980 59 6 Parties, Publicity, Promotion—and Lobbying for the
Federal Reserve Chairmanship, 1980–1987 71 7 Lincoln Savings and Loan Association, 1984–1985 85 8 “The New Mr. Dollar”: Chairman of the Federal Reserve, 1987 95
Introduction to Part 2—The Pinnacle of
Power, 1987–2006 103 9 The Stock Market Crash and the Recession That
Greenspan Missed, 1987–1990 109 10 Restoring the Economy: Greenspan Underwrites the
Carry Trade, 1990–1994 121 11 Cutting Rates and Running for Another Term as
Chairman, 1995–1996 133
vii viii Contents
12 The Productivity Mirage That Greenspan Doubted,
1995–1997 145
13 “Irrational Exuberance” and Other Disclosures, 1995–1998 157
14 In a Bubble of His Own, 1998 169
15 LongTerm Capital Management: A Lesson Ignored, 1998 181
16 Greenspan Launches His Doctrine,
November 1998–May 1999 191 17 “This is Insane!!” June–December 1999 203 18 Greenspan’s Postbubble Solution: Tighten Money,
January-May 2000 215 19 The Maestro’s Open-Mouth Policy, June–December 2000 227 20 Stocks Collapse and America Asks: “What Happens
When King Alan Goes?” 2001 237
21 The Fed’s Prescription for Economic Depletion, 1994–2002 251
22 The Mortgage Machine, 1989–2007 265
23 Greenspan’s Victory Lap: His Last Years at the Fed,
2002–2006 283
Introduction to Part 3—The Consequences of
Power, 2006–2009 301
24 The Great Distortion, 2006 307
25 Fast Money on the Crack-Up, 2006 315
26 Cheap Talk: Greenspan and the Bernanke Fed, 2007 327
27 “I Plead Not Guilty!” 2007–2008 337
28 Greenspan’s Hometown, 2008 349
29 Life after Greenspan, 2009– 361
Appendix: The Federal Reserve System 367
Acknowledgements 369
Index 371
Author’s Note
Following are some explanations of how words with broad general meanings are used specifically.
Money is used in its broadest form. The distinctions between “money” and “currency” (e.g., the dollar) are not addressed.
Bank refers to the large banks. There are about 8,300 federally chartered banks in the United States. Maybe 300 of these share responsibility for the current financial debacle. If a different type of bank is discussed, it is identified, such as a savings and loan. This also applies to hedge funds and privateequity funds. Most of them stick to their knitting and act honorably.
Banks, as they existed when they are first discussed (the 1950s), no longer exist. For instance, at that time, the distinction between commercial and investment
banks was clear. Now, they cross each other’s lines of business. The easiest description of these businesses is “financial institutions.” It is comprehensive, but it is vague. Therefore, firms are described according to the topic under discussion. For instance, Goldman Sachs falls under a discussion of “brokerage firms,” even though it was (until recently) an investment bank. Likewise, Goldman Sachs stands under the “underwriters” umbrella when underwriters are discussed.
An economist—in this book—has received a graduate degree, probably a Ph.D., in economics.
Most of the economists discussed in this book are the public performers from government–academia–Wall Street and appear on CNBC. There are many economists who do very good work, but are not part of this book. The best are generally unknown to the public, since the only means by which the public would learn of them would be through the publicity they would receive if they joined the performers.
Acquisitions, takeovers, buyouts, and leveraged buyouts (LBOs). The vocabulary can be confusing. This book only addresses the peak periods.
In the late 1980s, acquisitions (also called takeovers or buyouts) of companies were often in the form of what were called leveraged buyouts. The buyouts during this manic final phase were marked by much more debt financing (bonds, bank loans) than equity financing (cash, stock). The companies leading the buyouts were commonly (though imprecisely) called leveraged buyout or LBO firms. This period is discussed in Chapter 6.
The largest of these “LBO firms” were actually private equity firms (for example, Kohlberg Kravis Roberts & Co. (KKR). The “private” refers to equity not traded on a public exchange. During the culmination of the (circa) 2004-2007 buyout mania, some private equity firms were, once again, using less equity financing and much more debt financing. For all intents and purposes, these deals were LBOs. The media had a difficult time deciding the correct vocabulary (since the amount of equity was so small compared to the amount of debt) and firms such as KKR were called private equity firms, or LBO firms, or sometimes buyout firms. These terms are used interchangeably in Chapter 25.
This book stops at the peak. Sort of. Greenspan could not stop talking. He continued his open-mouth policy into 2009. The more he reminded the public of his existence, the more his reputation suffered. This belated condemnation of Greenspan was inseparable from current events. Also, Bernanke’s Federal Reserve is inseparable from the financial terrain that Alan Greenspan bequeathed to him. I have not attempted to describe this postbust period comprehensively, but only incidentally.
The book concentrates on the United States and mentions events overseas only as they relate to the United States. The change in how Americans thought and behaved over the past half-century has applications in other countries, but that is a very large topic.
INTRODUCTION TO PART 1
PRELUDE TO POWER
1926–1987
[O]peration in securities is not mainly a matter of reasoning at all.… The stock market … is just a bunch of minds—there is no science, no IBM machine, no anything of that sort, that can tame it.1
—Edward C. Johnson II, 1963, President, Fidelity Investments
Alan Greenspan’s success was partly due to good timing. He reached maturity at mid-century. His strengths attracted an America in which the process of thinking was changing. Substance was yielding to superficiality. Matter surrendered to abstraction.
Money was becoming more abstract. In 1900, Americans, and citizens of most western European countries, held a currency that was convertible into gold. Americans who distrusted the dollar’s value had the right to trade their paper for gold at a fixed, statutory rate. The value of the dollar fluctuated within a narrow range, and the prices of goods and services were more or less fixed.
Today, a dollar is worth whatever we wish it to be. It is a symbol, no longer fixed to a disinterested, inert metal. Inflation is one result. The successful careers of pandering politicians and clever opportunists are another. An object that cost $1 in 1913 (when the Federal Reserve Act was passed) costs $20 today. Inflation of money was integrated into the
1 First Annual Contrary Opinion Foliage Forum,” 1963, from Charles D. Ellis and James R. Vertin (eds.), Classics: An Investor’s Anthology (Homewood, III.: Dow Jones-Irwin, 1988), p. 392.
1 twentieth-century inflation of words, constant distractions, and media promotion. Thus, there came the worship of celebrities simply because they are celebrities and the success of one pandering politician and clever opportunist: Alan Greenspan.
Alan Greenspan grew up in New York City, a metropolis that illuminates the changing tendencies and aspirations of Americans. Greenspan spent his young adulthood near or on Wall Street. In 1945, New York was the largest manufacturing city in the United States.2 It was a city that made things. By 2008, it was no longer a working-class town. Nor was it a middle-income town. In Manhattan, 51 percent of neighborhoods were identified as being high-income and 40 percent as being low income.3 Publicity and finance priced out the factories. The chairman of Lever Brothers, a soap manufacturer, explained why, in the mid-1950s, he moved his headquarters to Manhattan: “The platform from which to sell goods to America is New York.”4
Lever Brothers sold an image; the image sold soap. Alan Greenspan also sold an image—productivity—but it was debt that boomed until it was too large to be paid back. From the time Greenspan was named Federal Reserve chairman until he left office, the nation’s debt rose from $10.8 trillion to $41.0 trillion.5 Greenspan usually referred to the debt as “wealth.” This image matched what he was selling—first stocks, then houses. He expanded money and credit; he oozed praise for derivatives. The larger volume of credit shrunk the consequences of immediate losses. It was easy to overlook the areas of the economy that had shriveled and the instability of finance that had compounded over the past half-century. In early 2007, this massive inflation of paper claims, many of which were claims on abstractions rather than on material assets, tottered, then collapsed. The first to go was the subprime mortgage market.
Credit creation filled the void of falling production. In 1950, 59 percent of U.S. corporate profits were from manufacturing; 9 percent were from financial activities. During the past decade (2000–2008), 18 percent of profits were from manufacturing and 34 percent were from finance.6
2 Robert A. M. Stern, Thomas Mellins, and David Fishman, New York 1960: Architecture and Urbanism between the Second World War and the Bicentennial (New York: Monacell: Press, 1995), p. 19.
3 Sam Roberts, “Study Shows Dwindling Middle Class,” New York Times, June 26, 2006.
4 Stern et al., New York 1960, p. 61.
5Figures from end of years he entered and left office. “Beginning of office” is December 31, 1987, from Federal Reserve Flow of Funds Account; “end of office” is December 31, 2005.
After graduating from New York University in 1948, Greenspan took a job at the Conference Board. He received a master’s degree from NYU in 1950; then studied economics under Arthur Burns at Columbia University. The two became lifelong friends. Arthur Burns served as chairman of the Council of Economic Advisers under President Dwight Eisenhower. He would become Federal Reserve chairman under President Richard Nixon. Greenspan headed President Gerald Ford’s Council of Economic Advisers (CEA) when Arthur Burns was Federal Reserve chairman.
In 1953, investment advisor William Townsend recruited Greenspan; the pair formed an economic consulting firm, TownsendGreenspan & Co. When William Townsend died in 1958, Greenspan became the sole owner.
Greenspan is sometimes described as a disciple of Ayn Rand’s Objectivist philosophy or as a libertarian. However, he may not even have understood what Rand was talking about. Nathaniel Branden, who was closest to Greenspan’s mind during this period, reflected decades later: “I wondered to what extent he was aware of Ayn’s opinions.”7 Alan Greenspan’s contributions to group discussions were meager. Alan Greenspan was not philosophical; he was practical and, either by nature or by design, vague, remote, and impenetr
able.
Greenspan used his Randian acquaintances to climb the political ladder. He joined Martin Anderson’s policy research group during Richard Nixon’s 1968 campaign for the presidency. Anderson, who traveled in Objectivist circles, later introduced Greenspan to Ronald Reagan.
Greenspan was riding the wave of the growing influence of accredited economists. By the late 1950s, Greenspan’s stock market predictions and economic forecasts were quoted in Fortune and the New York Times. His forecasts were usually wrong, as are those of most economists. Accuracy was less important than publicity.8
6 Bureau of Economic Analysis (BEA) National Income and Product Accounts (NIPA) Table 6.16B,C,D. Income by industry has been so erratic over the past decade that the totals for 2000–2008 are averaged as a comparison to 1950.
7 Nathaniel Branden, My Years with Ayn Rand, (San Franciscio: Jossey-Bass, 1999) p. 160.
8 The pervasiveness of publicity was to smother American life, but it was not new; the old may have been even bolder than today. From the pitch to sell the movie Alimony in 1924: “Brilliant men, beautiful jazz babies, champagne baths, midnight revels, petting parties in the purple dawn, all ending in one terrific smashing climax that makes you gasp.”
Greenspan observed Federal Reserve Chairman William McChesney Martin Jr. lose the fight against inflation. In 1957, Martin warned the Senate that the current inflation problem that had persisted since World War II had been fostered by “economic imbalances,”9 of which the heaviest hit were those who could not protect the value of their income or their savings10—the “little man”11. Martin predicted that those with “savings in their old age would tend to be the slick and clever rather than the hardworking and thrifty.”
This was a foresighted summary of the period from 1957 to the present. Greenspan seemed to understand that permanent, underlying inflation supported asset prices. In 1959, he told Fortune that an “artificial liquidity in our financial system” could power “an explosive speculative boom.” According to the Fortune reporter: “Once the Federal Reserve was set up, Greenspan reasons, the money supply never really got short. With one eye necessarily cocked towards politics, the Fed has always maintained a more than adequate money supply even when speculative booms threaten.”12
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 1