Greenspan’s audiences soaked up his subpar predictions as if they were front-page news. In fact, they were. A front-page headline from the January 31, 1990, New York Times read: “Recession Chances Have Diminished, Greenspan Says.”33 In August of 1990, he pronounced, “ ‘those who argue that we are already in a recession are reasonably certain to be wrong.’”34 The recession’s official starting date was July 1, 1990.35 Greenspan never mentioned the existence of a recession until four years later.
In 1994, Alan Greenspan produced a history lesson that served the interests of Alan Greenspan. He spoke of a credit crunch in the spring of 1989. The Federal Reserve chairman had anticipated the problem: “In an endeavor to defuse these financial strains, we moved short-term rates lower in a long series of steps in the summer of 1992, and we held them at unusually low levels until the end of 1993—both absolutely, and, importantly, relative to inflation.”36
Greenspan’s reconstruction of his own actions grew more heroic: “Lower interest rates fostered a dramatic improvement in the financial condition of borrowers and lenders. Households rolled outstanding mortgages and consumer loans into much lower-rate debt… . And banks, which had cut back on credit availability partly because of their own balance sheet problems, were able to strengthen their capital positions.”37
32 Louis Uchitelle, “Caution at the Fed,” New York Times, January 15, 1989, p. SM18.
33Robert D. Hershey Jr., “Recession Chances Have Diminished, Greenspan Says,” New York Times, January 31, 1990, p. A1.
34Prakash Loungani, “The Arcane Art of Predicting Recessions,” Financial Times, December 18, 2000.
35 The National Bureau of Economic Research dates recessions.
36 James Grant, The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New Year: Times Books, 1996), p. 195. Greenspan’s reconstruction is covered in depth.
In The Trouble with Prosperity, James Grant wrote. “A search of the literature for examples of the personal and institutional foresight to which the chairman had alluded was unavailing.”38
Despite the fevered attention commanded by the Federal Reserve chairman when he appeared before this or that committee, Greenspan’s ignorance of the recession had gone unnoticed. The media would rather embellish a González-Greenspan feud. It made better copy.
The relationship between Greenspan, the politicians, and the press is not dissimilar to the rise of Chauncey Gardner in Jerzy Kosinski’s novel Being There. Chauncey is a slow-minded gardener whose only recreational activity is watching TV. Chauncey cannot read or write. Louis Uchitelle’s description of Greenspan’s office is from a visual age. Greenspan was said to watch CNBC in his office. Chauncey becomes a mystical seer in Washington. His fame rising, he meets the president. Chauncey tells him that growth in the garden comes in the spring and summer, but then we have fall and winter: “As long as the roots are not severed all is well and will be well again.” The president interprets this to be an economic forecast, and he “must admit … [it] is one of the most refreshing and optimistic statements I’ve heard in a very, very long time.”39
The parallel is of a man who mesmerized large pockets of seemingly intelligent people, not by any complete thought, but by phrases and words, such as “irrational exuberance,” “conundrum,” “measured,” “soft spot,” and “productivity”. His forecasting record was abysmal, yet his face would adorn the front pages of newspapers the day after he issued another meandering statement. As the Fed continued to lose control of money, Greenspan’s monetary policy seemed to be all that mattered. As his forecasts grew worse, he moved markets all the more.
Greenspan succeeded in a visual culture that was limited to short bursts of attention and limited memories.
37 Ibid., p. 195.
38 Ibid.
39 Jerzy Kosinski, Being There (New York: Grove Press, 1999), p. 54.
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10
Restoring the Economy— Greenspan Underwrites the Carry Trade
1990–1994
I think we partially broke the back of an emerging speculation in equities. . . . We pricked that bubble [in the bond market] as well. . . . We also have created a degree of uncertainty; if we were looking at the emergence of speculative forces, which clearly were evident in very early stages, then I think we had a desirable effect.1
—Alan Greenspan, February 28, 1994
The sluggish economy was probably more of a burden to Alan Greenspan than similar downturns had been to his predecessors. The failure of the New Economics (managing the economy by adjusting spending and taxes) in the 1960s and 1970s had discredited fiscal policy as a means of managing the economy. Paul Volcker received wide acclaim for reviving the economy in the early 1980s. Thus, monetary policy was thought to be capable of stimulating the American economy in the early 1990s. Why the government needed to prevent a capitalist economy from recession was rarely discussed, least of all by the socalled capitalists who expected Washington to solve their problems.
1 FOMC meeting transcript, February 28, 1994, p. 3.
121
The finger pointing was not only from the White House and congressional committees, but also from members of the FOMC. Federal Reserve Governor Wayne Angell thought that problems could have been averted if the Fed had recognized the recession sooner. Angell explained the consequences of the Fed’s late start: “[I]f we hadn’t had the recession then we wouldn’t have ended up with a three percent fed funds rate.”2 The funds rate had briefly flirted with 10 percent in early 1989. It encountered no headwinds as it plummeted to 3 percent by late 1992.
Bank solvency improved and capital was restored with a nod of thanks to Greenspan. The Fed cut the funds rate 24 consecutive times between 1989 and 1993.3 Banks refinanced their balance sheets by borrowing short and lending long. In this case, they were lending to the government—buying longterm Treasury securities. This preference for 10-year Treasuries meant the marginal dollar was not lent to business: “Greenspan and others took every chance they could to urge, if not beg, banks to lend.”4 Tacitly, Greenspan approved the banks’ preferred strategy by steadily cutting the funds rate. A surprise rate increase during this tumble might have frightened the brazen. Political pressure may have deterred Greenspan from initiating a change in direction. Both Greenspan and George Bush were running for reelection.
Greenspan’s 1991 Reelection
Greenspan’s term as Fed chairman was to expire on August 11, 1991.5 President Bush did not divulge his inclinations. The Fed cut the discount rate on August 6, 1991. Bush reappointed Greenspan to a new term as Fed chairman on August 9.6 Normally, changes in monetary policy (such as increasing or decreasing rates) are made at meetings of the Federal Open Market Committee (FOMC). The FOMC meets about every six weeks. It had last met on July 2–3, and it would next meet on August 20, 1991. In this case, the FOMC held a conference call between meetings, and its decision to reduce the discount rate was announced the next day, August 7. At the July 2–3 meeting, the FOMC had voted unanimously “to stay on hold and in neutral.”7 The committee may have been anxious (legislators had introduced a bill to strip Fed presidents of their vote on monetary policy), but the next meeting was only two weeks after the conference call.8 The chairman’s stars were aligned: the timing of the conference call, the decision to cut the discount rate, the president’s reappointment, and the date on which Greenspan’s term was to end were a fortunate combination.
2 Steven K. Beckner, Back from the Brink: The Greenspan Years (New York: John Wiley & Sons, 1996), p. 215.
3 James Grant, The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New York: Times Books, 1996), p. 192.
4 Beckner, Back from the Brink, p. 245. In early 1991, Greenspan told the Senate Banking Committee that the Fed had seriously considered buying commercial bank loans to ease the credit crunch. The looming question, Greenspan explained, was whether the
Fed should become “effectively a commercial banker.” Ibid., p. 226.
5 Ibid., p. 432: “Bush made what is known as a recess appointment while Congress was not in session. Greenspan’s term as chairman expired on August 11, 1991, and his term as governor on January 31, 1992. Announced August 9, the recess appointment took effect August 10. Not until March 2, 1992 was Greenspan formally designated to a second four-year term, expiring March 2, 1996. He was also given another full 14-year term as a member of the Board of Governors, expiring January 31, 2006.”
This was a recess appointment, since Congress was not in session. The legislators would vote on the president’s choice in 1992. On December 17, 1991, President Bush, who had been talking cheerfully about the economy, spoke bluntly: “I am less interested in what the technical definition [of recession] is. People are hurting. When there’s this kind of sluggishness and concern—definitions—heck with it. Let’s get on with the business at hand.”9 The next day, General Motors announced that it was laying off 70,000 workers and closing 21 manufacturing plants.10 Two days later, on December 20, 1991, the Fed cut the discount rate by a full percent (from 4½ percent to 3½ percent) and the funds rate by onehalf of one percent (from 4½ percent to 4 percent).11
The Senate Banking Committee delayed Greenspan’s reconfirmation. On January 29, 1992, the senators grilled Greenspan, then gave him a long list of questions to answer in writing.12 It looked as if they were keeping the Federal Reserve chairman after school for punishment.
6 Ibid., p. 244.
7 Ibid., p. 243
8 Ibid.
9 Ibid., p. 260.
10 On 21 plants and Bush quote, ibid.; on 70,000 laid off, Doron P. Levin, “General Motors to Cut 70,000 Jobs; 21 Plants to Shut,” New York Times, December 19, 1991. 11 Beckner, Back from the Brink, p. 261.
12 Ibid., p. 269.
Congress had little to complain about. The lack of credit extended by the banking system stymied the economy, but it is not clear that the conduits of a recovery—businesses and households—wanted to borrow. Nonfinancial businesses reduced their debt loads in 1991 and 1992. Consumers continued to borrow more, but at a slower rate than in the 1980s. The Fed had cut reserve requirements for banks in late 1990, an unusual move for the Federal Reserve Board and certainly indicative of the Fed’s efforts to get the machinery moving.13
A more orthodox approach is for the Fed to pump money into the banking system. Banks then lend and the economy grows. Usually. There was a snag though—the banks were short of capital, so lending was constrained.
But the relationship between banking and business was changing The bond market and derivative growth played a larger role in refloating the American economy in the 1990s. The bank credit system would recover, but it would not reclaim its predominant role in the economy. In 1980, banks handled 58 percent of savings and investment assets in the U.S. economy. This had faded to 33 percent by 1994.14 Since the Fed is directly involved in the money supplied to the banking system but has limited sway over the bond market, monetary policy would have less influence over the economy.
Financial innovation played a larger role in nonfinancial corporations. Since the 1970s, corporate treasury departments had embraced derivatives to survive interest-rate and exchange-rate volatility (after the gold standard was abandoned). These were the real McCoy—derivatives used by a manufacturer to hedge against currency losses when, for instance, a company sold soap in a country other than where its production plant was located.
Leveraged Speculation Restores the Economy
Investment banks, most of them publicly traded companies by now, took more risk. They sold complicated derivative products to their clients, who absorbed much of this risk, often unwittingly. In the early 1990s, treasury departments of the largest department stores and computer manufacturers used such strategies to heal wounded balance sheets.
13 Ibid., p. 209. On December 4, 1990, the Fed announced that it was eliminating the 3 percent requirement on nonpersonal time deposits and net eurocurrency liabilities by December 27, 1990. This added $13.6 billion to the credit system.
14 Peter Warburton, Debt and Delusion: Central Bank Follies That Threaten Economic Disaster (Princeton, N.J.: WorldMetaView Press, 2005), p. 9.
As the Fed dropped the overnight funds rate to 3.0 percent, the spread between short-and longterm yields grew more profitable. Commercial bank borrowing of government securities leapt from $30 billion in 1989 to over $100 billion in 1991 and 1992.15 In both these latter years, commercial banks reduced both commercial and consumer credit lending.16
The investment banks had gone beyond underwriting and now acted as an alternative source of credit. They expanded their balance sheets, leveraging the capital that stood behind their solvency. They were extending more credit to the brokers and hedge funds that were buying the profitable derivative products created by the investment banks.
Bear Stearns was one investment bank that lent to speculating hedge funds. William Michaelcheck, a senior managing director of the firm, analyzed the market: “We think that there has got to be $100 billion to $200 billion of this right now, of investment partnerships, going from the biggest to the smallest, buying one-, two-and three-year Treasuries and financing them day to day, speculating on interest rates. And the people who have done this over the past year have made a fortune.”17
Michaelcheck was quoted in October 1991, when the funds rate was 5¼ percent. Fortune making grew in magnitude, and apparent ease, as the Fed lowered the funds rate to 3.0 percent a year later. It would sit at 3.0 percent until February 1994, when it was raised to 3¼ percent.
There are no margin requirements in the government bond market.18 If the lender is willing, the borrower’s leverage is unlimited. In The Trouble with Prosperity, James Grant tells of meeting with an investor who had earned $300,000 over the previous weekend. Every dollar contributing to this return had been borrowed—all $769 million of them.19 This was to be known as the “carry trade.” Speculators borrowed at a cheap rate—such as a Treasury bill, yielding 3 percent. They bought higher-yielding securities, such as Japanese government bonds that yielded around 6 percent. They expected (or hoped) that the borrowed asset would not rise in price. They leveraged the 3 percent spread at 10:1 or 100:1. Up to the present, the carry trade has funded fortunes in New York, London, Tokyo, and Shanghai. The securities that were borrowed and lent would change, but the strategy did not. This was another reason that central banks had less influence than they had during the chairmanship of William McChesney Martin. Financial flows were channeled away from funding potentially profitable enterprises. The FOMC’s calibration of interest rates could not keep pace with the evolving motivations of borrowers.
15 Federal Reserve Flow of Funds Accounts Z.1, http://www.federalreserve.gov/releases/ z1/Current/data.htm.
16 Federal Reserve Flow of Funds Accounts Z.1
17 Grant, The Trouble with Prosperity, p.191.
18 Ibid., p.187.
19 Ibid.
Congress did not quibble. Maybe it did not understand the economy was bound together with leveraged finance. In any case, it had reason to keep quiet: the federal deficit rose from $155 billion in Ronald Reagan’s final year of service to $290 billion in 1991.20 Demand for Treasuries from speculators held the cost of government borrowing down. (In 1991, longterm Treasury yields fell from 8.3 percent to 7.3 percent.)
How Can One Save?
Americans are admonished for not saving, but it was difficult to save when being propelled along the roller coaster of volatile interest rates, inflation, and the stock market. During the 1970s, the middle class had been jarred by inflation. As the Federal Reserve loosened its monetary policy in the early 1990s, interest rates fell across the spectrum of maturities. An investor might have been too frightened to step into the stock market during the 1980s (memories of the 1966–1982 swoon remained vivid) but could earn 13 percent on a certificate of deposit.21 By 1992, CDs yielded only 4 percent. In 1990, food prices rose at th
e fastest rate since 1980.22 Saving looked more and more like the losing proposition of the 1970s.
20 research/stlouisfed.org/fred2/data/FYFSD.txt.
21 Maggie Mahar, Bull! A History of the Boom, 1982–1999 (New York: HarperBusiness,
2003), p. 114.
22Food and beverage inflation was 4.6 percent in 1990; www.bls.Gov/opub/ted/1999/
Jun/wk5/art01.txt.
This does not seem like the time the population at large would embrace the stock market. The recession led to a slowing of consumer borrowing, yet net cash flows into stock mutual funds rose from $8 billion in 1985 to $13 billion in 1990 to $79 billion in 1992 and to $127 billion in 1993. In 1992 and 1993, money market funds suffered net outflows.23 The stock market was about to replace the bank deposit system (and money market funds) as the backbone of household wealth.
The Recovery: Cutting Workers and Investment
The economists declared the recession was over in March 1991, but there was little evidence of a recovery. Moreover, the large layoffs that followed were different from previous recessions; now, management was dismissed en masse. When 70,000 workers were laid off from General Motors in December 1991, CEO Robert Stempel announced that GM’s salaried workforce (that is, management) was being cut from 140,000 in 1985 to 70,000 by 1995.24
The median household income fell from $46,670 in 1989 to $44,665 in 1994. It would start to rise again, but this was not much above the $43,677 median income in 1973.25 More important than the data were the mass firings that made a “career” seem more a wish than a pursuit.
Layoffs and capital spending reductions had a salutary effect on companies that had bulked up on debt in the 1980s. Squeezing costs to raise profits may be just what any one company needs. When applied across the economy, however, the capacity for real economic growth withers. This recovery lacked investment in capital equipment.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 14