30 Ibid.
31 Ibid., p. 129.
It would be difficult to overstate the influence of the quarterly productivity announcement in the great bull market in the late 1990s. During the technology boom, anticipation of this news release emptied pharmacies of antacid tablets. Yet, it was a hoax.
The geometric averaging and quality adjustments inspired by the Boskin Commission were—and still are today—only a few of the false adjustments to inflation. The mathematical hijinks increased the “real” gross domestic product calculation, but GDP itself is not real. It overstates growth by adding “real” adjustments, as is true with the “productivity” calculations.
Entering the second half of the nineties, the stage was set: the Federal Reserve chairman, who had been wrong on almost every prediction he had ever made, would lift markets to heights never before achieved, largely because of his predictions. These were not even of the stock market itself, but of a supposed link between the government’s rising productivity measurement and the correct price for the stock market. The measurement was false and was probably not believed by the Federal Reserve chairman. Nevertheless, the productivity calculation and its link to the stock market dominated headlines once the Federal Reserve chairman emphasized its importance. There was little rebuttal. Those who rebutted (and there were vocal dissenters) were shouting into a gale.
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13
“Irrational Exuberance” and Other Disclosures
1995–1998
Federal Reserve Board Chairman Greenspan isn’t talking about the stock market these days. In fact, the word among Fed officials is: don’t use the word “stock” and “market” in the same sentence. No one wants the blame for the crash.1
—Wall Street Journal, November 25, 1996
In tandem with his recommendations to Congress that government inflation calculations be changed, Greenspan used the FOMC as a sounding board for his productivity claim. At the August 1995 FOMC meeting, Greenspan alerted committee members to “a major statistical problem.” He also offered a solution: “[W]e are getting increasing evidence that we probably are expensing items that really should be capitalized. This is the issue with software.”2
Software was the perfect boost to the productivity measurements. Just before Greenspan spoke, a Fed staffer said: “At present, when software is not bundled with the computer, it is counted as an intermediate product.”3
1 “The Outlook: Worried Fed Watches Markets Climb,” Wall Street Journal, November 25, 1996, p. A1.
2 FOMC meeting transcript, August 22, 1995, p. 6.
3 Ibid.
157
Intermediate products are not included in the national product—the GDP. The staffer had explained that reclassifying software as final output would increase productivity. (More accurately, it would boost the government’s measurement of productivity. The government’s accounting categories do not affect the productivity of the economy.) The staffer tutored the FOMC novices. He explained the relationship between higher GDP and productivity: “If output of software has been growing faster than other output, that would push up ‘true’ output growth. . . . [I]t may well be that productivity is growing faster and that we just are not measuring output properly.”4
Greenspan explained the relationship between his inference and the stock market: “We have all seen, as I think you are aware, a number of industries in which the ratio of the stock market value to book value is much higher than one. . . . The stock market is basically telling us that there has indeed been an acceleration of productivity if one properly incorporates in output that which the markets value as output.”5
It is a brave man who declares “what the stock market is . . . telling us.” Another interpretation would consider the Netscape initial public offering two weeks before this meeting, calculate the Nasdaq’s 36 percent year-to-date rise, reflect on the Fed’s July decision to loosen money, and postulate that the stock market had decided the Fed was throwing fuel on the fire and it was time to make fast money.
Greenspan’s interpretation was bound by an airtight equation: the stock market price is always correct. It is the known quantity. The economy is a menagerie of variables. In the years to come, Greenspan would introduce, interpret, reinterpret, reconstruct, and abandon particular variables. Here, at the unveiling, it is an understated book value that must be reconstructed by turning an expense into a capital investment.
The infallibility of the stock market was most important to Greenspan, since he was retreating from responsibility, or even a discussion of asset bubbles. The entire miracle economy consisted of a series of abstractions: stock market prices; software output; productivity; a “conceptual economy.”
4 Ibid. 5 Ibid.
In November, two meetings later, Michael Prell, the director of research at the Fed, tried to enlighten the chairman: “On the trend of potential output growth . . . recent evidence of surprises in productivity growth disappears. We seem to be running on a trend that has been in place for well over a decade. . . . It doesn’t suggest that there has been a radical revolution over this decade relative to where we were running before.”6 At the same meeting, Alan Blinder, vice chairman of the Federal Reserve, warned the FOMC not to “get excited about something that is not there.”7 Daniel Sichel, an economist on the Fed staff, who resigned and wrote a book. The Computer Revolution, published in 1997, rebutted the acceleration of productivity: it was a myth.8
Greenspan was not to be deterred. Years later, the Wall Street Journal reviewed the chairman’s campaign:
Alan Greenspan began to push a reluctant Federal Reserve to embrace his New Economy vision of rapid productivity growth and rising living standards. . . . In October 1995, a group of supply managers from various industries visited the Fed to discuss the latest in high-efficiency “just-in-time” inventory management. . . . [One of the] executives described routing goods to drugstores: “They would load up a truck and without having orders send the truck out. The drugstore computer system would call the supplier, which would call the truck on the road and say, ‘Go to suchand-such store and deliver the following items’” . . . To [Edward] Kelley, the retiring Fed governor . . . who referred to himself as “an old inventory manager” . . . this was like “going to Mars.”9
The Greenspan Hypothesis
The Fed chairman presented his proposal as a coherent whole at the December 19, 1995, FOMC meeting. He raised “a broad hypothesis about where the economy is going over the longer term and what the underlying forces are.”10 Greenspan was puzzled: “One would certainly assume that we could see [the acceleration of technological change] in the productivity data, but it is difficult to find it there. In my judgment there are several reasons, the most important of which is that the data are lousy. . . . [W]e are not capitalizing various types of activities properly. . . . That creates economic value in the stock-market sense, and we are not measuring it properly.”11 He had been looking at business cycles since the late 1940s, and “there was just nothing like this earlier.”12
6 FOMC meeting transcript, November 15, 1995, p. 16.
7 Ibid., p. 18.
8Daniel E. Sichel, The Computer Revolution (Washington DC: Brookings Institution, 1997).
9Greg Ip and Jacob Schlesinger, “Did Greenspan Push US HighTech Optimism Too Far?” Wall Street Journal, December 28, 2001.
The Federal Reserve chairman might control the debate, but he did not control the government numbers. It would be best if the productivity figures supported his hypothesis. The reclassification of software as a capital expenditure in 1999 helped.
The gestation of his productivity brainstorm approximated the period in which he was cutting the fed funds rate during his 1995–1996 reelection campaign. Greenspan broached his productivity rationalization at the August 1995 meeting and turned it into a hypothesis at the December 1995 meeting. The Federal Reserve cut the funds rate by 0.25 percent on July 6, 1995, December 19, 1995, and January 31, 19
96.
Irrational Exuberance
Alan Greenspan’s speeches will not tax the editors of Bartlett’s, but one phrase has stuck: his warning of “irrational exuberance” on December 5, 1996. That it struck such a nerve is more important than the phrase itself. He could not have raised the possibility in a more tentative fashion. (“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”13) There was no mention of manias or crashes. He used the word bubble only to imply that he was not anxious: “We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability.”
10 FOMC meeting transcript, December 19, 1995, p. 35.
11 Ibid., p. 37.
12 Ibid.
13 Speech available at http://www.federalreserve.gov/boarddocs/speeches/1996/ 19961205.htm.
He was speaking in the midst of a stock market bubble, and almost everyone feared it or knew it, including the Federal Reserve. On November 25, 1996, the Wall Street Journal had reported: “Federal Reserve Board Chairman Greenspan isn’t talking about the stock market these days. In fact, the word among Fed officials is: don’t use the words ‘stock’ and ‘market’ in the same sentence. No one wants the blame for the crash.”14 Two days later, the Bank for International Settlements (the central bankers’ central bank) warned about the “prevailing euphoria” in global credit markets.15
At the September 24, 1996, FOMC meeting, Greenspan said: “I recognize that there is a stock market bubble problem at this point. . . . We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it. My concern is that I am not sure what else it will do.”16 Of course he couldn’t know what else it would do, but he had identified a stock market bubble and that he could burst it. He would later deny that he could do either.
Splicing his statements from the September 24, 1996, meeting to the December 5, 1996, speech, the drama of how the Fed would respond to a bubble was over. At the September FOMC meeting, the chairman would not act, since he was “not sure what else it will do.” On December 5, Greenspan stated that the Fed would only act if “a collapsing financial asset bubble does not threaten to impair the real economy.” Since any popped asset bubble will not only threaten but also to some degree impair the real economy, his dilemma could never be resolved. He spent the next 10 years talking.
Greenspan Raises the Funds Rate—Once
Greenspan raised rates in 1997 once: from 5.25 percent to 5.50 percent in March. It would have been far better if he had not raised rates the Fed Funds rate at all. At the March 1995 meeting, Federal Reserve Governor Lindsey reminded the FOMC of its tentative communiqués in the spring of 1993. (That was when the Fed held the funds rate at 3 percent, funding the carry-trade recapitalization of the banking industry). Lindsey had said, “I have to conclude that doing that, if anything, cemented the market’s view that we were stuck at a particular rate. It only built the market’s confidence that they could borrow at 3 percent and lend at 6 percent, which is literally what they were doing.” Lindsey warned the FOMC not to sound tough (in the form of an “asymmetric” public statement, asymmetric being any meaningful change in language from the Fed’s previous statements) if it did not have the courage to stick to its convictions (in which case it should release a “symmetric” statement, indicating no change in the Fed’s outlook): “[I]f what we fear is a bubble, we should not in my view go asymmetric unless we really expect to raise rates. . . . [Meaning—once the Fed started raising rates, and indicated publicly that it intended to pursue an objective, it should keep raising rates until the stock market’s speculative atmosphere disappeared.—author’s note] Given what we did in 1993 . . . I am afraid we would only strengthen the conviction of the market and maybe actually exacerbate the bubble.”17
14 “The Outlook: Worried Fed Watches Markets Climb,” Wall Street Journal, November 25, 1996, p. A1.
15 Grant’s Interest Rate Observer, December 5, 1996, p. 1.
16 FOMC meeting transcript, September 24, 1996, pp. 30–31.
Lindsey resigned in early 1997. The FOMC made the one-time hike in 1997 without the benefit of Cassandra’s wisdom. As in the Greek myth, Lindsey was right. After the FOMC it tightened once in 1997 and then backed off, speculators had no fear. The market never looked back. The statements by Greenspan at the early 1994 FOMC meetings show he knew that one-time rate hikes were not enough. What had changed by 1997?
The politicians may have frightened Greenspan. In January 1997, he told the Senate Committee on the Budget that “the stock market continued to climb at a breathtaking rate.”18 Before the Senate Banking Committee on February 26, 1997, Greenspan did warn, in his fashion, that the stock market was overpriced: “[R]egrettably, history is strewn with visions of such ‘new eras’ that, in the end, have proven to be a mirage. In short, history counsels caution. Such caution seems especially warranted with regard to the sharp rise in equity prices during the past two years.”19 Responding to a senator’s question, he repeated his most famous phrase, making a distinction that a three-year-old would understand: “It’s not markets that are irrational. It’s people who become irrationally exuberant.”20 That he thought it was worth mentioning signifies his timidity.
17 FOMC meeting transcript, March 28, 1995, p. 48.
18 Senate Committee on the Budget, “Performance of the U.S. Economy,” January 21, 1997.
Senator Phil Gramm from Texas disagreed with the errant forecaster: “I think people hear what you are saying and conclude that you believe equities are overvalued. I would guess that equity values are not only not overvalued but may still be undervalued.”21 On March 4, Greenspan spoke before the House Committee on the Budget.22 Congressman Jim Bunning from Kentucky told Greenspan that the chairman’s stock market forecast was “misguided.”23 This may seem like a topic that was beyond the congressman’s brief, but he was vectoring toward the most destabilizing influence of Greenspan’s freelance opinions: his inflammation of the stock market. “ ‘My question to you,’” Bunning said, “ ‘is why have you, on two occasions, taken to jawboning the U.S. stock market and the U.S. bond market with your comments to affect a free and open market as head of the Federal Reserve Board, which is in charge of setting monetary policy?’”24
Chairman Greenspan replied that markets have a direct influence on monetary policy.25 This is true. Greenspan would deny this link— and the Federal Reserve’s responsibility—as the bubble grew fearsome. While stocks rose, there was no one person who was more responsible for the stock market mania. The chairman disowned his personal influence when he responded to Bunning: “ ‘Nobody can affect [markets] in a fundamental way.’” This may be true, but Bunning questioned Greenspan because the chairman’s influence was anything but fundamental. It was—take your pick—emotional, abstract, spiritual, or absurd, but not fundamental. Richard W. Stevenson, a reporter at the New York Times, wrote the next day that Bunning was “clearly not satisfied with Mr. Greenspan’s protestations of innocence and impotence.”26 This is a remarkable summation of Greenspan’s road to success. Congressman Bunning, a former major league pitcher, winner of 224 games and member of baseball’s Hall of Fame, achieved that success by preying on hitters’ weaknesses. Greenspan’s self-effacing innocence and impotence was obvious to the hurler, who hit more batters than all but 10 pitchers in the history of baseball.
19 Senate Committee on Banking, Housing, and Urban Affairs, “The Federal Reserve’s Semiannual Monetary Policy Report,” February 26, 1997.
20 Floyd Norris, “A Warning Investors Have Ignored Before,” New York Times, February 27, 1997, p. D1.
21 Jerome Tuccille, Alan Shrugged: The Life and Times of Alan Greenspan, the World’s Most Powerful Banker (Hoboken, N.J.: Wiley, 2002), p. 226. Tuccille also
gives comments from Jim Bunning, writing as if Bunning were a senator and speaking at the same meeting as Gramm. Bunning was a congressman at the time.
22 House Committee on the Budget, “Bias in the Consumer Price Index,” March 4, 1997.
23 Tuccille, Alan Shrugged, p. 226.
24 Richard W. Stevenson, “Terse Congressman Questions Greenspan’s Market Motives,” New York Times, March 5, 1997.
25 Ibid.
The day after the chairman’s February 26, 1997, testimony before the Senate, he was in the headlines of the New York Times: “Greenspan Warns Again that Stocks May Be Too High.” If that didn’t upset the markets, there was another headline in the same newspaper “Greenspan Speaks and Stocks Plunge.” The Times published seven articles that mentioned Greenspan on February 27.27 The following day, it published seven more, including an editorial: “Wise Warnings to Giddy Investors.”28
Whether it was fear of politicians or not, Greenspan did not raise the funds rate again. He worked on his productivity hypothesis instead.
The Subprime Warning
Other markets were running amok. Asset-backed derivatives had spread beyond the homely mortgage and credit card receivables. The market was buying untested securities such as future receipts of Pakistan Telecommunication Corporation, credit card transactions in Mexico, airline-ticket payments for TACA International (an El Salvadorian airline), automobile installment payments in Thailand, and David Bowie’s future album receipts (a rock star who had peaked in the 1970s).29 Closer to home, the fastest growing subprime lenders were filing for bankruptcy (e.g., Jayhawk Acceptance), suffering downgrades (e.g., Olympic Financial), and disclosing fraud. (In February, Mercury Finance Company, “the Mercedes-Benz of the subprime auto lending industry,” disclosed that 50 percent of its 1996 net income never existed.30)
26 Ibid.
27 Source for New York Times articles: proquest.bpl.org.
28 The seven articles include “If Groundhogs Were Boastful: ‘I Hate to Say I Told You So.’”
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 18