Over the coming months, this cycle of subprime lending unwound. Nonpayment on mobile-home loans produced default charts that looked like hockey sticks. These loans would never have been offered if the financier had not been able to sell them to an investment bank. The investment bank acted as a veteran second baseman in a double play—it bought the mortgage (from the financier) and sold it (in an asset-backed security) as quickly as possible to an investor. A pension fund or mutual fund investor now owned the trailer (through the purchase by its yield-and bonus-chasing money manager). Each of the participants along the assembly line profited. Bankers earned fees and pension plans earned interest until the defaults swelled. The pension plan bore all the losses. (The evicted trailer owner was none the better, either.)
“Bulldog,” a 325-pound automobile repo man and “credit adjuster” from Dallas, explained the inevitable consequence of lending in the subprime loan market: “Aw, it’s just a bunch of Wall Street intellectuals showing how dumb they are. How are you going to make money off people that don’t have any money? I don’t think these Wall Street folks have any idea what they are dealing with.”31 Nor did the Fed.
At the time Bulldog shared his sound banking philosophy, subprime home lenders were sprouting wings. Ameriquest Mortgage, New Century Financial Corporation, and Countrywide Credit Industries Inc., were busy selling subprime mortgages to Wall Street firms. It was not a coincidence that they were based in or around Irvine, California, home to Lincoln Savings and Loan and other detritus of the previous decade’s savings and loan fraud.
29 Grant’s Interest Rate Observer, February 14, 1997, p. 9.
30 Ibid., p. 2.
31 Ibid., p. 4.
At the December 1996 meeting, two weeks after the chairman’s irrational exuberance speech, Lindsey broadened the FOMC’s concerns beyond stocks. He warned that 1997 would be a “very good year for irrational exuberance” in credit.32 Bank lending had exploded. Broad credit expansion as calculated in the Fed’s M3 measurement was rising at the fastest rate since 1987, and before that, at the fastest rate since the early 1970s.33 A large proportion of the 1970s’ growth rate included price inflation. In 1987, M3 growth veered toward asset inflation—stocks, bonds, and derivatives. This was also true in 1997, a year in which the Nasdaq rose 22 percent.
The carry trade was a giant of its former self. Net borrowings of government bond dealers doubled between early 1994 and early 1998.34 Dealers borrow so that they can lend to investors and to speculators, or to leverage their own positions. Commercial banks, over which the Federal Reserve had regulating authority, played an important role.
“As I Noted Earlier”—When? Where?
As the Greenspan Fed withdrew from monitoring asset bubbles and bank lending, the chairman’s hypothesis was about to go public. The chairman revealed it to Congress at intervals. Before the House Committee on the Budget on October 8, 1997, Greenspan claimed: “Clearly, impressive new technologies have imparted a sense of change in which previous economic relationships are seen as being less reliable now. . . . An acceleration of productivity growth, should it materialize, would put the economy on a higher trend growth path than [federal agencies] have projected”35 [author’s italics]. Later in October, Greenspan told Congress: “While productivity growth does appear to have picked up in the last six months . . . it will take some time to judge the extent of a lasting improvement.”36
He continued to discuss productivity in this tentative form before
32 FOMC meeting transcript, December 17, 1996, pp. 28–29.
33 M3 grew 7.3 percent in 1997, 9.9 percent in 1998, and 10.4 percent in 1999.
34 Grant’s Interest Rate Observer, February 27,1998, chart, p. 2.
35 House Committee on the Budget, “Economic and Budgetary Outlook,” October 8, 1997.
36 Before the Joint Economic Committee (“Turbulence in World Financial Markets”) on October 29, 1997.
Congress in late January and early February 1998.37 In testimony before Congress in February 1998, he shifted from the future tense to the here and now: “As I noted earlier, our nation has been experiencing a higher growth rate of productivity—output per hour worked—in recent years. The dramatic improvements in computing power and communication and information technology appear to have been a major force behind this beneficial trend”38 [author’s italics].
“As I noted earlier” was presumptuous. His only previous theorizing before Congress was in the test-tube stage (“should it materialize”).39 His discourse also diluted such otherwise urgent questions as: “Are you concerned with the stock market?” Bubble talk was everywhere, including to the FOMC, but the chairman ignored it.
37 Senate Committee on the Budget, “The Current Fiscal Situation,” January 29, 1998; House Committee on Banking and Financial Services, “The Current Asia Crisis and the Dynamics of International Finance,” January 30, 1998; he repeated this testimony before the Senate Committee on Foreign Relations, February 12, 1998.
38 House Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, The Federal Reserve’s Semiannual Monetary Policy Report, February 24, 1998.
39 At the January 29, 1998, appearance before the House Budget Committee he thought, “productivity appears to have accelerated sufficiently last year to damp increases in unit labor costs.”
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14
In a Bubble of His Own
1998
I won’t take up your time with the umpteenth restatement of our skepticism regarding the sustainability of these valuation levels.1—Michael Prell, Federal Reserve economist, in presentation to the FOMC, at June 30–July 1, 1998, meeting
It might be forgotten now, but the astounding close to the second millennium was preceded by an already astonishing run. Between 1992 and 1997, the S&P 500 Index compounded at 27 percent a year.
Southeast Asia had drawn investment flows in the early 1990s. Foreign investment then stalled. In mid-1997, Asian markets buckled. Investment exited, and many of the Asian stock and currency markets had collapsed by the end of the year.
The U.S. stock and bond markets were a natural outlet for funds. This boosted the dollar. U.S. interest rates fell, and lower interest rates fueled more borrowing and leveraging. The atmosphere fed on itself: there grew a cadre of enthusiasts who sometimes quit their jobs to “day trade.” A late 1997 Montgomery Securities poll showed that investors expected a 34 percent annual stock market return over the next decade. Upon such an achievement, the Dow Jones Industrial Average would top 151,000.2
1 FOMC meeting transcript, June 30–July 1,1998, p. 14.
2 Centurion Counsel Market Neutral N-30D, for December 31, 1997; www.secinfo.com The DJIA was 7,908 on December 31, 1997 and 13,264 on December 31, 2007. It fell to 6,457 on March 9, 2009 before its recent recovery.
169
Yet Greenspan was deaf and blind to the manic mood, or at least he pretended to be. He needed to certify his productivity thesis to deter bubble talk. At the December 16, 1997, FOMC meeting, Jerry Jordan (president of the Cleveland Fed) tried to steer the conversation toward inflating asset prices: “Some Board members referred earlier to the dichotomy between the prices of services and the prices of goods. … [T]he notion of dichotomy also has to be applied in the case of asset prices.”3 Jordan drew a conclusion that contradicted the Fed’s myopic concentration on a steady price level of goods and services. Jordan proposed that in the 1920s, “U.S. monetary policy was … too expansionary for asset prices.”4 Putting words in Jordan’s mouth, this led to the 1929 stock market crash. He continued: “I think that it’s a useful reminder of what can go wrong if we are too narrow in thinking about words like ‘inflation’ or ‘deflation’. … What do [people] mean by the word ‘inflation?’ Clearly, it cannot refer simply to the current prices of goods.”5
When Jordan finished speaking, Greenspan called on another board governor (Ned Gramlich) to speak. This was a comm
on tactic of Greenspan’s to stifle any topic he’d rather not discuss.
Greenspan thought that “[s]omething very different is happening.”6 The “something” that Jerry Jordan had identified was never addressed by the chairman. Somethings that differed from Greenspan’s somethings were never discussed by the chairman, if he could avoid them. He usually succeeded.
At the December meeting, Greenspan grew excited over his coagulating thesis: “[W]e keep getting reams of ever-lower CPI readings that seem outrageous in the context of clearly accelerating wages and an ever-tighter labor market. … I was startled by this morning’s CPI report. We cannot keep getting such numbers and continue to say that inflation is about to rise.”7 Jordan had just told Greenspan that prices were rising. In more colloquial terms, it was the share price of Microsoft rather than the store price of mayonnaise that was inflating.
3 FOMC meeting transcript, December 16, 1997, pp. 57–58.
4 Ibid., p. 58.
5 Ibid.
6 Ibid., p. 68.
7 Ibid., pp. 68–69.
The lower CPI readings were not startling. The chairman should have expected them. Of everyone in the room, he, at least, should have remembered that the Bureau of Labor Statistics was adapting the Boskin Commission’s recommendations to reduce the government-sanctioned inflation rate. The crisis in Asia had sparked an export surge. Indonesians were selling goods at any price for the privilege of importing a hard currency.
The Fed’s data hound apparently did not know Asian currencies had fallen against the dollar by over 30 percent in the past two years, the sharpest fall being in the weeks lending up to the December 1997 FOMC meeting.8 Goods exported from Asia to the United States were bought with fewer dollars. Yet Greenspan was “startled” that dollars bought more goods. Greenspan had good reason to ignore deflationary Asia: ignorance boosted his productivity argument.
“Nobody Challenged Him or Dared Say Anything”
The FOMC met again on February 3 and 4, 1998. This was about three weeks before Greenspan’s “As I noted earlier, our nation has been experiencing a higher growth rate of productivity” congressional performance. He lectured: “Productivity gains clearly have kept increases in unit labor costs at a very modest level.”9 (What happened to the “clearly accelerating wages and an ever-tighter labor market” that he asserted at the December meeting?) Maybe they had, but the FOMC was not convinced. In Maestro, Bob Woodward’s biography of Greenspan, the author wrote that the chairman’s “language was highly idiosyncratic, often not fully grounded in the data. He was prone to take leaps. At the FOMC, [Federal Reserve governor Janet] Yellen noticed the Ph.D.s on the committee, or some of the members of the staff, would be nearly rolling their eyes as the chairman voiced his views about how the economy might be changing. Nobody challenged him or dared say anything, but it weakened his hold on the committee.”10
How this “weakened his hold” is not clear, since the FOMC always voted as Greenspan wished. At the February 1998 meeting, Fed Governor Jerry Jordan might have weakened Greenspan’s hold when he queried a Fed staffer about “a wide array of other financial indicators that do not suggest a restrictive monetary policy at all.”11 If indeed the Fed’s monetary policy was loose, a lively debate concerning Greenspan’s productivity gains should have been in order. There was no discussion.
8 Andy Lees, UBS, “Terms of Trade,” January 7, 2008.
9 FOMC meeting transcript, February 3–4, 1998, p. 112.
10 Bob Woodward, Maestro: Greenspan’s Fed and the American Boom. (New York: Simon and Schuster, 2000), p. 169.
Three weeks later, on February 24, 1998, Greenspan appeared before Congress.12 He expanded on his productivity revelation. He observed that “computing power and communication and information technology” were now “available to as many homes, offices, stores, and shop floors as possible, [having] produced doubledigit annual reductions in prices of capital goods embodying new technologies.”13
Many (though not all) of these reductions were from hedonic pricing (for example, the annihilation of true computer prices had been adopted) and from the flood of Asian goods. This was so obvious that it apparently didn’t deserve mention. Currencies had collapsed and prices had soared in Asia. By August 2008, Indonesian food prices had doubled.14 President B. J. Habibie asked his people to fast two days a week—an unnecessary request, given their already shrinking waistlines.15 Financial collapse spread around the globe. Russia defaulted on its debt obligations in August 1998, and bond markets around the world scurried for cover.
11 Ibid., p. 102. Jordan then listed a series of exuberant markets: “These include not just the ample availability of credit from the banking industry but from the financial services industry more broadly, the relatively rapid growth of various measures of money, and the ongoing strength in various asset markets.”
12 Greenspan was so busy that a chronology of his early 1998 speeches and testimony might be helpful: a January 29 appearance before the Senate Budget Committee, The Current Fiscal Situation; a January 30 appearance before the House Committee on Banking and Financial Services. The Current Asia Crisis and the Dynamics of International Finance; a February 12 performance before the Senate Foreign Relations Committee (same testimony titled slightly differently: The Current Asian Crisis …); a February 24 lecture to a subcommittee of the House Committee on Banking and Financial Services, The Federal Reserve’s Semiannual Report on Economic Conditions and the Conduct of Monetary Policy, a March 3 appearance before a subcommittee of the Senate’s Committee on Appropriations, The Current Asian Crisis; and a March 4 appearance before the House Committee on the Budget, Coming Budgetary Challenges. The FOMC met on February 3–4. It next met on March 31.
13 House Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, The Federal Reserve’s Semiannual Monetary Policy Report, February 24, 1998.
14 Steven R. Tabor, World Bank Institute, “General Food Price Subsidies in Indonesia: The 1997/1998 Crisis Episode,” December 8, 2000 presentation, World Bank Institute, Washington, DC, p. 5.
The United States benefited from these calamities in obvious ways. The dollar rose against currencies that fell. These countries would sell anything, at any price, to get dollars. This was disinflationary in the United States. Lower inflation and the global flight to quality created an obsession with a single destination for global assets. The elephants in the room that Alan Greenspan failed to see outnumbered those in the Kalahari Desert. That this public servant received such applause from economists is unpardonable.
In his February 24 testimony before Congress, Greenspan linked productivity to the extremely ambitious IPO and stock market: “Critical to this process has been the rapidly increasing efficiency of our financial markets. … Capital now flows with relatively little friction to projects embodying new ideas. Silicon Valley is a tribute both to American ingenuity and to the financial system’s ever-increasing ability to supply venture capital to the entrepreneurs who are such a dynamic force in our economy.”16
Wall Street firms that had opened offices in Silicon Valley during the IPO mania could not have hired a better public relations representative. Their behavior was often scandalous (that, we knew at the time) and criminal (as the courts would decide, in due course). Greenspan capped off his ode to the venture capitalists who lined Sand Hill Road in Menlo Park, California, in a stellar summation: “More recent evidence remains consistent with the view that this capital spending has contributed to a noticeable pickup in productivity.”17 Within weeks, Michael Wolff, an entrepreneur who had taken full advantage of the pickup in productivity, published his memoir. He described Silicon Valley companies that had nothing to sell, other than common stock. In Burn Rate: How I Survived the Gold Rush Years on the Internet, Wolff admitted: “Optimism is our bank account; fantasy is our product; press releases are our good name.” His book was intended as “a sort of anti-press release.”18 Wolff, applying his American ingenuity,
diverted capital flows, or “dumb money” (his words), from the rich.19 This was the most prominent dynamic force in Silicon Valley.
15 Seth Mydans, “Vote Places Habibie in Firm Control of Indonesian Politics,” New York Times, July 12, 1998.
16House Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services, “The Federal Reserve’s Semiannual Monetary Policy Report,” February 24, 1998.
17 Ibid.
Greenspan was not as innocent as he might seem. He had shown some knowledge of how markets work three years earlier, at the December 19, 1995, FOMC meeting: “The sharp decline in longterm yields has struck me as quite extraordinary. … [W]e are getting issues of 100-year bonds. … The fact that some borrowers are issuing these bonds is terrific. Until you get somebody dumb enough to buy them.”20 By 1998, Greenspan’s productivity circumlocutions were drawing ever dumber money into the chairman’s efficiently priced stock market.
Dot-com IPOs exited Silicon Valley at a rate comparable to the speed at which they went out of business. A few of the forgettable gimmicks for raising $100 million to $1 billion from the summer and fall of 1998 include NetGravity, Broadcast.com, GeoCities, Fatbrain.com, NBCi, and uBid. They couldn’t even spell, how were they going to sell? In fact, they didn’t; these companies either burned through their cash or had been acquired by late 2001.21
Such exuberance might have frightened the investing public. However, Abby Joseph Cohen, market strategist at Goldman Sachs, was second only to Greenspan in relieving market anxieties. When Cohen spoke, it was widely and immediately reported. She referred to her model quite often; it was a happy model, happy with the world and the stock market alike. She spent much of her time on television and, like Greenspan, was invariably courteous, pleasant, and vague. It was often said she reassured investors because she looked like a middle-class housewife. This became a cliché, yet the cliché itself was reassuring.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 19