Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

by Frederick Sheehan

  CHAIRMAN GREENSPAN: I tried not to convey a view that was other than that. President Stern.10

  By calling on Gary Stern, president of the Minneapolis Federal Reserve Bank, Greenspan avoided Moskow’s comment. While Greenspan had acknowledged that Moskow was correct, he effectively dismissed the observation from FOMC discussions. Profit projections for 2003 were Greenspan’s sole lifeline at the December meeting. (For now: profits fell for the next few years, and Greenspan would hone his hypothesis accordingly.) His tactic of cutting off an uncooperative FOMC member (Moskow) by calling on someone else (Stern) was old hat.

  In retrospect, this was the meeting at which Greenspan conceded his productivity argument. Maybe he didn’t realize it; maybe nobody realized it. He would continue with his merry-go-round of justifications for the stock market, but the chairman had now introduced his escape hatch: even if he was wrong about productivity, about analyst earnings, and about all the other hokum that blessed the price of stocks, it no longer mattered from a practical sense. Having declared that a central bank could not see a bubble until after it burst, the Federal Reserve would do nothing, whatever the circumstances.

  The Federal Reserve was not alone in funding the stock market: 34 central banks cut rates 66 times in the last three months of 1998.11 Central bankers, by and large, wanted to debase their currencies.

  “The Central Banker as God”

  Alan Greenspan was now God, according to the Economist. On November 14, 1998, the hallowed periodical published an article entitled “The Central Banker as God,” which stated: “Today, Alan Greenspan . . . is revered as a god by most investors.” Yet his holiness was debated in financial periodicals. On September 29, 1998, financial writer James Grant offered a more earthly view in the Wall Street Journal’s lead op-ed, with the title: “Alan Greenspan Isn’t God.”

  No, but unquestioned faith was a dangerous gamble. This productivity thing was, of course, beyond most investors, since it was beyond Alan Greenspan. They knew about it, though, and as long as Greenspan was reported to be pleased with it, and with analysts and projections and technology and whatever else he was talking about, they bought stocks. Bob Woodward put it well: “He has become both a symbol and a means of explaining and understanding the economy.”12

  One Greenspan biographer, Justin Martin, summed up the average American’s verdict. Martin wrote of the post–LongTerm Capital Management atmosphere: “During the nervous days of 1998, Greenspan showed infallible instincts in steering the U.S. economy. It was a masterful performance, and a crucial one.”13

  Martin captured the idiom of the moment: “Greenspan’s deft handling of the Asian Contagion [the collapse of Asian markets in 1997] turned him into a bona fide celebrity. Years in the future, social historians will look back on the heady days of economic prosperity that immediately followed the crisis as Greenspan’s defining moment. The Fed chairman was promoted to iconic status and joined the ranks of Harry Houdini, General Douglas MacArthur, and Madonna.”14

  11 John Kirton, University of Toronto, “Canada as a Principal Financial Power,” 2000; http://www.g7.utoronto.ca/scholar/kirton2000/phase2.htm.

  12 Bob Woodward, Maestro: Greenspan’s Fed and the American Boom (New York: Simon & Schuster, 2000), p. 227.

  13 Justin Martin, Greenspan: The Man behind Money (Cambridge, Mass.: Perseus, 2000), p. xvii.

  The New Economy and the Old Economy were fashionable terms. Technology was New; nontechnology was Old. Stephen Koffler, an analyst at Donaldson, Lufkin & Jenrette, explained why: “[The] Internet changes valuation standards because it’s a pivotal point to changes in the economy. The Internet . . . is driving tremendous gains in productivity. It’s hard to find other times in history where that’s been true.”15 He might have considered the lightbulb, the steam engine, or the wheel.

  In March 1999, apparently losing ground with his analyst rationale, and certainly having lost credibility with Chicago Federal Reserve President Michael Moskow at the December 1998 meeting, Greenspan took the next step: “[S]ecurity analysts . . . are speaking to corporate management and getting an excess dose of optimism.”16 Greenspan expounded: “[Their expectations] are obviously not independent observations.”17 Yet, analysts remained his crutch. Greenspan noted the “extent of the acceleration in productivity” by relying on “that terribly flawed number we often discuss, the expected longterm growth in earnings per share of the S&P 500 as estimated by security analysts.”18 The admission that analyst predictions were terribly flawed was new. With any such retreat, though, a forward advance generally followed. These bursts of insight that reversed setbacks might be likened to Marshal Foch’s message during the Battle of the Marne: “My center is giving way, my right is retreating, situation excellent. I am attacking!” That was in 1914. In March 1999, Marshal Greenspan thrust analyst forecasts into the breach by “presum[ing] that the bias in those numbers has not changed significantly over the years.”19

  14 Ibid., p. 221.

  15Ibid., Greg Ip, “Internet Valuations Explode, Sparking Debate,” Wall Street Journal, December 28, 1998.

  16 FOMC meeting transcript, March 30, 1999, p. 54.

  17 Ibid., p. 55.

  18 Ibid., “acceleration in productivity,” p. 53; “terribly flawed number,” p. 54.

  Why would Greenspan presume that? His new consistent bias theorem had never been measured; at least, the Fed chairman cited no evidence other than his own assertion. He would repeat this refrain about bias over the next few meetings. The “we” who “presumed” the consistent bias was one Alan Greenspan (although some others were starting to hop aboard). Consistent bias was enough of a fig leaf to control the board’s tactless suggestions that productivity as justification for current stock prices was a tall tale.

  There was a more straightforward measure of productivity that Greenspan could have consulted: corporate profits. If he had pursued such a route, he would probably have consulted the Bureau of Economic Analysis (BEA) corporate profit calculations.20

  In fact, at the February 1999 FOMC meeting, Federal Reserve Economist Michael Prell emphasized the divergence between recent corporate profits the BEA had calculated, which were falling, and profit projections from Wall Street strategists, which were shooting up. Prell showed the committee a chart that displayed the two trends.21 The Wall Street projections were from I/B/E/S, the Institutional Broker’s Estimate System. To quote Alan Greenspan from a forthcoming speech, I/B/E/S is “a Wall Street research firm that compiles these estimates for the S&P 500.22 The 1999 I/B/E/S forecast looked like a hockey stick.23

  There are problems with any collection of data, but in an era when government data accentuate the positive, BEA calculations looked bleak.

  19 Ibid., p. 54.

  20 These are the National Income and Product Accounts (NIPA) produced by the Bureau of Economic Analysis.

  21 On the Federal Reserve Web site with FOMC transcripts, “Presentation Materials” are also stored. Prell’s chart can be found on p. 10, chart 3, with the heading “Earnings Outlook,” for the February 2–3, 1999 meeting.

  22Alan Greenspan, “The American Economy in a World Context,” speech at the 35th Annual Conference on Bank Structure and Competition of the Federal Reserve Bank of Chicago, Chicago, May 6, 1999.

  23 FOMC meeting transcript, February 2–3, 1999, pp. 22–23.

  Profits in the United States had peaked back in 1997. Nonfinancial profits had fallen from $508.4 billion in 1997 to $470.1 billion in 1998. This was a 7 percent drop. Given Greenspan’s remarkable history of hopping on a wagon just as it explodes, it is not surprising that the computer industry fared far worse than America as a whole: computer company earnings had fallen 84 percent, from $25.3 billion in 1997 to $3.9 billion in 1998.24

  Stock market analysts were another exploding bandwagon. They were front-page news by 1998. There was, for instance, Henry Blodget, a rookie analyst at CIBC Oppenheimer. On December 15, 1998, Amazon. com common stock traded at $242 per share. Blodget predicted that
it would rise to $400 per share. On December 30, Amazon reached $350; on January 7, 1999, it opened trading at $411, and on the next day, January 8, 1999, it rose again to $597.25 The idea that analysts would issue “price targets” was unheard of a few years back. Now, both the analysts and their firms thrived on publicity from such predictions.

  A landmark that was more noteworthy for celebration than for substance was the Dow Jones Industrial Average crossing 10,000 on March 30, 1999. CNBC turned the studio into a replica of the New Year’s countdown in Times Square. The Wall Street Journal prepared a next-morning edition stuffed with ads congratulating the stock market. Traditional measurements, such as price/earnings ratios, could no longer be calculated. Often the bellwethers had no earnings; sometimes they had no sales. This opened the way for a book that captured the latest American dream, Dow 36,000, by James K. Glassman and Kevin A. Hassett. They posted a preview on the editorial page of the Wall Street Journal on March 17, 1999: “Our calculations show that with earnings growing in the longterm at the same rate as the gross domestic product and Treasury bonds below 6%, a perfectly reasonable level for the Dow would be 36000—tomorrow, not 10 or 20 years from now.”26

  24 Richebächer Letter, July 2004, p. 11.

  25 These prices are adjusted to negate a 3:1 stock split on January 5, 1999.

  26 James K. Glassman and Kevin A. Hassett, “Stock Prices Are Still Far Too Low,” Wall Street Journal, March 17, 1999.

  Greenspan’s “Veritable Army of Technicians”: Stock Market Analysts

  Greenspan spoke at a conference sponsored by the Federal Reserve Bank of Chicago on May 6, 1999. He heralded a new era—that of a century before: “I do not say we are in a new era. . . . There was far greater justification to view the future with the unbridled optimism of a presumed new era a century ago. . . . In a very short number of years the world witnessed an astounding list of new creations: electric power and light, radios, phonographs, telephones, motion pictures, x-rays, and motor vehicles, just to begin the list.”27 This is an impressive start.

  The chairman then listed reasons that the current non-New-Era New Era was so exciting: “[I]nformation access in real-time resulting from processes such as, for example, checkout counter bar code scanning and satellite location of trucks, fostered marked reductions in delivery lead times.”28 In the words of retired Federal Reserve Governor Edward Kelley, Greenspan and his space-age delivery system were still “going to Mars.”29 Greenspan offered further evidence: before this “veritable avalanche of IT innovations, most of twentieth century business decisionmaking had been hampered by limited information.”30 Given the current price of the stock market, some would say that the more limited information was preferred to the veritable avalanche, but Greenspan held the opposite opinion: “Owing to . . . the . . . emergence of more accurate price signals and less costly price discovery, market participants have been able to detect and to respond to finely calibrated nuances in consumer demand.”31

  For the first time, Greenspan rolled out his own finely calibrated nuance in public (before, only the FOMC had been exposed to this aberration): “[My] view is reinforced by securities analysts who presumably are knowledgeable about the companies they follow. This veritable army of technicians has been projecting increasingly higher five-year earnings growth, on average, since early 1995, according to I/B/E/S, a Wall Street research firm that compiles these estimates for the S&P 500.” Greenspan did not mention the divergence on Michael Prell’s chart between I/B/E/S predictions and BEA profits.

  27 Greenspan, “The American Economy in a World Context.” He avoided “New Era” in public but was more colloquial in private. For example, at the March 30, 1999, FOMC meeting (transcript, p. 54): “I think the question on the table is whether we are looking at an aberration or at emergence of a new era.”

  28 Ibid.

  29 Greg Ip and Jacob M. Schlesinger, “Did Greenspan Push His Optimism About the New Economy Too Far?” Wall Street Journal, December 28, 2001.

  30 Greenspan, “The American Economy in a World Context.”

  31 Ibid.

  The chairman continued: “In January 1995, the analysts projected five-year earnings to rise on average by about 11 percent annually. After successive upward revisions, the March 1999 estimate was set at about 13.5 percent. . . . While there are ample data to conclude that these estimates are biased upward, there is scant evidence to suggest the bias has changed.. . . [C]ompanies are apparently conveying to analysts that, to date, they see no diminution in expectations of productivity acceleration. This does not mean that the analysts are correct, or for that matter the companies.”32

  Here his confidence in the amazing American economy is checked by disclaimers—“presumably are knowledgeable,” “apparently conveying”—and then he states that his cadre of informants and the companies they relied upon for information might know nothing at all. Reading FOMC transcripts, there is no record of companies expressing a view on productivity, accelerating or not. In summation, the speech was a catalog of platitudes: claims were disclaimed; absolutes were qualified; enthusiasm was contingent; veritable armies of technicians may be wrong or right. The speech was a smash hit.

  Coincident with the chairman’s remarks was the Royal Society for the Arts publication of Opening Minds: Education for the 21st Century. It quoted science historian James Burke. The author prophesied: “Instead of judging people by their ability to memorize, to think sequentially and to write good prose, we might measure intelligence by the ability to pinball around through [sic] knowledge and make imaginative patterns on the web.”33 Burke’s view of the future was speaking at the Federal Reserve Bank of Chicago on May 6, 1999. Greenspan’s mental pinging was not lost on his critics, one of whom referred to the Federal Reserve chairman as “Pinball Al” in his weekly commentary.34

  32 Ibid.

  33Royal Society for the Arts, Opening Minds: Education for the 21st Century (London: Royal Society for the Arts, 1999), p. 7. The study quoted from James Burke, The Pinball Effect, (Boston: Back Bay Books, 1997), Introduction, no page numbers.

  It is unimaginable that Messrs. Volcker, Burns, and Martin would consider such hypotheses about the future of technology a suitable topic for the Federal Reserve chairman. It is both inappropriate and beyond the Federal Reserve’s brief. Yet, he spoke as the expert. Greenspan styled his mental doodling as hypotheses, knowing that the public accepted them as dogma.

  His admission that analysts’ projections were biased upward with “scant evidence to suggest the bias has changed” is divorced from historical evidence (analysts grow more optimistic the longer a boom booms35). Making five-year guesses is an impossible task. Most important, though, this is a very strange train of thought by which to set central bank policy. (It is also a very strange reason to buy stocks.)

  Volcker Expresses Skepticism

  One who differed on the interpretation of corporate profits was Paul Volcker. On May 14, 1999, the former Federal Reserve chairman spoke at American University. His message resonates and contrasts for its succinct and timely qualities: “The fate of the world is dependent on the stock market, whose growth is dependent on about 50 stocks, half of which have never reported any earnings.”36

  To borrow from Volcker and expand on his summary: Productivity is the lifeblood of the economy. It is productivity, more exactly, the belief in rising productivity, that prevents an otherwise manic stock market from collapsing. It is the stock market that now runs the economy, rather than the market functioning as a mechanism to finance business.

  34 Christopher Wood, author of Greed&fear, his weekly market commentary to clients of CLSA (Credit Lyonnais Southeast Asia).

  35 At the end of the eighties’ boom—in September 1990—analysts predicted 22 percent earnings growth for the following year; instead, profits fell 11 percent over that period. Gloom, Boom & Doom Report, February 1, 2008, p. 1.

  36 Fleckenstein and Sheehan, Greenspan’s Bubbles, p. 67. Volcker’s speech was the commencement a
ddress at American University, School of Public Affairs/Kogod School of Business.

  It is the accelerated tendencies of the enriched American consumer and their outsized spending that keeps a downsized Asia working. It is the upwardly biased Wall Street forecasts—that we have decided are no more upwardly biased than in the past—that validates productivity, the U.S. stock market, the U.S. economy, provokes U.S. consumption, and which feeds and shelters most of humanity.

  17

  “This Is Insane!!”

  June–December 1999

  I’m not saying [security analyst] forecasts are any good as far as earnings projections are concerned. Indeed, they’re awful. They are biased on the upside, as they are made by people who are getting paid largely to project rising earnings in order to sell stocks, which is the business of the people who employ them.1

  —Federal Reserve Chairman Alan Greenspan, October 5, 1999, FOMC meeting

  The chairman had not told the public or Congress about the Federal Reserve’s bubble trouble. His contention of Federal Reserve impotence still snoozed at the FOMC conference table. Until Chairman Greenspan took his central bank vision public (i.e., we can’t see a crash before the carcass has fallen off a cliff ), this academic constraint brayed through Ivy League common rooms. As for Wall Street, this was to be a gift from God, the god who hypothesized in the Eccles Building.

  June 17, 1999, was the day that Greenspan disclosed his doctrine to Congress: “The 1990s have witnessed one of the great bull stock markets in American history. Whether that means an unstable bubble has developed in its wake is difficult to assess. A large number of analysts have judged the level of equity prices to be excessive, even taking into account