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

by Frederick Sheehan

  1 FOMC meeting transcript, October 5, 1999, p. 48.

  203

  the rise in ‘fair value’ resulting from the acceleration of productivity and the associated longterm corporate earnings outlook.”2

  Assuming that he was speaking logically (and not just pinballing), Greenspan was acknowledging that the stock market was now accelerating at a faster pace than analysts’ five-year projections. Apparently, Greenspan’s equation—stock market price gains are justified by productivity—was breaking down. Had reality run ahead of his ability to dissemble? No, Greenspan was on top of his game. He next advanced his case for impotency: “But bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”3

  The claim was ridiculous—but it worked. Betting against markets may be precarious, but that is exactly what an investor does with each portfolio decision. Just as he had sprung “can’t see a bubble” on the FOMC in December 1998, Greenspan now announced this central bank restriction to Congress. The next day, a New York Times editorial expressed its tentative acceptance of Greenspan’s most outlandish claim: “The new Greenspan is brimming with self-assurance. Let us hope the market does not test his new confidence.”4 If only the New York Times had brimmed with enough self-confidence to state that the Federal Reserve chairman was abandoning the Federal Reserve’s responsibility.

  Maybe the Times was too stunned for such a response. In one gulp, it learned that the Fed did not, and could not, see the hot-air balloon it had so generously expanded—mostly with Greenspan’s hot air. The editors had long trusted the chairman. When Greenspan had issued his stock market warning in February 1997, the Times stood by Greenspan in an editorial with the title: “Wise Warnings to Giddy Investors.” (This was when Congress reprimanded Greenspan for jawboning the stock market down.5) In the editors’ words: “To ward off the bad outcome, Mr. Greenspan gently reminded investors that stock prices fall as well as rise. . . . He also reminded them that the Fed will not shrink from raising interest rates—which will draw money out of stocks.” The 1997 editorial went on to remind readers that those on Wall Street who “contend that the American economy is heading toward unprecedented prosperity” lack perspective: “like any story that says the future will be unlike the past, the predictions are probably wrong.”6

  2 Joint Economic Committee, “Monetary Policy and the Economic Outlook,” June 17, 1999.

  3 Ibid.

  4 Editorial, “Hints of a Mild Fed Action,” New York Times, June 18, 1999.

  5 Jawboning is giving a verbal warning or threat.

  The Times did not know that between 1997 and 1999 Greenspan would echo the giddy cheerleaders on Wall Street—that this was an unprecedented moment in history. Once Greenspan declared our good fortune, he had no reason to monitor the stock market. The June 1999 speech simply informed the public of the chairman’s decision to do nothing.

  Greenspan’s brimming nonchalance was evident throughout his “don’t worry, be happy” testimony on June 17, 1999: “While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy.” He told the (presumably) puzzled congressmen: “[W]hile the stock market crash of 1929 was destabilizing, most analysts attribute the Great Depression to ensuing failures of policy” [author’s italics].7

  This directly contradicted what he had written in 1966. In his essay “Gold and Economic Freedom,” Greenspan had placed the blame entirely on Fed policy before the crash. (From his 1966 article: “The excess credit which the Fed pumped into the economy [in 1927] spilled over into the stock market—triggering a fantastic speculative boom.”)

  The detachment of the FOMC from reality grew worse. Between May 29 and June 29, 1999 (the month leading up to the June 29–30, 1999, FOMC meeting), the New York Times discussed the stock market bubble in 10 separate articles. (A headline on May 30: “Pop! Goes the Bubble.”8) The word bubble was used only once at the June 29–30 conclave. The stock market was mentioned 21 times at this meeting.

  6 Editorial, “Wise Warnings to Giddy Investors,” New York Times, February 28, 1999.

  7Alan Greenspan, “Monetary Policy and the Economic Outlook,” Joint Economic Committee, June 17, 1999.

  8Gretchen Morgenson, “Pop! Goes the Bubble,” “Market Watch,” New York Times, May 30, 1999.

  The FOMC raised the fed funds rate from 4.75 percent to 5.00 percent—the first change since the three interest rates cuts following the LTCM troubles in late 1998 (described in Chapter 15). If the stock market was the reason the FOMC tightened, it was well disguised. Forty pages of the transcript prattle on about the FOMC communiqué: should it be of a symmetric or an asymmetric nature? A Fed staffer then read the draft statement. This had been handed out before the meeting started. It passed with a single dissent (Dallas President Robert McTeer).9

  The chairman’s sole contribution to stock market analysis at this meeting lifted the bar of either banality or understatement to a new level: “We are observing market capitalizations that are telling us something very interesting even as we simultaneously argue that stock market prices are overvalued. We are seeing a very dramatic shift in the changing capitalizations of hightech versus low-tech companies.”10 Whatever argument he referred to was not made at this meeting. In the past 10 years of transcripts, there had never been an FOMC argument.

  On August 27, 1999, in Jackson Hole, Wyoming, Greenspan talked about assets. Greenspan’s talk confirms that he still understood markets are not always efficiently priced and that the consequences of market crashes are substantial. In his speech, the Federal Reserve chairman explained: “[W]hen events are unexpected, more complex, and move more rapidly than is the norm, human beings become less able to cope.” The failure “to be able to comprehend external events almost invariably induces fear.” This induces “disengagement from an activity.” The “attempts to disengage from markets … means bids are hit and prices fall.”11 In his roundabout way, Greenspan had described a market crash.

  Such waves of emotional instability beg the question of how derivative models can successfully anticipate fear that causes bids to be hit and prices to fall. Greenspan told his audience that models fail in unusual circumstances: “Probability distributions that are estimated largely, or exclusively, over cycles excluding periods of panic will underestimate the probability of extreme price movements because they fail to capture a secondary peak at the extreme negative tail that reflects the probability of occurrence of a panic.”12 Yet, he seemed content to let bank models monitor risk.

  9 FOMC meeting transcript, June 29–30, 1999, p. 113.

  10 Ibid., pp. 84–85.

  11Alan Greenspan, “New Challenges for Monetary Policy,” speech at a symposium

  sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 27, 1999.

  At about the same time Greenspan delivered his speech, Fred Hickey was preparing the September 1999 edition of his monthly HighTech Strategist, a highly regarded newsletter devoted to technology investing. The probability of a rising “secondary peak at the extreme negative tail” grew more obvious upon reading Hickey’s letter.

  Hickey noted that the Philadelphia semiconductor index tripled from October 1998 through August 1999. Yet, semiconductor sales had peaked at $150 billion in 1995. Money poured into the fastest-rising mutual funds, which then funneled the flows into the largest stocks. Hickey wrote: “The six biggest capitalization tech stocks (Microsoft, Intel, IBM, Cisco, Lucent, Dell) are now valued at $1.65 trillion, up $460 billion this year.… [T]here’s been no revenue growth in the world P.C. [personal computer] industry in 21⁄2 years.” Hickey went on: “Just today, on September 3, 1999, the melt up caused by the ‘favorable’ unemployment report added $63 billion to the market valuations of the ‘Big 6.’ One day’s gain. At their lows in late 1990, all of the stocks in [Hickey’s top-10 model techn
ology portfolio: IBM, Hewlett-Packard, Intel, Microsoft, Motorola, Cisco, Sun Microsystems, Texas Instruments, Oracle, and Micron Tech] could have been purchased for a grand total of $52 billion. Essentially, most of the technology industry in 1990 is an even swap for one day’s gain of 6 stocks today. This is insane!!”13

  The Road to Fame: Tell the People What they Want to Hear

  James Glassman and Kevin Hassett, celebrities now, were on the editorial page of the Wall Street Journal touting Dow 36,000: “[W]hy should certain P/Es constitute a ceiling? … When you apply our model, the market looks like a very good deal, even at today’s prices.”14 Greenspan spoke five days later at the Gerald R. Ford Foundation in

  12 Ibid.

  13 Fred Hickey, HighTech Strategist, September 3, 1999.

  14James K. Glassman and Kevin A. Hassett, “Bursting Mr. Greenspan’s Bubble,” Wall Street Journal, September 3, 1999.

  Grand Rapids, Michigan. Before the former president, Greenspan made a sweeping and unverifiable claim: “It is safe to say that we are witnessing this decade, in the United States, history’s most compelling demonstration of the productive capacity of free peoples operating in free markets.”15 Soon after, Abby Joseph Cohen gave a speech at the Waldorf-Astoria. Its title: “Supertanker America, Still on Course.”16 This competing celebrity was as repetitious as Greenspan, which was why she was so valuable. In the words of another legendary self-promoter, Jim Cramer: “Every time she spoke, she turned around the futures, or broke the nasty selling waves, as she explained why panicking was wrong and we were in a rip-roaring bull market. In a market that had come to see this frumpy curly-haired nerd as a double-hulled supertanker herself.… Cohen had stayed bullish … not wavering for an instant from her Supertanker America thesis.”17

  The kinetoscope of images, incessant noise, and juvenile vocabulary exploded like shrapnel in the face of a world that had already run out of superlatives. Television ads promoting Internet companies featured a college student belching the alphabet, ravenous wolves attacking a highschool band, gerbils shot from cannons, children tattooed in day-care centers, a world in which “practically no bodily function is too private and no rude behavior too coarse to be featured in a spot.”18

  From the Horse’s Mouth: Analysts Are Paid

  to Sell Stocks

  The Fed raised the funds rate another 0.25 percent in August 1999, in November 1999, in February 2000, and in March 2000 to 6.00 percent.

  15 Alan Greenspan, “Maintaining Economic Vitality,” speech in the Millennium Lecture Series sponsored by the Gerald R. Ford Foundation and Grand Valley State University, Grand Rapids, Michigan, September 8, 1999.

  16 Abby Joseph Cohen, “Supertanker America, Still on Course,” speech at the Financial Executives International (FEI), Current Financial Reporting Issues Conference, Waldorf-Astoria Hotel, New York City, November 15, 1999.

  17 James J. Cramer, Confessions of a Street Addict (New York: Simon & Schuster, 2002), p. 222.

  18Patricia Winters Lauro, “Dot-Com Companies Have Built Their Brands by Using More Ads, in Good Taste or Not. Often Not,” “The Media Business: Advertising,” New York Times, September 30, 1999.

  There is little in the transcripts to suggest that the stock market played a role in these decisions, although it is probable that some worrywarts who had warned of a crash latched onto any rationale expounded (no matter how trivial) to slow the supply of credit into the stock market.

  But credit was not slowing. The markets barely noticed these rate hikes. The expected rate of return by borrowers—Americans and foreigners alike—was far greater than 6 percent. The enthusiasm spilled over into the real economy, which was building more houses and selling more cars. In a March 1999 speech to the Mortgage Bankers Association, Greenspan had told the congregation: “The past few years have been remarkable for your industry.”19

  Greenspan’s productivity miracle was so calcified by the October 1999 meeting that it was no longer controversial. He informed the FOMC: “[W]e are seeing a remarkable acceleration in economic activity now, which under our old regime … would lead us to say that this expansion is getting dramatically out of hand.”20 The “old regime” was an addition to the Greenspan lexicon, presumably in lieu of the “old era/new era” construction. The new regime would be shooed into the tumbrels within six months. Security analysts were no longer enough; he juggled farther out on the gangplank: “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.”21 (This inside information never reached a wider audience. Greenspan would, in the future, admit that analysts were prone to optimism, but not that they were corrupt, until he scolded the bunch of them after the Enron affair.)

  Greenspan plunged on by introducing a new measurement: corporate executives were lowering their costs. The new metric is corporate executives, who apparently could be taken at their word. This was another bandwagon Greenspan grabbed hold of just in time for it to explode.

  19 Alan Greenspan, “Mortgage Finance,” speech at the Mortgage Bankers Association, Washington, D.C., March 8, 1999.

  20 FOMC meeting transcript, October 5, 1999, p. 49.

  21 Ibid., p. 48.

  A year before, BusinessWeek had published an advertising supplement that addressed the priorities of corporate executives. Chief financial officers responded to the question: “As CFO, I have fought off other executives’ requests that I misrepresent corporate results.” In response, 55 percent replied, “Yes, I fought them off,” while 12 percent answered: “I yielded to the requests.”22 In Bull! A History of the Boom and the Bust, 1982–2004, Maggie Mahar writes: “That two-thirds of these CFOs freely admitted that they had been asked to goose the numbers suggested that the type of person who might blanch at such a suggestion had probably fallen off the corporate ladder early on in the bull market.”23 That Greenspan would still take the word of corporate executives at face value is difficult to believe.

  Greenspan’s Y2K Fear: Another Dog That

  Did Nothing in the Nighttime

  Greenspan’s Y2K fear (“Year 2000”) was contributed by technology companies, the same experts who were compressing information from months to minutes. Computers built 20 or 30 years earlier were not capable of calculating the “2” digit to succeed the “1” when “1999” came to a close. We were doomed: the developed world would cease to function at midnight on New Year’s Eve. Planes and elevators would fall from the sky; sewage plants would burst, ruining water supplies; financial calculations (in statements and security prices) would make us all billionaires, or broke.

  Greenspan may have believed the prophecies, or he may have feared that panic ahead of the millennium would drain the banking system of cash. Whatever the case, he told the Senate Banking Committee that the Fed was preparing to let loose $50 billion into the banking system.24 The gates were so wide open that there was nothing the Fed could do to slow the market’s ascent. Yet there was very little talk of Y2K in FOMC meetings. It had been discussed a couple of times at meetings over the previous two years, but never in reference to monetary policy.25 No one mentioned the $50 billion. Given the amount of time the FOMC debated symmetric and asymmetric communiqués, a word or two about $50 billion dropped into the banking system would seem appropriate.

  22 BusinessWeek, July 13, 1998, p. 113 “The Seventh Annual BusinessWeek Forum of Chief Financial Officers,” polling provided by Meridia Audience Response, Plymouth Meeting, Pennsylvania.

  23 Maggie Mahar, Bull! A History of the Boom and the Bust, 1982–2004 (New York: Harper Business, 2004), pp. 269–270.

  24 Jerome Tuccille, Alan Shrugged: The Life and Times of Alan Greenspan, the World’s Most Powerful Banker (Hoboken, N.J.: Wiley, 2002), pp. 244–245.

  “The Most Fascinating Person of 1999”

  Th
e chairman sounded no worse for wear at the FOMC meeting on December 21, 1999. “I see no overheating other than in the stock market.”26 Maybe so, but he was viewing the world through the clogged end of a drainpipe: the stock market was the economy.

  Greenspan prefaced his stock market assessment with a lesson in stock market aesthetics: “To talk in terms of momentum, or price/sales ratios, or, even better, how much in losses a firm has experienced as reasons for higher stock prices is clearly just nonsense. The fundamental consideration is that a buyer is purchasing claims against future cash.”27 This was not true. Day trading was sweeping the nation—teachers and lawyers quit their jobs and traded stocks from their bedrooms. Their future was lunchtime.

  Greenspan’s dyspeptic (for him) outburst was probably in reaction to staff economist Michael Prell’s earlier discussion of an IPO prospectus. The indefatigable Prell had discussed VA Linux, which entered the carnival on December 9, 1999. VA Linux jumped 700 percent on its first day of trading. It was valued at $9 billion. Prell compared the current atmosphere to that of England’s South Sea Bubble fiasco in 1720 which so devastated Isaac Newton, he would not discuss it for the rest of his life. He quoted from the South Sea share offering: “ ‘A company for carrying on an undertaking of great advantage, but nobody to know what it is.’”28

  25 For FOMC comments, see William A. Fleckenstein with Frederick Sheehan, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve (New York: McGraw-Hill, 2008), pp. 78–79.

  26 FOMC meeting transcript, December 21, 1999, p. 49. This FOMC meeting is discussed at greater length in Fleckenstein and Sheehan, Greenspan’s Bubbles, pp. 76–79.

  27 FOMC meeting transcript, December 21, 1999, pp. 46–47.

  Greenspan had taken to ignoring—not even mentioning—warnings from the FOMC and the staff. Why he felt a need to respond (that is, assuming that he was responding to Prell’s specific claim with: “how much in losses a firm has experienced”) would be conjecture, but his insistence that stocks were bought for their estimated profits in 2004 (five years hence) must have left some FOMC members wondering why they were spending their time listening to his malarkey.