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

by Frederick Sheehan

  There were real Internet businesses pulling in real revenue, the accomplishment of which turned traditional business planning on its head. The New York Times reported in October 1999 that the top 10 online brokers (those that facilitate stock and bond trading on the Internet) had dedicated $1.5 billion to their advertising budgets for the next year. This was approximately the same as Ford’s annual advertising allowance and far above those of Coca-Cola and Walt Disney combined.29 Deciding that the Internet ruckus was more fun than making a buck, American Express offered free trading; E*TRADE paid $150 per person to convert one competitor’s customers’ brokerage accounts; and Ameritrade gave new customers two round-trip tickets to London, Mexico, or Hawaii.30

  The A&E Biography television network named Greenspan the “most fascinating person of 1999.” He even appeared on the cartoon shows: “[A] suitably dour animated likeness of the Fed chairman appeared on [The Simpsons].… Bart tries to high-five the Fed chairman, but Greenspan ignores him.”31 The CNBC financial network (which was more whimsied than The Simpsons) “took to providing live coverage even of some of the Fed chairman’s minor testimony, with the tag line: ‘Greenspan Speaks.’ It also introduced a wildly popular and widely imitated feature called the Briefcase Indicator”32: as Greenspan walked to his office in the Eccles Building on the mornings of FOMC meetings, CNBC would stake out his path. The premise: if his briefcase was thin, the chairman was in harmony with the world; if it was thick, a conundrum brewed. In the latter instance, CNBC deduced that a change in policy was on the table. CNBC anchors rattled on with step-by-step commentary during his stroll, to background music such as the theme song from Mission: Impossible.33

  28 Ibid., p. 10.

  29Joseph Kahn, “The On-Line Brokerage Battle,” “The Media Business: Advertising,” New York Times, October 4, 1999.

  30Patrick McGeehan, “Latest Lure on the Web: Free Trades,” “Investing,” New York Times, November 14, 1999. AMEX offered “commission-free stock purchases for anybody who deposited $25,000.” E*TRADE’s offer applied to Discover Brokerage Direct (of Morgan Stanley Dean Witter). Ameritrade offered the free round-trip flights to anyone who opened an account with a minimum balance of $5,000 (from full-page advertisement in the Wall Street Journal October 27, 1999, p. C9).

  The question hung heavy: was Greenspan aware of the pageantry? A CNBC producer observed: “This is one of the most powerful men in the world. Why doesn’t he just get dropped off at the front door?”34 Although Greenspan claimed to be an introvert, he certainly was an exhibitionist.

  31 Justin Martin, Greenspan: The Man behind Money (Cambridge, Mass.: Perseus, 2000), p. 225.

  32 Ibid., p. 223.

  33 Ibid.

  34 Ibid.

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  18

  Greenspan’s Postbubble Solution: Tighten Money

  January–May 2000

  I would not only reappoint Mr. Greenspan; if Mr. Greenspan should happen to die, God forbid … I would prop him up and put a pair of dark glasses on him.1

  —Presidential candidate John McCain, 2000

  The millennial media coverage fed the growing consensus of one world converging—unless it collapsed on New Year’s Eve. The dire Y2K predictions by technology experts went unfulfilled. Not an elevator plunged nor a computer failed. The experts contended that never-ending overtime work had corrected any potential problems. There is no question that late-night shifts by computer programmers modified and improved computer systems. Nevertheless, that not a single silicon wafer anywhere failed sowed seeds of doubt about the expertise of the experts.

  In preparation for panic, Alan Greenspan stuffed the banks with money. This was prudent, but it once again calls into question why he was roaming the country making speeches about technology.

  Money chases an inflating asset. The Nasdaq average rose 54 percent from mid-October 1999 through January 3, 2000. The Nasdaq average

  1“Excerpts from New Hampshire Debate Involving G.O.P. Presidential Candidates,” New York Times, December 3, 1999.

  215

  had risen 907 percent over the previous five years. Japan’s Nikkei index, widely considered the largest stock market bubble in a major industrialized country, had appreciated only 230 percent in the five-year run-up before it burst a decade before. The price/earnings ratio of the Nasdaq was now around 200:1. Japanese stocks had peaked on December 31, 1989, at 80:1.2

  In January 2000, the Federal Reserve started to absorb the dollars it had printed in 1999. The Fed expanded the monetary base at an annualized rate of 44 percent between October 20, 1999, and December 29, 1999. It reduced the base by 20.4 percent from December 29, 1999, to February 23, 2000.3 This doomed the stock market.

  A trio of waves peaked and then collapsed in 2000. The Internet silliness topped off in March. The telecommunications wave carried mutual fund managers into the fall, and the optical networking mania finally ran out of energy in early winter.

  Corporate earnings, the neglected story of the past two years, continued to tumble. Profits of the big five technology companies (Microsoft, Cisco, Intel, Oracle, and Dell) were falling, even as their stock prices skyrocketed. These five stocks now comprised 25 percent of the Nasdaq average.4 Their ascent fed on itself as flows into mutual funds demanded that they be invested in technology.

  The Y2K scare formed the peak of the stock market cycle for a second reason. Companies had been frightened into buying the latest computer gear beforehand. They were also scared to death that the Internet would compromise their businesses. They had spent extravagantly on technology equipment. The corporate shopping cycle was over.

  Greenspan’s third term as Fed chairman was drawing to an end. In contrast to the cat-and-mouse games of 1996, President Clinton gleefully nominated Greenspan on January 4, 2000. The president was star-struck. Federal Reserve Chairman Greenspan’s “devotion to new technologies has been so significant, I’ve been thinking of taking Alan.com public—then we could pay off the debt even before 2015.”5 It was a time of infinite extrapolation.

  2 Fred Hickey, HighTech Strategist, January 4, 2000.

  3 St Louis Federal Reserve, U.S. Financial Data, “Adjusted Monetary Base” chart, March 2, 2000.

  4 Hickey, HighTech Strategist, January 4, 2000.

  In January, the town of Halfway, Oregon, changed its name to Half.com.6 In February, James Wolfensohn, president of the World Bank, told the Financial Times: “In Ethiopia, I met a man who was trading goats over the internet with Ethiopian taxi drivers in the US.”7 The nutters could only applaud, missing the point that there was a screw loose.

  This was true in the nation’s financial capital, as reported by a morning stroller: “I went downstairs to Fifth Avenue to get a pretzel.… and a rainbow-colored double-decker bus rumbled past me … with the following message plastered along its length: ‘IPOS FOR EVERYONE! EVERYONE CAN WIN! COME SEE US AT MAINSTREETIPO.COM!’ The bus stopped a block down the avenue … and people came off the sidewalks on both sides of the avenue and surrounded the driver-side window asking questions.”8

  Giving Greenspan “Credit for the Golden Age”

  On January 26, 2000, the Senate Banking Committee held its quadrennial deposition of Greenspan as candidate for another term as Fed chairman. The senators did not so much interrogate him as they did worship him. “Members of both parties heaped praise on Mr. Greenspan,” recorded the New York Times.9 The generosity of Republican Senator Phil Gramm from Texas flowed over: “If you were forced to narrow down the credit for the golden age that we find ourselves living in, I think there are many people who would be due credit, and there are more who would claim credit. But of those who are in a position of authority, I think your name would have to be at the top of the list.”10 Such adulation was a sure sign that the stock market was peaking. When a “golden age” is proclaimed, it is time to sell.

  5 http://money.cnn.com/2000/01/04/markets/greenspan/AG.

  6 William A. Fleckenstein, The Contrarian
, siliconinvestor.com, January 24, 2000.

  7Alexandra Nusbaum, “Bridge to Span Technology Gap: Interview with James Wolfensohn,” Financial Times, February 15, 2000.

  8 William A. Fleckenstein, The Contrarian, siliconinvestor.com, March 1, 2000.

  9Richard W. Stevenson, “Greenspan Holds Forth before a Friendly Panel,” New York Times, January 27, 2000.

  10 Ibid.

  Greenspan kicked off his 2000 speaking tour on January 13, with a speech entitled (what else?): “Technology and the Economy.” He had nothing new to say, but in the tradition of the best publicists, he knew that “[p]olitical propaganda … is aimed at the broad masses.… Its task is the highest creative art of putting sometimes complicated events and facts in a way simple enough to be understood by the man on the street.”11 Serenading the Economic Club of New York, the accomplished musician simplified his composition to a variation on “Chopsticks”: “Before this revolution in information availability, most twentieth-century business decisionmaking had been hampered by wide uncertainty. … Decisions were made from information that was hours, days, or even weeks old.”12 Greenspan seemed never to tire of repeating this refrain, despite growing evidence of the worst decision making seen in generations.

  Inevitably, he leaned on his crutch: “[S]ecurity analysts, reflecting detailed information on and from the companies they cover, have continued to revise upward longterm earnings projections.”13 He went on to tell the economists that “the American economy was experiencing a once-in-a-century acceleration of innovation, which propelled forward productivity, output, corporate profits, and stock prices at a pace not seen in generations, if ever.”14

  The economists gushed. They should at least have known that corporate profits, having peaked in 1997, continued to fall. The data from the Bureau of Economic Analysis (BEA), which Greenspan did his best to ignore, were diverging more than ever from Wall Street forecasts. Staff economist Michael Prell would not let Greenspan ignore the “rosy earnings forecasts of security analysts” (in February 2000) that, in Prell’s view, were “rather wacky” (in March 2000).15

  11 Joseph Goebbels, speech at 1934 Nuremburg rally, translation by Randall Bytwerk; http://www.calvin.edu/academic/cas/gpa/goeb59.htm.

  12 Alan Greenspan, “Technology and the New Economy,” speech at the Economic Club of New York, New York, January 13, 2000.

  13 Ibid.

  14 Ibid.

  15FOMC meeting transcript, February 1–2, 2000, p. 16; FOMC meeting transcript, March 21, 2000, p. 30.

  The BEA calculated that machinery profits had fallen from $209.0 billion in 1997 to $150.6 billion in 1999. Of the current obsession, computer industry profits peaked at $25.3 billion in 1997. By 1999, the industry was losing $6.5 billion.16 This never received much publicity: technology companies in the aggregate had turned from profit-making to loss-making enterprises during the most fevered years of the technology stock bubble.

  The stock market was still rising. The Dow Jones Industrial Average (which is not oriented toward technology companies), peaked on January 14, 2000, when it closed at 13,722. The Nasdaq rose another 20 percent and peaked on March 10, with a closing price of 5,048.

  Margin Discussions That Never Happened

  During the January 26, 2000, Senate Coronation, the politicians could at least imagine black clouds. Total margin debt had risen 45 percent between October 1999 and February 2000.17 A chart comparing the parabolic rise of borrowed shares and the stock market warned of a close linkage. The Federal Reserve has the authority to raise margin requirements at any time.18 Current requirements were 50 percent—in other words, for every $50 paid for stock (cash payment to the broker), an investor could borrow $50 from the broker. But the Fed could wave its wand and dictate a 60 percent or 100 percent cash payment for a $100 exposure to the stock market.

  Democratic Senator Chuck Schumer of New York thought the stock market might be speculative. He asked Greenspan if the recent surge in borrowed shares was a concern. Greenspan told Schumer the Fed was studying the problem. The Fed Chairman said that such an increase would have little effect on the stock market. Yet, Greenspan did express concern over rising margin purchases: “They have moved up at a pace which has created a good deal of evaluation on our part and, obviously, the supervisory regulators.”19

  16 Richebächer Letter, July 2004, p. 11; from Bureau of Economic Analysis, Commerce Department Survey of Current Business.

  17William A. Fleckenstein with Frederick Sheehan, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve (New York: McGraw-Hill, 2008), p. 87. This is New York Stock Exchange Margin debt.

  18 The Securities Exchange Act of 1934 delegated the authority to regulate broker loans to the Federal Reserve.

  Just who was doing the evaluating remains unknown. There had been no discussion at the FOMC about margin requirements over (at least) the previous three years. Greenspan went on to tell the committee that “all of the studies have suggested that the level of stock prices have nothing to do with margin requirements.”20 The Federal Reserve Web site posts one study of margin requirements, in 1997.21 If this was read by FOMC attendees, it was never mentioned at their meetings. Greenspan, possibly concocting his spiel on the fly, discovered that he was an ardent populist: limits on borrowing would hurt small investors more than institutions.

  In his best bedside manner, Greenspan soothed the committee by claiming: “We, obviously, have also been discussing what alternatives there are.… I don’t want to suggest that we’re about to do anything at this stage, but I would confirm that we obviously are doing a good deal of thinking about the whole process.”22 If alternative thinking was ever a topic at the FOMC, it must have been by semaphore.

  Greenspan claimed that margin requirements would not change behavior, but there was, in fact, another regulatory authority that thought differently. Just two days prior to the chairman’s testimony, the New York Mercantile Exchange had raised margin requirements on heating oil, effective immediately, by 80 percent.23

  Henry Kaufman, who moved markets when he spoke from Salomon Brothers in the 1980s, and whose opinion was worth whatever his private clients now paid, disagreed with Greenspan: “When you raise margin requirements, you express concern that is telegraphed to the market at large. You express a concern about speculation, and the inappropriate use of credit and risks that it may expose to the financial system.”24 Kaufman was dismissive of Greenspan’s comment that he had asked security regulators to study the issue: “Does that mean that to do something, we have to have a long experience with it and a major problem?”25 Under Greenspan’s new regime, the answer would always be yes.

  19 Stevenson, “Greenspan Holds Forth before a Friendly Panel.”

  20Senate Committee on Housing, Banking, and Urban Affairs, “Nomination of Alan Greenspan, of New York, to Be Chairman of the Board of Governors of the Federal Reserve System,” January 26, 2000, p. 30.

  21 Paul H. Kupiec, Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since the Crash? Finance and Economics Discussion Series 1997-22, Federal Reserve Board, April 1997.

  22 Stevenson, “Greenspan Holds Forth before a Friendly Panel.”

  23 Fleckenstein and Sheehan, Greenspan’s Bubbles, p. 88.

  Paul Volcker was interviewed by the New York Times. He was forthcoming about the stock market: “I think it is a kind of casino. It’s all the rage, trading certificates that have no intrinsic value.”26 There is no hint that Volcker had anyone specifically in mind when he told the interviewer: “I was so proud of being in government all my life. [P]ublic service at almost all levels has come into various disrepute. You don’t get the people in government that you should.”27

  A sign of mental instability was another Youth Movement. R. W. Huntington Jr., a veteran of several decades in the insurance industry, observed the scene from his investment post at Connecticut General Life Insurance Company in 1929: “We old fogies have been told time and again that we have entered a n
ew era which we were incapable of understanding; that the past used to be the best guide for the future … but [is] no good now.” Huntington acknowledged the capacity for youth to make a fortune during a bull market, since it was not inhibited by knowledge: “[F]or the last six years the prudent and experienced have not made money on paper … as much as the rash and inexperienced who have never seen hard times or severe recessions.”28

  In the Go-Go Years, 26-year-old conglomerateurs made fortunes. In April 2000, there was Tom Hadfield. The 17-year-old entrepreneur had floated his second Internet start-up (Schoolsnet.com). The Financial Times noted that Hadfield had founded his first Web site, Soccernet, when he was only 12. It was owned by Walt Disney at the time of this second flotation.29

  24 Gretchen Morgenson, “Something Borrowed May Leave Market Blue,” “Market Watch,” New York Times, January 30, 2000, p. B1.

  25 Ibid.

  26Alex Berenson, “After the Fed, a Large Presence,” New York Times, January 23, 2000, p. B2.

  27 Ibid.

  28 R. W. Huntington, “The Company’s Investment Policy,” in Charles D. Ellis and James R. Vertin (eds.) Classics: An Investor’s Anthology (Homewood, Ill.: Dow Jones-Irwin, 1989), pp. 61–62.

  The Wall Street Journal introduced its readership to Justin Hendrix, a “spike-haired, 19-year-old freshman at Seattle University with a messy bedroom and a summer job maintaining ice-making machines at local supermarkets.” Known as “Dr. Wall Street,” he offered up-to-the-minute advice: “This is the new economy, and you can learn as much about Wall Street on the Internet in two years as you could in the 10 or 15 years it used to take others.”30 Strictly speaking, Hendrix was correct, given the advice that Wall Street firms were offering their clients and the public.