by Robert Rubin
I was torn about whether to say something publicly. On the one hand, I did not want to be in the position of cheerleading the stock market, since that is intellectually dishonest, very unlikely to work, and potentially counterproductive with respect to confidence. On the other hand, the great nervousness and uncertainty in the U.S. financial markets seemed to call for a reassuring presence. Larry Summers, Alan Greenspan, Gene Sperling, and I decided, after much discussion, that I should make some statement. We didn’t want or expect to affect the market’s direction, but we did want to try to diffuse a panicky environment. Our hope was simply that whatever was going to happen would happen in a calm, orderly fashion, as opposed to what had occurred in 1987.
With Greenspan at the Treasury, the four of us spent more than an hour with other Treasury officials constructing a brief statement. It said that I had been in touch with other officials, that we’d been monitoring developments closely, and that these consultations indicated that market mechanisms, such as the systems for settling trades, were working effectively. The statement continued, “It is important to remember that the fundamentals of the U.S. economy are strong and have been for the past several years.” As a final note, we added that the prospects for continued growth with low inflation and low unemployment remained good.
The delivery of this statement was a dramatic moment. I walked down the steps of the Treasury Department and read the statement we’d worked out to a vast number of television cameras. Then I turned around and, ignoring the questions being shouted by members of the press, walked back inside. This was treated as a major news event; the networks broke into their regular programming to carry it live.
The next day, the stock market recaptured some of its losses, and the news media expressed a general view that my comments had served a useful purpose. Having somebody who is viewed as possessing some measure of credibility with respect to markets and economic matters speak in a calm and thoughtful fashion, even if he says nothing that is relevant to the immediate market phenomenon, probably does contribute positively to the psychology of a volatile situation. One advantage of avoiding frivolous market commentary is that one builds and maintains a credibility that can be drawn upon when it is really needed.
Given the remarkable rise in the Dow following Clinton’s election in 1992, political people in the White House often wanted the President to take credit for the strength of the stock market. I argued that for Presidents to validate their policies by pointing to the stock market’s performance was always a mistake. The stock market could fluctuate for all kinds of reasons and could overstate or understate reality for extended periods. I sometimes dissuaded Clinton’s advisers by using the argument that if the President took credit for the rise in the stock market, he’d get the blame for the fall as well. Live by the sword, die by the sword.
BECOMING SECRETARY of the Treasury greatly increased my interaction with the Federal Reserve. At the NEC, I had always supported the Fed’s independence with regard to monetary policy, and I continued to do exactly that at Treasury. The basic logic here is familiar: the head of a country’s central bank has the job of acting countercyclically—prompting growth during economic slowdowns and constricting the money supply when strong growth threatens to produce inflation. The latter task is intrinsically unpopular. As the longest-serving Federal Reserve chairman in history, William McChesney Martin, famously said, the Fed chairman is the fellow who takes the punch bowl away just when the party is getting going. That’s why the chairman should have a fixed term, which he does, rather than serving at the pleasure of the President. This helps insulate him from political pressure.
Before 1993, Presidents and Treasury Secretaries had sometimes opined on what the Fed should be doing with regard to interest rates and sometimes tried to lean on the Fed chairman in various ways. Bill Clinton, by contrast, always adhered to the principle of not commenting publicly on Fed policy. Whenever the contrary suggestion was made inside the White House, I argued that commenting was a bad idea for several reasons. First, and most fundamental, the Fed’s decisions on monetary policy should be as free from political considerations as possible. Second, evident respect for the Fed’s independence can bolster the President’s credibility, economic confidence, and confidence in the soundness of our financial markets. Third, the bond market might be affected by any belief that the Fed chairman was under political pressure that could affect the Fed’s actions. There was also another factor I came to recognize after moving to Treasury: we advised other countries around the world, such as Mexico during the peso crisis, that their central bank governors should be insulated from political pressure. Attempting to put political pressure on our own central bank could undermine that prescription.
Whatever a President’s philosophy about publicly commenting on the Fed, every President probably complains about it privately from time to time. There’s a natural tendency to second-guess any decision not to let the economy grow faster, especially when such a decision comes in advance of an election. Even with President Clinton, who respected the Fed’s independence both in principle and in practice, behind-the-scenes discussions sometimes grew rather heated. In 1994, a few people in the White House suspected—totally wrongly—that Alan Greenspan, a Republican, might be raising interest rates more than necessary out of some kind of political bias. I responded that Greenspan seemed to me to be trying to extend the recovery by preventing the economy from overheating. That would ultimately benefit the President politically when he ran for reelection in 1996.
Greenspan’s actions in 1994 were vindicated by subsequent economic developments. But such suspicions of political motivation, though not warranted in this case, leave nagging questions. What should be done if the Fed chairman is consistently wrong or ineffective or politically motivated, and who should make those judgments? We obviously never had to face those quandaries with Greenspan, but they have no easy answer.
At Treasury, my personal relationship with Greenspan also grew much more familiar. The Treasury and Fed staffs work closely together on a range of issues, despite what has historically been some degree of institutional competition. There is a tradition, maintained by Lloyd Bentsen before me, that the Treasury Secretary and Fed chairman meet on a regular basis. So I now got together with Alan at least once a week for breakfast either at my office or at his, and before too long Larry Summers also joined us.
Our discussions ranged all over the place. Sometimes we were dealing with issues of crisis, such as Mexico or Asia. Other times we would be preparing for one of the several different international meetings of finance ministers and central bank governors or considering some issue expected to arise in Washington. But many times, we simply debated and explored issues about the U.S. and world economies. These meetings were a cross between a graduate seminar in economics and a policy-planning meeting, with bits of gossip thrown in. We were looking at intellectually complicated issues in the context of immediate, practical issues and decisions. While these discussions were serious, they could also be very funny—assuming you shared Alan’s taste for jokes about the yield curve.
One of the issues the three of us returned to again and again was the strong performance of the American economy. By mid-1996, the expansion was well established and still going strong. The growth rate was higher, and unemployment lower, than prevailing views would have said was possible without igniting inflation by putting upward pressure on wages and prices. People were throwing around the phrase “new economy,” suggesting that advances in technology had revised the familiar rules and limits. Some investors appeared to be falling prey to the timeless boom-era temptation to believe that the business cycle had been tamed, that companies would never fail in their earnings, and that the next economic slowdown would never come.
Yet amid such indicators of what Alan called irrational exuberance, real signs suggested that something had indeed changed for the better. With unemployment so low, a Fed chairman’s normal instinct would be to raise rates to prevent
inflation. But there were no signs of increased inflation. The question was whether—as Clinton had intuitively argued in our internal discussions in 1994—the American economy could safely grow faster than during the previous few decades. Though there was no real evidence at the time, Clinton’s instinct turned out to be correct.
This apparent change in the so-called speed limit of economic growth strongly suggested that productivity growth—which had greatly slowed from the early 1970s through the early 1990s for reasons not fully understood—had now picked up again. Productivity increases work wonders on an economy, allowing faster growth without inflation. Understanding why productivity growth first faded and then apparently returned would help us estimate future growth and develop policies to promote it.
Most economists were initially skeptical about increases in productivity. But as time went on, Alan said that the data he was poring over didn’t reconcile unless productivity was substantially higher than was generally thought. One of Alan’s great strengths is his wide-ranging focus on data and his insight in drawing inferences from it. He’d show up at breakfast and ask what I thought about the latest railcar shipments of some type of wheat I had never heard of. “Alan,” I’d say, “I don’t know how I missed that figure in the paper, but I did.” He would have worked out a whole hypothesis around it. Greenspan was the first of the three of us to reach the tentative conclusion that productivity growth did explain the absence of expected inflation. That meant that the speed limit on economic growth was higher than we’d thought. Larry and I followed in agreement somewhat later.
In my view, a critical factor in the return of productivity growth was the restoration of sound fiscal policy. That helped catalyze productivity-enhancing investment by contributing to lower long-term interest rates, increased business and consumer confidence, and greater foreign capital flows into the country. Another key factor was advances in technology, which raised an interesting question. Europe and Japan had access to the same technologies we did in the 1990s but did not experience increased productivity growth. I think the explanation for the difference lies in a third factor: America’s cultural and historical disposition to take risks and embrace change. That inclination helped to explain why American companies invested much more heavily in new technologies than companies in other countries. A fourth factor, related to the third, was our more flexible labor market, which meant that companies could more readily benefit from productivity-enhancing investment, and our greater availability of risk capital. Japan and Europe were and are far less change oriented, more mired in structural rigidities, and shorter on risk capital.
A fifth factor, also related to our cultural tendency to embrace change, was our relatively low trade barriers. My initial belief in open markets was based on the standard comparative-advantage argument that dates from the great nineteenth-century British economist David Ricardo—that all countries will benefit if each specializes in the areas where it is most efficient compared to the others and then trades with the others. But Alan once made another point that never had occurred to me until he said it. The biggest advantage of free trade, he said, is competitive pressure within the United States from foreign producers. Companies have to become more efficient in order to meet competitive threats from outside our borders. Trade drives companies to reorganize and invest in pursuit of increased productivity. Conversely, Japan’s and Europe’s relatively less open markets protected companies and reduced their incentive to become more efficient.
But did these seemingly real changes in America’s productivity growth justify the tremendous rise in stock prices that was taking place? Again, Alan, Larry, and I reached a similar, tentative conclusion: something real was happening in the economy, but at the same time, the markets were probably overreacting to that real thing. That is what the great Austrian émigré economist Joseph Schumpeter said: almost every transformative, productivity-enhancing development also results in financial market overreaction. To me at least, that tendency seems grounded in human nature. Markets—which are expressions of collective behavior—tend to go to excess, in both directions, because human nature tends to go to excess.
Some of our continuing discussion was about what, if anything, people in our position could or should do to mitigate that inherent tendency to excess. As discussed earlier, none of us thought that economic policy makers should become market commentators, or that we could guide financial markets the way the Japanese and some previous administrations in this country had tried to do, by talking them up or down. I tended to believe, however, that regulatory measures might possibly have some effect in inducing investors to exercise discipline, and could certainly help protect the financial system itself. Disclosure requirements were obviously the place to start and were generally not controversial, at least in principle. But such mechanisms were like the old adage: you can lead a horse to water, but you can’t force it to drink. All the disclosures in the world won’t help if investors don’t care about risks or valuation. The boom in Internet stock prices in the late 1990s occurred despite full disclosure by companies with no real earnings.
Given the limits on what could be accomplished through disclosure requirements, I thought limiting leverage was also necessary both to constrain market excesses and to mitigate the harm they can create. For many years, banks and registered broker dealers had lived with capital requirements, and all investors were subject to margin requirements when they borrowed against stocks. But other kinds of financial institutions, including hedge funds, had no regulatory leverage constraints other than the margin requirements, if any, associated with the instruments they bought or sold short. My own view was that it wasn’t necessary to impose special leverage rules on hedge funds as a class of investor. I still think that is right, though as they become a larger and larger part of trading activity, policy makers may revisit that question, if some systemic risk is thought to be at stake. I do think, however, that derivatives, with leverage limits that vary from little to none at all, should be subject to comprehensive and higher margin requirements. But that will almost surely not happen, absent a crisis.
While economically useful under most circumstances for more precise risk management, derivatives can pose risks to the system when market conditions become very volatile. That occurs because of various technical factors that can cause derivatives users to suddenly need to buy or sell in the underlying markets to maintain appropriate hedge positions. With the truly vast increase in the amount of derivatives outstanding, it is at least conceivable that the effect on already disrupted markets could be vast. Some evidence of that potential appeared in the third quarter of 2003, when a rapid spike in interest rates changed the hedging requirements for mortgage-backed securities. The result was substantial exacerbation of that spike. Similarly, in 1987, some traders estimated that “portfolio insurance” selling of stock index futures added substantially to the October 19, 1987, stock market collapse. In a later speech at the Kennedy School at Harvard, Larry characterized my concerns about derivatives as a preference for playing tennis with wooden racquets—as opposed to the more powerful graphite and titanium ones used today. Perhaps, but I would still reduce the leverage allowed on derivatives substantially.
ANOTHER FOCUS OF MINE, which was less typical for a Treasury Secretary, was poverty and the distress of inner cities as critical economic issues. We set up, for the first time at Treasury, an office to focus specifically on these matters, headed by an extremely able and highly committed former Supreme Court clerk, Michael Barr. Such questions were often framed as debates about whether or not to help the poor. But, as important as moral and ethical issues are here, you don’t need to rely on altruism to make the case for tackling poverty. It is in everyone’s self-interest to reduce the societal consequences of deprivation. Poverty can foster crime and health care problems and in various other ways increase social costs and affect the lives of people who aren’t poor.
I learned very quickly, however, that advancing programs to help the p
oor—especially for minorities living in inner cities—was very difficult. Many people object to the idea of government assistance for the poor on principle; even well-designed programs meant to encourage work instead of welfare faced strong opposition. And the poor are not easily mobilized to advance their own economic interests. All sorts of groups could bring great pressure to bear when their concerns were at stake: environmentalists, labor, the elderly, business, and many, many others—but not the poor. You couldn’t count on a major letter-writing campaign in support of food stamps or inner-city job programs.
A significant accomplishment in this area by the Clinton administration was a large expansion of the Earned Income Tax Credit, a payment under the tax code to low-income working families to help lift them out of poverty. However, the EITC increase and other measures—though they had substantial impact—were not even remotely commensurate with the scale of the problem. But our ability to do more was limited. For our first two years, deficit reduction and health care reform were our highest priorities. For the next six years, control of Congress was in the hands of people who rejected most government involvement in these issues.
Nonetheless, real progress was made in combating poverty during Clinton’s years in office, largely because of the strength of the American economy. As unemployment fell back to levels not seen since the 1960s, the number of Americans living below the poverty line dropped steadily and gains by minorities were very strong. Births to teen mothers, which had been rising for forty years, finally began to fall. Welfare rolls began to decline significantly, even before the passage of a welfare reform bill in 1996. In New York, as in other big cities, the homeless population declined visibly. Clinton used to say that the best social program is a strong economy, though he always added that that wasn’t sufficient. He was right. Some people focus only on the economy and neglect the necessity of well-designed programs. Others focus on the programs and miss the central importance of a healthy economy.