Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (21 page)

After the congressional study was completed, Alan Greenspan dismissed it as unnecessary. He described the risk of derivatives as “negligible.”
⁴⁶
Congress chose to believe Greenspan and ignore Soros.

Worse than misapprehending the derivative menace, Greenspan, Congress, and probably most economists did not contemplate the possibility that such an unbalanced economy would eventually not respond to Federal Reserve money stimulus.

At the October 6, 1992, FOMC meeting, Federal Reserve Governor Wayne Angell addressed the attenuating influence of finance on an economy. “Since we have watched the Fed funds rate come down from 9.9% to 3.0%—that’s 690 basis points—and it has had less than the intended effect upon credit and upon spending, then it seems very appropriate for us to look again at this model.”
⁴⁷

⁴³
Ibid., pp. 131–132.
⁴⁴
Ibid., p. 117.
⁴⁵
Ibid., p. 114.
⁴⁶
Hubert B. Herring, “Business Diary,”
New York Times
, May 29, 1994.

In early 2009, the Federal Reserve and Treasury attempted to rouse the economy by extending trillions of dollars to banks and industries. It is want of imagination to fill the patient with ever larger doses of the same medicine. Yet, this remains the Federal Reserve’s modus operandi.

⁴⁷
FOMC meeting transcript, October 6, 1992, p. 21.

1995–1996

I think the downside risks are basically coming from the possibility of significant increases in stock and bond prices. … Ironically, the real danger is that things may get too good. When things get too good, human beings behave awfully.
¹

—Alan Greenspan, March 1995

The back half of the 1990s looked gloomier than the first half. In early January 1995, the
Wall Street Journal
,
New York Times
, and
Barron’s
published annual reviews and forecasts, all of which agreed that Wall Street and Main Street were in a funk. Top brokerage firm analysts were interviewed. One was David Shulman, chief equity strategist at Salomon Brothers, who confirmed that “cash is in a bull market right now.” Most of the experts expressed caution; about half of those interviewed expected the stock market to fall in 1995.
²

¹
FOMC meeting transcript, March 28, 1995, pp. 42–43.
²
David Kansas, “Analysts Figure Either Stocks or Bonds Must Give Ground to the Other This Year,”
Wall Street Journal
, January 3, 1995, p. R3.

133

The
New York Times
special section “Outlook 1995” captured the consensus: “Rarely since World War II have … citizens [of the world’s most powerful economies] been so worried that the good times are about to end before they get their share of the bounty.” The
Times
observed that the United States had suffered 20 years of job stagnation, and “workers [are] convinced that economic upturns benefit everyone but them.”
³

The gloominess may have been overdone. The refinancing of corporate balance sheets was rewarded—corporate earnings more than doubled between 1992 and 1997.
⁴
From 1989 to 1994, business debts grew by just 5.6 percent ($204 billion). On the other hand, the combination of downsizing and offshoring was grinding down the middle class. Consumer debts grew by 36 percent over the 1989 to 1994 period ($1.2 trillion)—six times the growth of business debts.
⁵

Constraining Money Growth and

Boosting Credit

What tided over the indebted was the rise in available credit. The Federal Reserve has a direct hand in the size of the monetary base. Through the mid-1990s, the Fed was slowing down this contribution to the economy. (The monetary base rose by 10.2 percent in 1993, by 8.1 percent in 1994, and by 3.9 percent in 1995, and would increase 4.0 percent in 1996.
⁶
) This showed discipline, but the Fed was ceding control over the monetary aggregates that are more responsive to commercial bank lending policies. It had reduced reserve requirements (mentioned in Chapter 10) and permitted banks to “sweep” assets from retail checking accounts. This latter practice reduced bank reserve requirements by about $4.5 billion (around 8 percent) in 1995.
⁷

³
David E. Sanger, “Global Prospects Brighten for Most,”
New York Times
, January 3, 1995, p. C1.
⁴
Jim Rogers, “For Whom the Closing Bell Tolls,” welling@weeden, http://www.welling.
weedenco.com, August 8, 2003. The 15 largest mergers in 1994 were stock or cash
transactions. The LBO was dead. From: Greg Steinmetz, “Mergers and Acquisitions Set Records but Lacked that ’80s Pizazz,”
Wall Street Journal
, January 3, 1995, p.R8.
⁵
Richebächer Letter
, July 2003, p. 4.
⁶
Federal Reserve Statistics and Historical Data, H.3, Table 1: “Aggregate Reserves of Depository Institutions and the Monetary Base (Adjusted for Changes in Reserve
Requirements—SA and NSA)”; http://www.federalreserve.gov/releases/h3/hist/.

A much broader measure of growth—one that is more attuned to
credit
than to
money
—is M3. The rate of credit creation within the limits of M3 rose 2.6 percent in 1994, 6.2 percent in 1995, 9.9 percent in 1997, and 10.4 percent in 1998.
⁸
The Fed interest rate increases through 1994 and early 1995 were for naught, since banks’ lower reserves permitted them to lend more. To an extent, borrowed funds went into the stock market and other speculative activities.

This was the period when Alan Greenspan became a household term (
term
, since “Alan Greenspan” seemed as much a thing as a person). It was also the period when credit decisions beyond bank lending—such as securitizing subprime assets—further reduced the influence of the Fed (should it wish to restrain the economy).

Bailing Out Mexico—With an Eye to Greenspan’s 1996 Reelection

The bailout of a foreign country is a political decision made by Congress and the executive branch of the government, which is not a topic for this book. However, Alan Greenspan’s insertion of the Federal Reserve requires an abbreviated peso detour.

Through the 1980s and early ’90s, Mexico had been spending too much. The peso was pegged to the dollar. In late December 1994, the Mexican government devalued and let the peso float. It fell 42 percent in a matter of days. The possibility of political upheaval and a drop in trade (the United States ran a trade surplus with Mexico in 1994) served as an incentive to bail out the Mexican government.
⁹

⁷
In 1990, the Fed eliminated the 3 percent requirement on nonpersonal time deposits and net eurocurrency liabilities. In 1992, the Fed lowered the required reserve ratio transaction deposits from 12 percent to 10 percent. See Joshua N. Feinman, “Reserve Requirements: History, Current Practice, and Potential Reform,”
Federal Reserve Bulletin
, June 1993, pp. 569–589. In 1995, banks took more advantage of “sweeping” depositors’ checking account balances into money-market deposit accounts that earn interest. Since no reserves are required to be held against the deposit account, the bank can then lend against the sweep. This reduced bank reserve requirements by about $4.5 billion in 1995.
New York Federal Reserve Annual Report 1995
, pp. 13–30;
www.newyorkfed.org/aboutthefed/annual/annual95/omkt.pdf.

⁸
St. Louis Federal Reserve, Economic Data, Monetary Aggregates, M-3 and Components.

Treasury Secretary Robert Rubin led the bailout effort. Congress rebelled. President Clinton diverted funds for the bailout. Rubin took his case to the legislators. He had only recently been installed as treasury secretary. Alan Greenspan carried more political weight on Capitol Hill. Greenspan accompanied Rubin to the Senate and House office buildings “testifying and lobbying in support of the package.”
¹⁰

This was quite a compromise by the Federal Reserve chairman. Federal Reserve Governor John LaWare put it bluntly: “ ‘It politicized the Fed to the extent that we were asked to endorse a political settlement or agreement. … It was a compromise of Federal Reserve independence and something that we have obviously jealously guarded for a long, long time.’ ’’
¹¹
But LaWare understood that Greenspan was playing a more important political game. Greenspan needed to be “ ‘a friend of the guy who has the power to keep him in power.’”
¹²
Keeping him in power probably refers to Greenspan’s reappointment in 1996. FOMC decisions in 1995 may have been influenced by Greenspan’s reelection campaign.

1995: A Midyear About-Face To many, 1995 was the year when the financial system inflated beyond redemption.

In February, the Fed raised the funds rate to 6 percent.
¹³
Then, in July, the Federal Reserve cut the rate to 5 ¾ percent. Such a quick turnabout is unusual. The Fed runs the risk of looking like a chicken with its head cut off. The FOMC was motivated to loosen money by slowing retail sales and car sales, rising unemployment claims, and a lower purchasing managers’ index.
¹⁴
At the July meeting, Greenspan told the committee: “[T]he data of the last few weeks clearly are moving in the direction that … we at least seem to have reached the maximum risk potential and probably are now somewhat on the other side”
¹⁵
(meaning that recessionary risks had abated). He recommended a 25 basis point cut even while stating: “[S]ince the risks are beginning to ease slightly, there is no urgency here.”
¹⁶

⁹
Steven K. Beckner,
Back from the Brink: The Greenspan Years
(New York: John Wiley & Sons, 1996), p. 379.
¹⁰
Ibid., p. 382.
¹¹
Ibid.
¹²
Ibid.
¹³
Ibid., p. 389.
¹⁴
Ibid., pp. 396–401.

The decision was Greenspan’s. FOMC members had plenty of time to air their views (71 pages of transcript), but a clue to Greenspan’s grasp on the committee arises from a plaintive question after the decision had been made. An unidentified speaker asks, “Is there a press release?” Greenspan responded, “I am sorry. The draft reads as follows: ‘Chairman Alan Greenspan announced today that the Federal Open Market Committee decided.’”
¹⁷
Greenspan had brought the committee’s communiqué to the meeting.

“The Greenspan Fed” Was Exactly That When Volcker ruled, the board was not a rubber stamp. There was no such unruliness under Greenspan. There was rarely an interesting discussion.

Alan Blinder was appointed to the vacant post of vice chairman of the Federal Reserve in 1994. A Princeton undergraduate, he earned his Ph.D. at MIT, where his dissertation was supervised by Robert Solow (also one of Ben S. Bernanke’s thesis sponsors).
¹⁸
Blinder served on the Council of Economic Advisers in the first Clinton administration (where his greatest contribution may have been as algebra homework consultant to Chelsea Clinton).
¹⁹
Blinder was filling the home stretch of a 14-year term vacated by David Mullins. Clinton wanted to reappoint Blinder to a full 14-year term in 1996, but Blinder declined. Instead, he returned to Princeton. Blinder did not speak publicly about his decision, but when Felix Rohatyn, investment banker from Lazard Frères and “Evening Hours” companion of Alan Greenspan, decided to pursue the opening, Blinder asked: “Why are you doing it? I’m leaving because I can’t stand it.”
²⁰

¹⁵
FOMC meeting transcript, July 5–6, 1995, p. 56.
¹⁶
Ibid., p. 59
¹⁷
Ibid., p. 72.
¹⁸
Bernanke’s thesis sponsors at MIT were Stanley Fischer, Rudiger Dornbusch, and
Robert Solow; http://econ-www.mit.edu/about/economic.
¹⁹
John Cassidy, “Fleeing the Fed” (“Annals of Finance”),
New Yorker
, February 19, 1996, p. 39.

Laurence Meyer served as a Federal Reserve governor from 1996 to 2002. In
A Term at the Fed
, Meyer wrote that Greenspan drafted the statements about the economy and economic policy that the FOMC issued after it met. In Meyer’s words: “[T]he fact that the statements were prepared by the Chairman without any real input from the Committee, created a degree of tension … that never diminished during my term.”
²¹
The July 1995 transcript shows how the Greenspan FOMC operated.

Alan Blinder was most surprised that when decisions were to be made, most often, the board was offered only one option: the staff recommendation.
²²
When Janet Yellen resigned as governor in 1997, she considered it a “great job, if you like to travel around the country and read speeches written by the staff.”
²³
Earlier, Yellen had met with the staff to understand the process used in its economic forecast. Greenspan “became concerned when he saw Yellen talking to the staff, fearing she might ‘impurify’ the staff forecast.”
²⁴
Such control may be explained by another aspect of Greenspan’s character. Bert Ely, a consultant on federal involvement in the credit system, believed: “ ‘The chairman is not a secure man. He has to be the one in the spotlight, and he doesn’t want competition. Blinder was somebody who was extremely well qualified to challenge Greenspan.’ ”
²⁵
The chairman—at least Chairman Greenspan—controlled the topics under discussion, the structure of an argument, the conclusion of a debate that never existed, and the vote. As vice chairman, Blinder sat in the office next to Greenspan’s, yet they often went a week at a time without speaking to each other. In Laurence Meyer’s autobiography, he has little of a personal nature to say about Greenspan, since they were barely acquainted, despite his 5 ½ years of service.
²⁶
It is fair to say that when decisions of the Greenspan Fed are evaluated, it was Alan Greenspan who set policy.