Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (43 page)

⁷⁶
“Housing Groups Refute Housing ‘Bubble,’ Laud Greenspan Testimony,”
Business Wire
, July 22, 2002.
⁷⁷
Federal Reserve Flow-of-Funds Accounts, Z-1, Historical Data Tables.

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2002–2006

That the economists . . . can explain neither prices nor the rate of interest nor even agree what money is, reminds us that we deal here with belief not science.

—James Buchan, author of
Frozen Desire
(1997)
¹

On February 27, 2002, the Senate Banking Committee attended a forecasting session conducted by Chairman Greenspan. He declared himself “guardedly optimistic” of economic growth. The politicians and the press furrowed their brows. On March 7, Greenspan’s optimism was back on track. To quote the headline from the
New York Times
: “What a Difference a Week Makes: After Recent ‘Maybe,’ Greenspan Now Says Recovery Is On.”
²
It required the top of the crop to interpret for the
Times
: “A close parsing of Mr. Greenspan’s words shows a slight but nonetheless significant change in his discussion of the labor market, said Jan Hatzius, senior economist at Goldman Sachs. Last week, Mr. Greenspan said performance of the labor market ‘is’ expected to lag. This week he said this performance ‘was’ expected to lag. ‘In discussing the labor market’s deterioration, he

¹
James Buchan,
Frozen Desire: The Meaning of Money
(London, Picador, 1997), p. 180.
²
Gretchen Morgenstern, “What a Difference a Week Makes,”
New York Times
, March 8, 2002.

283

presented the view that he was talking in the past tense,’ Mr. Hatzius said.” These arcane distinctions could melt down markets, though Greenspan had not yet addressed the Nasdaq bubble.

Infamous Speeches: Number One

In March 2002, Greenspan gave a speech in which he again discussed Wall Street analysts—he scolded them: “The sharp decline in stock and bond prices following Enron’s collapse has chastened many of the uncritical practitioners of questionable accounting.”
³
This was spoken by the most uncritical practioner of all, and he did not sound a bit chastened. (Nor did he mention the Enron Prize for Distinguished Service.) As for this “sharp decline in stock and bond prices following Enron’s collapse,” prices had gone
up
. From the previous October, the Nasdaq had risen about 5 percent. This may have been a furtive attempt to blame the stock market’s problems on Enron.

Then he really let the analysts have it: “[L]ongterm earnings forecasts of brokerage-based securities analysts, on average, have been persistently overly optimistic. Three-to five-year earnings forecasts for each of the S&P 500 corporations . . . averaged almost 12 percent per year between 1985 and 2001. Actual earnings growth over that period averaged about 7 percent.”

Almost anyone with experience knew that this was true before Greenspan started serenading analysts’ forecasts in the previous decade. Given the 1985 starting date, Greenspan’s productivity charade was build on estimates that had already produced 13 years of incompetence (1985 to 1998) by the time he insisted that they proved his hypothesis. The chairman continued to lash out: “[T]he persistence of the bias year after year suggests that it more likely results . . . from the proclivity of firms that sell securities to retain and promote analysts with an optimistic inclination. Moreover, the bias apparently has been especially large when the brokerage firm issuing the forecast also serves as an underwriter for the company’s securities.”

Greenspan was by no means the only celebrity without regrets. On August 1, Glassman and Hassett asserted their credentials: “When our book, ‘Dow 36,000,’ was published in September, 1999, the Dow Jones Industrial Average stood at 10,318. The Dow closed yesterday at 8,736. What went wrong? Actually, nothing.”
⁴

³
Alan Greenspan, “Corporate Governance,” speech at the Stern School of Business, New York University, New York, March 26, 2002.

Speech Number Two

Each year, the Kansas City branch of the Federal Reserve System holds a late-summer symposium in Jackson Hole, Wyoming. The discussions are meant to be more reflective than immediate. Chairman Greenspan’s 2002 contribution is still cause for reflection. It deserves an entire chapter. It was the most lamentable speech of his career.

He claimed that the “struggle to understand developments in the economy and financial markets since the mid-1990s has been particularly challenging for monetary policymakers. We were confronted with forces that none of us had personally experienced. Aside from the recent experience of Japan, only history books and musty archives gave us clues to the appropriate stance for the policy.”
⁵

The man who preened about his 50 years of market experience now admitted that his accumulated knowledge was useless. Since he, the FOMC, thousands of Federal Reserve studies, and the Federal Reserve models were useless, why were economists on the payroll?

The chairman continued. The Fed “considered a number of issues related to asset bubbles—that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact— that is, when its bursting confirmed its existence.”

There is little point in discussing this. He knew exactly how to prick a bubble in 1994, 1995, and 1996, but then hid in the tall grass. His memory lapse also applies to the following Jackson Hole assertion:

“The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion.”
⁶
Again, his mid-1990s actions and statements show that he held the opposite view.

⁴
James K. Glassman and Kevin A. Hassett, “Dow 36000 Revisited,”
Wall Street Journal
, August 1, 2002.
⁵
Federal Reserve Bank of Kansas City’s Annual Economic Symposium, “Economic Volatility,” Jackson Hole, Wyoming, August 30, 2002.
⁶
Ibid., p. 3.

Greenspan continued to rewrite history, his own history: “Some have asserted that the Federal Reserve can deflate a stock-price bubble— rather painlessly—by boosting margin requirements. The evidence suggests otherwise.” He clung to this “rather painlessly” qualification again and again. This had been the biggest stock market bubble in the history of the world. Nobody in his right mind would make such a statement.

The
Economist
commented: “[T]he correct test is not whether a bubble can be deflated without some loss of output. Rather, it is whether the early pricking of a bubble causes less pain than letting it grow only to burst later. The longer a bubble is allowed to inflate, the more it encourages the build-up of other imbalances, such as too much borrowing and investment, which have the power to turn a mild downturn into something nastier.”
⁷

Greenspan’s speech met some resistance, but was generally accepted as gospel. Still, he may have found the Jackson Hole speech was not quite the success he had expected. He launched a two-pronged attack from the podium for the rest of the year. First, an embellishment of his “can’t see a bubble” line. Second, a new emphasis on “price stability.”

Speaking to the Economic Club of New York on December 19, 2002, the chairman rationalized his inaction from a different angle: “The evidence of recent years, as well as the events of the late 1920s, casts doubt on the proposition that bubbles can be defused gradually.”
⁸

This contradicted the chairman’s “Gold and Economic Freedom” essay of 1966. It is reasonable to suppose he may have changed his mind. But that is not so. Congressman Ron Paul handed Greenspan a copy of his essay and asked if he would like to add a disclaimer. Greenspan replied with uncharacteristic candor: “No. I reread this article recently—and I wouldn’t change a single word.”
⁹

⁷
“To Burst or Not to Burst,”
Economist
, September 7, 2002.
⁸
Alan Greenspan, speech to the Economic Club of New York, New York, December 19, 2002.
⁹
William Bonner and Addison Wiggen,
Financial Reckoning Day: Surviving the Soft Depression of the 21st Century
(Hoboken, N.J.: Wiley, 2003), p. 159.

Terrorizing the American People— Great Depression II

On June 25, 2003, the FOMC cut the funds rate to 1.00 percent. This was as low as it would go until December 18, 2008. Three-month Treasury bills traded at 0.90 percent, the lowest yield in nearly half a century.
¹⁰
It is said that Americans know very little history, but of one sequence, three-quarters of a century back, Americans come mentally equipped: the 1929 stock market crash was followed by the Great Depression. Ergo, a deflation and a depression go hand in hand.

The Fed was more interested in pumping up the housing market, but it tactfully developed its depression thesis. New theses were never hard work. Whatever the Fed said, was. It controlled the debate, talked it up, then down. Greenspan may not have made the front cover of
People
magazine—then again, maybe he has—but he defined what economists and Wall Street debated.

Greenspan’s emphasis on price stability is a case in point. It was by no means true that central banks had, in the past, targeted only the prices of goods and services (a glance through William McChesney Martin’s speeches is a case in point), but now, if one were to hear a Fed official, economist, or the media, this sole focus was writ in stone.

Speeches by Federal Reserve governors linked deflations with depressions. We
needed
inflation. This was new to the FOMC’s table of woes, but now the man who wrote the book (at least part of it) was sitting at the table:
Inflation Targeting: Lessons from the International Experience
(Princeton University Press, 1999).
¹¹
According to Professor Bernanke the economy needed positive price inflation to prevent deflation. Now was the time to test his thesis on a laboratory of 300 million Americans.

Besides writing, Bernanke talked. On November 21, 2002, Federal Reserve Vice Chairman Ben Bernanke stood at the Washington National Economists Club’s podium and delivered a fearful message: “Deflation: Making Sure ‘It’ Doesn’t Happen Here.”

¹⁰
Sidney Homer and Richard Sylla,
History of Interest Rates
, 4th ed. (Hoboken, N.J.: Wiley, 2005); the previous yield below 0.90 percent was 0.88 percent in 1958.
¹¹
There were four authors: Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, and Adam S. Posen.

Bernanke offered several strategies to choke this gorgon, including a most frightful prospect: “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation . . . the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
¹²

The branch banks spread the word. In May 2003, the Dallas Federal Reserve Bank published a research paper. The authors declared the “Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter.” The authors also proposed a tax on savings. To make sure Americans kept spending, the currency would be stamped periodically, and savers would pay a tax “in order to retain its status of legal tender.” They seemed to favor 1 percent a month, or 12 percent a year.
¹³

The whole Fed team marketed “price stability” as its sole function. In 2005, St. Louis Federal Reserve Bank President William Poole responded to the question of whether the institution should identify and manage asset price bubbles: “I’m really a hardliner on this. . . . I think it is incompatible with a market economy to have a government agency setting asset prices that are meant to allocate capital.”
¹⁴
Milton Friedman also lectured from the audience: “The role of the Fed is to preserve price stability. Period. . . . It should not be concerned with the asset markets as such, only as they affect indirectly—somehow—the price stability as a whole.”
¹⁵
The professor’s argument turns on itself. Asset bubbles destabilize an economy. The larger question is how Poole (and such “freemarket” advocates as Friedman and Greenspan) could ignore the central bank’s influence on capital allocation from its monopoly of short-term interest rates.

¹²
Ben Bernanke, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” speech at the National Economists Club, Washington, D.C., November 21, 2002.
¹³
William A. Fleckenstein with Frederick Sheehan,
Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve
(New York: McGraw-Hill, 2008), p. 147; Evan F. Koenig and Jim Dolmas, “Monetary Policy in a Zero-Interest Rate Economy,” May 2003. This was a presentation made to the Federal Reserve Bank of Dallas.
¹⁴
Doug Noland,“Credit Bubble Bulletin,” Prudent Bear Web site, July 8, 2005, p. 11. Noland writes that the Poole and Friedman quotes are “from a recording of Wednesday’s [that is, July 6, 2005] Western Economic Association’s panel in San Francisco.”

These certified economists were the most detached bureaucrats since mandarins from the Zhou Dynasty. Between the fall of 1997 and the fall of 2002, the average house price in the United States rose 42 percent. In New York City, prices had risen 67 percent; in Jersey City, 75 percent; in Boston, 69 percent, and in San Francisco, 88 percent.
¹⁶
The median price for an existing, single-family house in California rose from $237,060 in April 2000 to $262,420 in April 2001 to $319,590 in May 2002 to $369,290 a year later.
¹⁷
An application of the Fed’s pro-inflation policy appeared in a November 2002
Time
magazine article with some timely advice: “Cash Out Now! It Only Sounds Crazy. Here’s Why You Should Borrow against Your House and Buy Stocks.”
¹⁸