Maestro

by Bob Woodward

  With a somewhat severe face, bespectacled, a bit hunched, narrow eyed and pensive, Greenspan radiated gloom. He spoke in a gravelly monotone, often cloaking his thoughts in indirect constructions reflecting the economist’s “on the one hand, on the other hand.” It was almost as if his words were scouting parties, sent out less to convey than to probe and explore.

  A cautious man, Greenspan didn’t want to overstate his fears about the economy to his colleagues at his very first FOMC meeting. The staff report assembled by the Fed’s 200 expert economists headed by Michael J. Prell, a small, bearded Fed veteran, forecast “moderate growth.”

  “While the staff forecast is in a way the most likely forecast,” Greenspan told the FOMC, “I’d be inclined to suppose that the risks are clearly on the upside.” Growth and inflation were much more likely to be higher than the staff had predicted. “And my last forecast is that that’s likely the way Mike will come out the next time around.”

  One member suggested, at least half-jokingly, that Greenspan was trying to pressure Prell, whose next report would come in six weeks, just before the FOMC’s next scheduled meeting.

  “In case there’s any doubt,” Greenspan replied confidently, “I think the real world is going to influence him.

  “The risk of snuffing out this expansion at this stage with mild tightening is extraordinarily small,” he went on, referring to increasing interest rates that make it more difficult to borrow money. “I just find it rather difficult to perceive a set of forces which can bring this expansion down.”

  Greenspan could see that the other committee members didn’t share the alarm he felt and had somewhat concealed. He realized he didn’t know enough yet. And he also didn’t think, having been there only a week, that he could walk into the room and expect loyalty and support from everyone. It would not happen. If he had proposed raising the fed funds rate, he could not be sure he would get the votes. It would, he concluded, take quite a while to gain intellectual control of the committee and persuade the members to let him lead them. For Greenspan, it was a sobering moment.

  • • •

  During the next weeks, Greenspan pored over the economic data, attempting to pinpoint the volume in inventories, shipping times, sales and prices that explained the real condition of the economy. He knew where to get the numbers about production and orders for rolled steel, specific kinds of cotton fabric or any other industry he might want to examine. From the data and the charts he could reasonably forecast where the next point on a graph would be plotted, or the general direction and the range of next points. From this, he made his own predictions about how fast the economy was growing. He could see pressures on prices and wages brewing, and he was convinced that momentum in the overall economy was building. It was clear to him that they would have to move interest rates up, sooner rather than later.

  Since the FOMC was not scheduled to meet until late September, Greenspan had other options. The seven-member Board of Governors set the other interest rate that the Fed controlled, the so-called discount rate, which is the rate that the Fed charges banks for overnight loans. The economic impact of the discount rate is small compared to that of the fed funds rate controlled by the FOMC, but in 1987 changes in the discount rate were publicly announced and changes in the fed funds rate were not. The discount rate was the Fed’s only public announcement vehicle, and changes to it could send a loud public message. It was the equivalent of hitting the gong—exactly what Greenspan was looking for—and declaring publicly that the Fed was worried about possible inflation.

  All the Fed governors were full-time and had their offices in the main building, set off wide, attractive marble corridors that seemed a strange cross between a European villa and a funeral parlor. Greenspan made an effort to get to know each governor, seeking some out in their offices or inviting them to his office for unhurried but pointed discussion of the economy. He called this “bilateral schmoozing.” Over about a week, he sounded out and convinced the governors to support a discount rate increase. A graceful listener, he nonetheless made it clear what he wanted. In private he could convey more of the urgency he felt.

  On September 4, two weeks after Greenspan’s first FOMC meeting, the Board of Governors met under slightly unusual circumstances. Two were out of town and there was one vacancy on the seven-member board, so only four voting members were present. But Greenspan was in a hurry. The four governors voted unanimously to raise the discount rate 1/2 percent to 6 percent. It was the first increase in over three years. The press release announcing the increase said the rate hike was designed to deal with “potential” inflation.

  • • •

  Greenspan went to his office after the announcement. Okay, now, he told himself as he settled into his chair in his brightly lit office.

  It was the most risky time for a sharp rate increase, with stock prices so high and the Dow Jones average over 2,500. There was no way to control the secondary consequences of their decision. He turned to the screen on his computer to see how the markets were going to react—the stock market, the bond market, the foreign exchange markets. He knew the reaction would be negative. Had they done too much? Greenspan wondered. There was no way to know yet. He felt tension. He scanned the charts and graphs and numbers he had followed for so long—and suddenly, there before his eyes, he could see the dips he was causing. It was one of the most unusual experiences of his life. As he watched, he felt almost as if an earthquake were occurring and the building were rattling. He didn’t know whether the building would collapse, but he hoped the situation would calm down. Finally the markets stabilized, with the Dow Jones down only 38 points on the day.

  He got word that Paul Volcker was on the phone.

  “Congratulations,” Volcker said in his booming voice. “Now that you’ve raised the discount rate, you’re a central banker.”

  “Thank you,” the new chairman said.

  Greenspan felt that it was crucial to maintain both the Fed’s credibility and his own credibility as an inflation fighter. He did not want to see the unwinding of the Volcker era, when runaway inflation had been effectively slain.

  With the discount rate move, Greenspan felt he had put a stamp on his general philosophy of not allowing inflation to take hold. And as he wanted, he had done it earlier rather than later. He felt confident in his knowledge of the markets and the economy, but he was also nervous.

  Then he concluded, “If you’re not nervous, you shouldn’t be here.”

  Nervousness and doubt were central to the task.

  • • •

  Over the next few weeks, the stock market remained high, with the Dow right around 2500, while long-term interest rates on government and business bonds, which the Fed did not control directly, were also going up. That was rare, Greenspan realized, an unsustainable phenomenon. High interest rates meant higher returns on bonds for investors, which would eventually attract money from the stock market. As investors left stocks for bonds, the stock market should move down accordingly. The higher bond rates or borrowing rates for businesses would also depress business earnings and profits, and that too should have sent the stock market down as investors expected less return. But it wasn’t happening. As the prices of stocks went up, their yields in dividends went down. These yields were so low compared to the higher bond yields that it was becoming almost irrational to own stocks.

  With the economy running too fast and too hot, Greenspan had little choice but to keep quiet about his concerns. If he talked about the stock market problem in public, he was liable to trigger the very collapse he feared.

  What to do?

  • • •

  In 1952, Greenspan met the philosopher and novelist Ayn Rand, a proponent of rational self-interest and radical individualism. The author of The Fountainhead, a popular novel about a libertarian architect, took the young Greenspan, then 26, into her circle. Greenspan was a high-IQ mathematician and economic technician who had adopted the philosophy of “logical positivism,” wh
ich held that nothing could be known rationally with total certainty. He was an extreme doubter and skeptic. The two got into a long series of debates on the issue of values, ethical systems and the nature and origin of morality.

  Young Greenspan, intense, with thick, black, slicked-back hair, thought he could outdo anybody in an intellectual debate, but Rand regularly cornered him. It was like playing chess, and all of a sudden, out of nowhere, she would checkmate him. Rand was compelling, and the young man was enthralled.

  Rand and Greenspan argued about the nature of society and the power of the state. She pushed him hard. The matters they disagreed on were those that were not provable one way or the other, Greenspan felt, but he believed that the debates and the intellectual rigor gave him a sense of how to determine what was right and what was wrong in his value system. He felt acutely conscious that he would know when he was compromising the market-oriented, procapitalist principles he and Rand shared.

  After forming Townsend-Greenspan, Greenspan’s skill with numbers and data soon had him advising the chief executive officers of major corporations. He became particularly attuned to addressing the anxieties of the person at the top who wanted to know what was going to happen. Yet even when providing his forecasts for high-paying clients, Greenspan’s natural precision and doubt stayed with him. He said often that the future is unknowable, and he did not overstate his conclusions. He spoke in terms of most likely outcomes and probabilities.

  In 1968, Greenspan became an economic policy adviser to Republican presidential candidate Richard Nixon. His first prolonged contact with Nixon occurred during a meeting of campaign insiders on Long Island. Nixon opened the meeting by uttering more four-letter words than Greenspan knew existed. He was shocked by the contrast between Nixon’s public piety and his private profanity and anger. It was no less, he concluded, than Dr. Jekyll and Mr. Hyde. He was the only member of the senior group not to take a position in the Nixon administration.

  A “strict” libertarian, as he termed himself, Greenspan was a believer in the efficacy of free markets. Attempts by government to tamper with them or direct them were folly. He was appalled when President Nixon ordered wage and price controls in his first term—the ultimate intervention into the markets, a disfiguration of capitalism by government.

  In the summer of 1974, Nixon asked Greenspan to become chairman of the President’s Council of Economic Advisers, one of the most distinguished posts in government for an economist.

  “There’s a very good chance I might feel the necessity of resigning in three months,” Greenspan warned Nixon’s chief of staff, Alexander M. Haig. New wage and price controls would trigger his departure. “I physically would not be able to function and I would have no choice but to resign. And I wouldn’t want to do that to you and I wouldn’t want to do that to me.”

  Haig and others assured Greenspan there would be no more forays into wage and price controls.

  Greenspan finally accepted the post but took an apartment in Washington on a month-to-month lease, figuratively keeping a packed suitcase by the door. In an unusually graphic comparison, he said coming to Washington to advise a president in a free-market economy that might suddenly shift to one with wage and price controls was like a gynecologist being asked to practice proctology.

  He stayed on after Nixon resigned in 1974 and Gerald Ford assumed the presidency. Greenspan thought that Ford was bravest and most correct when he didn’t meddle with free markets during the recession of 1974–75, even at the risk of his own political future.

  • • •

  Now, Greenspan’s job as Fed chairman made him perhaps the federal government’s foremost regulator, and the irony was not lost on him. Still, he didn’t want to lose his sense of the virtue of keeping his hands off free markets.

  At the next FOMC meeting, September 22, 1987, the chairman remarked that the economy was clearly quite strong. He was uncertain, however, about where they might be in the inevitable ups and downs of the business cycle. “There is always something different; something that does not look like all the previous ones. There is never anything identical, and it is always a puzzlement.” But, he said, he had not detected what was unusual about this economic situation, though the main problem of overheating was evident. “We do not yet have any evidence of actual inflation,” he said, recommending no change in interest rates. The FOMC agreed unanimously. “The actions we are taking,” the chairman said, underscoring the point, “basically would indicate that we did nothing at this meeting.”

  • • •

  A month later, over the weekend of October 17–18, Manuel Johnson—now elevated to the vice chairmanship of the Board of Governors—spent hours and hours attempting to find a buyer for the largest savings and loan in the United States, the American Savings & Loan Association. American Savings had secretly informed the Fed they were going to have to announce bankruptcy on Monday unless someone took them over. The thrift had a portfolio of so-called junk bonds—bonds that paid high interest rates—and they had taken a severe beating. The price of bonds moves the opposite of interest rates, so as interest rates had soared, the value of their bonds had sunk to the point that the thrift was effectively broke.

  Johnson was unable to find a buyer, he reported unhappily to Greenspan. To make matters worse, the stock market had been down on Friday. It looked as though it was going to be a rough Monday.

  Greenspan took a professorial approach. Great, if a buyer can be found, he said, but if not, market forces will work it out.

  On Monday, October 19, the stock market was down in the morning but then started back somewhat. Greenspan decided to stick to his schedule, which included a speech at the American Bankers Association convention in Dallas the next morning. By the time he left for the airport, the stock market was back down again, by several hundred points, and the situation looked awful. He debated whether to back out and stay in Washington, but he concluded that canceling the speech would send the wrong message, a message of crisis. At midafternoon, he boarded American Airlines flight #567 bound for Dallas.

  The plane had no phone, so when he got off in Dallas he immediately inquired about the market.

  “It was down five oh eight,” replied Jim Stull, a senior vice president at the Dallas Fed who had come to meet him.

  “Wow, what a terrific rally!” Greenspan said. The market was down only 5.08 points. Whew!

  No, 508.

  That meant close to $1 trillion in wealth—more than 20 percent of the stock market’s total value—was wiped out for the moment.

  “There has never been a decline in one day over 20 percent,” Greenspan said soberly. A serious decline in the stock market did not come as a surprise, but the severity of the one-day drop was a shock because it was without precedent.

  He had studied the Black Tuesday crash of October 29, 1929, a critical turning point in history. That crash had triggered bank failures and a recession, which led to the Great Depression of the 1930s. The market crash of 1929 had been 11.7 percent, compared with the 22.6 percent drop that had just been reported.

  At the Federal Reserve headquarters in Washington, Johnson was the official crisis manager. He was struck by the tomblike hush in the corridors. He contacted the senior staff. Don’t go home, he told them, we need to go over this. Everyone gathered in the small library across from the board and FOMC meeting room. Johnson took out a one-inch-thick binder with a pink cover that had emblazoned diagonally across its front a large bold warning: “RESTRICTED—CONTROLLED.”

  He read, “Summary Papers on Risks in the U.S. Financial System.” He turned to the tab on the stock market: “STRICTLY CONFIDENTIAL, STOCK MARKET RISKS.” The seven-page section stated that the current prices were “probably unsustainable.” The options for action, Johnson read, included open market buying of bonds to keep money in the banking system and short-term interest rates from rising. Some options were extreme. “Try to organize stock purchases by major securities firms,” he read. That would be an unheard-of
market intervention. Was it that bad? Johnson didn’t know. Another option, he read, “an off-the-wall suggestion: targeted Fed lending specifically designed to support stock values.” Again, another extreme idea. He wondered how it could be done. Still another option included shortening stock market trading hours or even a trading halt. The papers weren’t very helpful.

  Greenspan finally reached the Adolphus Hotel in downtown Dallas and held a conference call with Johnson and the others. Some were saying, Well, let’s wait and see.

  “You people have not been around long enough,” Greenspan said. He had been around, around money, around the markets, around people on the verge or in panic, for decades. “This is a shock to the system,” he said. “You don’t assume it’s going to wear off.” Greenspan knew that a crash of that magnitude was like a gunshot to the entire financial system. The full pain would not be felt right away. There would be ripple effects for a long time, a possible convulsion in the economy and in society.

  Someone on the phone said that everything might be okay.

  “You know what just happened?” Greenspan said. “We just destroyed a huge chunk of wealth in this country.”

  Drafts of a possible statement by the Fed or by Greenspan were being cobbled together. Without having made a decision, the chairman and others agreed to regroup on the phone the following morning well before the stock market opened.

  Greenspan said he would stay and give his speech the next morning. It was important not to appear panicky, he said. The speech was on bank regulation, and he attempted to graft several reassuring paragraphs onto it about the stock market. He was not happy with the result.

  No one knew the answer to the main question of why the market had crashed. Was something fundamentally wrong with the businesses whose stock had suddenly plummeted 20 percent? Had the doubt and overvaluing triggered more doubt, starting a landslide of reactive sellers bailing out in anticipation of more declines and doubt? Had the process just been overwhelmed, some self-reinforcing spiral downward unique to the moment?