Maestro

by Bob Woodward

  Bush and Brady had failed to engineer their survival, but Greenspan had succeeded in engineering his.

  • • •

  When President-elect Clinton invited Greenspan to visit him in Little Rock on December 3, the chairman jumped at the chance. As they talked alone in the Governor’s Mansion, Greenspan found himself quite taken with the new young leader. Clinton was totally focused, as if he had no other care in the world and unlimited time. They ranged over topics from foreign policy to education, and Greenspan saw that Clinton’s reputation as a policy junkie was richly deserved. The president-elect seemed not only engaged but totally engrossed, as best Greenspan could tell. He saw an opening to give an economics lesson. The short-term interest rates that the Fed controlled were at 3 percent, as low as they could practically go in these economic conditions, he said. But they could keep them there.

  The long-term rates—the 10-year and longer rates—were an unusual 3 to 4 percent higher than the short-term fed funds rate, at about 7 percent. The gap between the short-term rate and the long-term rate, Greenspan lectured, was an inflation premium being paid for one simple reason. The lenders of long-term money expected the federal deficit to continue to grow and explode. They had good reason, given the double-digit inflation of the late 1970s and the expanding budget deficits under Reagan. They demanded the premium because of the expectation of new inflation. The dollars they had invested would, in the near and distant future, be worth less and less.

  Perhaps no single overall economic event could do more to help the economy, businesses and society as a whole than a drop in the long-term interest rates, Greenspan said. The Fed didn’t control them. But credible action to reduce the federal deficit would force long-term interest rates to drop, as the markets slowly moved away from the expectation of inevitable inflation. Business borrowing costs, mortgages and consumer credit costs would go down. Clinton was so sincere and attentive, and full of questions and ideas, that Greenspan continued. Establishing credibility about deficit reduction with the markets would lower rates and could trigger a series of payoffs for the economy, he said.

  Greenspan outlined a blueprint for economic recovery. Lower long-term rates would galvanize demand for new mortgages, refinancing at more favorable rates and more consumer loans. This would in turn result in increased consumer spending, which would expand the economy.

  As inflation expectations and long-term rates dropped, investors would get less return on bonds, driving investors to the stock market. The stock market would climb, an additional payoff.

  The federal deficit was so high and cumulatively unstable, Greenspan said, that increased government spending to increase jobs—in accordance with the traditional Keynesian model—no longer worked. The economic growth from deficit reduction could actually increase employment—a critical third payoff.

  Greenspan noted that the economy was rebounding, but there was no telling if it would last. As had happened in the past, he said bluntly, the recovering economy could fall on its face. Getting the long-term rates down and keeping them down with a strong deficit reduction program could sustain and increase economic growth even more than the conservative estimates that were circulating in the government or privately.

  This extraordinary conversation continued for two and one-half hours. Greenspan had not intended to stay for lunch, but he did. From the beginning he sensed a kind of academic atmosphere, which he liked. To his mind, Clinton was close to being an intellectual, inclined and willing to talk about abstract ideas. He was different from the four Republican presidents Greenspan had seen up close—Nixon, Ford, Reagan and Bush. The chairman left the meeting thinking, Either this guy has a lot of the same views as I do, or he is the cleverest chameleon I have ever run into. The first would be a compliment, Greenspan thought. The second: Oh, wow, this guy is something if he can fool me.

  Clinton’s conceptual ability was impressive, but Greenspan wondered whether Clinton was too thoughtful—whether he might know too much on both sides of the major questions of the day. Might the new president be indecisive, like Hamlet, incapacitated by endless debate and doubt?

  On the five-hour trip back to Washington, Greenspan tried to assess what he had observed. Clinton was a politician and a notorious schmoozer. Had the session been some kind of show? That, Greenspan felt, would really be impressive. If it was a show, it had been a remarkable one. No, he concluded, it was straight and sincere. Clinton was what Greenspan termed an “intellectual pragmatist.” He didn’t necessarily like to use the term because it was slightly pejorative, but he couldn’t think of another that captured Clinton. It fit, and it also applied to Greenspan himself. Part of Clinton’s campaign promise included tax increases on the wealthy, a violation of Republican orthodoxy. But increasing taxes reduced the federal deficit—and those deficits, Greenspan thought, were such a threat to the future of the economy that it might just be worth it to support Clinton’s proposal.

  One of the main paradoxes, Greenspan realized, was that by running up the federal budget deficits, Reagan had effectively borrowed from the period that was now going to be the Clinton era. In his era, Clinton would have to pay it back by paying down the deficit in some way. The irony was that Clinton probably wouldn’t have been elected if Reagan hadn’t created the deficits. Reagan had bequeathed Bill Clinton his major problem, but he had also given him his opportunity to win the presidency.

  Clinton was happy that Greenspan had not made the typical Republican plea against raising taxes on the rich.

  “We can do business,” Clinton told Vice President–elect Al Gore after the Greenspan meeting.

  7

  * * *

  PRESIDENT-ELECT Clinton named Thomas “Mack” McLarty, his friend from kindergarten in Hope, Arkansas, as his White House chief of staff. McLarty, 46, the small, gracious CEO of the Arkansas-based natural gas company Arkla, had succeeded by cultivating personal relationships. He was soon identified as the new president’s main man. Mullins, also from Arkansas, knew McLarty from high school football. Mullins’s father had been president of the University of Arkansas when McLarty had been president of the student body.

  Greenspan asked Mullins to arrange a private dinner for the three of them at the Metropolitan Club. The downtown Washington establishment was so old world that members were not allowed to use working papers or conduct business at the tables in the main dining room. Greenspan was a member.

  Mullins was happy to act as a go-between for such powerful figures. Obviously Greenspan felt vulnerable and out of touch with an incoming Democratic president. At dinner, Mullins noticed that Greenspan was attempting to soften his image as a conservative intellectual. The chairman turned on the charm and schmoozed. Hillary Rodham Clinton was going to oversee a health care reform program, and Greenspan said he would be delighted to talk to her about the issue. He invited McLarty to address the boards of directors of the district banks when they came to Washington. The boards comprised some of the United States’s most prestigious businesspeople.

  • • •

  Greenspan’s real connection to the new administration was going to be Lloyd Bentsen, the former Texas senator who was now Clinton’s treasury secretary. They were close friends and regularly played tennis together. Greenspan thought that the aristocratic and leathery-faced Bentsen, 71, looked and acted like a president. Bentsen had beaten George Bush in 1970 for the Senate and later had run unsuccessfully as the Democratic vice presidential candidate in 1988.

  Though a partisan Democrat, Bentsen had been the powerful chairman of the Senate Finance Committee and was conservative on fiscal and money matters. Greenspan considered him more Republican than Nick Brady.

  Bentsen arranged for Greenspan to see Clinton on Thursday, January 28, the eighth day of the new administration. Greenspan told the president that it would be dangerous not to confront the deficit very soon. The problem would not make itself immediately apparent during the next several years, because defense spending cuts would obscure the balloon
ing deficit. After 1996, though, the data showed—as persuasively as any numbers could—that the deficit and interest on the federal debt would become explosive.

  “You cannot procrastinate indefinitely on this issue,” Greenspan warned. Without action, he forecast “financial catastrophe.”

  Clinton made it clear he had received the message.

  Greenspan thought Clinton and his team were learning that campaigning for president was a great deal easier than being president. Campaigning was just identifying the problem—like a practice swing in golf, without a ball. Everyone could do it well. But governing was real, and it was all a lot harder with the ball on the tee.

  Bentsen urged the president to develop a personal relationship of trust with Greenspan and to listen to him on the critical question of cutting the federal deficit. He also emphasized to Clinton the importance of deficit reduction as a catalyst for lower long-term interest rates.

  With Bentsen, Greenspan went further. He urged the new administration to set ambitious deficit reduction targets for the federal budget. On February 5, the White House economic advisers sent Clinton a 15-page memo that summarized budget options and Greenspan’s analysis.

  It read, in part: “Greenspan believes that a major deficit reduction (above $130 billion) will lead to interest rate changes more than offsetting” the contraction to the economy caused by less government spending. This meant the long-term rates would come down if the deficit reduction was sufficient to have credibility in the financial markets, not that Greenspan would lower the fed funds rate.

  On his copy, Bentsen had written with his lead pencil referring to Greenspan, “He urges 140 or above,” meaning Greenspan thought a $140 billion reduction in the economic plan four years out (1997) would be more credible than $130 billion. It revealed their most private, confidential talks. In a sense, Bentsen and Greenspan were using each other. For Bentsen, Greenspan’s view on a specific deficit target was a potent weapon in the Clinton administration deliberations. For Greenspan, a big reduction in the federal deficit would make his job immensely easier, because lower deficits would likely mean lower actual inflation. Bentsen, and perhaps Clinton, could help Greenspan fight inflation.

  Greenspan didn’t worry that the president or Congress would cut the federal deficit so much as to induce economic chaos. He recalled that Paul Volcker had once said that no one was kept awake at night for fear that Congress would overdo deficit reduction.

  Bentsen and all of Clinton’s other top economic advisers recommended the $140 billion target. Some of Clinton’s populist political advisers, such as James Carville and Paul Begala, unaware of Greenspan’s indirect role as ghostwriter, thought it was too much deficit reduction, and they fought hard for less—perhaps just $5 billion less. But it was as if the $140 billion target, which included spending cuts and tax increases to add revenue, were carved in the sacred tablets, and Clinton adopted it. Bentsen told President Clinton that they had effectively reached a “gentlemen’s agreement” with Greenspan.

  When Clinton unveiled his economic plan at his first State of the Union address to a Joint Session of Congress on February 17, Greenspan was there in the gallery, in seat A6—right between Hillary Clinton and Tipper Gore, the vice president’s wife, on full display as the national television cameras swung over to get reaction. The First Lady had invited him to sit in her box for the speech, and Greenspan had accepted on the basis that protocol dictated he not refuse her invitation.

  As Clinton spoke, Greenspan applauded stiffly. He believed the White House had given him enormous power, because if he chose to criticize the Clinton economic plan, he could do substantial damage—even perhaps do it in. They had elevated him in the power structure very significantly, he believed. But the large deficit reduction portion was in part his own design, and he was hardly going to shoot it down.

  Greenspan was due to testify before Congress in two days about the plan. To make sure he was on solid ground, he canvassed the FOMC to make sure there was not so much as a razor-thin bit of difference between his views and those of the other committee members. On February 19, in testimony before the Senate Banking Committee, Greenspan said that the Clinton plan was “serious” and “credible,” making major headlines with his support.

  Greenspan thought that Clinton had broken the gridlock on dealing with the deficit. He couldn’t say it publicly, but he believed the president had displayed an element of political courage. He was taking a stance that some in his own party would fight him on. In Greenspan’s view, Clinton deserved commendation if there was any justice in the crazy town of Washington.

  It had been a remarkable four months for Greenspan. His impact on the new Democratic president was real and positive—a degree of influence he had not begun to approach during the more than five years he had been chairman under Reagan and Bush.

  Within a week, long-term interest rates began to fall, and Clinton said in a speech, “Just yesterday, due to increased confidence in the plan in the bond market, long-term interest rates fell to a 16-year low.” The yield on the 30-year bond had dropped below 7 percent.

  Bentsen was delighted. He was all over Greenspan, peppering him with questions about the chairman’s forecast and projections for the bond market. The long-term bond rate was the new talisman in the Clinton administration.

  • • •

  On March 10, Greenspan was in his office, sitting at his desk, staring into the computer screen. “The Buck Starts Here,” read a large plaque nearby.

  He glanced at the summary on the screen. The fed funds rate was at 215/16 percent, just below the Fed’s target of 3 percent. Slight variations in the market were inevitable, and the 1/16th percentage point lower meant the market was calm. With a stroke of button A on his computer, Greenspan moved on and checked the Treasury bill market, where demand for Treasury bills was up slightly. From there, it was on to a minute-by-minute breakdown of the Dow, which was down 4.31 points. He hit more keys, which took him through the foreign currency exchange markets—the yen, the deutsche mark—which were updated every 15 minutes and had daily numbers all the way back to January.

  Greenspan then checked the relationship between the British pound and the deutsche mark, which was a vital indicator of what was happening in the European markets. He called up the commodities market and looked at spot gold prices, then moved on to the Eurodollar deposit rates in London for short-term instruments—three months, six months and a year. He checked the important international interest rates and then moved on to oil prices.

  In all, Greenspan accessed about 50 charts by using button A on his computer. He hadn’t programmed the computer himself, but he had made sure that all of the information he wanted was always a click or two away. It was a calm day, so he checked the charts only once every half hour or so. He always checked regularly, because, as he liked to put it, he could never know for sure that something was not happening.

  • • •

  Greenspan felt that a growing part of his task was to anticipate the unexpected. He was increasingly convinced that the unexpected, in one form or another, would occur. He knew that what seemed impossible at first was often what happened, so preparation for dealing with the inconceivable was a necessary part of his job.

  The way he read the history of the 1950s and the 1960s, the Fed had been able to have a fairly expansionist, low–interest rate policy that helped the economy grow without significant inflation. There was almost a presumption that the system would not allow inflation to take hold. As a result, the key long-term interest rates important to businesses and consumers were always modest to low. The cost of the Vietnam War eventually cracked the system, and the deficits blew up in the late 1970s. Greenspan recalled one period in 1979 when long-term interest rates went up an incredible 5 percent. This was the runaway inflation that his predecessor Paul Volcker had tackled.

  The lingering residue of that runaway inflation was that an inflation expectation, which had been nonexistent prior to Vietnam, was now app
arently built into the system. One result was a psychology of inflation that was, at least initially, more important than real inflation. At any sign that inflation might be coming or that the Fed wasn’t vigilant, the long-term rates would shoot up in response. As Greenspan had told Clinton and his advisers, the magic bullet of any successful economic plan was to keep those long-term rates down.

  Of course, reducing the inflation expectation in the economy made it easier to keep actual inflation down. In a sense, the president and Congress, with their reduced spending, were taking on some of the inflation-fighting role of the Fed.

  To a large extent, that meant catering to the bond market. Businesses and government had trillions of dollars in outstanding debt in bonds, having borrowed the money at fixed interest rates for specific time periods. Bondholders would benefit as rates dropped and the value of the bonds that they held increased. But Greenspan believed he had argued successfully to Clinton and the Congress that there was a much bigger payoff for the overall economy and society. In the end, if they did it right and kept inflation in check, both the bondholders and the wage earners would gain. The income skewing of the 1980s, when the rich got richer and the poor got much less, would start to reverse, he believed.

  On the evening of April 19, 1993, Greenspan laid out some of this history in a speech to the Economic Club of New York.

  “Regrettably,” he said on page 12 of his speech, droning on, “the inflation excesses of the 1970s still condition the inflationary expectations of today.” The wide gap between short-term rates and long-term rates—the inflation premium—“reflects deep-seated investor concerns that inflation will significantly quicken in the latter part of this decade and beyond.” He said he didn’t think that inflation would occur, because the banks and the financial lenders were still recovering from the early 1990s—meaning that business expansion was not likely to get out of control and overheat the economy. But, he cautioned, “We need to be especially vigilant not to be mesmerized by the current tranquillity of the inflation environment.” Just 10 days earlier, the consumer price index for the previous months had shown a mere 1/10 percent increase, indicating no real problem with inflation.