Maestro

by Bob Woodward

  “I must say the discussion this morning has been one of the best discussions I have heard around this table in quite a long while,” Greenspan said when the others had finished. He said he would not dismiss the comments of Blinder and Yellen.

  “I think we are behind the curve,” he added after offering a brief assessment of the economy. “I think that creating a mild surprise would be of significant value.”

  The chairman then remarked that the markets had already factored in a rate increase above the 1/2 percent that some were arguing for—and that they needed to be out ahead of those expectations. “So, I think that we have to be very careful at this stage and be certain that we are ahead of general expectations. I think we can do that with 3/4 of a point.”

  To underscore his strong feelings, the chairman added, “I must tell you that 1/2 percent makes me a little nervous. No, I take that back: It makes me very nervous, and I would be disinclined to go in that direction.” Anyone voting against him, in other words, was in favor of a very nervous chairman.

  “I fear that doing 3/4 of a point today rather than 1/2 of a point may send us down an oversteering path,” Blinder said. He reminded the committee that “the Greenspan Fed has never once moved the fed funds rate by 3/4 of a point in either direction. Not once. When this Fed has erred, it has been on the side of caution. . . . I always thought that was a good idea.

  “I think this will be like feeding red meat to the bond market lions,” Blinder went on. “They will chew it up and ask for more. A Federal Reserve that did 1/4, 1/4, 1/4, 1/2, 1/2, 3/4 does not look to an outside observer like it is about to stop. I think we will create what are already strong expectations that we are not about to stop.

  “My personal preference is strongly for 1/2,” Blinder concluded. “. . . I thought hard about whether I should dissent on this matter, and I did not decide until last night. I finally decided that I won’t. . . . I think it is better to show a united Federal Reserve against the criticism that we are surely going to get for this move.” Blinder would go along with the rate hike, but he made it clear that he would stand strongly against raising rates again at the next meeting.

  “Okay,” Greenspan said, right on the tail of Blinder’s long speech about his struggle. “I propose that we move 3/4 percent.”

  All 12 members voted yes.

  Blinder had gone with the chairman because he didn’t want to use the power of his dissent on what could be seen as a tactical dispute. The practical difference between 1/2 percent and 3/4 percent, in terms of measurable effects on the economy, was quite small. Blinder’s chief concern was where they might be heading in the months to come.

  He also knew that there was a tradition at the Fed that members go along with the chairman unless they are really uncomfortable, terribly uncomfortable. This is especially true of the vice chairman. Nobody at the Fed, as far as Blinder knew, could remember the last time a vice chairman had dissented from the will of the chairman.

  Finally, Blinder realized that there would be more arguments about when the Fed would stop raising rates, and that those arguments would be more important than this argument. If he shot his cannonball now, it would be wasted—because he wasn’t going to change the decision. He would have fallen on his sword for no reason.

  Blinder came from an academic environment, where he was used to following his conscience. It had become clear to him that voting solely on the basis of his convictions and economic conclusions wouldn’t work at the Fed.

  • • •

  Greenspan made his speaking rounds to business groups, including the Business Council.

  We cannot raise prices, CEO after CEO told him. Many had tried and been cut down by their competitors.

  What do you mean, you’re having problems? Greenspan pressed one group at his table. Profit margins are going up. Stop complaining.

  The CEOs explained that their competition would invest in new technology, bring their costs down and then bring their prices down, grabbing market share.

  Greenspan suspected that it was productivity growth again. In the real world, productivity, the measure of how much a worker produced in an hour, was obviously shooting up. But the methods of measuring it and the habits of economists who insisted on years and years of data before reaching even a tentative conclusion were keeping the world from learning of a potentially stunning change.

  10

  * * *

  ON CHRISTMAS night, Sunday, December 25, Greenspan met with Guillermo Ortiz Martinez, the Mexican finance minister, and Lawrence H. Summers, the 40-year-old undersecretary of the treasury for international affairs. Summers, a Ph.D. economist who had won full tenured professorship at Harvard at the extraordinarily young age of 28, wanted to make sure the Fed and its chairman were involved in the major economic initiatives undertaken by the Clinton administration so they would have a stake in the outcomes.

  Mexico was experiencing a significant crisis, and its leaders had decided to devalue the peso a few days earlier. The country had experienced a burst of economic growth by relying heavily on foreign investment, particularly from the United States. Confidence in the currency and investment potential in Mexico had now plummeted, and the country had just about run out of dollars. Mexico’s basic solvency was in doubt.

  The foreign investment surge in Mexico in the early 1990s was largely attributable to the high return investors found there. Investors could earn about 12 percent on short-term Mexican debt—several times what could be made on short-term U.S. debt. Both experienced Wall Street firms and U.S. mutual funds had poured money in. But in early 1994, political instability—an uprising in the province of Chiapas and a political assassination—caused investor momentum to shift away from Mexico, and money flowed out.

  The Mexican authorities’ response to the situation had reinforced Greenspan’s faith in monetary gradualism and aggressive inflation fighting. Mexican authorities at first failed to raise interest rates, apparently loath to risk a recession—which then forced them to raise rates dramatically later, a drastic move that had helped create the current crisis.

  Now, the Mexican government wanted a sizable financial support package of loans, and then everyone would live happily ever after.

  Greenspan didn’t like the idea. Loans or guarantees from the United States would risk “moral hazard,” a term used by economists to refer to bailing out those who had made risky investments—creating an expectation that they would be bailed out the next time. He believed strongly that the government should not insulate free-market investors from risk. At the same time, he admired the way Mexico had over the previous decade shifted from an inflation-prone, highly unstable, rigid, government-controlled economy toward free markets. Mexico had become the world’s poster child for emerging third world economies—a model dozens of other countries were following or being urged to follow. That was part of the problem. Mexico’s ruin could mean, at least temporarily, the ruin of the cherished free-market model. Discrediting the model might have a larger impact on the world economy than whatever might happen to Mexico, pushing many other developing countries off the cliff. On top of that, new computers and communication had created the globalization of finance. Money flowed instantaneously across borders. Catastrophe in Mexico could trigger a worldwide contagion before they could calculate the full impact.

  The Fed could have guaranteed U.S. bank liabilities or loans in Mexico, but Greenspan immediately dismissed such involvement as utterly inappropriate. U.S. investors should not be protected in such high-risk investments.

  Over the first two years of the Clinton administration, Greenspan had worked with Bob Rubin, but he did not know him well. Now Rubin, about to take over from Bentsen as treasury secretary, initiated a running meeting over several days at Treasury about the Mexican crisis, which worsened as 1995 began. Rubin invited Greenspan and Ted Truman, 53, the outspoken, strong-willed head of the Fed’s Division of International Finance since 1977.

  Greenspan was immediately attracted to the n
ature of the debate at Treasury. Summers presented all the arguments for a financial assistance package to Mexico, then gave many of the reasons why not to assist.

  Rubin’s questions showed he was acutely aware of the uncertainties. As the group seemed to move toward a decision to assist, Rubin would insist on airing the 3 or 10 reasons why that course of action was a bad idea. Chief among them was the argument that U.S. assistance would be viewed as a bailout of U.S. investors in Mexico and revive arguments that Mexico was “too big to fail.” As the others seemed then more comfortable with not providing direct assistance, Rubin would veer back to the arguments in favor of assistance. Vigorous dissent was appreciated and invited. Neither Rubin nor Summers seemed to be selling his own ideas; instead, each was trying to find a solution. It was the group decision making that Greenspan found very attractive as he floated in and out of the discussion.

  Rubin pressed, insisting on systematic thinking about their choices and the relative probability of the various options working or not working.

  Finally, the weight of evidence suggested that some sort of direct assistance from the United States was called for. The risk to the world and U.S. economies was real, and an aid package with tens of billions of dollars in loans, with strict terms and high interest rates, would be a minimal investment in international stability.

  Greenspan said that some assistance package was what he called “the least-worst” of the alternatives. We have to do something. If they were going to provide loans, the basic rule, he said, should be to figure out how much might be needed and then to do more. It was the same principle that former chairman of the Joint Chiefs of Staff, General Colin Powell, had applied in the 1991 Gulf War. Powell’s doctrine of overwhelming military force called for sending enough to guarantee success. There were no absolute guarantees in a foreign debt crisis, but Greenspan had a refinement of the principle: Send enough to reduce the probability of failure to below your point of tolerance. If they tried and failed, it would send an awful message to the world and U.S. financial markets about the inability of the U.S. government to affect outcomes in international financial crises.

  To top it off, Mexico’s Ortiz came to Washington and declared to Greenspan and Treasury officials that as finance minister he had no idea what he was going to do—saying, in effect, It’s not our problem, it’s your problem.

  Rubin was convinced that there was a possibility of what he called “systemic impact,” meaning that an economic meltdown in Mexico would trigger a cascading international financial crisis with no foreseeable stopping point. He wanted Greenspan behind him.

  On January 11, 1995, Rubin took the oath of office as treasury secretary at the White House. He then proposed to the president that the administration request an aid package of some $25 billion from Congress to loan to Mexico. Some of Clinton’s political advisers, including Chief of Staff Leon Panetta, noted that if, on Clinton’s urging, the United States loaned $25 billion to Mexico and it didn’t come back, the failure could cost the president reelection.

  The president posed a number of questions. If Mexico was going to collapse financially, when would they know it was inevitable? Would they have days or weeks of warning?

  Rubin and Summers said that the $25 billion would be given not at once, but in installments. The first installment would be only about $3 billion, and there would be some solace, but not a lot, that they would then be able to see if the financial markets found the package credible before they had actually to loan more from the $25 billion.

  Rubin noted that markets were psychological animals, and if the world financial markets came to believe the package was sufficient to have a meaningful impact on Mexico, then international investment money would start to flow back into the country. Money alone would not necessarily solve Mexico’s problem. The country had to regain the credibility of its people and the world investment community.

  Rubin and Summers made it clear that the penalty for failure would far exceed any reward if they succeeded. Applying Greenspan’s doctrine of sending more than they thought was needed, they upped the price tag. They proposed that the president ask Congress to appropriate $40 billion in loan guarantees to Mexico. To be relevant to the outcome, they had to be willing to put a massive amount of money on the table. Nobody had ever done anything quite like it before.

  There was another factor. Ted Truman, the Fed’s international chief, had authored a paper concluding that a collapse in Mexico would have such a severe impact, it would lead to a 2 percent decline in annual growth in the United States. That was a staggering number. No one had to remind Clinton that such a decline would have immense political repercussions in the year before he would be running for reelection.

  “After all this chickenshit ethical stuff,” Clinton said, referring to the continuing investigations of Independent Counsel Kenneth W. Starr, “I’m doing this because I think this is the right thing to do, even if we lose the election.” He seemed to relish the decision. “I couldn’t sleep at night if I didn’t do this.”

  He added that he could do it only because Mexico is on the U.S. border. If the problem were in India or some other country, he wouldn’t be in a position to do it.

  During his first year as president, Clinton had pushed through the controversial North American Free Trade Agreement (NAFTA), which opened the doors to trade with Mexico. He had invested much political capital in free trade, and he was not going to let Mexico fall into economic chaos. He approved the $40 billion request. He then called the congressional leaders, Senate Majority Leader Bob Dole and House Speaker Newt Gingrich, to the White House to brief them on the crisis and his $40 billion request. Both Republican leaders, Dole and Gingrich, gave their support.

  Soon conservative Republicans in the Senate and House were in near rebellion. They didn’t want to dump so much money into another country.

  Gingrich asked Greenspan to call Rush Limbaugh, the popular conservative radio talk show host, and lobby him on the Mexican loan proposal and explain why it was essential. The ratings claimed that Limbaugh had 20 million listeners, and he was giving Gingrich a hard time, having great fun denouncing and ridiculing the Speaker’s support of Clinton’s plan to give away $40 billion of U.S. taxpayer money south of the border.

  Greenspan took the position that if anyone wanted to know his views, he would offer them. He reached Limbaugh by phone, saying Newt had asked him to call, and laid out the arguments in about 10 minutes. He didn’t want to push particularly hard, wanting only to make sure that Limbaugh was aware of the possible consequences.

  On Thursday, January 12, Greenspan joined Rubin at the White House to give a background briefing to reporters on the $40 billion plan. The camera lights were turned off in the White House press room, and under the ground rules they could be identified only as “senior United States officials.”

  Greenspan was not used to the skeptical questioning of the White House press corps, and he seemed slightly flustered by the interrogation.

  On January 13, Greenspan accompanied Rubin to Capitol Hill to lobby for the $40 billion. Included was a two-hour meeting with 100 legislators.

  Despite the support of the Republican and Democratic leadership in the Congress, it soon was absolutely clear the $40 billion request would not pass. Mexico was really on the ropes now, and a dangerous impasse had developed.

  • • •

  One of the senators on the banking committee whom Greenspan had cultivated was Robert Bennett, a 6-foot-5-inch Utah Republican who had been elected in 1992. As a freshman senator initially in the minority, Bennett was generally ignored. But he went to banking committee hearings and did something unusual—he actually stayed after the opening statements, listening, questioning witnesses intently and absorbing. Greenspan invited him to periodic one-on-one breakfasts at the Fed. Bennett had been an entrepreneur millionaire, heading firms that made audio discs for talking toys and then another that produced calendar day planners and organizers.

  Senate Majority Le
ader Dole appointed Bennett to come up with a way out of the Mexican crisis. Bennett spent that weekend studying. On Sunday he invited Wayne Angell, the former Fed governor who was a key informal economic adviser to Dole, over to his house. Angell, who was now chief economist for Bear Stearns, said that the only alternative was to use the Exchange Stabilization Fund (ESF), which had been set up 60 years earlier to permit Treasury to intervene to stabilize currencies in an emergency. There was some $30 billion in the fund, and Treasury had full control of it. Was Treasury willing to go out on a limb?

  Bennett called Greenspan to explain.

  “You can’t do that,” Greenspan said. “Wayne is wrong.”

  Bennett said it would require a little backbone, but Congress had authorized and provided money for the fund over the years. “Why do you need congressional approval?”

  “Because if we do it without congressional approval,” Greenspan explained patiently, “Congress will come down on us with their fury. We can’t do that.”

  “What happens if you do it,” Bennett replied, “and Congress is silent?”

  There was a long pause. “That would work,” Greenspan said, “if you could guarantee Congress’s silence.”

  On Monday, January 16, Martin Luther King Jr.’s birthday holiday, Bennett reached Dole.

  “We can solve this without a vote,” Bennett said, explaining what the Exchange Stabilization Fund was. Congress would have to be silent—not literally, of course, because there would be the inevitable speeches and denunciations. But as majority leader, Dole could guarantee there would be no vote.