by Bob Woodward
“Call Rubin,” Dole said.
“Absolutely not,” Rubin said when Bennett reached him. “No way, forget it, don’t even talk about it. We can’t go that route.” It would be an end run around Congress—which, if angered, could cut off funding or change the law.
Bennett said that Greenspan thought it was possible if Congress did nothing.
“Well,” Rubin said, “I’ll talk to Alan.”
Over the next several weeks, Dole and House Speaker Newt Gingrich had some of the governors from the states along the Mexican border to Gingrich’s office. Texas’s new governor, George W. Bush, was one of the strongest voices. The border economy would just go completely down the drain, he said. You guys got to do something.
Dole called Clinton, and the next day, January 31, the administration announced it was using $20 billion from the fund. Many congressional Republicans howled, claiming that the administration was circumventing Congress.
Rubin figured that the Republican opponents were most comfortable criticizing the administration, because they lacked the courage to act to prevent the assistance. The critics were obviously worried that if they blocked it and all hell broke loose, they would be blamed.
Rubin called Bennett.
“Senator,” the treasury secretary said, “it took us two weeks to figure it out, but you were right.”
Treasury eventually loaned the Mexican government $12.5 billion, and the Mexican economy improved and stabilized. The interest rate on the assistance loans was so high that Mexico paid the whole balance back early, in full. Greenspan considered it the first crisis of the new international financial order.
• • •
Prior to the February 1 FOMC meeting, Greenspan again made his private rounds with some of his committee members. He told Blinder he wanted a 1/2 percent rate increase.
Since November, Blinder had admitted to himself that the 3/4 percent rate hike made that month had probably been a good idea. Based on the data now available, he had been wrong to oppose it. But he thought that yet another hike, particularly of 1/2 percent, was taking things way too far. In less than a year they had raised rates 21/2 percent, and it was time to wait to see if that would be enough castor oil to do the job.
After a brief meeting, Greenspan left, without the assurance that Blinder would vote with him.
Greenspan also told Yellen that he was inclined to favor a 1/2 percent increase. Like Blinder, she didn’t think it was a good idea. The economy seemed to be slowing, she thought, and she did not commit to support him.
Yellen had attended several FOMC meetings by now, and she thought that every time she walked into the meetings she heard the same arguments: The economy is hot, we have to raise rates. My God, she thought, it was a good thing they met only every six weeks and not every single week, or the rates would be through the roof. She half wanted to scream out, There’s a lag here, folks! Rate increases take a year or more to have a real impact.
Yellen and Blinder conferred. Maybe they should dissent, oppose Greenspan, put a stop to this overkill. Before they knew it, they would be in a recession that their acquiescence might have caused. They talked to Governor Larry Lindsey, who was also very uncomfortable with the informally proposed 1/2 percent hike. Lindsey also considered dissenting, but Greenspan sounded Lindsey out and persuaded him not to dissent.
Blinder and Yellen continued to discuss it. Maybe it was time. It would be a real statement. As the two Clinton-nominated board members, they felt that a dissent from just the two of them would be widely viewed as political, especially a year before the presidential election—but they continued to flirt with the idea.
In the February 1, 1995, meeting, Greenspan pushed for the 1/2 percent increase. He didn’t know for certain that it would be the last increase in the current tightening cycle, but he believed they were getting close. The bond market was signaling that it expected more inflation and more rate increases, and the FOMC was still behind the curve. When they were behind, they had to jump to try to close the gap if possible. Inflationary expectations fed on themselves. Raising rates might contain those expectations, so that they would gradually dissipate.
When it was their turn to vote, Blinder, Yellen and Lindsey all went with Greenspan’s recommendation. The vote was unanimous. In one year, the fed funds rate had been doubled, from 3 to 6 percent.
Blinder didn’t like being steamrollered. In a speech in Richmond, Virginia, two weeks later, he declared that the preemptive strategy of raising rates to cut off the top of a boom suggested that the Fed had to be prepared to lower rates preemptively even before the economy might slow. Policy speeches were typically the domain only of the chairman, and Blinder knew that his speaking openly about Fed policy would needle Greenspan. That was exactly what he wanted to do.
Word reached Blinder through the staff that Greenspan was unhappy. As usual, Greenspan said not a word about it.
In prepared testimony before the Senate Banking Committee a few days later on February 22, Greenspan noted that the Fed had acted “to head off inflation pressures not yet evident in the data.” He continued, “Similarly, there may come a time when we hold our policy stance unchanged, or even ease despite adverse price data.”
It was the first time the chairman had spoken of such a strategy in public. Blinder was delighted when some market analysts suggested that he had pushed these words into Greenspan’s mouth, although it wasn’t the first time Greenspan had raised the possibility of the need for preemptive easing. He had done so earlier in internal Fed meetings. Blinder viewed Greenspan’s public discussion of the possibility of preemptive easing as a tacit admission that the Fed had gone too far in raising rates.
Blinder also thought that Greenspan’s public remarks effectively took away the tightening effects of the 1/2 percent increase that Blinder had opposed. Immediately in the wake of Greenspan’s remarks before Congress about possible preemptive easing, the long-term bond rates went down. Greenspan’s speech had reassured the market that the Fed wouldn’t clamp down too hard on the economy. Although Blinder had voted with the chairman for a rate increase, the net effect on the economy—after Greenspan’s testimony—was almost as if the Fed hadn’t raised rates at all.
For Greenspan, wringing inflation expectations out of the economy often required that the Fed increase rates an extra time, take one more turn of the screw to really make sure they’d gone far enough. This was not always necessary in a tightening cycle, but he believed that it was necessary now.
In the months after February, data began flowing into the Fed suggesting that the economy was slowing substantially. Blinder went to Greenspan a number of times and beseeched him to lower rates. Greenspan would sometimes give Buddha-like responses, listening, hardly saying a word; other times he would argue with Blinder. Overall, Blinder thought that the chairman showed a fair amount of sympathy to his desires to ease up on the economy, but Greenspan made it clear that he did not want to rush things.
For Greenspan, preemptive action was more important on the tightening side, in order to keep inflation in check. Failing to ease rates early enough could be corrected with little difficulty, but allowing inflationary pressures to build without preemptive action might mean the difference between continued economic prosperity and a relatively severe Fed-induced recession if they had to increase rates suddenly and sharply. He remembered too well the Volcker era, when the Fed had driven short-term rates to 19 percent in order to stomp out inflation.
• • •
By the summer of 1995, Greenspan was feeling quite pleased. Inflation was still in check, and overall economic growth was slowing. Perhaps the soft landing was working—a slowdown without a recession. Was it possible? He wasn’t sure. In the past, economic slowdowns had often become recessions.
On Wednesday, June 7, 1995, in an unusual appearance, Greenspan answered reporters’ questions at an international banking conference in Seattle. Threading his way carefully through his own doubts and the media’s desire to know the future, he m
anaged to present both good news and bad news.
On the good news front he said, “I don’t see any problems that really disturb me.”
As to possible bad news, he said, “As a consequence of the sluggish economic outlook, the probabilities, as some of my colleagues have indicated, of a recession have edged up, as indeed one would expect.”
The result was contradictory headlines:
“Greenspan Sees Chance of Recession”—The New York Times.
“Recession Is Unlikely, Greenspan Concludes”—The Washington Post.
Greenspan laughed at the differing interpretations. He called it “constructive ambiguity.” Since he didn’t want to make inadvertent news, he deemed the press conference successful.
On Sunday, White House Chief of Staff Leon Panetta was on Meet the Press and was asked if the Fed should reduce interest rates.
“Well,” Panetta said, “it would be nice to get whatever kind of cooperation we can get to get this economy going.” Growth was hovering at an anemic 2 percent.
Asked if he was jawboning the Fed to get rates lower, Panetta replied with his overeager grin, “Is that what it’s called?”
Treasury Secretary Bob Rubin was furious. The administration had been so disciplined, avoiding any public or even private effort to pressure Greenspan. The soft landing would occur because the administration and Greenspan didn’t let the economy get out of control. It wasn’t science, Rubin knew, but he believed Greenspan was making a series of highly informed judgments—the best they had. White House pressure to cut rates could have the opposite impact and actually prevent a rate cut.
In addition, Panetta, the former Clinton budget director, was too often acting as if he were the primary economic policy spokesman—to let people know he was the man. As treasury secretary, Rubin was the primary economic policy spokesman.
Rubin immediately went public with a rebuke for Panetta and an assurance, almost an apology, to Greenspan. Of Panetta, Rubin said in a public statement, “I can assure you that his comments were not intended to signal any shift. Our policy with regard to the Federal Reserve has been consistent from the beginning of the administration—and that is not to comment.” He even added that Panetta had been “careless in how he responded.”
President Clinton seemed to agree with Rubin. It appeared that Panetta was briefly put in the doghouse—an unusual place for the White House chief of staff, who was supposed to be managing the executive branch on behalf of the president. Rubin and others knew that a side of Clinton agreed with Panetta, but in terms of politics and public perception, Clinton’s relationship with Greenspan and the Fed was more important than his relationship with his chief of staff.
Lay off, Rubin had said in effect to the president, remember the soft landing and long-term interest rates—those used by businesses to finance expansion and economic growth. The bond market was coming back, and long-term rates had dropped a sharp 11/2 percent since the fall. They were getting the payoff.
Greenspan took Panetta’s comments as a cheap and ineffective hit. Rubin had it right, not because of their growing friendship, but because Rubin saw it was in the president’s self-interest to avoid political meddling with the Fed. What was interesting, Greenspan realized, was that his relations with the administration were so good that the White House was more concerned about the perception of Panetta’s comments than Greenspan was himself.
• • •
Two weeks later, in a June 20 speech to the Economic Club of New York, Greenspan again left contradictory impressions.
“Doubts Voiced by Greenspan on a Rate Cut”—The New York Times.
“Greenspan Hints Fed May Cut Interest Rates”—The Washington Post.
Now Greenspan had a chance to practice some of his finetuning. Having doubled interest rates from 3 to 6 percent during 1994 and early 1995, he realized that he might have overshot, but only slightly. To bring the economy in for the soft landing now required a mild reversal—a slight easing. On Thursday, July 6, 1995, Greenspan proposed a rate cut of 1/4 percent. It would be the first decrease in nearly three years and the first rate cut during the Clinton administration.
Yellen was sure that they had overshot. She noted that the data since the last meeting had been overwhelmingly negative. Growth was so slow that it could conceivably build into a recession. They would probably have to cut rates even more, she said.
There was only one formal dissent. Thomas H. Hoenig, president of the Kansas City Fed, wanted no rate cut because he believed the economy needed no help and would pick up on its own.
On news of the cut, the Dow jumped 48 points to a new record high of 4664.
• • •
Both Greenspan and Rubin were concerned about the extraordinary strength of the stock market. Over the summer, Rubin called a meeting of key Treasury and Fed personnel at the Treasury Department. The question he wanted addressed was why the stock market was going up so fast. Greenspan and several Fed experts attended. The initial conclusion was that the increase in corporate earnings and profits was attributable to the spread of capitalism abroad into Russia, Eastern Europe and Latin America.
Greenspan was skeptical and wanted to know how much U.S. corporations were making abroad. He asked Steven A. Sharpe, a Fed Ph.D. economist who tracked corporate profits, to go further and see if he could develop an economic model to track and attempt to account for the high stock prices.
“Knowing what’s going on with profits is critical,” the chairman said. Healthy profits generally meant a healthy economy. Early detection of a decline in profits was essential for locating turning points in the economy.
• • •
In New York, Felix Rohatyn, perhaps the city’s best known investment banker, had been closely watching the first two and a half years of the Clinton era. An ardent Democrat and outspoken liberal who had been briefly considered as Clinton’s treasury secretary, he believed that the president was not getting the full story on the economy. Rohatyn, 67, a managing partner at Lazard Frères Co., was the grandson of a member of the Vienna stock exchange. He had immigrated to the United States during World War II and had a European manner, polished and engaging behind a pair of thick glasses. He cultivated wide connections in the international investment banking community. In the 1970s, he was tapped by the governor of New York to head the Municipal Assistance Corporation, which had rescued New York City from near bankruptcy.
Rohatyn knew CEOs who had reengineered their businesses and were passionately convinced that the American economy could grow at a faster rate than the old model of 21/2 percent a year without inflation. He had written articles sounding this theme for The Wall Street Journal and the New York Review of Books. He spoke with Erskine Bowles, the White House deputy chief of staff and a former North Carolina investment banker. A golfing buddy of the president’s, Bowles urged Clinton to meet with Rohatyn and a group of CEOs before going on vacation that summer.
The group that assembled in the Oval Office included Rohatyn and five CEOs—Paul Allaire of Xerox, Dana Mead of Teneco, George David of United Technologies, Bernard Schwartz of Loral and Paul O’Neil of Alcoa.
Bowles, Laura Tyson, the new head of the National Economic Council in the White House, and Treasury Secretary Rubin also attended.
The president ran the meeting as one CEO after another described how they had restructured their businesses. They delivered a single message on the economy: Greenspan was going to slow it down, and he didn’t need to. Higher growth without inflation was possible. The old perceived wisdom did not apply to a new emerging economy dominated by firms that were leaner and better organized.
Rohatyn said he was absolutely certain. He believed that markets at times did not work and government had to be more interventionist, more “can do.” The low rate of economic growth was not enough to meet the social and public investment needs of the country. The opportunity for a new, pro-growth policy was at hand.
Rohatyn left the meeting feeling that the president, Bowl
es and Tyson were sympathetic.
Rubin had sat silently, listening, taking notes.
• • •
Rohatyn and his wife, Elizabeth, had two adjoining weekend houses in Southampton on Long Island, New York. Greenspan and his steady date, NBC television correspondent Andrea Mitchell, visited one weekend that summer.
“I hear you’re not worried about inflation,” Greenspan asked Rohatyn as the two strolled in the garden.
No, Rohatyn said emphatically, he just believed the economy could grow faster than 21/2 percent a year without inflation.
Okay, Greenspan said noncommittally.
• • •
In the White House, Tyson could see that the president was taken with Rohatyn’s approach. It was a theory of economics that was neither pessimistic nor dreary. So many economists were busy telling Clinton what he couldn’t do that the president was happy finally to have someone tell him what he could do. It was as if he wanted to say, Get these economists out of my life.
Some political advisers were warning Clinton that Greenspan was a dangerous independent. Look what he did to Bush; he’s going to do it to you, several warned him. And here comes Rohatyn saying, It’s a new world. Tyson thought Clinton had found in Rohatyn the economic equivalent of his then chief political strategist, Dick Morris, someone bubbling with new ideas and plans, someone who could take the president’s wishes and convert them to action. Someone who would not be constrained by old approaches or theories. The recessive liberal activist Democrat in Clinton seemed to be stirring.
On November 30, Rohatyn published an op-ed piece in The Wall Street Journal arguing that higher non-inflationary growth was within reach. He blasted both the Republican Congress and the Democratic president. “Their greatest sin is to accept, and implicitly condemn, the United States to our present growth rates.”
• • •
Greenspan was still feeling confident. The economic expansion was five or six months longer than normal, a tentative indication that the soft landing might be working. It would take another six months to tell for sure. He still believed the soft landing was just theory, but at moments he was proud that they just might have carried it off. He quite extravagantly compared the theory to Albert Einstein’s theory of relativity, which revolutionized the understanding of the universe, light, matter and energy. Einstein, for example, had hypothesized that light would bend, but it took years for physicists to prove he was right.
