by Bob Woodward
At the FOMC meeting on Tuesday, March 25, 1997, the staff report provided mounting evidence that the economy was more than robust. Consumer spending, business capital expenditures and housing construction were all up. Though there was no sign of inflation, Meyer and some of the others wondered whether it was time to increase rates, perhaps by a large amount, a preemptive move similar to what the Fed had done in 1994.
Speaking first, Greenspan had proposed a 1/4 percent increase, arguing that such a move would be the other side of the prudence that had led them not to raise rates the previous fall.
Brilliant, Meyer thought. Here Greenspan, the poster boy for the New Economy, was playing the old economy, inflation hawk card. The chairman was keeping a foot in both camps, both the New Economy/higher productivity school and the old economy/inflation-fighting school. It was a masterly management of the process, Meyer concluded. He voted with the chairman.
From the dovish side, Alice Rivlin believed that the economy was beginning to heat up. The stock market was feeding economic growth and perhaps getting the economy into inflationary trouble. Maybe they should at least look vigilant. The Fed hadn’t acted in more than a year. A 1/4 percent hike wouldn’t make any real difference one way or the other. It wouldn’t hurt, she figured, aware of the irony of the situation—which was that inflation was actually going down. But she voted with the chairman. So did all the other committee members.
The 1/4 percent increase, which put the fed funds rate at 51/2 percent, was again front-page news. The Greenspan Fed had never made just a single move up or down, so the expectation was that more increases were around the corner. The Wall Street Journal said that Fed watchers bet on one, two or even three additional increases over the rest of the year. The Washington Post said only one or two more 1/4 percent hikes were expected.
• • •
In one of his first discussions with Greenspan, Meyer had asked if there were any guidelines for giving public speeches. No formal rules, Greenspan said, but there were informal rules. Rule one: Don’t do speeches. The chairman noted that no one followed rule one. So rule two: Don’t say anything that will move markets.
Meyer had agreed to give a speech April 24 at a luncheon at the Forecasters Club in New York City. He carefully typed out his 25-page speech and had an advance text released to the press.
“I am a strong and unapologetic proponent of the Phillips Curve and the NAIRU concept,” he declared. These economic concepts held that low unemployment would eventually lead to high inflation. If there weren’t enough unemployed workers, wages would shoot up.
Meyer said also that the economy was growing at an “unsustainable” rate, and that the previous month’s 1/4 percent interest rate hike was “small, prudent, and preemptive.” The tone suggested that more rate increases were coming.
About 1:30 p.m., the wire service headlines read, “Fed Poised to Raise Interest Rates in May” and “Fed Gov. Meyer Signals More U.S. Interest Rate Increases Likely.” The Dow fell 20 points and the bond market dropped, with 30-year Treasuries losing $2.50 for every $1,000 of face value.
The next morning Meyer read a front-page story in The Wall Street Journal. The headline read, in part: “How Hard Mr. Meyer Tries Not to Move the Markets; Why He Failed Yesterday.” He was slightly sick, but no one at the Fed said much to him.
Shortly thereafter Greenspan invited Meyer down to his office. Let’s just talk about the economy, the chairman proposed, and the Fed’s interest rate decisions.
They talked about the forces on the economy and the data they had. Meyer confessed that he was on the edge and was struggling. His own forecast and those of many other private forecasters showed repeatedly that the economy should slow down, and it hadn’t. All the forecasts expected inflation to pick up, and it hadn’t. The models he had grown up on and had used for so long in his own forecasting business dictated that growth was too high and unemployment was too low. He particularly choked on the idea that unemployment could go this low and stay there at a sustainable rate without inflation. The unemployment rate for April had dropped to 4.9 percent—the lowest since 1973.
Let me tell you what I’m thinking about, Greenspan said. This is why I’m not concerned. He went over the disaggregated data on productivity in more detail. The world and the economy were changing. It was their job to figure out how and why.
They were two of the best economists in the country, and they could talk, and they did—for a long time.
Meyer was impressed. It had been a wonderful discussion. The chairman wasn’t asking for his vote or even his support. He realized that Greenspan had a particular vulnerability. Tradition dictated that the chairman couldn’t be on the losing side of a vote. Meyer thought that the chairman was entitled to know, in advance, where members were when they walked into the FOMC meetings. If he himself were going to vote against the chairman, he would warn him. When he walked into the meetings, Meyer felt he had already made a commitment. He didn’t care how convincing anybody else was. He might say, You’ve changed my mind, but you haven’t changed my vote. If so, then he’d walk out of the room and tell the chairman, Sorry, next meeting you don’t have me anymore.
Because of the deference shown the chairman, Meyer realized that Greenspan went into FOMC meetings with a bunch of votes stuffed in his pocket. If Meyer wanted to change interest rate policy, he would have to change the chairman’s mind first.
Greenspan had a subtle but firm hold on him. The chairman was an agnostic on the notion that unemployment could go only so low before triggering inflation. What was the number? It was amorphous, non-observable. It all depended on economic conditions, and rigid adherence to a specific level made little sense.
Some others on the FOMC were unhappy that Meyer was running around declaring that too many people were employed. Ed Boehne, the longest-serving member of the committee, thought Meyer was a public relations disaster. How could the Fed justify or explain itself to the public when one of its governors made such declarations? For Boehne, the lowest possible unemployment rate without inflation was not a fixed number—perhaps it floated between 3.5 percent and 6.5 percent. It might be a useful analytical tool for economists, but it was not good for interest rate policy makers to fixate on it.
Greenspan thought Meyer was a bit tone-deaf politically, but as usual he didn’t say anything.
• • •
On Tuesday, May 20, 1997, Meyer came to his office well before the 9 a.m. FOMC meeting scheduled for that day. Normally he didn’t have time to read the newspapers, but he picked up The Wall Street Journal and made his way to the editorial page, which didn’t like interest rate hikes that seemed designed to stifle growth.
“The Meyer Fed?” blared the headline. “The bond market has since recovered from its Meyer shock,” he read. The editorial ridiculed him and his ancient thinking, especially the concepts that low unemployment causes inflation. “The notion, in other words, is that inflation is caused by too many people working.” Though praising Greenspan in general, the editorial read, “Trouble is, Mr. Greenspan today sounds a lot like Mr. Meyer.”
When Meyer arrived at the meeting, some members ribbed him, laughing at the idea that he had hijacked the Fed. Perhaps he should give the Fed back to the chairman, one joked.
Greenspan again said nothing. His task was to sound just enough like Meyer but not too much, keep a foot in the camp of the anti-inflation hawks like Meyer as well as the pro-growth New Economy apostles. If The Wall Street Journal thought Meyer had unusual influence, all the better.
After a long discussion of the economy, Greenspan recommended no immediate interest rate move but an asymmetric directive, with a tilt toward raising rates. Meyer voted with him. The sole exception was J. Alfred Broaddus Jr., a vehement anti-inflation hawk who headed the Richmond bank. Broaddus, 57, a Ph.D. economist who had spent almost his entire career in the Richmond bank, wanted to raise rates immediately.
That month the Dow was up over 7000.
• • •
At the White House, Gene Sperling, who had succeeded Laura Tyson as head of the National Economic Council, had been interviewing candidates to fill Lawrence Lindsey’s seat at the Fed. He believed he had found the perfect person, so he called Greenspan. Sperling liked to let Greenspan know in advance, so if he absolutely went crazy, they had a chance to reconsider.
We’re going to put up Roger Ferguson, Sperling reported.
Who is he? Greenspan asked. I’ve never heard of him.
A B.A. in economics, a law degree and a Ph.D. in economics—all three from Harvard. A partner at McKinsey, the premier international management consulting firm, and currently their director of research. And he’s African American.
I understand you have many goals, Greenspan said.
The Clinton administration had made diversity a prominent priority. It’s a difficult time, the chairman added, and the Fed needed technical expertise. Ferguson’s career path was somewhat unusual for a Fed appointee, and Greenspan wanted someone who could come in and hit the ground running on some of the regulatory and technical banking issues.
Sperling said Ferguson had given one of the best interviews he had ever seen. Summers also thought Ferguson was terrific.
What we do here day in and day out can be very technical, Greenspan repeated. The board was shorthanded.
Sperling said Ferguson was the man for the job.
It’s the president’s decision, Greenspan replied. It’s very nice of you to call and give me a heads-up.
The White House had come up with too many unqualified candidates. Greenspan had wanted them to nominate Ted Truman, the Fed’s controversial, brilliant and bombastic international chief, as a governor, but they had refused.
Ferguson was nominated and soon confirmed.
About a month later, Greenspan called Sperling.
“I just want you to know Roger Ferguson is terrific,” he said. “You were right. This guy is outstanding.” Ferguson knew a great deal about the check payment system, technology, computers, productivity.
• • •
On July 22, Chairman Greenspan provided his own dose of exuberance. “We have as close to stable prices as I have seen, certainly since the 1960s,” he told the House Banking Committee. Though cautioning that the fed funds rate of 51/2 percent “will need to be changed at some point to foster sustainable growth and low inflation,” he attributed much of the boom to increased productivity. “We do not now know, nor do I suspect can anyone know, whether current developments are part of a once- or twice-in-a-century phenomenon that will carry productivity trends nationally and globally to a new higher track.” The Dow jumped 155 points, closing over 8000.
But the March 1/4 percent rate increase had had an unintended impact on the global financial markets. Many global investors were borrowing money in Japan, which had interest rates in the range of 1 percent, and then using the money to invest billions of dollars in Thailand. Because of the risk in Thailand’s booming but shaky economy, investors were receiving returns on bonds and other debt in the range of 15 percent. Borrowing low in Japan and investing with high returns in Thailand was creating a profit bonanza on the interest rate spread somewhere in the range of 14 percent.
The Fed increase of 1/4 percent in March and the presumption that more increases might follow seemed to suggest that long-term interest rates in the United States would soon be going up, perhaps way up. Though the U.S. long-term rates would never approach Thailand’s 15 percent, the much safer U.S. bonds were suddenly much more appealing. New York Fed officials who watched the international markets closely believed this contributed at least in part to a sell-off in Thailand by foreign speculators.
That summer, Thailand went into economic crisis. Though it was not yet widely known, the central bank of Thailand was effectively bust.
Rubin consulted with Greenspan. Some at Treasury wanted to use the Exchange Stabilization Fund, which had been used to rescue Mexico, to prop up Thailand. Rubin said this wasn’t Mexico and that the Republican Congress would be skittish about use of the ESF.
“Look,” Rubin said at one meeting with Greenspan, “we don’t know what’s going to happen, but it may be we’re going to need that ESF, and if we use it now, and Congress actually takes our ability to use it away, then what would happen when we really need it?”
Greenspan thought there were forces at work in the Asian economies that they didn’t fully understand. Several questions had to be raised: What might be the impact on the United States economy? What was the degree of interconnectedness? What could the United States do to affect the outcome? Should the United States try to assist whenever a country was in economic distress or turmoil? As they had worried vis-à-vis Mexico, suppose the United States tried to help and failed? Would that send an awful message to the financial markets about U.S. impotence? Rubin wanted to leave Thailand to the International Monetary Fund (IMF) and support their efforts. Greenspan agreed. Unpredictability in the global financial markets was putting everyone’s teeth on edge.
• • •
In the fall, Greenspan sent out contradictory public messages about interest rates, the economy and the stock market, reflecting some of his own uncertainty. On October 8, in testimony to the House Budget Committee, he declared, “The economy has been on an unsustainable track,” adding, “It clearly would be unrealistic to look for a continuation of stock market gains of anything like the magnitude of those recorded in the past couple years.” Three weeks later, on Monday, October 27, the Dow plunged 554 points—the largest point drop in history. This sent Rubin out to declare publicly on the Treasury steps: “Remember that the fundamentals of the U.S. economy are strong.”
But the economic fundamentals of a number of other countries were growing increasingly unsound. Businessmen abroad were playing dangerous investing games.
The day before Thanksgiving, the Fed and Treasury learned that South Korea was in real trouble. Its central bank reserves were pouring out of the country at about $1 billion a day. They had only several days of reserves left, and the South Korean economy was on the verge of collapse.
Rubin, his deputy Larry Summers, other Treasury experts and Greenspan went into crisis mode. Korea was the eleventh largest economy in the world. It had graduated into an investment-grade country, meaning that it was considered a solid place to invest. This wasn’t Thailand or Indonesia. Could Korea go into default? What would be the consequences?
The exposure of Japanese and European banks in Korea was greater than that of the U.S. banks. Given the weakness of the Japanese economy and its shaky financial markets, Korean default could trigger a catastrophic chain reaction.
Greenspan understood that new technology, which had created the global economy in which capital flowed quite freely, had a punishing downside. The shock of a financial disturbance in one large country could be transmitted swiftly and decisively around the world. Generally, markets worked best if they were allowed to suffer on their own. But in this case, while the probability of a disaster might be small, the outcome could not be left merely to chance, Greenspan believed. A vicious cycle of growing and self-reinforcing fear could destroy the underpinning of any financial market—confidence.
Greenspan felt the threat could resemble the 1987 stock market crash. Even 10 years later, he could still find no credible explanation for the abrupt one-day decline in stock values that had built up over years. The shock of uncertainty could lead to withdrawal and then denial and even panic or paralysis. On the other hand, uncertainty could also lead to wishful thinking, which was just as dangerous.
By mid-December, the Korean crisis had reached extremis, and on Thursday, December 18, Rubin invited his Treasury team and Greenspan to dinner in a private room at the Jefferson Hotel, where Rubin lived. They went round and round. Nobody seemed to have a good idea how to avoid default or manage default.
“Some problems have no solutions,” Rubin remarked. He mentioned again the danger of acting and then failing, which would provid
e the world with evidence of U.S. powerlessness.
Was there some way to get the United States and other world banks to extend the terms of their outstanding loans in Korea? That might give Korea time. Could they stop the bleeding? That would mean seeking voluntary restraint on the part of the banks. Who could speak with the banks?
Greenspan was not sure that the treasury secretary should do it. Treasury had no direct regulatory control over the banks, but that power belonged in part to the independent comptroller of the currency, who technically reported back to the treasury secretary.
And the Fed, Greenspan believed, had a substantial conflict of interest because of its direct regulatory role. The banks could conceivably decline Rubin’s request, but they could not resist the chairman of the Federal Reserve, who could retaliate. “They can say no to him,” Greenspan said. “They could not say no to me.”
• • •
Rubin called John Reed, the veteran chief of Citicorp bank. Citi had for decades been the lead bank for Rubin’s old firm, Goldman Sachs. When Rubin was Goldman’s chairman, he had visited Reed each year to share Goldman’s confidential numbers on its extraordinary profits.
They agreed that Korea had the possibility of turning into a classic run on the system, as banks all over the world were pulling out. Rubin had been trying to see if the U.S. government could put up $10 billion and U.S. banks raise another $10 billion, hoping that that would stabilize the situation.
No, Reed said. He believed that no one in his right mind would lend money to Korea with reserves going down $1 billion a day. He thought it possible that the banks could agree to a standstill to extend the terms of outstanding loans in Korea. Billions in loans were coming due on January 1, and banks everywhere didn’t want to see a collapse. “Why don’t you let us try to solve the problem without any money?” Reed asked.
Rubin said fine.
It took several days for Reed and other private bankers to get an informal standstill agreement.
