by Bob Woodward
Rubin also worked out an agreement with the finance ministers of the major economic powers, to try to persuade the banks in their countries to extend the terms of Korean loans.
Now it fell to Rubin to make the calls to the U.S. banks, to make sure everyone was on board for the standstill. He had to make it clear that it was voluntary. He also had to make sure it happened. He had a compelling case: The United States was not going to put any money in. There would be no bailout. Without a standstill it would come to an end, to default.
Rubin found that the main New York banks were sophisticated enough to know the benefits of collective action. Those calls weren’t difficult. One Chicago bank was reluctant. The CEO asked, Why should we do it? Rubin spent some time in conversation, and the CEO agreed to go along.
Some bankers felt they were being coerced. Summers felt it was as if the best cancer specialist in the world were recommending an amputation and saying, It’s your choice, your decision, but there is no alternative. The choice was rolling over a loan versus losing the money or a large portion of the money if Korea collapsed.
On Christmas Eve, Rubin was out of touch, and one of the bank CEOs reached Summers. Summers explained the choice.
“This is a hell of a Christmas present,” the banker said angrily, knowing he would have to go along.
The loan delays saved Korea from defaulting.
As Greenspan was coming more and more to the center of the American and world economic story, he nonetheless had taken a backseat on Korea. He was central to the enforcement decision made by the firm, but Rubin and Summers were the front-line enforcers.
• • •
Over the holidays, Greenspan and Andrea invited a number of the Fed governors, bank presidents and other friends to their home in Northwest Washington for a party. Philadelphia Fed president Boehne wound up next to the chairman, looking out over the pleasant, deep-wooded area at the back of the house. For 10 years, Boehne had watched with amusement how Greenspan, who constantly attended parties, still seemed uncomfortable in social settings—even in his own home.
“Andrea thinks she wants a dog,” Greenspan said, attempting small talk. He apparently took Boehne’s background—raised and educated in Indiana—as an indicator that he would know about animals.
“Tell me about a dog?” Greenspan asked, as if he wanted the full story.
Taking him literally, Boehne explained that a dog needed to be let out every 8 to 10 hours, had to be fed daily, that a puppy would have to be house-trained—sometimes a frustrating task.
Greenspan had already decided that a dog would definitely be too disruptive to their lives, and they were not going to get one. Period. But with meditative nods, he permitted Boehne to continue.
A dog owner couldn’t go out of town on the weekends, Boehne said, unless someone came in regularly to walk and feed it. The other alternative was expensive boarding at a kennel. A male would go out in the back and spray all over, he noted, and a female would be a problem because she would be chased by the other dogs.
“Well,” Greenspan asked, “how do you tell your wife you don’t want a dog?”
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ON FRIDAY, January 30, 1998, Greenspan, Rubin and Summers appeared before the House Banking Committee to defend their efforts in the Asian crises. Greenspan was supporting the Clinton administration’s request for increased U.S. funding for the International Monetary Fund, which was providing money and loans to the Asian countries.
“I will just cut this short by saying a few months ago, I would have been an unequivocal no in opposition,” said Maxine Waters, a Democrat from Los Angeles, during her opening statement. Waters, 59, represented South Central Los Angeles and Watts. Like many liberals in Congress, she objected to providing huge amounts of money to the IMF while a number of American inner-city areas remained underdeveloped.
“Today,” she went on, “I have an open mind, and one of the reasons I have an open mind is because of something as simple and fundamental as Chairman Greenspan being willing to listen to what I am concerned about, and taking that trip to South Central Los Angeles and walking along a block that can be redeveloped, that can be invested in.”
Waters had asked Greenspan to accompany her on a visit to South Central Los Angeles several weeks earlier. She didn’t think that Greenspan would want to go with her. This was the same man, after all, who as CEA chairman in 1974 had testified to Congress that “percentage-wise,” the people who were most hurt by recession were Wall Street brokers. In a room filled with consumers and minorities, Greenspan had literally been booed, and following a public outcry, Greenspan later qualified his statement, saying, “Obviously the poor are suffering more.”
But the Greenspan of 1998 had accepted Waters’s invitation, taking a walking tour of some of her district’s hardest hit areas. After they returned, Waters told a number of people that the chairman had been absolutely terrific on the trip—curious, caring.
“And because of that,” Waters concluded, “my mind is open, and I hope we can fashion a solution that works.”
Privately, Greenspan felt that throwing government money into underprivileged areas was largely a waste. Nurturing capitalism and property ownership were the only long-term solutions.
Rubin, Greenspan and Summers presented a one-two-three punch in support of the administration’s policies. They represented a broad center section of the political spectrum, spanning the moderate Democratic to the moderate Republican. They were a phalanx, and no one could breach their ranks. One of them alone—let alone all together—could overwhelm almost any member of Congress with economic facts, history, analysis and technical detail.
At one point in his testimony, Rubin said that Deutsche Bank AG, the largest bank in Europe, had set aside $777 million in reserves for its losses in Asia.
“$773,” Greenspan interjected.
“$773,” Rubin corrected. “I apologize.” After a moment’s reconsideration, he added, “Well, I’m not so sure. I bet you a nickel.”
“You’re on,” Greenspan said.
“We have got a nickel, even-odds bet,” Rubin said playfully. “There is a slight side bet between the chairman and me, which he will probably win.”
An aide soon whispered in Greenspan’s ear. Rubin had been right. Greenspan pulled out a $20 bill from his wallet and handed it to Rubin.
Later, when he was asked about the possible creation of an international bank regulator, Greenspan replied, “I would be very concerned if we were looking at some major superregulator. Super-regulators tend to overregulate and make unbelievable mistakes.
“I would suspect that I would know most of the people who would be in charge of making the types of judgments that would be required for that, and I will tell you that they don’t have a clue as to what to do. I would much prefer to allow very complex market forces to tell us.”
In other words, leave the deciphering—and, ultimately, the regulation—of that complexity to the firm of Greenspan, Rubin and Summers.
No one challenged the presumption.
• • •
On Tuesday, May 5, Greenspan went to the Oval Office to see the president. It was the fourth month of Whitewater Independent Counsel Kenneth Starr’s investigation of Clinton’s relationship with former White House intern Monica Lewinsky. There was a sense that the investigations were closing in.
Greenspan had not visited the president formally for 16 months, and Clinton’s economic team wanted Clinton to bask a little in the positive domestic economic news. In any case, an hour with Greenspan was always educational and worthwhile, and on this occasion it would be a momentary diversion from the president’s mounting personal and legal troubles. Rubin, Summers and Sperling also attended.
“This is the best economy I’ve ever seen in 50 years of studying it every day,” Greenspan told Clinton. There had been a boom in productive capital. Money that businesses were spending was yielding an extraordinary return because of increased worker pro
ductivity. The computer and high-technology investments were paying off. And those payoffs had to be real, because the higher profits and economic growth had continued for several years now.
The president asked whether Greenspan had seen an article in The Economist comparing the United States and Japan.
Greenspan said that Japan had failed to attack the consequences of its stock market decline, a mistake the United States had avoided by dealing relatively quickly with the banking crisis and the savings and loan collapse.
He said that the stock market was very high by historical standards, but it could stay high. Despite his statements about “irrational exuberance,” the chairman said, it’s basically an illusion to think that the Fed could tinker with the stock market. At the same time, the huge stock market run-up had made people feel wealthy, and he was concerned that the spillover would have an impact on the real economy. Spending would go up and possibly drive inflation up as well.
Overall, the growth and spread of technology had been vital, Greenspan said. Computerization ensured that there were few shortages or bottlenecks in the economy, allowing for quick replacement and quick refurnishing. The only constraint on the economy was labor. There was a limited supply of workers, and there were starting to be more shortages. The reserve army of workers was shrinking, which had the positive effect of bringing less educated people, and people from the welfare rolls, into the workplace, but there might also be a negative effect. Normally, with so few people unemployed, wages should begin to rise. History tells us that there should be more inflation than there is, Greenspan said. At the same time, he noted that the economy was experiencing its lowest rate of inflation since 1970.
Sometimes, the chairman told the president, you learn a lot when things don’t turn out as they’re supposed to.
The way astronomers discovered the planet Pluto, Greenspan said, was that Neptune was not strictly following the law of gravity. Some force, then unseen, had to be operating on it. Astronomers figured out where to look and discovered the new planet.
In a similar way, the economy was not following the laws of economics. He did not have any hard evidence why this was happening—hard in the sense of being provable to economists. He really had only anecdotal evidence. Technology, global competition from our own open markets and the competitive environment within the United States were all keeping prices down.
Greenspan added that there were so many more people with money in the stock market than there used to be. The millions who used to follow the Brooklyn Dodgers baseball team years ago were now following their 401(k) retirement and pension accounts.
• • •
In a rare television interview that August, former President Bush said that Greenspan had been responsible for his 1992 defeat. “I think that if the interest rates had been lowered more dramatically that I would have been reelected president, because the recovery that we were in would have been more visible,” Bush said, adding a zinger, “I reappointed him, and he disappointed me.”
Greenspan found it sad. In 1992, Bush and Brady had been urging him to lower rates more and faster. Greenspan knew that the economy had actually been in an economic recovery in 1992, and that it was President Bush who had failed to explain that politically. But he chose not to challenge the former president. He still felt a deference toward anyone who had served as president, and he didn’t feel the issue was one for him to raise with Bush.
• • •
On Monday, August 17, 1998, President Clinton appeared before independent counsel Starr’s grand jury to testify under oath. He acknowledged his relationship with former intern Monica Lewinsky. That evening, in a speech to the nation, he said that he had misled everyone—the public, his wife.
That day, the Russian government devalued the ruble and declared a moratorium on debts, sending another shock around the world—but one that was overshadowed by Clinton’s troubles.
At the New York Fed, Bill McDonough saw Russia as an accident waiting to happen. The markets had been acting as if the worldwide contagion from Thailand to Korea were over. It wasn’t. The Russian debacle’s initial impact was chiefly on bonds, a market inadequately covered by the financial press. McDonough watched it more closely than any other market, because it was the most important.
With bonds, investors act like a bank, loaning money to businesses and governments in exchange for a fixed interest rate of return and the eventual repayment of the principal amount of the loan. The total value of outstanding bonds or loans to businesses and governments internationally was about $35 trillion—four times the total annual U.S. gross domestic product. The Russian default sent bond interest rates way up. Since the price moves in the opposite direction of the interest rate, the values of most foreign and corporate bond portfolios dropped dramatically.
With public attention focused on Clinton and on the stock market—the ups and downs of both—the public and media paid scant attention to the bond market. In certain respects, it was the hidden market.
The size of the bond market had grown astronomically over the last two decades. Borrowing in the bond market was four to five times that of bank lending, making it the main source of credit in the United States.
There had been only one bear bond market—a sustained falling in price—in the last two decades, and that had been in 1994. Since then, the largest financial institutions in the United States—Goldman Sachs, Merrill Lynch and some of the other firms—had calculated that they had comparatively small risks in their bond market investments. In general, the firms calculated their risk assessments on the largest measurable interest rate variations of the past two decades. After the Russian collapse, some bond interest rates varied 5 to 6 percent—dramatically more than even the most sophisticated investors had calculated to be the maximum risk. This continued to drive prices and the value of many bond holdings down substantially.
Within a week of the Russian default, there was little to no bond market trading. Prices were being quoted, but few would buy or sell. Selling could mean losing as much as half of an investment in a bond. And no one really wanted the bonds, because their value could drop further. Investors ran to quality bonds, especially U.S. Treasuries. It was becoming difficult, if not impossible, for people or businesses to borrow money. The markets had seized up. None of the big investment firms could gauge their possible losses, because with all the turbulence the value of their bond portfolios was unclear. Though there were some news stories about volatility and instability in the bond market, the magnitude of the problem was largely unreported.
Over at the Treasury Department, Deputy Secretary Larry Summers was getting reports from staff who talked to key people in the markets. Some were frank about their inability to trade, which meant that bonds, though still certainly valuable in the long run, were not liquid. Summers realized it was not hugely in anybody’s interest to advertise this degree of illiquidity, so it wasn’t being reflected in the media coverage.
• • •
Over the weekend of August 29–30, Greenspan attended the Kansas City Fed’s annual Jackson Hole conference. After dinner one night, he gathered small groups of FOMC members in attendance and quietly moved from one group to the next, hoping to avoid attention. He told his colleagues that he wanted to send a public signal. They had not moved interest rates in nearly 18 months, and they still had an asymmetric directive with an upward bias. He explained that he wanted at least to signal that they would be getting rid of the upward bias. The others assured him they agreed.
On August 31, the Dow plunged 513 points, a 6 percent drop that erased the gains of the entire year. The trouble in the bond market was spilling over into the stock market.
Greenspan talked by phone with McDonough. McDonough, who had not been at the conference, agreed that a senior Fed official needed to say something fast, and not at a press conference. That would be a little too dramatic.
Greenspan was scheduled to give a speech at the business school at Berkeley on September 4. Rep
orters had been alerted to keep an eye out. Greenspan included some comments about the problems abroad. Speaking obliquely, as usual, he said, “It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.” What was happening abroad fed back in the U.S. financial markets. Earlier in the year, he said, the FOMC was worried mainly about inflation—but at the August meeting, a day after the Russian collapse, there had been little concern. Now, he said, “The committee will need to consider carefully the potential ramifications of ongoing developments since that meeting.” Front-page news stories reported accurately that the chairman was hinting at an interest rate cut.
• • •
At the Greenwich, Connecticut, headquarters of Long Term Capital Management (LTCM), a secretive and powerful speculative partnership of very wealthy investors, the Russian collapse had triggered an earthquake. Founded in 1994 by John Meriwether, the former vice chairman of the Salomon Brothers investment bank, and former Fed Vice Chairman David Mullins, LTCM included two Nobel Prize winners and dozens of Ph.D.’s. LTCM was a hedge fund. Hedge funds aggressively play both the expected ups and downs in the market, essentially doubling their bet by investing heavily in the stocks expected to rise and short selling those expected to decline. LTCM was also highly leveraged, meaning it borrowed 95 percent or more of the money it invested.
LTCM’s overall investing theory, based on complicated mathematical formulas, was to identify temporary price discrepancies in various world markets and to bet that those discrepancies would converge toward historical norms. Many trading numbers or rates operate around a norm. Notice the variations, invest assuming that the numbers will return to the norm and most of the time an investor will be right. On one level, it was an important discovery, to capitalize on small variations that seemingly made no sense.
As an example, in an early investment LTCM’s data showed that 291/2-year U.S. Treasury bonds were less expensive than the 30-year Treasury. The partners in the firm figured that the values of the two bonds would converge over time, so they bought $2 billion of the 291/2-year bonds and sold short another $2 billion of the 30-year bonds. By putting up only $12 million of their own capital, LTCM took a $25 million profit on the transaction just six months later.
