by Bob Woodward
Greenspan was slightly uncomfortable. Congress’s tacit acceptance of the Fed’s interest rate decisions was critical, and he was reluctant to expend any of his capital on a side issue. But when the House committee had tried to haul McDonough up alone in the immediate aftermath of the LTCM rescue, Greenspan said he thought it would be appropriate to invite him also.
When Greenspan and McDonough took their assigned seats at the witness table, there was an empty chair between them. Sit here, Greenspan said quietly, pointing to the empty chair and motioning McDonough over to sit by his side.
McDonough was touched by Greenspan’s show of solidarity. He was convinced that an LTCM collapse would have triggered a severe world financial crisis that could have turned into a world economic crisis, possibly even a recession in the United States. Greenspan seemed less certain of that, but the chairman was making it clear publicly that there was not a sliver of difference between him and McDonough.
Greenspan’s concern was fear in the marketplace—a delicate psychological condition, whether rational or not. Fear or uncertainty caused people to withdraw or disengage. They could dump good and bad investments unthinkingly and wildly. Risk taking was necessary for the making of money in the investment world. Leverage had enhanced the growth of the economy and raised the standard of living in the United States. He didn’t think it possible to regulate human folly or stupidity, especially in the environment of investment opportunity that had so many payoffs. He realized he was more laissez-faire than most and might tolerate a freer market; he also realized that these hedge funds could almost as easily operate outside the United States, and that any effort to regulate them would drive them overseas.
The session began with Representative James A. Leach, the Iowa Republican and committee chairman, criticizing hedge funds such as LTCM. “They are seen by some to be run-amok, casinolike enterprises, driven by greed,” Leach said. Some congressmen then voiced suspicions that the Fed had bailed out their Wall Street friends—“high-flying dude billionaires,” Paul Kanjorski, a Democrat from Pennsylvania, called them.
Later in the hearing, Kanjorski noted the absence of television and other media at the public hearing. The world was obsessed with the unfolding Lewinsky scandal, as Clinton seemed on the road to impeachment. “I am just wondering, is there any way you can inject sex into this so we can get a little more national attention? . . . We are talking about the potential meltdown of the world’s economic system instead of a fling at the White House, and yet nobody in the world seems to understand what may have transpired or may have been at risk in the last two weeks.” Kanjorski then asked a number of questions about why the government shouldn’t regulate hedge funds more closely.
“I am scarcely defending hedge funds,” Greenspan responded. “But many of the things which they do in order to obtain profit are largely arbitrage-type activities”—buying in one market in order to sell in another—“which tend to refine the pricing system in the United States and elsewhere, and it is that really exceptionally and increasingly sophisticated pricing system which is one of the reasons why the use of capital in this country is so efficient. It is why productivity is the highest in the world, why our standards of living, without question, are the highest in the world.” He was giving them a dose of his militant free-market capitalism. Keeping the government’s hands off the market allowed people to develop ingenious ways to make money. As long as it was legal, he supported it because of the pure market efficiency.
“I am not saying that the cause of all of this great prosperity is the consequence of hedge funds,” he went on. “Obviously not. What I am saying is that there is an economic value here which we should not merely dismiss.”
Representative Bernie Sanders, a Socialist from Vermont who is treated as a Democrat in the House, pressed Greenspan. “According to the United Nations, Mr. Chairman, the world’s 225 richest individuals have a combined wealth of over $1 trillion, equal to the bottom 47 percent of the world’s population—225 people have as much wealth as almost half the world’s population.
“Does that concern you? Do you think that that is just? . . . Does that concern you, Mr. Greenspan?”
Greenspan said that he generally would prefer less concentration of wealth. He also said, “It is not by any means clear to me that if you were somehow to take these 225 individuals and merely indicate to them that they no longer have any wealth, and you put them away on a desert island, that the state of the rest of the world would be improved in the slightest.” Throughout history, Greenspan said, the mistakes of powerful and wealthy individuals have always created consequences for others.
Greenspan did not believe in short-term compassion. Redistributing $1 trillion from the 225 richest to the 3 billion poorest would not achieve much in the long run. In reality, those 3 billion people live on an average of less than $2 a day; the $1 trillion could provide them an additional $1 a day for a year. But Greenspan believed that only structural change, capitalism, the rule of law and the creation of private property ownership would lift up the world’s poor. Endeavors to help those living at the Malthusian levels of survival were often counterproductive, creating longer-term problems. He did not share all his thoughts with the committee.
“I think we ought to, instead of looking at what we have now as some incredibly corrupt, unequal, unethical system, try to look at what the United States has become relative to what used to exist 100, 200, 300 years ago.” The bottom line, Greenspan said, was, “The average American is far better off than at any time in our history.”
Leach called the hearing to a close after four and a half hours. “I sense the chairman of the Federal Reserve Board is losing his voice but not his mind,” he said.
McDonough thought that the shelling was probably the most unpleasant experience Greenspan had ever had before Congress. Thank you for your support, he told Greenspan later. Greenspan could have easily left him high and dry.
• • •
The markets got worse. Uncertainty and illiquidity continued. The interest rate yields on new 30-year Treasuries were nearly 1/4 percent below those with maturities just a couple of months earlier. If the markets were functioning properly, there would be only a slight interest rate spread. It made no sense. The market was dysfunctional.
McDonough called Greenspan to recommend that the chairman exercise his authority and lower rates another 1/4 percent before the next FOMC meeting. It would hammer home two points—the Fed was concerned, and the Fed was in charge. It would be very deliberate showboating, McDonough admitted. It was time to bang the gong, declare: Look at us, pay attention. The psychological message would be immensely important.
Greenspan did not commit himself.
Laurence Meyer strongly opposed interest rate moves between meetings. They shifted more power to the chairman, who already had plenty. He felt that meetings every six weeks, when the members had time to have their say and vote formally, were sufficient. But he, too, was getting calls from friends and associates.
One said, I called my broker to see if I could unload some positions in the bond market, and he told me they would give me prices but they wouldn’t buy or sell at those prices.
A former client phoned Meyer to say, “You know, I don’t ever call you, but I’m doing you a favor here because I want to just tell you what’s going on.” He described torment in the market. He could not buy or sell positions of any size.
What the hell did interest rates mean, Meyer thought, if you couldn’t buy or sell at those rates? Were the very foundations of the financial markets and capitalism—prices—in some kind of jeopardy?
Ed Boehne, whom Greenspan considered one of the most balanced members of the FOMC, reported that he had been traveling all over his district of Delaware, southern New Jersey and Pennsylvania. Clearly, the FOMC had not cut rates enough. On his tour, Boehne said, he had checked into a hotel in State College, Pennsylvania. When the check-in clerk noticed he was from the Fed, he said, “Oh, you’re from the Fed.
You didn’t do enough.” Boehne told Greenspan, “When hotel clerks in central Pennsylvania tell you that you didn’t do enough, it’s time to do more.”
• • •
On Monday, October 12, McDonough was in Washington to give three speeches. He briefed Rivlin about the dire market conditions. The FOMC vice chairman and the board vice chairman decided to go to Greenspan together.
In his office, they pressed for a rate cut. If they waited for the next FOMC meeting in November, it would look like business as usual—1/4 percent in September, 1/4 percent in November.
McDonough argued that the conditions were anything but business as usual. Market business was as shaky as he had seen it. The Fed had to deliver an attention-getting surprise. Rivlin agreed.
After about a half hour, Greenspan finally said that he thought they were right, but then he added ambiguously that he wasn’t sure it was time to make a big splash. Maybe we ought to wait. They didn’t want to be seen as panicky. Business as usual had its benefits. But he agreed to a conference call of the FOMC. McDonough and Rivlin could present their view to the others.
Rivlin left believing that Greenspan was prepared to cut rates again, but that he was not moving as fast as she and McDonough thought necessary. McDonough was not sure how to read Greenspan. Was he just appearing to be reluctant? Was he perhaps thinking the whole time, Thank God these people are pushing me, so he could cite his two vice chairmen to bring along reluctant FOMC members? How Machiavellian was Greenspan? Or was he playing Socrates, perhaps trying to lead them, by questions and doubts, to what was really his own conclusion? McDonough didn’t have an answer.
• • •
On October 15, Greenspan convened a telephone conference call of the FOMC. Risk aversion in the financial markets had increased, volatility was increasing and borrowing and lending were increasingly constrained. He was considering lowering rates another 1/4 percent, he said, in accordance with the directive that had included the bias toward further easing. What did the others think? He turned it over to McDonough.
The international financial markets are simply not functioning, McDonough said. They had begun the necessary remedial work with the first 1/4 percent easing two weeks earlier. They had to move again now. They couldn’t afford to wait until the next meeting, because the wait was too long and would appear to be business as usual. Drama was necessary.
Rivlin, in a calm voice, then chimed in. She fully supported the move.
Even Meyer supported the rate cut. The believer in the old economic models, the opponent of chairman-directed rate moves between FOMC meetings, said he believed the cut was necessary.
McDonough thought that if they didn’t have Meyer, they would have to invent him. Having Meyer on board underscored the seriousness of what they were confronting and what they were doing.
None of the others voiced any real objection.
Without taking a vote, Greenspan said that he had decided and would order a 1/4 percent rate cut. It was announced at 3:15 p.m. The bond market soared, and the Dow, already up, registered a 330-point increase for the day—the third largest point increase in history.
Meyer believed the rate cut was simply a declaration, a way of telling people to relax: We at the Fed understand that the markets are not functioning, we take it upon ourselves to help restore smooth functioning of the markets, we will get the job done, whatever it takes.
For the Fed to be saying that, as the power over the sovereign currency, was saying a lot. Soon Meyer was getting reports from people in the markets near the epicenter of the crisis. One of the most important moves the Federal Reserve ever made, said one. Another went so far as to say that it was the greatest thing that had ever happened in modern times to help the markets.
• • •
On Tuesday, November 17, 1998, the FOMC convened for its regular meeting. Conditions in the financial markets had settled down, but Greenspan proposed another 1/4 percent rate cut as a kind of insurance policy. Maybe another cut was not necessary, he said, but it was important to get the situation in the markets behind them. A financial collapse would envelop the United States. That was the risk. A 1/4 percent cut could be taken back later. He feared the appearance of a larger credit crunch. He noted that there was no international structure of finance, no United Nations central bank, to oversee the crisis. They had to take action ad hoc. The financial markets had one feature: no buyers, only sellers. Another 1/4 percent cut would send a message that the Fed was prepared to backstop the system.
Several said they thought it was a close call, but only Jerry Jordan, the Cleveland bank president, dissented from the chairman’s recommendation. In a press release, the Fed announced the rate cut and said that it planned no more rate cuts to help stabilize the global financial markets.
The cut put the fed funds rate down to 43/4 percent, the lowest it had been in more than four years.
14
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ON JANUARY 14, 1999, Mike Prell, the veteran director of research and statistics for the Fed, spoke at the Charlotte Economics Club in North Carolina. For a dozen years he had been in charge of presenting the staff forecast to the FOMC. He acknowledged that his forecasts were frequently wrong, and at the end of his talk, he posed an unusual question: “Might people—business managers, consumers, investors—be taking risks that they would not have taken were it not for an exaggerated confidence in the ability of the Fed to cushion the economy and financial markets against any and all shocks? If so, there conceivably could be greater potential instability in the system than is readily apparent at this time.”
Greenspan himself was concerned about a potential “exaggerated confidence” in the Fed’s ability. But he figured there was nothing he could do about it other than to go about his job.
Alice Rivlin, who attended a lot of international financial meetings as vice chairman, had discovered that Greenspan was even more a mythic figure abroad—an Olympian symbol of financial stability in a booming economy that was the envy of the world. Central banks around the world were attempting to model themselves on Greenspan’s, each interpreting differently how to apply the model. What could Greenspanism mean without Greenspan?
Since Rivlin had been at the Fed, articles praising the chairman had flowed off the presses as if he were the latest rock star. Fortune: “In Greenspan We Trust.” BusinessWeek: “Alan Greenspan’s Brave New World.” She raised the downside of all this with the chairman. Alan, she said, it is important for you to reinforce the notion that you do not run the world. He had to demonstrate that the FOMC was a collective body. The more some of the rest of them were out making speeches and explaining policy, the better it would be for him.
He said he agreed, but soon enough he was not acting as if he did. The chairman kept himself out front, giving frequent speeches and serving as the face of the Fed before Congress and the rest of the world, a constant presence that fostered an identification between Greenspan and the excellent economy.
Rivlin was concerned that if something were to happen to Greenspan, the entire world would think something terrible had happened to the U.S. economy. He was becoming a cult figure.
When Clinton’s Lewinsky troubles led to his impeachment in the House and trial in the Senate, Rivlin and Greenspan discussed it on several occasions. They shared their sorrow. Greenspan acted more like a mourner than a critic.
What a shame, he said, wagging his head in disbelief. Here was this very smart man, clearly head and shoulders above most of the presidents of the United States in terms of intellect, grasp of policy, seriousness, political skill and charm—yet he didn’t have self-discipline. To risk so much for apparently so little. Neither Greenspan nor Rivlin could comprehend it.
In early February 1999, Time magazine featured Greenspan, Rubin and Summers on the cover as “The Committee to Save the World.” The feature story described the role the three had played in preventing global economic meltdown from Thailand to Korea to Russia. Greenspan realized that if there had been
a meltdown, the headline would have read, “The Committee That Destroyed the World.”
On March 4, a New York Times editorial was headlined “Who Needs Gold When We Have Greenspan?”
• • •
By May, it was clear to Greenspan that the economy was growing very rapidly again, up to about 41/2 percent annually—more than expected. He saw no real signs of inflation, but long-term bond rates were going up: the yield on the 30-year Treasury was up from about 5 percent to 5.9 percent over the past half year, signaling that investors feared inflation would soon increase. Consumer prices had increased .7 percent the previous month—the biggest monthly increase in six years. Despite his efforts to send a public signal back in 1994 when they had started to raise rates, the increases had come as a shock to the markets, driving long-term interest rates up significantly. If a rate increase became necessary soon, and it increasingly looked as if it would be, he wanted the public signal to be loud and clear.
At the May 18 FOMC meeting, Greenspan emphasized the uncertainty of the outlook. Productivity growth for businesses was in the 4 to 5 percent range each quarter, making believers of even the biggest skeptics like Meyer. These numbers were still helping to contain wage and price increases. But for how long? Overall uncertainty about the economic outlook was the dominant feature of what they were looking at. The chairman proposed that they not raise rates at once but adopt an asymmetric directive tilted toward a future increase. To make the message clear, they agreed to announce the tilt toward an increase that same day—the first such public declaration in the Fed’s history.
The vote was once again unanimous.
“Fed Won’t Hike Rates—For Now,” announced the headline on the front page of The Washington Post the next morning. The tilt or bias toward future rate increases was big news. Other than the lone 1/4-point rate hike in 1997, the Fed had not significantly raised rates in a full stair-step tightening cycle since 1994 and early 1995—more than four years before.
