Maestro

by Bob Woodward

  The Nasdaq rose more than 14 percent, or 325 points—the biggest percentage and point gain since the index was created in 1971.

  Greenspan does not like to see the stock market jump sharply in either direction. The decline had been sufficiently substantial over the last nine months that a further sharp decline was now unlikely. In a practical sense, a low stock market was more stable.

  The real problem in his view was the sudden economic contraction of December. He hoped it was the bottom. It nonetheless was a real turning point. Monetary policy, he knew well, could basically set a platform for stable economic growth, maintain and improve the financial liquidity of the system. But it could not produce economic growth. It is a background force. He looked for an analogy. Monetary policy, the setting of the short-term interest rate, was like the law of contracts. Without a body of contract law that made written agreements within society and the economy enforceable, there would be chaos. Contract law didn’t produce anything itself, but it was a structure and foundation that made binding agreements possible. Without them, no business could function; orders and commitments wouldn’t be met; consumers wouldn’t pay their credit card charges. Monetary policy, by stabilizing the currency and keeping inflation under control, provided the conditions for a growing economy. But businesses were now experiencing severe stress.

  • • •

  The Senate Budget Committee asked Greenspan to testify later in January and to address the possibility of a federal income tax cut—perhaps the main domestic political issue of the day and central to the new Congress. The federal government was projecting surpluses amounting to trillions of dollars over the next decade. President George W. Bush, the former Republican Texas Governor who had just assumed office, had campaigned hard on the pledge to return a portion of that projected surplus in a tax cut plan then estimated at $1.6 trillion over ten years. Many Democrats had proposed a tax cut of about half that amount.

  Greenspan settled in to prepare his testimony and began examining all kinds of economic reports, particularly those on worker productivity—the critical output per hour. The big acceleration in productivity he had detected years earlier was now going to be tested. What would happen in an economic downturn? Indeed, he found that productivity had gone down but not nearly as much as he expected. He reviewed the long-term productivity estimates prepared by the Congressional Budget Office (CBO) and the White House Office of Management and Budget (OMB). They were just too low, he believed. With higher productivity the federal government was going to be collecting more in tax revenue than expected over the next decade. He calculated that at a point in about six years the federal government could have paid off its entire debt of several trillion dollars and accumulated some $500 billion in excess surplus. No one could know where the economy might be in that year, 2006. If that excess was suddenly returned as a tax cut then, it could be disastrously inflationary.

  Accordingly, the CBO and OMB had understated the available money in surpluses, he believed. Over the years, Greenspan had concluded that if the federal government accumulated surpluses, it was best economically for the money to be used to pay down the government debt. Second best was returning the money as tax cuts. Least desirable was for the government to spend the money in new or expanded federal programs. Since the projections were what Greenspan considered startling, the surplus was going to grow by hundreds of billions of dollars, and, according to his numbers, be more than transitory. One result might be that the federal government could have so much extra money that it might start buying stocks, essentially becoming a large investor on Wall Street. Internal Fed figures showed that the federal government could wind up with a dangerously large portion of private stock holdings in the coming years.

  Greenspan was so deeply worried that he told a colleague, “Can you imagine either Lyndon Johnson or Richard Nixon with all of that moola out there, essentially refraining from using it for political purposes?” Then answering his own question, he said, “The chances of that are zero.” Such vast sums under the control of the government would create all kinds of potential for mischief, Greenspan felt.

  In the first draft of his testimony, he laid out this danger. As he thought more about it and dug deeper into the numbers, he noticed that the CBO showed federal surpluses running well past the year 2030. Though this was admittedly shaky and uncertain, he decided that he needed to speak out.

  As he read over the first draft he mused: If this is true, then there is something that has got to be focused on very sharply and stated publicly, because no one had identified the problem. He decided it was time to cut taxes now to forestall the possibility of the government gaining control of so much money by becoming a giant potential investor in the stock market.

  The goal, he reasoned, should be near-zero federal debt to be achieved by paying off government bonds and then returning any excess surplus to the taxpayers. This would prevent the government from playing the stock market. As a caveat, he decided to include a suggestion that would limit the tax cut if the projected surpluses did not materialize in future years. When he was done, Greenspan had written that a tax cut was “required”—unusually strong, even unprecedented, language for him. He knew it was a stark conclusion, and he made it clear he was supporting only the principle of a tax cut, not the Bush proposal or the lesser tax cut proposed by various Democrats. Since nearly everyone seemed to be for some kind of tax cut, he was not taking sides or being partisan, he felt.

  As he wrote out his thoughts and conclusions, he realized that his formal testimony would be more complex than usual. Greenspan decided it would be unfair to spring it on the Budget Committee cold without giving them advance warning. So he sent copies up to the Hill the day before so the senators and staff could prepare questions.

  Senator Kent Conrad, the outspoken senior Democrat on the budget committee, invited Greenspan to his office to discuss his upcoming testimony late on the afternoon of Wednesday, January 24, the day before the chairman was scheduled to appear.

  Such an unequivocal conclusion would be a serious mistake, Conrad told him. It might be too subtle for people to understand and would be interpreted as the chairman of the Fed giving everybody carte blanche to cut taxes. The radical tax cutters, Bush and the Republicans, would use his testimony as support. The declaration that tax cuts were “required” was too strong. Greenspan would be opening a Pandora’s box.

  Greenspan said he just didn’t believe his generalized support for a tax cut would have that much of an impact. He noted that Democrats, including Conrad, were in favor of tax cuts ranging up to $800 billion over the 10 years. It was a matter of degree; he was not supporting either plan, his testimony was not partisan. If you think it’s unbalanced, Greenspan replied, do me a favor: During the question and answer period ask me these questions and I will give you the answers I’m giving now.

  Conrad said that the forecasts of trillions of dollars of surplus were riddled with uncertainties. You don’t bet the farm on a 10-year forecast. CBO was saying that there was only a 10 percent chance that the forecast number would be true. There was a 45 percent chance there would be more money and a 45 percent chance there would be less money. Conrad said his worry was that Greenspan’s testimony would lead to an abandonment of fiscal discipline and run the serious risk of putting the federal government back into deficits. It is critically important that the floodgates not be opened again, he said. He had spent 15 years trying to help get the federal budget back in order after the disasters of the 1980s and the huge, debilitating deficits. Conrad had been the North Dakota tax commissioner for five years in the 1980s and the danger of debt was forever seared into his head. Please reconsider your testimony, Conrad requested.

  I can’t fail to tell the truth, Greenspan said. I can’t fail to report the numbers.

  No one’s asking you not to tell the truth or to report the numbers, Conrad said. But it’s got to be put into context.

  Greenspan promised he would do that.

  Conrad
also said he thought it was a flawed choice about what to do with the surplus. Greenspan’s choices—spend it, return it in the form of tax cuts or the government acquires stocks—were not the only choices. New laws could be passed that would insulate government officials from investment decisions, as has been the case with various government pension plans.

  When the Fed chairman left, Conrad called Bob Rubin, the Treasury Secretary who had worked hand in hand with Greenspan during the Clinton years in an unusual alliance that had helped eliminate the annual federal budget deficits.

  The senator explained that Greenspan was about to declare that tax cuts were “required,” and summarized the rationale about the stock market in the prepared testimony. Call Greenspan, Conrad urged, and try to talk him out of it.

  Rubin was somewhat baffled. After all the years they had worked together on fiscal discipline, why would Greenspan shift from urging federal debt repayment to urging tax cuts? He called his friend and tried gently to raise the question of whether this was a good or necessary thing to do.

  Greenspan explained that his testimony was carefully balanced and expressed his conclusions from the projected surpluses. “Bob,” Greenspan asked at one point, “where in my testimony do you disagree?”

  Rubin had not seen the testimony, but he suggested that the surpluses could be given as refundable tax credits when they actually materialized. Since Greenspan was talking years in the future, this did not have to be addressed now. He added that as he understood the testimony Greenspan would be seen as embracing Bush. It’s all perception, Rubin said. It did not take much to see how the news media would treat it.

  “I can’t be in charge of people’s perceptions,” Greenspan said. “I don’t function that way. I can’t function that way.”

  • • •

  The chairman’s testimony leaked. “Greenspan to Back Tax Cuts,” blared the large lead headline in USA Today the morning of his testimony.

  As he testified, Greenspan tried to be careful. He read the last line of his testimony twice, emphasizing the importance of resisting policies that, he said, “could readily resurrect the deficits of the past.”

  The next morning’s near-banner headline in The Washington Post said, “Greenspan Supports a Tax Cut.” The paper’s veteran Greenspan watcher, John M. Berry, wrote that the chairman had “endorsed the idea of a major federal tax cut as not only fiscally prudent but also necessary.” A front-page analysis said, “Bush’s Hand Greatly Strengthened.” It noted that overall the testimony “dispelled the notion that Bush’s plan to cut taxes might be reckless, dangerous or even massive”—the central charges that Democrats had made in the presidential campaign against Bush’s plan. “You could almost hear the ice cracking across the Capitol.”

  Republicans, including Bush, immediately embraced Greenspan as an ally. The president said he was “pleased” and Greenspan’s words were “measured and just right.” Many leading Democrats voiced shock, saying that Greenspan had taken the lid off the punch bowl and would start a stampede. The Wall Street Journal called it an “about-face.”

  Senator Conrad, more influenced by Greenspan than Greenspan by him, said the testimony was “balanced.”

  Greenspan had also addressed the question of which way the economy might be heading, and he said that the question “is going to be resolved one way or the other in three months or so.” He believed they’d know very soon. In business cycles, downturns and upturns are generally clear in a matter of months. The economy does not stay in neutral for prolonged periods of time. That would turn out to be his worst forecast in years.

  On January 31, the FOMC announced another 1/2 percent cut in the rate. Greenspan reasoned that if the economy’s adjustment process was accelerated, the FOMC would have to accelerate its monetary policy and cut rates more and faster.

  On Sunday, February 11, Greenspan read a long New York Times op-ed piece by Bob Rubin, headlined, “A Prosperity Easy to Destroy.” It was accompanied by a drawing of two smiling men sawing down a large tree. It did not mention Bush or Greenspan by name, but it wasn’t necessary. The article was carefully aimed at the large tax cut and its supporters. “We should avoid committing ourselves to dramatic courses of action that are hard to reverse in the face of the inherent uncertainties of any projections.” It was an argument for moderation and prudence—the kind of language normally found in Greenspan’s remarks.

  On February 14, The New York Times hit Greenspan with a Valentine’s Day rebuke. In his regular column, Paul Krugman, a Princeton economist respected by Greenspan, excoriated the chairman by reporting a “rumor” that Greenspan “is now engaged in a backdoor campaign to limit the damage” from his assist to those who favor “huge, irresponsible tax cuts.

  “If those rumors are true, Mr. Greenspan’s performance” in not backing off his tax cut support is “a profile in cowardice.” Krugman implied that Greenspan was protecting himself, was not being forthright, did not believe his own argument and had failed “a test of character.”

  Greenspan realized he was being called a hypocrite. He rarely called a reporter or columnist to protest. On occasion he just took it out on his wife, Andrea. “Is this a colleague of yours?” he once asked her. “He ought to get an education.”

  Greenspan believed that reporters should normally have two sources for such accusations, and Krugman didn’t even seem to have a single source. He was reporting a rumor. Greenspan called him.

  “Paul, for God’s sakes, you begin your piece by stipulating . . .” the chairman began. To base a column on a rumor! “Lift up the phone, call me and ask me whether it’s true,” he added. “In fact, it is false. I have never said, nor in fact do I believe, that the tax cut is too high. It’s not that large a tax cut, frankly.” He noted that he believed in some mechanism or trigger that would limit the tax cuts if the surplus didn’t materialize. “You’re accusing me of things that you could have found out whether it is true or false by just calling and asking.”

  “I didn’t think you were available,” replied Krugman. He was shocked that such a prominent figure as Greenspan would call to complain. Krugman was relatively new to writing a high-profile column for the Times and was accustomed to the comparative isolation of academic life.

  In a later interview, Krugman accused Greenspan of “violating the trust of his office” by taking a public position on a political issue that was not monetary policy. He said that the chairman of the Federal Reserve “should be scrupulously above politics” and his support of a tax cut was a “colossal misjudgment.” Greenspan should have presented a menu of options that were economically acceptable but not endorsed any single one.

  It was getting rough out there.

  At the Fed, some of Greenspan’s colleagues were almost as unhappy as Krugman that Greenspan had endorsed a tax cut—even though he had said, “I speak for myself and not necessarily for the Federal Reserve.” How could the Fed chairman be separated from his official role, especially one as powerful and visible as Greenspan? He didn’t say. Governor Laurence Meyer had deep reservations about the Fed or its chairman, even under cover of speaking only for himself, taking positions on issues outside the scope of monetary policy. Greenspan had put himself in a position to be used in the political process, Meyer believed, and he put his concerns in writing, though he never circulated it. Greenspan never saw it or heard about it, such was the chairman’s isolation from internal criticism.

  For his part Greenspan was unrepentant. The concern about the federal government getting into the stock market was real. He alone had identified the problem and blown the whistle. Since everyone was for a tax cut of some sort, all he was doing was agreeing with everyone. As far as the politics were concerned, his assessment was that Congress was going to pass a substantial tax cut no matter what he said.

  Greenspan defended his decision privately. To a suggestion that he should have been more cautious, he said, “I would be saying less than I knew, less than I understood, less than I thought was r
ight. And why would I do that?” He said he fudged only when he was worried that his comments might have an impact on the financial markets. “Am I going to fudge because it has political effects? The answer is, I can’t do that.” He added, “If I had fudged at that particular time, I would have been doing, I think, an injustice to my sworn obligation around here to tell it like it is.”

  To those who had worked with Greenspan over the years, both inside and outside the Fed, it was obvious that he was aware of the political impact, that he was giving a giant assist to the new Republican president and his friend Vice President Cheney. It was also more than possible that Greenspan had been accommodating to Democrats Clinton and Rubin in order to have smooth relations. With Republicans in control of the White House, he could return to his natural, true beliefs. He liked less government, and to lower taxes when the government was running a surplus made both economic and political sense.

  • • •

  Given that it generally took 6 to 18 months for cuts in the interest rate for short-term fed funds to have their impact on helping the economy, there was widespread understanding within the Federal Reserve that they were really working on next year, 2002, as they were raising rates in 2001. With the suddenness of the steep economic decline, 2001 was pretty much settled.

  On March 20, the FOMC again cut the Fed funds rate another 1/2 percent. Greenspan wanted to communicate to the financial markets a consistent, overall strategy of large, frequent 1/2 percentage point cuts as the economic news continued to be bad.