Proxmire was concerned with Greenspan’s lobbying efforts. Among other ventures, a top project was Sears’s attempt to offer banking services. Proxmire addressed the candidate: “[Y]ou think, if you erected Chinese walls, you can still merge banking and commerce. And that shocks this Senator, and I think it should shock many others. You, in my judgment, favor an increased concentration of banking.”11
10 Senate Committee on Banking, Housing and Urban Affairs transcript, July 21, 1987, pp. 36–37.
11 Ibid., p. 60.
Proxmire had a second reason for concern. Prior to the nomination hearing, Greenspan submitted a statement to the White House and Congress, a full disclosure of relationships that might present conflicts of interest. In that statement, Greenspan did not disclose either Sears, Roebuck and Company or Lincoln Savings and Loan.12 In the public record, there is an attachment to Greenspan’s disclosure, a “response to a query by Chairman Proxmire.”13 Greenspan responded to Proxmire’s request for “information about certain client relationships.”14 The attachment (a letter dated June 30, 1987, from Greenspan to Proxmire) distinguished Sears and Lincoln from the relationships listed in his full disclosure by slipping them in the side pocket of “advocacy projects.” He was paid by each to lobby for banking deregulation.15
Proxmire reminded Greenspan that the Federal Reserve was acquiring greater control of the banking system: “[A]s Chairman of the Federal Reserve Board … you are the country’s leading bank regulator. The Fed, as we know, regulates a large number of State member banks … [and] the bank holding companies that control an increasing proportion of all the commercial banking in our country. You take over this position at a time when there’s a headlong drive toward increasing bank concentration.”16
Proxmire tutored Greenspan on the menace of financial concentration: “As Chairman of the Federal Reserve Board you and your agency play the key role in approval or disapproval of these massive bank mergers… . I would feel much better about this appointment if there was somewhere in your record an indication of your awareness of the dangers to our economy of excessive financial concentration. Maybe you can reassure us that you understand that banking should be separated from commerce and the unique multiplicity of banking in this country is an immense source of strength for our small businesses.”17 The candidate and director of J. P. Morgan and Company as well as its banking subsidiary, Morgan Guaranty Trust Company, was not Proxmire’s ideal central banker in this regard. Large banks are generally indifferent to small business.
12 Nathaniel C. Nash, “Greenspan Says He’d Sit Out Some Federal Reserve Votes,” New York Times, July 11, 1987.
13 Senate Committee on Banking, Housing and Urban Affairs transcript, July 21, 1987, p. 73.
14 Ibid., p. 78.
15 Ibid., pp. 78–79.
Proxmire knew what to expect from Greenspan. Proxmire described Greenspan elsewhere in the hearing as a “get along, go along, comfortable” CEA chairman.18 Over the course of Greenspan’s term at the Fed, banks would merge and expand until they were no longer banks. They take deposits, make loans, trade for their own accounts, manage privateequity funds, manage hedge funds, serve as brokers for competing hedge funds, offer mortgages, securitize mortgages, sell securitized mortgages, then sell credit derivative swaps to protect the buyer against default from the securitized mortgages they previously sold. The chairman’s statements and questions were spoken to Greenspan, but may have been directed as much at members of the Senate Banking Committee. Proxmire saw danger ahead and found few kindred spirits among his fellow legislators. He resigned himself to a lonely outpost: “It seems to me that banking in this country and finance in this country is … likely to move very sharply … in the direction of concentration… . I think, most Senators, if they thought very long about it, might be very concerned about it. And I think the American people would be too.” (He also spoke as a man with little use for the Federal Reserve: “You will move in with a Board of clones—not clowns, clones.”)19
Proxmire concluded: “[T]his nomination should result in a slambang debate in committee and on the floor. It won’t. And it is startling, in view of what you have told us.”20
Senator Proxmire did not run again for the Senate. His term expired in 1989. Later in 1989, the Federal Reserve permitted J. P. Morgan to underwrite Xerox debt, the first such issue from a commercial bank since 1933, the year of the Glass-Steagall Act. (That legislation had separated commercial from investment banking.) In what Time magazine called “the widest breach of Glass-Steagall yet,”21 the Federal Reserve permitted J. P. Morgan to underwrite stock in 1990.22
18 Ibid., p. 4.
Today, Greenspan’s forbearance from regulating banks and derivatives is ascribed to his Ayn Rand–freemarket beliefs. Greenspan has no such beliefs. Senator Proxmire understood competitive banking. Competition was disappearing. After the Glass-Steagall Act was repealed in 1999, the largest banks devoured the minnows until the supermarketmegabanks were so large that they did not compete. The behemoths kept adding leverage. They deflected criticism (“we’re hedged”) until they grew so large, leveraged, and reckless that they were capable of devouring the world economy.
The Death of TownsendGreenspan
The TownsendGreenspan firm died quietly on July 31, 1987. The government asked Greenspan to remove his name from the firm, and he complied.23 The furniture and computers were sold at the beginning of August.24 Greenspan was required to place his $2.9 million of assets in a blind trust.25 The White House request was fortuitous. Pierre Rinfret, a New York consulting economist (who had served with Greenspan on Nixon’s 1968 economic advisory panel), refuted the common perception: “Everyone thinks that Greenspan gave up a lucrative consulting business to go to work in the public sector. In actuality, his business had been losing clients steadily to the point where he hardly had any left by the middle of the nineteen eighties.”26 The new Fed chairman had spent the past few years lobbying at 1600 Pennsylvania Avenue in lieu of studying livestock and mobile home sales. TownsendGreenspan had been hollowed out.
21 “American Notes: Banking,” Time, October 1, 1990.
22“History of J. P. Morgan Chase, 1799 to the Present”; www.jpmorgan,com/pages/ jpmorgan/investbk/about/history.
23“Greenspan’s Firm Is Closing,” New York Times, July 30, 1987, p. D5.
24 Ibid.
25 Justin Martin, Greenspan: The Man behind Money (Cambridge, Mass.: Perseus, 2000), p. 156.
26 Tuccille, Alan Shrugged, p. 154.
INTRODUCTION TO PART 2
THE PINNACLE OF POWER
1987–2006
A permanent Governor of the Bank of England would be one of the greatest men in England. He would be a little ‘monarch’ in the City. . . . He would be the personal embodiment of the Bank of England; he would be constantly clothed with an almost indefinite prestige. . . . Practical men would be apt to say that it was better than the Prime Ministership, for it would … have a greater jurisdiction over that which practical men would most value,—over money.
—Walter Bagehot, Lombard Street (1873)
On August 11, 1987, his hand placed on the Torah, the economist who had refused his bar mitzvah was sworn in as Federal Reserve chairman.1 Shortly after Greenspan revealed himself as a man who could keep a straight face no matter what he said.
Greenspan was tested immediately by the stock market crash on October 19, 1987. In retirement, Alan Greenspan would declare the 1987 stock market crash was a key educational experience during his tenure.2 Among the lessons not learned was to distrust derivative sales pitches. The derivative product that set off this crash was excused by
1 Justin Martin, Greenspan: The Man behind Money, (Cambridge, Mass.: Perseus, 2000), pp. 157–158. “Cousin Wesley brought along the copy of the Torah used at Greenspan’s CEA swearing in that was signed by Gerald Ford.”
2 Anthony Massucci, “Greenspan Cites 1987 Stock Crash, 9/11 as Key Education at Fed,” Bloomberg, June 1, 2007.
103 one
of its inventors, Mark Rubinstein: “[A] day like this wouldn’t be expected to happen during the lifetime of the universe.”3 We would hear other “once in the lifetime of the universe” excuses in 1994 (discussed in Chapter 10), 1998 (the topic of Chapter 15), and again in 2008. Each time, Greenspan followed by singing the virtues of derivatives. He seemed to be a slow learner.
The most charitable interpretation of Americans’ love affair with Greenspan would acknowledge people’s mental laxity. It is not too strong a description to say that many Americans worshipped Greenspan. At the very least, most Americans who listened to Greenspan took him at his word—even though they did not know what he was saying. This included the Washington politicians, Washington-oriented economists, and Wall Street strategists.
They were well served by Greenspan. All interests inflated. Expansion surrounded us: the stock market, stock-option payouts, Fannie Mae, the reputation of central banking, and the growing opportunities to become a CNBC celebrity. This contrasted with the deflation of the middle class and the industrial economy.
A striking characteristic of Greenspan’s term at the Federal Reserve was how his reputation grew as the influence of the Fed diminished. Finance had become much bigger than the banking system. The Federal Reserve historically had acted to expand or contract the economy by adding bank reserves to or subtracting them from the banking system.
Alan Greenspan contributed to the Fed’s loss of control. He ceded the Federal Reserve’s mandate to regulate and rein in financial excess. He reduced or eliminated many reserve requirements for bank deposits. He effectively renounced the Federal Reserve’s authority over stock market margin requirements. While devolving the Fed’s real authority, he spent much of his term acquiring a mystical hold on the American imagination.
Whether by accident or design, his open-mouth policy averted attention from his deficiencies. He missed the recession of the early 1990s. Yet, before Congress in 1994, he reconstructed his heroic anticipation and foresighted action that had averted a deeper recession—the same recession that he never mentioned until it was over. The significance of this recession may not be appreciated.
3 http://www.derivativesstrategy.com/magazine/archive/1999/0799qa.asp.
The recovery was a unique one. It owed more to finance than to work. Banks had bungled in the late 1980s, making real estate loans that left them incapacitated. With the banks unable to lend, the Greenspan Fed cut the funds rate from 9.5 percent in early 1989 to 3 percent by late 1992. That rate sat at 3 percent until February 1994. Banks borrowed at 3 percent and bought longterm Treasuries yielding 6 percent. This refloated their balance sheets, but at a cost.
Banks were no longer the financial traffic cop for the economy. The bond market and derivatives played larger roles. The bank credit system would struggle and recover, but it would not reclaim its predominant role. Savings and investment assets were leaving the banking system and entering markets. The Federal Reserve controls only money supplied to and from the banking system; here again, it lost influence.4 Markets are more fickle than bank lending; thus, the financial machinery was less stable.
Greenspan gave his often quoted “irrational exuberance” speech in December 1996. This was his ever-so-muted warning that the stock market might be overpriced: “how do we know when irrational exuberance has unduly escalated asset values?”
Yet, he claimed he had popped a bubble in 1994. “I think we partially broke the back of an emerging speculation in equities. We pricked that bubble [in the bond market] as well.”5 He offered to pop the bubble at the September 1996 FOMC meeting: “I recognize that there is a stock market bubble problem at this point. . . . We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it.”
After his “irrational exuberance” speech, Greenspan gave a couple of warnings in early 1997. Critics told him that he should not make stock market predictions. He never addressed the bubble again—that is, until he decided that he could not identify one before it blew up. Greenspan donned his flak jacket before Congress in June 1999: “bubbles generally are perceptible only after the fact.”6 The same man had claimed credit for popping bubbles at four Federal Open Market Committee meetings in 1994. His see-no-evil, hear-no-evil bubble claim would become known as the Greenspan Doctrine among economists.7 His open money spigot policy whenever the stock market buckled became known as the “Greenspan put” among speculators. This was a government welfare program with consequences we continue to delay and magnify.
4 Peter Warburton, Debt and Delusion: Central Bank Follies That Threaten Economic Disaster (Princeton, N.J.: WorldMeta View Press, 2005), p. 9.
5 FOMC meeting, February 28, 1994, p. 3.
6 Joint Economic Committee, Monetary Policy and the Economic Outlook, June 17, 1999.
One of the most dismaying developments during the Greenspan era was the silence of professional economists. As a whole, they nodded their heads in agreement, no matter what the man said. Greenspan’s most enduring fabrication was productivity. The chairman’s cheerleading for productivity and technology was essential to the stock market bubble, and to Fed policy. Greenspan hypothesized that the stock market was not overpriced; it simply reflected improvements in productivity. Therefore, stocks were worth whatever the market considered the appropriate New Era price.
The gruesome contortions of the productivity calculation are addressed in Chapter 12. It was from this platform that Greenspan launched his tortured justifications for the Nasdaq trading at 200 times earnings by early 2000.8 Central banks around the world aligned their policies with the New Era. That central bank policy was driven by such effervescent claims shows the bankruptcy of economic thought among those making policy today.
Greenspan enthusiastically endorsed this road to the poorhouse. At one FOMC meeting in 2002, Greenspan remarked: “We know … that the average extraction of equity per sale of an existing home is well over $50,000. A substantial part of the equity extraction related to home sales, which is running at an annual rate close to $200 billion, is expended on personal consumption and home modernization, two components, of course, of GDP.”9
On February 23, 2004, the Federal Reserve chairman addressed the Credit Union National Association. Greenspan observed: “Many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages.”10 By early 2004, many house buyers could meet monthly payments only with an adjustable-rate mortgage. (These were sold at a low rate that would adjust to a higher rate in later years.) When those became unaffordable, “interest-only” and “negative-amortization” mortgages were necessary. In 2002, 2 percent of California residential mortgages were interest only. This rose to 47 percent in 2004 and 61 percent in January and February of 2005.11
7 A headline in the March 28, 2008, Financial Times for an article by Krishna Guha read: “Greenspan Doctrine on Asset Prices Questioned.” First sentence: “The Federal Reserve may have to rethink the Greenspan Doctrine that a central bank should not try to target asset prices.”
8 Fred Hickey, HighTech Strategist, January 4, 2000.
9 FOMC meeting transcript, September 24, 2002, p. 78.
Greenspan also elevated the housing boom by telling Americans how rich they were. He very rarely used the word debt—that is, the payments required to pay down mortgage principal. Instead, he threw out multitrillion-dollar figures for the “wealth” that Americans had accumulated through the rising values of house prices.
Shortly before retirement, Greenspan, seemed more forthcoming: “[W]e can have little doubt that the exceptionally low level of home mortgage interest rates has been a major driver of the recent surge of home building and home turnover and the steep climb in home prices.”12 In the same speech, he claimed that if house prices cooled, “these borrowers, and the institutions that service them, could be exposed to significant losses.”13
Greenspan stepped down from the Federal Res
erve on January 31, 2006.
10 Alan Greenspan, “Understanding Household Debt Obligations,” speech at the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C., February 23, 2004.
11 “Consumer Finance,” speech at Ruth Simon, “Concerns Mount About Mortgage Risks,” Wall Street Journal Online, May 17, 2005.
12Alan Greenspan, “Mortgage Banking,” speech at the American Bankers Association Annual Convention, Palm Desert, California (via satellite), September 26, 2005.
13 Ibid.
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9
The Stock Market Crash and the Recession That Greenspan Missed
1987–1990
Modern particle physics is, in a literal sense, incomprehensible. It is grounded not in the tangible and testable notions of objects and points and pushes and pulls but in a sophisticated and indirect mathematical language of fields and interactions and wave-functions. . . . Even within the community of particle physicists there are those who think that the trend towards increasing abstraction is turning theoretical physics into recreational mathematics, endlessly amusing to those who can master the techniques and join the game, but ultimately meaningless because the objects of the mathematical manipulations are forever beyond the access of experiment and measurement.
—David Lindley, The End of Physics (1993)1
[A] day like this wouldn’t be expected to happen in the life of our universe, which is 20 billion years. Indeed, it wouldn’t even happen if you were to live through 20 billion of those universes.2
—Mark Rubinstein, an architect of portfolio insurance, discussing the failure of his product on October 19, 1987
1 David Lindley, The End of Physics: The Myth of a Unified Theory (New York: Basic Books, 1993), pp. 18–19.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 12
