22 October 2002 - For Whom the Closing Bell Tolls

At a recent symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming, Alan Greenspan reflected on causes of the stock market bubble that grew at the end of the 20th century. He discussed how difficult it was to recognize when a bubble began and how anything he could have done as Federal Reserve chairman would have only made matters worse for the economy at the time.

“Bubbles,” Greenspan said toward the end of his speech, “thus appear to primarily reflect exuberance on the part of investors in pricing financial assets… Bubbles appear to emerge when investors either overestimate the sustainable rise in profits or unrealistically lower the rate of discount they apply to expected profits and dividends.” He said he did not know there was a bubble and could have done nothing even if he had figured out there was a mania. I wonder if he really believes that. Even my mother knows there was a bubble. Is he a charlatan or a fool? Perhaps both as we will see from his own earlier words and deeds.

I’ve got news for you, Alan: This stock market bubble was yours and could have been prevented. It didn’t have to happen. Don’t go blaming investors for so-called exuberance, irrational or rational. The only one who has acted irrationally, it seems to me, is you. You could have prevented it in the first place and certainly could have stopped the bleeding a long time ago.

I know, I know. This is not the way people want to think about Alan Greenspan. The way people often talk about him, you’d think he was up for sainthood. Back in 1999, Time magazine nominated him to the “committee to save the world.” Legendary journalist Bob Woodward wrote a flattering book about Greenspan called “Maestro.” Senator Phil Gramm of Texas called him the greatest central banker of all time. Even the Queen of England recently added her vote, knighting Greenspan and saying that Sir Alan has brought “economic stability to the world.” I guess she didn’t notice that there have been at least five major financial crises in the past eight years with perhaps more on the horizon.

Could someone please give me the phone number of Alan Greenspan’s public relations firm? Actually it was down in the board rooms of investment firms who used him to coin money, but even they have caught on by now.

Our current master of monetary policy has been at the helm since 1987, one of the longest-running tenures of any Fed chairman. Four different presidents-a Democrat and three Republicans-have held court at the White House, but Alan himself remained safely ensconced about a mile away at the Fed. I’m the first to agree that Alan Greenspan has had a tremendous impact on our economy. It’s just the facts and reality of his tenure will look horrible to historians. Looking back over his career in the past decade and a half, it’s pretty clear he made major mistakes that have gotten this country into a huge economic bind today.

Hindsight, as the saying goes, gives us 20-20 vision, but it does something else: it usually tells us the truth, even if it’s a little late to correct the mistakes.

In the long run, history’s going to remember Greenspan as the man who caused the stock market bubble and worse. If he doesn’t change his monetary policy, he’ll also be remembered as the man who created other bubbles to follow in its wake.

Let’s take a step a back in time and take a little history lesson. Think back to the gravy days of the 1990s. From 1992 to 1997, the S&P 500 soared 130 percent, or roughly 27 percent annually. It was the biggest bull market that many of us who’d been in the business for years had ever seen. All the economic indicators were pointing the right direction: Unemployment was down, manufacturing hours were up. Corporate profits rose about 120 percent over that period. The trade deficit wasn’t ballooning at its typical breakneck pace. The Japanese Central Bank was flooding the world with money so we had an unusually good period so far, but nothing too dangerous here. These were good days for the country and the Maestro began taking the credit.

But here’s the funny thing about the stock market, something even the most educated investors seem to forget when the going gets good: the stock market and economies move in cycles. It’s just the way it goes. Don’t take it personally. Markets have always done it; they always will. (Alan, are you listening?) A lot of people hoped the stock market had gone to a new, special place, that cosmic zone where stocks never go down. They continue to rise and we all get rich. The New Economy, I believe it was called – somewhat reminiscent of the New Era of the 1920s.

Well, we all know what happened to that myth. Corporate profits, we now know, peaked in 1997 and started to decline. Manufacturing hours were down. In the fall of 1997, the stock market, in turn, started to dip. Remember the other key thing about the stock market: It anticipates the future. It looks ahead. In other words, the stock market was recognizing that 1998 might not be a banner year for profits. When companies don’t earn as much, their stock loses value. It’s reality. Forget the Amazons: you need earnings to keep your stock price up.

But in the fall of 1997, something happened. We caught the flu, the Asian flu. Several key Asian economies, including Thailand and Malaysia, were the first to suffer when economies started heading down. Again, this was nothing unusual in economic cycles; marginal countries and companies always get caught first when declines begin. There is often an “event” which signals the normal end to bull markets, but the simple reality always is that it is time for that bull run to end for whatever reason. Schumpeter showed that instability is one of the strengths of capitalism. There is always destruction upon which the dynamic thrive and create for future growth. But it was bad news for major investment firms like Goldman Sachs and Fidelity who’d invested tons of money, through loans, bonds, and other financial instruments, in these countries. The phones started ringing in Washington. Who came to the rescue? Sir Alan. Greenspan started printing money and extending credit, pumping liquidity into the U.S. economy to make sure that the problems in the East wouldn’t rock his friends in the West.

To me, this was a pivotal moment in Greenspan’s career and a problematic decision. He should have let the markets correct themselves as they were already trying to do. Stocks would have fallen. Companies would have been hurt or possibly destroyed by the normal, economic decline. There would have been a bear market, panic and a selling climax. Many investors would have lost money. But that’s what bear markets often do: they chasten those who get a little too greedy. As the late Fed Chairman William McChesney Martin once put it, the central bankers’ job has always been to take away the punch bowl just when the party gets going. They have to step on the brakes before things get out of control. It’s no wonder Martin held the position of Fed chairman from 1951-1970, longer than anyone else in history.

The problem is that Greenspan didn’t take away the punch bowl or even let it empty naturally. He just kept pouring more into it. He overrode what would have been normal stock-market behavior. The same process repeated itself over the next three years. In the fall of 1998, it was the Russian collapse and the fall of the legendary hedge fund Long-Term Capital Investment. The stock market was already in trouble: roughly 60 percent of all stocks were down in 1998 and decliners also outnumbered advancers in 1999, even with Greenspan’s pumping. Remember profits had already peaked in 1997 and were in decline. The LTCM crisis probably would have been the normal selling climax for the bear market which had begun the year before, but the Maestro kept the presses running. After all, he was getting panic calls from his Wall-Street friends who feared some would fail. Again, it was just the normal workings – more creative destruction — of financial markets, but Greenspan has never really understood markets. In 1999, it was Y2K.

All along, Alan Greenspan’s Federal Reserve was pumping out cash and extending credit, helping to float the U.S. economy. From 1997 to 2001, M3, a broad measure of the money supply that includes all currency in circulation, and liquid assets like bank deposits, money-market mutual funds and time deposits, grew 48 percent, the fastest it’s ever grown. Greenspan pumped roughly $2.6 trillion into the economy, adding fuel to the fire. Off-balance-sheet debt and derivatives rose 185 percent to $59 trillion while non-government debt rose 52 percent. In 1997, syndicated loans totaled $423 billion. By June 2002, they were up 64 percent to $692 billion. Our foreign debts skyrocketed. Remember this was in a period when profits were declining steadily after a long climb from 1992 to 1997. Greenspan was trying to override normal economic history and laws for some reason.

Why did he do it? Why didn’t he let the markets simply correct themselves? I’m not sure. From what he said in Wyoming, it appears he thought he was doing the right thing. My guess is he was also doing it to appease his friends on Wall Street who went into a panic when the markets began normal declines. After all, these are the people who are always singing his praise. Heck, I’d praise him too if he kept bailing me out of the poorhouse.

It may well be that he too was eventually swept up in the fantasies he was creating. After all, on Feb. 17, 2000, he said, “Security analysts’ projections of long-term earnings, an indicator of expectations of company productivity, continued to be revised upward in January, extending a string of upward revisions that began in early 1995. One result of this remarkable economic performance has been a pronounced increase in living standards for the majority of Americans. Another has been a labor market that has provided job opportunities for large numbers of people previously struggling to get on the first rung of a ladder leading to training, skills, and permanent employment.”

He seems to have actually believed all the New Economy stuff we now know was garbage. Our Maestro was relying on Jack Grubman, Mary Meeker, Abby Cohen, and Henry Blodget to justify his credit pumps.

Remember how he began marveling at the “remarkable wave of new technologies” and a “once-in-a-century acceleration of innovation” and “a pivotal period of economic history” where “I see nothing to suggest these opportunities [of high rate of return productivity enhancing investments] will peter out any time soon” in 2000? He went on to tell Congress on Feb. 13, 2001: “From all indications, however, technological advance still is going forward at a rapid pace, and investment will likely pick up again if, as expected, the expansion of the economy gets back on more solid footing. Private analysts are still anticipating high rates of growth in corporate earnings over the long run, suggesting the current sluggishness of the economy has not undermined perceptions of favorable long-term fundamentals.” Now we know this “Maestro” was relying on Wall Street “analysts” and bubblevision for his “genius.” It is bad enough he listened, but he actually believed all that hype.

On Jan. 25, 2001, he explained to Congress on that budget surpluses would continue for years because of “the extraordinary pickup in the growth of labor productivity experienced in this country since the mid-1990s.” He went on to marvel at the “structural productivity growth.” You would think someone with the brains and ability to “save the world” would remember what happened “once in a century” in 1917-1927 when electricity, automobiles, airplanes, telephones, radio, wireless, refrigeration and several other things came together to generate productivity growth over twice as high as under Dr. Greenspan. Even in the 1950s and 1960s, U. S. productivity grew more than 60 percent faster than during the mania he was creating and justifying as “once in a century.”

Now we all make mistakes, but most do not have PR machines calling us maestros when we are actually just selling snake oil. He began by trying to bail out his old cronies and then by trying to override a normal bear market. The more money he printed and the more credit he created, the deeper we all got. Then he started believing TIME [who also named the CEO of Amazon as Man of the Year a few months later] and the Washington Post. Everyone loves a bubble, so few wanted to know the Emperor actually had no clothes, especially when the party seemed to be getting better and better. The few Cassandras were ignored again.

As we now know, even Alan Greenspan couldn’t stop the stock market from correcting itself in the end. Bubbles all work the same way. They eventually pop. In his speech in Wyoming, Greenspan said the Fed was “confronted with forces that none of us had personally experienced.” That’s just not true. There’ve been plenty of bubbles in his experience, from the stock-market bubble of the 1960s to the Kuwait Stock Exchange bubble in the 1970s to gold and silver two decades ago to the Texas real-estate bubble of 1980s to the Japanese bubble to the S&L/junk-bond bubble. Evidently history does not mean much to our wise Maestro since there are also numerous descriptions of past bubbles and how they have always worked. You’d think someone with the ability “to save the world” would have read a few books about markets.

The problem is the glut of money and credit that has been poured into the U.S. economy has created a host of new problems. The U.S. government’s fiscal budget is now in huge deficit because so many projections were based on revenues from capital-gains taxes that won’t be realized. Employee 401(k) plans are in the dumps, insurance companies, pension plans, whether they are corporate or government, are in trouble, some in danger of disappearing. Social Security and Medicare are certain to suffer in the long run.

It’s caused problems on a corporate level as well. All the easy credit that’s available is propping up companies that are basically zombies, companies that should have long gone out of business (read: Lucent?)to cleanse the system for the survivors. My guess is many of the corporate accounting problems now surfacing might not have happened if Greenspan had allowed the stock market to correct itself as profits declined. After all, he kept creating credit to prolong the bubble so companies played the stock-market game to keep their stocks and options participating.

Greenspan could have raised margin requirements — the ability to buy equities on credit — during all this to control the animal spirits loosened by his credit machine. He is even on record in 1996 stating: “I recognize there is a stock-market bubble problem at this point.” He went on to say: “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.” He was dead right. If he had followed through, many of these companies wouldn’t have been jiggering the books when times got tough.

More important, Greenspan’s reaction with regard to the stock-market bubble has caused two more bubbles to grow: a real-estate bubble and a consumer-debt bubble. Faithful readers know I believe the real-estate market will pop within a year or so. Many investors have simply transferred their assets from the stock market to the real estate market, thinking they can get rich quickly. Greenspan himself is certainly helping the effort, lowering interest rates 11 times in the last two years alone, allowing homeowners to refinance their mortgages, often borrowing even more money, without raising their monthly payments. This might be fine if people were using the money to pay off their credit cards and car loans and other debts, but that doesn’t appear to be true. Consumer-debt levels continue to soar as people take money from their homes and spend rather than lower debt or save. The U.S. savings rate, after all, is roughly 1 percent, one of the lowest in the world. A consumer-debt bubble is building and it will devastate many people when it bursts. Our Maestro is on record as saying this use of more unsustainable, non-productive credit is a sound basis for keeping the economy humming. I fail to see how pouring more debt into our houses which only produce more negative cash flow will save us down the road.

What would I do? I’m not the Federal Reserve chairman and it’s not a job I’d want. That said, I wouldn’t keep forcing lower interest rates. Way back when, before the central bank got involved, interest rates used to set themselves. If people borrowed a lot of money, rates were higher. If people didn’t borrow money, rates fell. Why shouldn’t it be any different now? The rest of the world is following these eternal verities these days. Plus, I’d aggressively encourage people to pay down their debt and start saving. Our system discourages saving and investing, but encourages consumption. The only way to make it through the hard times is if you’ve prepared for them. The U. S. desperately needs more saving and investment, not more SUVs and vacations in the casinos. We need to let inefficient companies fail to clean out the system. Japan over the past decade has proved that for all of us. Greenspan has even talked of Japan’s “ensuing failures of policy.” We need to build future productivity, not more bubbles. Hopefully, it’s not too late.

Greenspan is up for reappointment in 2004. He’s already lobbying to be reelected, hoping to surpass the late William McChesney Martin as the longest-running Federal Reserve chairman in history. He shouldn’t be reappointed. By then, things may be so bad that even he won’t be able to hide what he’s done. In his recent speech in Wyoming, Greenspan said, “As history attests, investors too often exaggerate the extent of the improvement in economic fundamentals.” Boy, did he speak from the heart and get that right, although he was trying to blame others for his mistakes. But who can blame investors for their rose-colored glasses when the Federal Reserve chairman — the man who allegedly makes the most important financial decisions for the entire nation — ignores history in order to protect his friends and his legacy?

On Sept. 25, 2002, Greenspan told a group of economists again not to worry about his approach of sustaining the economy with a new housing and consumption base with more credit piled on top of the huge debt increase of 1997-2001. He is getting in deeper while still trying to override normal economic history and rules. He said, “These episodes suggest a marked increase over the past two or three decades in the ability of modern economies to absorb shocks.” We do not need to worry he said because the world economy “has become more flexible.” He is now a believer once again — in a New Flexibility.

Among the most dangerous words in the world are: “It is different this time.” The Maestro still believes once again that things are now different. History will judge him one of the worst Central Bankers ever.