The Financial Tsunami Part III:
Greenspan’s Grand Design
By
F. William Engdahl, January
22, 2008
The Long-Term Greenspan Agenda
Seven years of Volcker monetary “shock therapy” had
ignited a payments crisis across the Third World. Billions of dollars in
recycled petrodollar debts loaned by major New York and London banks to finance
oil imports after the oil price rises of the 1970’s, suddenly became
non-payable.
The stage was now set for the next phase in the Rockefeller financial deregulation agenda. It was to come in the form of a revolution in the very nature of what would be considered money—the Greenspan “New Finance” Revolution.
Many analysts of the Greenspan era focus on the
wrong facet of his role, and assume he was primarily a public servant who made
mistakes, but in the end always saved the day and the nation’s economy and
banks, through extraordinary feats of financial crisis management, winning the
appellation, Maestro.[1]
Maestro serves the Money Trust
Alan Greenspan, as every Chairman of the Board of
Governors of the Federal Reserve System was a carefully-picked institutionally
loyal servant of the actual owners of the Federal Reserve: the network of
private banks, insurance companies, investment banks which created the Fed and
rushed in through an almost empty Congress the day before Christmas recess in
December 1913. In Lewis v. United States,
the United States Court of Appeals for the Ninth Circuit stated that "the
Reserve Banks are not federal instrumentalities…but are independent, privately
owned and locally controlled corporations." [2]
Greenspan’s entire tenure as Fed chairman was
dedicated to advancing the interests of American world financial domination in
a nation whose national economic base was largely destroyed in the years
following 1971.
Greenspan knew who buttered his bread and loyally
served what the US Congress in 1913 termed “the Money Trust,” a cabal of financial
leaders abusing their public trust to consolidate control over many industries.
Interestingly, many of the financial actors behind
the 1913 creation of the Federal Reserve are pivotal in today’s securitization
revolution including Citibank, and J.P. Morgan. Both have share ownership of
the key New York Federal Reserve Bank, the heart of the system.
Another little-known shareholder of the New York
Fed is the Depository Trust Company (DTC), the largest central securities
depository in the world. Based in New York, the DTC custodies more than 2.5
million US and non-US equity, corporate, and municipal debt securities issues
from over 100 countries, valued at over $36 trillion. It and its affiliates
handle over $1.5 quadrillion of securities transactions a year. That’s not bad
for a company that most people never heard of. The Depository Trust Company has
a sole monopoly on such business in the USA. They simply bought up all other
contenders. It suggests part of the reason New York was able for so long to
dominate global financial markets, long after the American economy had become
largely a hollowed-out “post-industrial” wasteland.
While free market purists and dogmatic followers of
Greenspan’s late friend, Ayn Rand, accuse the Fed Chairman of hands-on
interventionism, in reality there is a common thread running through each major
financial crisis of his 18 plus years as Fed chairman. He managed to use each
successive financial crisis in his eighteen years as head of the world’s most
powerful financial institution to advance and consolidate the influence of
US-centered finance over the global economy, almost always to the severe
detriment of the economy and broad general welfare of the population.
In each case, be it the October 1987 stock crash, the
1997 Asia Crisis, the 1998 Russian state default and ensuing collapse of LTCM,
to the refusal to make technical changes in Fed-controlled stock margin
requirements to cool the dot.com stock bubble, to his encouragement of ARM
variable rate mortgages (when he knew rates were at the bottom), Greenspan used
the successive crises, most of which his widely-read commentaries and rate
policies had spawned in the first place, to advance an agenda of globalization
of risk and liberalization of market regulations to allow unhindered operation
of the major financial institutions.
The Rolling Crises Game
This is the true significance of the crisis today
unfolding in US and global capital markets. Greenspan’s 18 year tenure can be
described as rolling the financial markets from successive crises into ever
larger ones, to accomplish the over-riding objectives of the Money Trust
guiding the Greenspan agenda. Unanswered at this juncture is whether
Greenspan’s securitization revolution was a “bridge too far,” spelling the end
of the dollar and of dollar financial institutions’ global dominance for
decades or more to come.
Greenspan’s adamant rejection of every attempt by
Congress to impose some minimal regulation on OTC derivatives trading between
banks; on margin requirements on buying stock on borrowed money; his repeated
support for securitization of sub-prime low quality high-risk mortgage lending;
his relentless decade-long push to weaken and finally repeal Glass-Steagall
restrictions on banks owning investment banks and insurance companies; his
support for the Bush radical tax cuts which exploded federal deficits after
2001; his support for the privatization of the Social Security Trust Fund in
order to funnel those trillions of dollars cash flow into his cronies in Wall
Street finance—all this was a well-planned execution of what some today call
the securitization revolution, the creation of a world of New Finance where
risk would be detached from banks and spread across the globe to the point no
one could identify where real risk lay.
When he came in 1987 again to Washington, Alan
Greenspan, the man hand-picked by Wall Street and the big banks to implement
their Grand Strategy was a Wall Street consultant whose clients numbered the
influential J.P. Morgan Bank among others. Before taking the post as head of
the Fed, Greenspan had also sat on the boards of some of the most powerful
corporations in America, including Mobil Oil Corporation, Morgan Guaranty Trust
Company and JP Morgan & Co. Inc. His first test would be the manipulation
of stock markets using the then-new derivatives markets in October 1987.
The 1987 Greenspan paradigm
In October 1987 when Greenspan led a bailout of the
stock market after the October 20 crash, by pumping huge infusions of liquidity
to prop up stocks and engaging in behind-the scene manipulations of the market
via Chicago stock index derivatives purchases backed quietly by Fed liquidity
guarantees. Since that October 1987 event, the Fed has made abundantly clear to
major market players that they were, to use Fed jargon, TBTF—Too Big To Fail.
No worry if a bank risked tens of billions speculating in Thai baht or dot.com
stocks on margin. If push came to liquidity shove, Greenspan made clear he was
there to bail out his banking friends.
The October 1987 crash which saw the sharpest one
day fall in the Dow Industrials in history—508 points—was exacerbated by new
computer trading models based on the so-called Black-Sholes Option Pricing
theory, stock share derivatives now being priced and traded just as hog belly
futures had been before.
The 1987 crash made clear was that there was no
real liquidity in the markets when it was needed. All fund managers tried to do
the same thing at the same time: to sell short the stock index futures, in a futile
attempt to hedge their stock positions.
According to Stephen Zarlenga, then a trader who
was in the New York trading pits during the crisis days in 1987, “They created
a huge discount in the futures market…The arbitrageurs who bought futures from
them at a big discount, turned around and sold the underlying stocks, pushing
the cash markets down, feeding the process and eventually driving the market
into the ground.”
Zarlenga continued, “Some of the biggest firms in Wall
Street found they could not stop their pre-programmed computers from
automatically engaging in this derivatives trading. According to private
reports they had to unplug or cut the wiring to computers, or find other ways
to cut off the electricity to them (there were rumors about fireman's axes from
hallways being used), for they couldn’t be switched off and were issuing orders
directly to the exchange floors.
“The New York Stock Exchange at one point on Monday
and Tuesday seriously considered closing down entirely for a period of days or
weeks and made this public…It was at this point…that Greenspan made an
uncharacteristic announcement. He said in no uncertain terms that the Fed would
make credit available to the brokerage community, as needed. This was a turning
point, as Greenspan’s recent appointment as Chairman of the Fed in mid 1987 had
been one of the early reasons for the market’s sell off.” [3]
What was significant about the October 1987 one-day
crash was not the size of the fall. It was the fact that the Fed, unannounced
to the public, intervened through Greenspan’s trusted New York bank cronies at
J.P. Morgan and elsewhere on October 20 to manipulate a stock recovery through
use of new financial instruments called derivatives.
The visible cause of the October 1987 market
recovery was when the Chicago-based MMI future (Major Market Index) of NYSE
blue chip stocks began to trade at a premium, midday Tuesday, at a time when
one after another Dow stock had been closed down for trading.
The meltdown began to reverse. Arbitrageurs bought
the underlying stocks, re-opening them, and sold the MMI futures at a premium.
It was later found that only about 800 contracts bought in the MMI futures was
sufficient to create the premium and start the recovery. Greenspan and his New
York cronies had engineered a manipulated recovery using the same derivatives
trading models in reverse. It was the dawn of the era of financial derivatives.
Historically, at least most were led to believe,
the role of the Federal Reserve, the Comptroller of the Currency among others,
was to act as independent supervisors of the largest banks to insure stability
of the banking system and prevent a repeat of the bank panics of the 1930’s,
above all in the Fed’s role as “lender of last resort.”
Under the Greenspan regime, after October 1987 the
Fed increasingly became the “lender of first resort,” as the Fed widened the
circle of financial institutions worthy of the Fed’s rescue from banks
directly—which was the mandated purview of Fed bank supervision—to the
artificial support of stock markets as in 1987, to the bailout of hedge funds
as in the case of the Long-Term Capital Management hedge fund solvency crisis
in September 1998.
Greenspan’s last legacy will be leaving the Fed and
with it the American taxpayer with the role as Lender of Last Resort, to bail
out the major banks and financial institutions, today’s Money Trust, after the
meltdown of his multi-trillion dollar mortgage securitization bubble.
By the time of repeal of Glass-Steagall in 1999, an
event of historic importance that was buried in the financial back pages, the
Greenspan Fed had made clear it would stand ready to rescue the most risky and
dubious new ventures of the US financial community. The stage was set to launch
the Greenspan securitization revolution.
It was not accidental, or ad hoc in any way. The
Fed laissez faire policy towards supervision and bank regulation after 1987 was
crucial to implement the broader Greenspan deregulation and financial securitization
agenda he hinted at in his first October 1987 Congressional testimony.
On November 18, 1987, only three weeks after the
October stock crash, Alan Greenspan told the US House of Representatives
Committee on Banking, “…repeal of Glass-Steagall would provide significant
public benefits consistent with a manageable increase in risk.”
[4]
Greenspan would repeat this mantra until final
repeal in 1999.
The support of the Greenspan Fed for unregulated
treatment of financial derivatives after the 1987 crash was instrumental in the
global explosion in nominal volumes of derivatives trading. The global
derivatives market grew by 23,102% since 1987 to a staggering $370 trillion by
end of 2006. The nominal volumes were incomprehensible.
Destroying Glass-Steagall restrictions
One of Greenspan’s first acts as Chairman of the
Fed was to call for repeal of the Glass-Steagall Act, something which his old
friends at J.P.Morgan and Citibank had ardently campaigned for. [5]
Glass-Steagall, officially the Banking Act of 1933,
introduced the separation of commercial banking from Wall Street investment
banking and insurance. Glass-Steagall originally was intended to curb three
major problems that led to the severity of the 1930’s wave of bank failures and
depression:
Banks were investing their
own assets in securities with consequent risk to commercial and savings
depositors in event of a stock crash. Unsound loans were made by the banks in
order to artificially prop up the price of select securities or the financial
position of companies in which a bank had invested its own assets. A bank's
financial interest in the ownership, pricing, or distribution of securities
inevitably tempted bank officials to press their banking customers into
investing in securities which the bank itself was under pressure to sell. It
was a colossal conflict of interest and invitation to fraud and abuse.
Banks that offered
investment banking services and mutual funds were subject to conflicts of interest
and other abuses, thereby resulting in harm to their customers, including
borrowers, depositors, and correspondent banks. Similarly, today, with no more
Glass-Steagall restraints, banks offering securitized mortgage obligations and
similar products via wholly owned Special Purpose Vehicles they create to get
the risk “off the bank books,” are complicit in what likely will go down in
history as the greatest financial swindle of all times—the sub-prime
securitization fraud.
In his history of the Great Crash, economist John
Kenneth Galbraith noted, “Congress was concerned that commercial banks in
general and member banks of the Federal Reserve System in particular had both
aggravated and been damaged by stock market decline partly because of their
direct and indirect involvement in the trading and ownership of speculative
securities.
“The legislative history of the Glass-Steagall
Act,” Galbraith continued, “shows that Congress also had in mind and repeatedly
focused on the more subtle hazards that arise when a commercial bank goes
beyond the business of acting as fiduciary or managing agent and enters the
investment banking business either directly or by establishing an affiliate to
hold and sell particular investments.” Galbraith noted that “During 1929 one
investment house, Goldman, Sachs & Company, organized and sold nearly a
billion dollars' worth of securities in three interconnected investment
trusts--Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue
Ridge Corporation. All eventually depreciated virtually to nothing.”
Operation Rollback
The major New York
money-center banks had long had in mind the rollback of that 1933 Congressional
restriction. And Alan Greenspan as Fed Chairman was their man. The major
money-center US banks, led by Rockefeller’s influential Chase Manhattan Bank
and Sanford Weill’s Citicorp, spent over one hundred hundreds million dollars
lobbying and making campaign contributions to influential Congressmen to get
deregulation of the Depression-era restrictions on banking and stock
underwriting.
That repeal opened the floodgates to the
securitization revolution after 2001.
Within two months of taking office, on October 6,
1987, just days before the greatest one-day crash on the New York Stock
Exchange, Greenspan told Congress, that US banks, victimized by new technology
and ''frozen'' in a regulatory structure developed more than 50 years ago, were
losing their competitive battle with other financial institutions and needed to
obtain new powers to restore a balance: ''The basic products provided by banks
- credit evaluation and diversification of risk - are less competitive than
they were 10 years ago.''
At the time the New
York Times noted that “Mr. Greenspan has long been far more favorably
disposed toward deregulation of the banking system than was Paul A. Volcker,
his predecessor at the Fed.” [6]
That October 6, 1987 Greenspan testimony to
Congress, his first as Chairman of the Fed, was of signal importance to understand
the continuity of policy he was to implement right to the securitization
revolution of recent years, the New Finance securitization revolution. Again
quoting the New York Times account,
“Mr. Greenspan, in decrying the loss of the banks' competitive edge, pointed to
what he said was a ‘too rigid’ regulatory structure that limited the
availability to consumers of efficient service and hampered competition. But
then he pointed to another development of ‘particular importance’ - the way
advances in data processing and telecommunications technology had allowed
others to usurp the traditional role of the banks as financial intermediaries.
In other words, a bank's main economic contribution - risking its money as
loans based on its superior information about the creditworthiness of borrowers
- is jeopardized.”
The Times
quoted Greenspan on the challenge to modern banking posed by this technological
change: ‘Extensive on-line data bases, powerful computation capacity and
telecommunication facilities provide credit and market information almost
instantaneously, allowing the lender to make its own analysis of
creditworthiness and to develop and execute complex trading strategies to hedge
against risk,’ Mr. Greenspan said. This, he added, resulted in permanent damage
‘to the competitiveness of depository institutions and will expand the
competitive advantage of the market for securitized assets,’ such as commercial
paper, mortgage pass-through securities and even automobile loans.”
He concluded, ‘Our experience so far suggests that
the most effective insulation of a bank from affiliated financial or commercial
activities is achieved through a holding-company structure.’ [7]
In a bank holding company, the Federal Deposit Insurance fund, a pool of
contributions to guarantee bank deposits up to $100,000 per account, would only
apply to the core bank, not to the various subsidiary companies created to
engage in exotic hedge fund or other off-the-balance-sheet activities. The
upshot was that in a crisis such as the unraveling securitization meltdown, the
ultimate Lender of Last Resort, the insurer of bank risk becomes the American
public taxpayer.
It was a hard fight in Congress and lasted until
final full legislative repeal under Clinton in 1999. Clinton presented the pen
he used in November 1999 to sign the repeal act, the Gramm-Leach-Bliley
Act, into law as a gift to Sanford Weill, the powerful chairman of Citicorp, a
curious gesture for a Democratic President, to say the least.
The man who played the decisive role in moving
Glass-Steagall repeal through Congress was Alan Greenspan. Testifying before
the House Committee on Banking and Financial Services, February 11, 1999,
Greenspan declared, “we support, as we have for many years, major revisions,
such as those included in H.R. 10, to the Glass-Steagall Act and the Bank
Holding Company Act to remove the
legislative barriers against the integration of banking, insurance, and
securities activities. There is virtual unanimity among all
concerned--private and public alike--that these barriers should be removed. The technologically driven proliferation of
new financial products that enable risk unbundling have been increasingly
combining the characteristics of banking, insurance, and securities products
into single financial instruments.”
In his same 1999 testimony Greenspan made clear
repeal meant less, not more regulation of the newly-allowed financial
conglomerates, opening the floodgate to the current fiasco: “As we move into the
twenty-first century, the remnants of nineteenth-century bank examination
philosophies will fall by the wayside. Banks, of course, will still need to be
supervised and regulated, in no small part because they are subject to the
safety net. My point is, however, that the nature and extent of that effort
need to become more consistent with market realities. Moreover, affiliation with banks need not--indeed,
should not--create bank-like regulation of affiliates of banks.” [8]
(Italics mine—f.w.e.)
Breakup of bank holding companies with their
inherent conflict of interest, which led tens of millions of Americans into
joblessness and home foreclosures in the 1930’s depression, was precisely why
Congress passed Glass-Steagall in the first place.
‘…strategies unimaginable a decade ago…’
The New York
Times described the new financial world created by repeal of Glass-Steagall
in a June 2007 profile of Goldman Sachs, just weeks prior to the eruption of
the sub-prime crisis: “While Wall Street still mints money advising companies
on mergers and taking them public, real money - staggering money - is made
trading and investing capital through a global array of mind-bending products
and strategies unimaginable a decade ago.”
They were referring to the securitization revolution.
The Times
quoted Goldman Sachs chairman Lloyd Blankfein on the new financial
securitization, hedge fund and derivatives world: “We've come full circle,
because this is exactly what the Rothschilds or J. P. Morgan, the banker were
doing in their heyday. What caused an aberration was the Glass-Steagall Act.”[9]
Blankfein as most of Wall Street bankers and
financial insiders saw the New Deal as an aberration, openly calling for return
to the days J. P. Morgan and other tycoons of the ‘Gilded Age’ of abuses in the
1920’s. Glass-Steagall, Blankfein’s "aberration" was finally
eliminated because of Bill Clinton. Goldman Sachs was a prime contributor to
the Clinton campaign and even sent Clinton its chairman Robert Rubin in 1993,
first as “economic czar” then in 1995 as Treasury Secretary. Today, another
former Goldman Sachs chairman, Henry Paulson is again US Treasury Secretary
under Republican Bush. Money power knows no party.
*********
Robert Kuttner, co-founder of the Economic Policy
Institute, testified before US Congressman Barney Frank's Committee on Banking
and Financial Services in October 2007, evoking the specter of the Great
Depression:
“Since
repeal of Glass Steagall in 1999, after more than a decade of de facto inroads,
super-banks have been able to re-enact the same kinds of structural conflicts
of interest that were endemic in the 1920s - lending to speculators, packaging
and securitizing credits and then selling them off, wholesale or retail, and
extracting fees at every step along the way. And, much of this paper is even
more opaque to bank examiners than its counterparts were in the 1920s. Much of
it isn't paper at all, and the whole process is supercharged by computers and
automated formulas.” [10]
Dow Jones Market Watch commentator Thomas Kostigen, writing in the early
weeks of the unraveling sub-prime crisis, remarked about the role of
Glass-Steagall repeal in opening the floodgates to fraud, manipulation and the
excesses of credit leverage in the expanding world of securitization:
“Time
was when banks and brokerages were separate entities, banned from uniting for
fear of conflicts of interest, a financial meltdown, a monopoly on the markets,
all of these things.
“In
1999, the law banning brokerages and banks from marrying one another — the
Glass-Steagall Act of 1933 — was lifted, and voila, the financial supermarket
has grown to be the places we know as Citigroup, UBS, Deutsche Bank, et al. But
now that banks seemingly have stumbled over their bad mortgages, it’s worth
asking whether the fallout would be wreaking so much havoc on the rest of the
financial markets had Glass-Steagall been kept in place.
“Diversity
has always been the pathway to lowering risk. And Glass-Steagall kept diversity
in place by separating the financial powers that be: banks and brokerages.
Glass-Steagall was passed by Congress to prohibit banks from owning
full-service brokerage firms and vice versa so investment banking activities,
such as underwriting corporate or municipal securities, couldn’t be called into
question and also to insulate bank depositors from the risks of a stock market
collapse such as the one that precipitated the Great Depression.
“But
as banks increasingly encroached upon the securities business by offering
discount trades and mutual funds, the securities industry cried foul. So in
that telling year of 1999, the prohibition ended and financial giants swooped
in. Citigroup led the way and others followed. We saw Smith Barney, Salomon
Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.
“At
brokerage firms there are supposed to be Chinese walls that separate investment
banking from trading and research activities. These separations are supposed to
prevent dealmakers from pressuring their colleague analysts to give better
results to clients, all in the name of increasing their mutual bottom line.
“Well,
we saw how well these walls held up during the heyday of the dot-com era when
ridiculously high estimates were placed on corporations that happened to be underwritten
by the same firm that was also trading its securities. When these walls were
placed within their new bank homes, cracks appeared and — it looks ever so
apparent — ignored.
“No one really questioned the new fad of
collateralizing bank mortgage debt into different types of financial
instruments and selling them through a different arm of the same institution.
They are now…
“When
banks are being scrutinized and subject to due diligence by third-party securities
analysts more questions are raised than when the scrutiny is by people who
share the same cafeteria. Besides, fees, deals and the like would all be
subject to salesmanship, which means people would be hammering prices and
questioning things much more to increase their own profit — not working
together to increase their shared bonus pool.
“Glass-Steagall
would have at least provided what the first of its names portends:
transparency. And that is best accomplished when outsiders are peering in. When
every one is on the inside looking out, they have the same view. That isn’t
good because then you can’t see things coming (or falling) and everyone is
subject to the roof caving in.
“Congress
is now investigating the subprime mortgage debacle. Lawmakers are looking at
tightening lending rules, holding secondary debt buyers responsible for abusive
practices and, on a positive note, even bailing out some homeowners. These are
Band-Aid measures, however, that won’t
patch what’s broken: the system of conflicts that arise when sellers, salesmen
and evaluators are all on the same team. [11]
(emphasis mine--f.w.e.)
Greenspan’s dot.com bubble and its consequences
Before the ink was dry on Bill Clinton’s signature
repealing Glass-Steagall, the Greenspan fed was fully engaged in hyping their
next crisis—the deliberate creation of a stock bubble to rival that of 1929, a
bubble which then, subsequently the Fed would pop just as deliberately.
The 1997 Asia financial crisis and the ensuing
Russian state debt default of August 1998 created a sea-change in global
capital flows to the advantage of the dollar. With Korea, Thailand, Indonesia
and most emerging markets in flames following a coordinated,
politically-motivated attack by a trio of US hedge funds, led by Soros’ Quantum
Fund, Julian Robertson’s Jaguar and Tiger funds and Moore Capital Management,
as well as, according to reports, the Connecticut-based LTCM hedge fund of John
Merriweather.
The impact of the Asia crisis on the dollar was
notable and suspiciously positive. Andrew Crockett, the General Manager of the
Bank for International Settlements, the Basle-based organization of the world’s
leading central banks, noted that while the East Asian countries had run a
combined current account deficit of $33 billion in 1996, as speculative hot
money flowed in, “1998-1999, the current account swung to a surplus of $87
billion.” By 2002 it had reached the impressive sum of $200 billion. Most of
that surplus returned to the US in the form of Asian central bank purchases of US
Treasury debt, in effect financing Washington policies, pushing US interest
rates way down and fuelling an emerging New Economy, the NASDAQ dot.com New
Economy IT boom. [12]
During the extremes of the 1997-1998 Asia financial
crises, Greenspan refused to act to ease the financial pressures until Asia had
collapsed and Russia had defaulted in August 1998 on its sovereign debt and
deflation had spread from region to region. Then, as he and the New York Fed
stepped in to rescue the huge LTCM hedge fund that had become insolvent as a
result of the Russia crisis, Greenspan made an unusually sharp cut in Fed Funds
interest rates for the first time, by 0.50%. That was followed a few weeks
later by a 0.25% cut. That gave the nascent dot.com NASDAQ IT bubble a nice little
“shot of whiskey.”
By late 1998, amid successive cuts in Fed interest
rates and pumping in of ample liquidity, the US stock markets, led by the
NASDAQ and NYSE, went asymptotic. In the single year 1999, as the New Economy
bubble got into full-swing, a staggering $2.8 trillion increase in the value of
equity shares owned by US households was registered. That was more than 25% of
annual GDP, all in paper values.
Glass-Steagall restrictions on banks and investment
banks promoting the stocks they had brought to market—the exact conflict of
interest which prompted Glass-Steagall in 1933—those restraints were gone. Wall
Street stock promoters were earning tens of millions in bonuses for
fraudulently hyping Internet and other stocks such as WorldCom and Enron. It
was the “Roaring 1920’s” all over again, but with an electronic computerized
turbo charged kicker.
The incredible March 2000 speech
In March 2000, at the very peak of the dot.com
stock mania, Alan Greenspan delivered an address to a Boston College Conference
on the New Economy in which he repeated his by-then standard mantra in praise
of the IT revolution and the impact on financial markets. In this speech he
went even beyond previous praises of the IT stock bubble and its putative
“wealth effect” on household spending which he claimed had kept the US economy
growing robustly.
“In the last few years it has become increasingly
clear that this business cycle differs in a very profound way from the many
other cycles that have characterized post-World War II America,” Greenspan
noted. “Not only has the expansion achieved record length, but it has done so
with economic growth far stronger than expected.”
He went on, waxing almost poetic:
“My
remarks today will focus both on what is evidently the source of this
spectacular performance--the revolution in information technology…When
historians look back at the latter half of the 1990s a decade or two hence, I
suspect that they will conclude we are now living through a pivotal period in
American economic history…Those innovations, exemplified most recently by the
multiplying uses of the Internet, have brought on a flood of startup firms,
many of which claim to offer the chance to revolutionize and dominate large
shares of the nation's production and distribution system. And participants in
capital markets, not comfortable dealing with discontinuous shifts in economic
structure, are groping for the appropriate valuations of these companies. The
exceptional stock price volatility of these newer firms and, in the view of
some, their outsized valuations indicate the difficulty of divining the
particular technologies and business models that will prevail in the decades
ahead.”
Then the Maestro got to his real theme, the ability
to spread risk by technology and the Internet, a harbinger of his thinking
about the then infant securitization phenomenon:
The
impact of information technology has been keenly felt in the financial sector
of the economy. Perhaps the most significant innovation has been the
development of financial instruments that enable risk to be reallocated to the
parties most willing and able to bear that risk. Many of the new financial
products that have been created, with financial derivatives being the most notable,
contribute economic value by unbundling risks and shifting them in a highly
calibrated manner. Although these instruments cannot reduce the risk inherent
in real assets, they can redistribute it in a way that induces more investment
in real assets and, hence, engenders higher productivity and standards of
living. Information technology has made possible the creation, valuation, and
exchange of these complex financial products on a global basis…
Historical
evidence suggests that perhaps three to four cents out of every additional
dollar of stock market wealth eventually is reflected in increased consumer
purchases. The sharp rise in the amount of consumer outlays relative to
disposable incomes in recent years, and the corresponding fall in the saving rate,
is a reflection of this so-called wealth effect on household purchases.
Moreover, higher stock prices, by lowering the cost of equity capital, have
helped to support the boom in capital spending.
Outlays
prompted by capital gains in equities and homes in excess of increases in
income, as best we can judge, have added about 1 percentage point to annual
growth of gross domestic purchases, on average, over the past half-decade. The
additional growth in spending of recent years that has accompanied these wealth
gains, as well as other supporting influences on the economy, appears to have
been met in equal measure by increased net imports and by goods and services
produced by the net increase in newly hired workers over and above the normal
growth of the workforce, including a substantial net inflow of workers from
abroad. [13]
What is perhaps most incredible was the timing of
Greenspan’s euphoric paean to the benefits of the IT stock mania. He well knew
that the impact of the six interest rate increases he had instigated in late
1999 were sooner or later going to chill the buying of stocks on borrowed
money.
The dot-com bubble burst
one week after the Greenspan speech. On March 10, 2000, the NASDAQ Composite
index peaked at 5,048, more than double its value just a year before. On
Monday, March 13 the NASDAX fell by an eye-catching 4%.
Then, from March 13, 2000 through to the market
bottom, the market lost paper values worth nominally more than $5 trillions, as
Greenspan’s rate hikes brought a brutal end to a bubble he repeatedly claimed
he could not confirm until after the fact. In dollar terms, the 1929 stock
crash was peanuts by comparison with Greenspan’s dot.com crash. Greenspan had
raised interest rates six times by March, a fact which had a brutal chilling
effect on the leveraged speculation in dot.com company stocks.
Stocks on margin: Regulation T
Again Greenspan had been present every step of the
way to nurture the dot.com stock “irrational exuberance.” When it was clear
even to most ordinary members of Congress that stock prices were soaring out of
control, and that banks and investment funds were borrowing tens of billions of
credit to buy more stocks “on margin,” a call went out for the Fed to exercise
its power over stock margin buying requirements.
By February 2000, margin debt had hit $265.2
billion, up 45 percent in just four months. Much of the increase came from
increased borrowing through online brokers and was being channeled into the
NASDAQ New Economy stocks.
Under Regulation T, the Fed had the sole authority
to set initial margin requirements for the purchase of stocks on credit, which
had been at 50% since 1974.
If the stock market were to take a serious fall,
margin calls would turn a mild downturn into a crash. Congress believed that
this was what happened in 1929, when margin debt equaled 30 percent of the
stock market's value. That was why it gave the Fed power to control initial
margin requirements in the Securities Act of 1934.
The requirement had been as high as 100 percent, meaning
that none of the purchase price could be borrowed. Since 1974, it had been
unchanged, at 50 percent, allowing investors to borrow no more than half the
purchase price of equities directly from their brokers. By 2000 this margin
mechanism acted like gasoline poured on a raging bonfire.
Congressional hearings were held on the issue.
Investment managers such Paul McCulley of the world’s then-largest bond fund,
PIMCO, told Congress, “The Fed should raise that minimum, and raise it now. Mr.
Greenspan says “no,” of course, because (1) he cannot find evidence of a
relationship between changes in margin requirements and changes in the level of
the stock market, and (2) because an increase in margin requirements would
discriminate against small investors, whose only source of stock market credit
is their margin account.” [14]
On the margin
But in the face of the obvious 1999-2000 US stock
bubble, not only did Greenspan repeatedly refuse to change stock margin requirements,
but also in the late 1990s, the Fed chairman actually began to talk in glowing
terms about the New Economy, conceding that technology had helped increase
productivity. He was consciously fuelling the market’s “irrational exuberance.”
Between June 1996 and June 2000, the Dow rose 93%
and the NASDAQ rose 125%. The overall ratio of stock prices to corporate
earnings reached record highs not seen since the days before the 1929 crash.
Then, in 1999, Greenspan initiated a series of
interest rate hikes, when inflation was even slower than it was in 1996 and
productivity was growing even faster. But by refusing to tie rate rises to a
rise in margin requirements, which would clearly have signaled that the Fed was
serious about cooling the speculative bubble in stocks, Greenspan impacted the
economy with higher rates, evidently designed to increase unemployment and
press labor costs lower to further raise corporate earnings, not to cool the
stock buying frenzy of the New Economy. Accordingly, the stock market ignored
it.
Influential observers,
including financier George Soros and Stanley Fischer, deputy director at the
International Monetary Fund, advocated that the Fed let the air out of the
credit boom by raising margin requirements.
Greenspan refused this more
sensible strategy. At his re-confirmation hearing before the US Senate Banking
Committee in 1996, he said that he did not want to discriminate against
individuals who were not wealthy and therefore needed to borrow in order to
play the stock market (sic). As he well knew, the traders buying stocks on
margin were mainly not poor and needy but professional traders out for a free
lunch, which Greenspan well knew. Interesting, however, was that that was
precisely the argument Greenspan would repeat for justifying his advocacy of
lending to sub-prime poor credit persons, to let the poorer get in on the home
ownership bonanza his policies after 2001 had created. [15]
The stock market began to
tumble in the first half of 2000, not because labor costs were rising, but
because limits of investor credulity were finally reached. The financial press
including the Wall Street Journal,
which a year before was proclaiming dot.com executives as pioneers of the new
economy, were now ridiculing the public for having believed that the stock of
companies that would never make a profit could go up forever.
The New Economy, as one
Wall Street Journal writer put it, now “looks like an old-fashioned credit
bubble." [16] In the second
half of that year, American consumers whose debt-to-income ratios were at
record highs, began to pull back. Christmas sales flopped, and by early January
2001 Greenspan reversed himself and lowered interest rates. In twelve
successive rate cuts, the Greenspan Fed brought US Fed funds rates, rates that
determined short-term and other interest rates in the economy, from 6% down to
a post-war low of 1% by June 2003.
Greenspan held Fed rates to
those historic lows, lows not seen for that length of time since the Great
Depression, until June 30, 2004, when he began the first of what were to be
fourteen successive rate increases before he left office in 2006. He took Fed
funds rates from the low of 1% up to 4.5% in nineteen months. In the process,
he killed the bubble that was laying the real estate golden egg.
In speech after speech the
Fed chairman made clear that his ultra-easy money regime after January 2001 had
as prime focus the encouragement of investing in home mortgage debt. The
sub-prime phenomenon—something only possible in the era of asset securitization
and Glass-Steagall repeal, combined with unregulated OTC derivatives trades—was
the predictable result of deliberate Greenspan policy. The close scrutiny of
the historical record makes that abundantly clear.
[1] Woodward, Bob, Maestro: Alan Greenspan's Fed and the American Economic Boom, Nov
2000. Woodward’s book is an example of the charmed treatment Greenspan was
accorded by the major media. Woodward’s boss at the Washington Post, Catharine
Meyer Graham, daughter of the legendary Wall Street investment banker Eugene
Meyer, was an intimate Greenspan friend. The book can be seen as a calculated
part of the Greenspan myth-creation by the influential circles of the financial
establishment.
[2] Lewis vs United States, 680 F.2d 1239 (9th
Cir. 1982).
[3]
Zarlenga, Stephen, Observations from the
Trading Floor During the 1987 Crash, in http://www.monetary.org/1987%20crash.html.
[4]
Greenspan, Alan, Testimony before the Subcommittee on Financial Institutions
Supervision, US House of Representatives, Nov. 18, 1987. http://fraser.stlouisfed.org/historicaldocs/ag/download/27759/Greenspan_19871118.pdf.
[5]
Hershey jr., Robert D., Greenspan Backs New Bank Roles, The New York Times, October 6,
1987.
[6]
Hershey, op.cit.
[7]
Ibid.
[8]
Greenspan, Alan, Statement by Alan Greenspan, Chairman, Board
of Governors of the Federal Reserve System, before the Committee on Banking and
Financial Services, U.S. House of Representatives, February 11, 1999, in
Federal Reserve Bulletin, April 1999.
[9]
Anderson, Jenny, Goldman Runs Risks,
Reaps Rewards, The New York Times,
June 10, 2007.
[10]
Kuttner, Robert, Testimony of Robert
Kuttner Before the Committee on Financial Services, Rep. Barney Frank,
Chairman, U.S. House of Representatives, Washington, D.C., October 2, 2007
[11]
Kostigen, Thomas, Regulation game: Would
Glass-Steagall save the day from credit woes?, Dow Jones MarketWatch, Sept.
7, 2007, in http://www.marketwatch.com/news/story/would-glass-steagall-save-day-credit.
[12]
Engdahl, F. William, Hunting Asian
Tigers: Washington and the 1997-98 Asia Shock, reprinted in http://www.jahrbuch2000.studien-von-zeitfragen.net/Weltfinanz/Hedge_Funds/hedge_funds.html.
[13]
Greenspan, Alan, The revolution in
information technologyBefore the Boston College Conference on the New Economy,
Boston, Massachusetts, March 6, 2000.
[14]
McCulley, Paul, A Call For Fed Action:
Hike Margin Requirements!, testimony before The House Subcommittee on
Domestic and International Monetary Policy on March 21, 2000.
[15]
Alan Greenspan as Fed chairman repeatedly asserted it was impossible to judge
if a speculative bubble existed during the rise of such a bubble. In August
2002, after his clear strategy of Fed rate rises was obvious to market players,
he reiterated this: “We at the Federal
Reserve considered a number of issues related to asset bubbles--that is, surges
in prices of assets to unsustainable levels. As events evolved, we recognized
that, despite our suspicions, it was very difficult to definitively identify a
bubble until after the fact--that is, when its bursting confirmed its existence.---Alan
Greenspan Remarks by Chairman Alan Greenspan Economic volatility At a symposium
sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming
August 30, 2002.
[16]
Faux, Jeff, The Politically Talented Mr.
Greenspan, Dissent Magazine, Spring 2001.