by John M. Curtis
(310) 204-8700

Copyright September 1, 2002
All Rights Reserved.

ausing the most disastrous stock market crash in U.S. history, Federal Reserve Chairman Alan Greenspan's clumsy management cost investors—and indeed corporate America—more than $7 trillion. Justifying a series of excessive rate hikes between July 1999 and March 2000, Greenspan choked off the nation's longest economic expansion. While he talked about a "soft landing" then, he's singing a different tune today. "The notion that a well-timed incremental tightening could have been calibrated to prevent the late-1990s stock market bubble is almost surely an illusion," said Greenspan, contradicting prior statements that Fed policies would contain inflation and preserve economic growth. When the Fed chairman spoke of "irrational exuberance" in 1996, booming markets barely hiccupped, fueling unprecedented escalation in equity values and market capitalization. In what amounts to colossal flip-flop, Greenspan insists that the Fed wasn't targeting the stock market—simply paying attention to cryptic signs of renewed inflation.

      Speaking at a Fed conference in Jackson Hole, Wyo., Greenspan tried to answer critics blaming him for today's economic malaise. During the late 1990s, unprecedented numbers of investors directed hard-earned dollars into stock mutual funds, fueling the progressive run-up in stock prices, giving otherwise cash-squeezed corporations piles of cash. Not only were consumers flush with cash, corporations had lavish market capitalization to fund expansions. With rising stock markets, corporate expansion, exploding capital gains and furious job-creation, budget deficits turned into whopping surpluses. Justifying a series of crippling rate hikes, Greenspan fixated on the GDP Deflator—AKA "the wealth effect"—to gauge inflation, despite conventional measures, including the Consumer and Producer Price Indexes, remaining in check. In 1999, Fed policy abruptly switched gears and began hiking rates. Making little sense, Greenspan told Fed watchers that "nothing short of a sharp increase in short-term rates" would have serious economic consequences. Yet Greenspan's slow water torture rate-hikes eventually upended the market.

      Since taking the reins from former Fed Chairman Paul Volker in 1987, Greenspan enjoyed a good reputation for fighting inflation. Some critics blame him for causing the speculative bubble, failing to tweak rates between 1996 and 1998. In reality, the speculative bubble was caused by hoards of new investors, directing unprecedented sums of cash into stock mutual funds. Those same investors—including pension fund managers—are now pulling out cash and placing it into safe havens like bonds and real estate, contributing to the market's relentless slide. Greenspan now says his concern about recession kept him from hiking rates before 1999. But if he were really worried about speculative bubbles, he would have followed a different path. Once he triggered the sell-off in March 2000, he waited too long before aggressively lowering rates. By the time he finally woke up, the market had already crashed. Anyway you cut it, he showed clumsy leadership before, during and after the crash.

      Still frozen in the Carter years of stagflation, Greenspan remained a one-trick pony, following Volker's paradigm of fighting inflation by hiking rates, inducing recession and causing unemployment. Even after he talked about "irrational exuberance," the Fed chairman insisted he wasn't targeting the stock market. "There has been a lot of commentary about the Fed targeting equity markets," said John Sylvia, chief economist at Wachovia Securities in Charlotte, N.C., noting that Greenspan was, in fact, consumed with run-a-way equity markets not simply fighting inflation. "We were confronted with forces that none of us had personally experienced," said Greenspan justifying his move to take down equity markets. Yes, Greenspan had never seen so many ordinary investors benefit from the rising stock market. He had never seen so much prosperity both for individuals and corporations. Greenspan was a big supporter of "the new economy," believing that "new technology" contributed to growing prosperity. He knew more than anyone that without healthy market capitalization, few "new economy" businesses could survive and eventually flourish.

      Greenspan's right saying that raising margin requirements, namely, the amount of credit to buy stock given to small investors, wouldn't have stopped the speculative bubble. Like any commodity, stocks increase when more buyers bid up prices. What Greenspan refers to as a "speculative bubble," was nothing more than unprecedented numbers of investors trusting the stock market to secure their futures. By precipitously raising rates and failing to lower them soon enough, Greenspan directly caused the worst market crash in U.S. history. His obsession with the "wealth effect," didn't apply when he bailed out Long-term Capital Management—a grossly mismanaged hedge fund connected with many of his Wall Street cronies. But small investors aren't bailed out watching their life savings and pensions evaporate. To Greenspan, lowly investors were doing too well—at least as measured by his GDP Deflator—to keep things rolling. Little did he know that corporate America was also in the same boat.

      Fed Chairman Greenspan secured his place in history by presiding over the most devastating market crash ever. Had he got with the program and realized that the entire economy was tied to expanding equity markets, he might have tinkered more skillfully with monetary policy. With slow reflexes, he couldn't deliver the "soft landing," waiting far too long to lower rates before the meltdown in March 2000. Trusting that the stock market could secure their futures, Greenspan failed to protect small investors from wild gyrations caused by knee-jerk monetary policy. Rather than celebrating "the wealth effect," he pulled the rug out from new investors, willing to tie their futures to corporate America. "I think it would be healthy if the Fed chairman didn't even talk about the stock market, quite frankly," said Stephen More, president of the Washington-based conservative Club for Growth, noting the carnage caused by Greenspan's flowery rhetoric. But the real issue isn't Greenspan's words, it's about the way he's done his job.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's a consultant and expert in strategic communication. He's author of Dodging The Bullet and Operation Charisma.

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