Table Of ContentPANDERER
TO
POWER
This page intentionally left blank
PANDERER
TO
POWER
THE UNTOLD STORY OF HOW
ALAN GREENSPAN
ENRICHED WALL STREET AND LEFT A LEGACY OF
RECESSION
FREDERICK J. SHEEHAN
New York Chicago San Francisco Lisbon London Madrid Mexico City
Milan New Delhi San Juan Seoul Singapore Sydney Toronto
Copyright © 2010 by Frederick J. Sheehan, Jr. All rights reserved. Except as permitted under the
United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any
form or by any means, or stored in a database or retrieval system, without the prior written permission of
the publisher.
ISBN: 978-0-07-161543-3
MHID: 0-07-161543-1
The material in this eBook also appears in the print version of this title: ISBN: 978-0-07161542-6, MHID:
0-07-1615423.
All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after
every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of
the trademark owner, with no intention of infringement of the trademark. Where such designations appear
in this book, they have been printed with initial caps.
McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales
promotions, or for use in corporate training programs. To contact a representative please e-mail us at
[email protected].
This publication is designed to provide accurate and authoritative information in regard to the subject
matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in
rendering legal, accounting, futures/securities trading, or other professional service. If legal advice or other
expert assistance is required, the services of a competent professional person should be sought.
—From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a
Committee of Publishers
TERMS OF USE
This is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw-Hill”) and its licensors
reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under
the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile,
disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute,
disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent. You
may use the work for your own noncommercial and personal use; any other use of the work is strictly
prohibited. Your right to use the work may be terminated if you fail to comply with these terms.
THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS
LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE
ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE
OBTAINED FROM USING THE WORK, INCLUDING ANY
INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA
HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY
WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED
TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR
A PARTICULAR PURPOSE. McGraw-Hill and its licensors do not warrant or
guarantee that the functions contained in the work will meet your requirements
or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor
its licensors shall be liable to you or anyone else for any inaccuracy, error or
omission, regardless of cause, in the work or for any damages resulting
therefrom. McGraw-Hill has no responsibility for the content of any information
accessed through the work. Under no circumstances shall McGraw-Hill and/or
its licensors be liable for any indirect, incidental, special, punitive, consequential
or similar damages that result from the use of or inability to use the work, even if
any of them has been advised of the possibility of such damages. This limitation
of liability shall apply to any claim or cause whatsoever whether such claim or
cause arises in contract, tort or otherwise.
To my father, who helped and encouraged me to write this book, even when
it seemed futile. My confidence and stamina often flagged; his never did.
This page intentionally left blank
Contents
Author’s Note ix
Introduction to Part 1—Prelude to Power, 1926–1987 1
1 Early Years: The Education of Alan Greenspan, 1926–1958 9
2 The Dark Side of Prosperity, 1958–1967 19
3 Advising Nixon: “I Could Have a Real Effect,” 1967–1973 31
4 President Ford’s Council of Economic Advisers, 1973–1976 47
5 The 1980 Presidential Election: Boosting Carter,
Reagan, and Kennedy, 1976–1980 59 6 Parties, Publicity, Promotion—and
Lobbying for the
Federal Reserve Chairmanship, 1980–1987 71 7 Lincoln Savings and Loan
Association, 1984–1985 85 8 “The New Mr. Dollar”: Chairman of the Federal
Reserve, 1987 95
Introduction to Part 2—The Pinnacle of
Power, 1987–2006 103 9 The Stock Market Crash and the Recession That
Greenspan Missed, 1987–1990 109 10 Restoring the Economy: Greenspan
Underwrites the
Carry Trade, 1990–1994 121 11 Cutting Rates and Running for Another Term as
Chairman, 1995–1996 133
vii Contents
viii
12 The Productivity Mirage That Greenspan Doubted,
1995–1997 145
13 “Irrational Exuberance” and Other Disclosures, 1995–1998 157
14 In a Bubble of His Own, 1998 169
15 LongTerm Capital Management: A Lesson Ignored, 1998 181
16 Greenspan Launches His Doctrine,
November 1998–May 1999 191 17 “This is Insane!!” June–December 1999 203
18 Greenspan’s Postbubble Solution: Tighten Money,
January-May 2000 215 19 The Maestro’s Open-Mouth Policy, June–December
2000 227 20 Stocks Collapse and America Asks: “What Happens
When King Alan Goes?” 2001 237
21 The Fed’s Prescription for Economic Depletion, 1994–2002 251
22 The Mortgage Machine, 1989–2007 265
23 Greenspan’s Victory Lap: His Last Years at the Fed,
2002–2006 283
Introduction to Part 3—The Consequences of
Power, 2006–2009 301
24 The Great Distortion, 2006 307
25 Fast Money on the Crack-Up, 2006 315
26 Cheap Talk: Greenspan and the Bernanke Fed, 2007 327
27 “I Plead Not Guilty!” 2007–2008 337
28 Greenspan’s Hometown, 2008 349
29 Life after Greenspan, 2009– 361
Appendix: The Federal Reserve System 367
Acknowledgements 369
Index 371
Author’s Note
Following are some explanations of how words with broad general meanings are
used specifically.
Money is used in its broadest form. The distinctions between “money” and
“currency” (e.g., the dollar) are not addressed.
Bank refers to the large banks. There are about 8,300 federally chartered banks
in the United States. Maybe 300 of these share responsibility for the current
financial debacle. If a different type of bank is discussed, it is identified, such as
a savings and loan. This also applies to hedge funds and privateequity funds.
Most of them stick to their knitting and act honorably.
Banks, as they existed when they are first discussed (the 1950s), no longer exist.
For instance, at that time, the distinction between commercial and investment
banks was clear. Now, they cross each other’s lines of business. The easiest
description of these businesses is “financial institutions.” It is comprehensive,
but it is vague. Therefore, firms are described according to the topic under
discussion. For instance, Goldman Sachs falls under a discussion of “brokerage
firms,” even though it was (until recently) an investment bank. Likewise,
Goldman Sachs stands under the “underwriters” umbrella when underwriters are
discussed.
An economist—in this book—has received a graduate degree, probably a Ph.D.,
in economics.
Most of the economists discussed in this book are the public performers from
government–academia–Wall Street and appear on CNBC. There are many
economists who do very good work, but are not part of this book. The best are
generally unknown to the public, since the only means by which the public
would learn of them would be through the publicity they would receive if they
joined the performers.
Acquisitions, takeovers, buyouts, and leveraged buyouts (LBOs). The
vocabulary can be confusing. This book only addresses the peak periods.
In the late 1980s, acquisitions (also called takeovers or buyouts) of companies
were often in the form of what were called leveraged buyouts. The buyouts
during this manic final phase were marked by much more debt financing (bonds,
bank loans) than equity financing (cash, stock). The companies leading the
buyouts were commonly (though imprecisely) called leveraged buyout or LBO
firms. This period is discussed in Chapter 6.
The largest of these “LBO firms” were actually private equity firms (for
example, Kohlberg Kravis Roberts & Co. (KKR). The “private” refers to equity
not traded on a public exchange. During the culmination of the (circa) 2004-
2007 buyout mania, some private equity firms were, once again, using less
equity financing and much more debt financing. For all intents and purposes,
these deals were LBOs. The media had a difficult time deciding the correct
vocabulary (since the amount of equity was so small compared to the amount of
debt) and firms such as KKR were called private equity firms, or LBO firms, or
sometimes buyout firms. These terms are used interchangeably in Chapter 25.
This book stops at the peak. Sort of. Greenspan could not stop talking. He
continued his open-mouth policy into 2009. The more he reminded the public of
his existence, the more his reputation suffered. This belated condemnation of
Greenspan was inseparable from current events. Also, Bernanke’s Federal
Reserve is inseparable from the financial terrain that Alan Greenspan bequeathed
to him. I have not attempted to describe this postbust period comprehensively,
but only incidentally.
The book concentrates on the United States and mentions events overseas only
as they relate to the United States. The change in how Americans thought and
behaved over the past half-century has applications in other countries, but that is
a very large topic.
INTRODUCTION TO PART 1
PRELUDE TO POWER
1926–1987
[O]peration in securities is not mainly a matter of reasoning at all.… The stock market … is just a
bunch of minds—there is no science, no IBM machine, no anything of that sort, that can tame it.1
—Edward C. Johnson II, 1963, President, Fidelity Investments
Alan Greenspan’s success was partly due to good timing. He reached
maturity at mid-century. His strengths attracted an America in which the process
of thinking was changing. Substance was yielding to superficiality. Matter
surrendered to abstraction.
Money was becoming more abstract. In 1900, Americans, and citizens of
most western European countries, held a currency that was convertible into gold.
Americans who distrusted the dollar’s value had the right to trade their paper for
gold at a fixed, statutory rate. The value of the dollar fluctuated within a narrow
range, and the prices of goods and services were more or less fixed.
Today, a dollar is worth whatever we wish it to be. It is a symbol, no longer
fixed to a disinterested, inert metal. Inflation is one result. The successful careers
of pandering politicians and clever opportunists are another. An object that cost
$1 in 1913 (when the Federal Reserve Act was passed) costs $20 today. Inflation
of money was integrated into the
1 First Annual Contrary Opinion Foliage Forum,” 1963, from Charles D. Ellis and James R. Vertin
(eds.), Classics: An Investor’s Anthology (Homewood, III.: Dow Jones-Irwin, 1988), p. 392.
1 twentieth-century inflation of words, constant distractions, and media
promotion. Thus, there came the worship of celebrities simply because they are
celebrities and the success of one pandering politician and clever opportunist:
Alan Greenspan.
Alan Greenspan grew up in New York City, a metropolis that illuminates the
changing tendencies and aspirations of Americans. Greenspan spent his young
adulthood near or on Wall Street. In 1945, New York was the largest
manufacturing city in the United States.2 It was a city that made things. By 2008,
it was no longer a working-class town. Nor was it a middle-income town. In
Manhattan, 51 percent of neighborhoods were identified as being high-income
and 40 percent as being low income.3 Publicity and finance priced out the
factories. The chairman of Lever Brothers, a soap manufacturer, explained why,
in the mid-1950s, he moved his headquarters to Manhattan: “The platform from
which to sell goods to America is New York.”4
Lever Brothers sold an image; the image sold soap. Alan Greenspan also
sold an image—productivity—but it was debt that boomed until it was too large
to be paid back. From the time Greenspan was named Federal Reserve chairman
until he left office, the nation’s debt rose from $10.8 trillion to $41.0 trillion.5
Greenspan usually referred to the debt as “wealth.” This image matched what he
was selling—first stocks, then houses. He expanded money and credit; he oozed
praise for derivatives. The larger volume of credit shrunk the consequences of
immediate losses. It was easy to overlook the areas of the economy that had
shriveled and the instability of finance that had compounded over the past half-
century. In early 2007, this massive inflation of paper claims, many of which
were claims on abstractions rather than on material assets, tottered, then
collapsed. The first to go was the subprime mortgage market.
Credit creation filled the void of falling production. In 1950, 59 percent of
U.S. corporate profits were from manufacturing; 9 percent were from financial
activities. During the past decade (2000–2008), 18 percent of profits were from
manufacturing and 34 percent were from finance.6
2 Robert A. M. Stern, Thomas Mellins, and David Fishman, New York 1960: Architecture and
Urbanism between the Second World War and the Bicentennial (New York: Monacell: Press, 1995), p. 19.
3 Sam Roberts, “Study Shows Dwindling Middle Class,” New York Times,
June 26, 2006.
4 Stern et al., New York 1960, p. 61.
5Figures from end of years he entered and left office. “Beginning of office” is
December 31, 1987, from Federal Reserve Flow of Funds Account; “end of
office” is December 31, 2005.
After graduating from New York University in 1948, Greenspan took a job
at the Conference Board. He received a master’s degree from NYU in 1950; then
studied economics under Arthur Burns at Columbia University. The two became
lifelong friends. Arthur Burns served as chairman of the Council of Economic
Advisers under President Dwight Eisenhower. He would become Federal
Reserve chairman under President Richard Nixon. Greenspan headed President
Gerald Ford’s Council of Economic Advisers (CEA) when Arthur Burns was
Federal Reserve chairman.
In 1953, investment advisor William Townsend recruited Greenspan; the pair
formed an economic consulting firm, TownsendGreenspan & Co. When William
Townsend died in 1958, Greenspan became the sole owner.
Greenspan is sometimes described as a disciple of Ayn Rand’s Objectivist
philosophy or as a libertarian. However, he may not even have understood what
Rand was talking about. Nathaniel Branden, who was closest to Greenspan’s
mind during this period, reflected decades later: “I wondered to what extent he
was aware of Ayn’s opinions.”7 Alan Greenspan’s contributions to group
discussions were meager. Alan Greenspan was not philosophical; he was
practical and, either by nature or by design, vague, remote, and impenetrable.
Greenspan used his Randian acquaintances to climb the political ladder. He
joined Martin Anderson’s policy research group during Richard Nixon’s 1968
campaign for the presidency. Anderson, who traveled in Objectivist circles, later
introduced Greenspan to Ronald Reagan.
Greenspan was riding the wave of the growing influence of accredited
economists. By the late 1950s, Greenspan’s stock market predictions and
economic forecasts were quoted in Fortune and the New York Times. His
forecasts were usually wrong, as are those of most economists. Accuracy was
less important than publicity.8
6 Bureau of Economic Analysis (BEA) National Income and Product Accounts (NIPA) Table
6.16B,C,D. Income by industry has been so erratic over the past decade that the totals for 2000–2008 are
averaged as a comparison to 1950.
7 Nathaniel Branden, My Years with Ayn Rand, (San Franciscio: Jossey-Bass, 1999) p. 160.
8 The pervasiveness of publicity was to smother American life, but it was not new; the old may have been
even bolder than today. From the pitch to sell the movie Alimony in 1924: “Brilliant men, beautiful jazz
babies, champagne baths, midnight revels, petting parties in the purple dawn, all ending in one terrific
smashing climax that makes you gasp.”
Greenspan observed Federal Reserve Chairman William McChesney Martin
Jr. lose the fight against inflation. In 1957, Martin warned the Senate that the
current inflation problem that had persisted since World War II had been
fostered by “economic imbalances,”9 of which the heaviest hit were those who
