Greenspan's
progress card
Saved a hedge-fund, ruined an economy
 It
was mere luck. Alan Greenspan inherited a booming economy. Paul
Volcker did the spadework. Courting, at times, unpopularity. He
broke the back-bone of inflation. Allowing productivity gains to
surface. Forcing companies to shed flab.
So, it was all cut out for Greenspan. The economy, airborne, was on
auto-pilot. A little bit of extra-fuelling was needed in 1987.
Otherwise a smooth flight. Interest rates could be left alone. With
corporate America moving on its own steam.
Armed with his lance Don Quixote was tilting at only one mill. At a
time Greenspan aims at multiple targets. The stock and the labour
markets and, of course, inflation. To the outside world he appears
in spotless white. Ordained to keep the US economy on an even keel.
Till it soft lands. Media-friendly, he succeeds telling others that
he is a restless soul. With a single lodestar in view.
So he was fine-tuning the interest rates. The overnight rates were
put up by 175 basis points. Since the middle of 1999. In six
instalments. Five of them quarter per cent each. Last he did it with
a bang. 50 basis points. To 6.50 per cent from 4.75 in 15 months
ago. For a sharper impact. The king is doing no wrong. Only right.
Always.
Is it so? A clear picture needed. So let us look it the anatomy (and
history) of Greenspan's fiddling with interest rates. The public
memory is proverbially short. But not for far too recent events.
Mark, the 150 basis point cumulative hike was not the product of
consistent thought process. With the Fed chairman following his
collection of 1800 indices.
It had a hilarious background. Before he started hiking the rates,
Greenspan was dropping them. By as much as 75 basis points. To 4.75
per cent. In three instalments. At short intervals. That way, the
net increase now is 100 basis points. That is one reason for its low
voltage.
Time to re-read Greenspan's body language and mind. And also his
ever so many sermons. Remember, when did Greenspan use the words,
over-exuberant? Dow was then moving between 7000 and 8000. He wanted
it settled at around 7500. At which point its P/E ratio corresponded
with the yield on bench-mark bonds.
A reasonable stand. Then followed his inexplicable tantrums. The
interest rate then was 5.50 per cent. In a couple of months or so,
it was pared down to 4.75 per cent. 75 basis points dropped in a
row. Why did he do so when the market was still over-exuberant? And
give the Dow fresh fuel to move up?
Any rational explanation? No. In the first place, the decision to
plug down interest rates was untimely. For the stock boom was not
purely speculative. The American industry had a long spell of brutal
restructuring. The companies became thin and leaner. Huge
investments on new technology boosted productivity.
In fact productivity is showing a four-fold increase over ten years.
Earlier it was confined to the early recovery stages. Then the US
budget came surplus. Inflation tamed. Helped also by cheaper imports
from the crisis-ridden emerging markets. On the whole ripe for
softer interest rates. At about this time Greenspan pooh-poohed a
suggestion (from a set of 'new economists') to wind down the
interest rates. They insisted that lower rates could still boost
technological growth.
The lower interest rates produced results which Greenspan earlier
disapproved of. Soft credit made US assets more attractive. The
flight of funds (from collapsing economies) accelerated. Rendering
their recovery difficult. Even so, he stopped using the word
over-exuberant. Defending at times what he rejected earlier. For
instance, his views on productivity took an 180-degree turn. For,
earlier, he saw productivity pick-up as cyclical. Now he says it is
permanent. And no limits.
Why this back-tracking? Frankly, no rational explanation. For an
answer one must look outside the mainstream of economic analysis.
Cynics attribute Greenspan's changed outlook to a company with a
four-word name. The controversial Long-Term Credit Management. LTCM,
for short.
Remember, how Greenspan (and his Treasury friend, Robert Rubin) went
out of the way to bail out the hedge fund. Which was on the brink of
bankruptcy. Till then the duo were preaching the virtues of market
forces. Both saw in the SA crisis only the play of market forces.
Corporate bankruptcies, especially in Japan, enraptured them. The
market forces are at work, they chirped. More corporates collapsed
the better. The economies would be better off. They cried foul when
Japanese government spoke in sympathy for some of the sinking
companies.
When it came to LTCM, the market forces were no longer inviolate.
For Greenspan, Rubin and co. to begin with. The hedge-fund was
floated by a financial expert with a dubious record. To enhance the
fund's sex-appeal he took on board two Nobel laureates in economics.
Proved there was good scope to mint money. In inter-market deals
while the currencies fluctuated.
Many were taken in. Before the year it wobbled, LTCM returned as
much as 40 per cent on investments. As against 30 per cent from
S&P's 500. Banks, corporates and rich individuals queued up to
put money in the hedge fund. In all fairness it closed its window
for a while. The minimum lot for investment was $10 million.
Unfortunately for LTCM, the markets had no respect for the Nobel
laureates. They refused to follow the dotted lines set by them. On
its part, LTCM did a lot of inverse pyramid building. It traded in
all market instruments and derivatives. Billions of dollars were at
stake. True in that situation, its collapse would have caused an
earthquake. Far beyond the gauge limits of the Richter scale.
Greenspan and Rubin looked off their moorings. Their enthusiasm for
free market evaporated. At the humble pie in short. And girded up to
bail the hedge-fund out. The Fed chairman went into an emergency
huddle with bankers. Which had immense stake in LTCM. Some were
arm-twisted. Finally they all agreed to chip in $4 billion. To shore
up the tottering fund's capital base. The rescue was completed in a
record time of just two days. As the time was running short.
The fund hauled out, Greenspan cut back the interest rates. By 75
basis points in quick succession. His words that he was doing so for
the US (and the world) economy were never taken at face value. In
fact he was lying. For it was a quid pro quo. The supporting banks
wanted at least that much. In return for their risks.
Looking back, the US (and the world) economy would have been better
off. If the overwrought fund had been left to the market forces.
Yes, it would have collapsed. Only those who took big risks would
have lost more. But the market, in the process, would have corrected
itself. Without Greenspan tampering with the interest rates. Which
did more harm than good.
What consequences of Greenspan's megalomania? Devastated are the
most dynamic segments of the economy. With the ICE section bearing
the brunt. Being new, they were only learning to stand up. For one,
the tight policy has made no dent on the wealth effect.
True both Dow and Nasdaq did not go further up. But, more important,
they recouped most of their losses.
We do not know much about Greenspan as an economist. But it is clear
he has not updated his economics. He just does not know the ABC of
new technology (better known as ICE) companies. As a rule, they
depend on venture capital and initial public offerings. Exuding the
spirit of Columbus. Taking unchartered routes. With the market down
and out (thanks to Greenspan), there is spreading infant
mortality.
Many a IPO have been cancelled. And venture capital funds, providing
the seed capital, dropped them like hot potatoes. As a result, a
wide range of high-tech, internet and bio-tech companies are left in
the lurch. Being loss-making, they can't have credit arrangements
for life-support. Nor can they fund their operations on their own.
Life-lines cut off by Fed, they will all soon be extinct.
History will not pardon Alan Greenspan. To save his favourite
hedge-fund he (and Rubin) killed off the driving force of the modern
US economy. Rest assured, he will not have a peaceful exit from Fed.
Already he has compromised the well-established independence of the
Fed. With the legislators delivering him a warning that the was
going too far. Toying with key interest rates.
A few scribes across north America, are investigating Greenspan's
love affair with LTCM. Circumstantial evidence is strong that he was
more concerned with its retrieval than the well-being of the economy
under his care. If it is so, there will be one more addition to the
flood of scandals that began with the Watergate.
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