[PEN-L:28268] It's Greedspan's Fault?

["Devine, James" <jdevine@xxxxxxx>]

Title: It's Greedspan's Fault?

Even if the analysts quoted below are right, it's not entirely AG's
fault. If he stopped pumping up the stock market bubble, that would have
encouraged the very-fragile economy to sink. If he keeps the economy up
(saving LTCM, containing the Asian and Russian contagions, etc., etc.)
that encourages the stock-market bubble. Between a rock & a hard place?
JD

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http://www.latimes.com/business/la-fi-greenspan21jul21.story

NEWS ANALYSIS
Fed Chief Now Blamed for Inflating Stock Bubble
By PETER G. GOSSELIN
Times Staff Writer

July 21 2002

WASHINGTON -- Americans desperately seeking to understand what happened
to their once-ballooning investments and retirement nest eggs were
offered a striking answer last week by the nation's premier economic
policymaker.

"Infectious greed" is behind the stock crash and corporate scandals that
are erasing trillions of dollars of paper wealth, declared Federal
Reserve Chairman Alan Greenspan. Otherwise, the economy is sound, he
asserted.

But a growing group of economists and financial players have come to
believe that the economy's troubles go beyond the avarice of a few
executives. Among the principal problems, they say, is Greenspan himself
and the pivotal role he played in feeding a classic stock-market bubble
that began to pop in early 2000.

"Greenspan clearly was the lead character in the drama of the market's
upside, and he's the lead now it's on the downside," said Stephen S.
Roach, chief economist at Morgan Stanley & Co. in New York and one of a
small group of analysts who long decried the dangers of an overheated
market.

As scandal has broken over one company after another, sending stocks
tumbling, Americans have been offered the comforting thought that
corporate America's problems--and therefore the economy's--could at
least partly be solved with a few accounting reforms and some jail time
for executive bad actors. Greenspan's prescription was only the latest
version.

What is really underway, analysts say, is the collapse of a classic
stock bubble, in which share prices were driven to stratospheric heights
by the hope of further gain rather than remaining tethered to something
fundamental like a company's profits.

If that is true, the future may require reduced expectations for
millions of Americans who staked their hope for their comfortable
retirement on stocks. The average recovery time--the length of time it
takes the market to return to its boom-time peak--during the big busts
of the 20th century was 20 years. Those declines were 1906, 1929 and the
late 1960s.

And, as even President Bush acknowledged in his Saturday radio address,
the effects are likely to reach well beyond retirees. "This is a crucial
moment for the American economy," he said. "Investors have lost money
... workers have lost jobs and the trust of the American people has been
betrayed."

So who or what was behind the stock bubble?

There was no single cause, but as much as any factor, say analysts, was
Greenspan's increasingly optimistic assessment of the economy during the
late 1990s and especially its high-tech productivity gains.

"His comments about productivity definitely were fuel for the bubble,"
said Gail Dudack, chief investment strategist for SunGard Institutional
Brokerage Inc. in New York. She was among the group of analysts who
warned of the bubble.

A comparison of the Fed chairman's current assessment of the economy and
the markets and his sunny pronouncements at the height of the 1990s boom
suggest that, at a minimum, Greenspan mistook some of the bubble's
effects for evidence of a new economy.

Given his knowledge of economic history and his own repeated mention of
bubbles during the final years of the decade, there is another
possibility as well. That is that Greenspan may have been aware that a
bubble was forming but decided he did not have the political power to
stand in its way. Perhaps he was willing to stand aside because he was
confident that he could guide the economy to a gentle landing when the
bubble popped.

Whichever is closer to the truth, both the country and the central
banker's reputation as an economic manager face a serious challenge now.

"Central banking was really invented to stand in the way of excesses,
whether it's in the real economy or financial markets," said Morgan
Stanley's Roach. "In this case, that didn't happen," he said.

Some observers argue that Greenspan can be forgiven for not wanting to
stand in the path of the expanding bubble when even his mildest, early
warnings set off a political hue and cry.

Consider, for instance, his December 1996 "irrational exuberance"
speech, which is remembered as the central bank equivalent of Horatio at
the bridge. In fact, the phrase came on the eighth page of a 10-page
speech on the history of central banking in America, and then only in a
question: "How do we know when irrational exuberance has unduly
escalated asset values ... ?" But the words made front-page news, and
the criticism directed at Greenspan was swift and savage.

Or consider the Fed's decision four months later to nudge up interest
rates a modest quarter of a point. "People went wild," remembered
veteran Fed watcher and economist David M. Jones. "I've never seen the
right and the left of the political spectrum so up in arms over such a
tiny move."

Even if Greenspan knew a bubble was forming, he can also be forgiven for
being confident he could protect the economy from it.

After all, he had already guided the country through the 1987 stock
crash and the late 1980s-early 1990s commercial real estate bust
seemingly without a scratch.

What is harder to understand is the lengths to which the Fed chairman
went after the early warnings of 1996 and 1997 to highlight positive
economic developments, especially involving productivity.

What's also hard to understand--or square with his current
assessment--is a slow shift in Greenspan's focus: from embracing the new
economy notion that technology was transforming America, to a seemingly
uncritical defense of sky-high and rising stock prices.

A review of Greenspan's speeches and testimony show that he knew as
early as 1995 that the stock market was changing the economic landscape.

He warned participants at the annual economic conference in Jackson
Hole, Wyo., that year that old ways of measuring prices and production
no longer worked.

"There are important but extremely difficult questions surrounding the
behavior of [stock] prices" that must be answered before policymakers
can be confident again of their ability to steer the economy, he said.

There are records showing that, in the fall of 1996 and again in the
spring of 1998, members of the policymaking Federal Open Market
Committee argued for raising interest rates to pop the bubble.

And in a May 1998 interview with Lawrence B. Lindsey, a former Fed
governor who has since become President Bush's chief economic advisor,
Greenspan acknowledged striking parallels between the years leading up
to the 1929 crash and the late 1990s. But he noted confidently that if
actions after the 1929 crash "were taken differently ... we would not
have had the deep fall that we know as the Great Depression."

Despite all these indications that Greenspan understood the danger, the
Fed chairman seemed to move ever closer to embracing the wild run-up in
stock prices.

When asked, for example, at a January 1999 congressional hearing how
much of the dot-com boom was "based on sound fundamentals and how much
is based on hype," Greenspan snapped, "You wouldn't get hype working if
there weren't something fundamentally, potentially sound under it."

In a speech a few months later, he suggested that Wall Street analysts
must have known what they were talking about when they predicted a
historically unprecedented 15% annual growth in profits for the
following five years because they were so close to the companies they
covered.

By June 1999, he appeared to have given up any effort to put a brake on
the upward arc of stock prices, arguing, in effect, that markets know
best. To conclude otherwise, he warned a congressional committee,
"requires a judgment that hundreds of thousands of informed investors
have it all wrong."

The Fed chairman's defenders argue he was deterred from acting against
the bubble by the triple whammy of the Asian currency crisis, Russian
debt default and the collapse of hedge-fund giant Long-Term Capital
Management. They point out that within weeks of the June testimony, the
central bank approved the first in a string of interest rate hikes that
brought an end to the great bull market of the 1990s.

But the fact that stocks have continued to tumble and that one company
after another has admitted using shady accounting to prop up share
prices suggests that the Fed's action came too late certainly to protect
investors and, perhaps, to protect the economy as well.

Indeed, some analysts worry the central bank's decision to reverse
course last year, driving interest rates to a 40-year low and hold them
there to limit the market damage and cope with fallout from Sept. 11,
could be setting the stage for the next bubble, this one in housing.

Greenspan said recently he does not see a housing bubble in the works.

In the late 1990s, "an irrationally exuberant equity bubble was ...
rationalized by a Fed that embraced the new economy with open arms,"
Morgan Stanley's Roach recently wrote.

"Today's script seems hauntingly familiar."

An overly long rise in housing prices "is being legitimized as a
sustainable source of economic expansion," he said.

"From bubble to bubble, there seems to be no stopping the follies and
perils of [stock-] and debt-driven economic growth."

Copyright 2002 Los Angeles Times