On the morning of Tuesday, August 18, 1987, Greenspan walked through the door of his private office and into the adjoining massive conference room at the vast marble Federal Reserve headquarters on Constitution Avenue in downtown Washington, D.C. He had been chairman of the Fed for less than one week. Gathering in the stately meeting room were the members of the Federal Open Market Committee (FOMC), which Greenspan now chaired.
The FOMC is an unusual hybrid consisting of 12 voting members -- all 7 Fed governors plus 5 of the 12 presidents from the Federal Reserve district banks around the country.
At its regularly scheduled meetings every six weeks, the FOMC sets the most important interest rate that the Fed controls -- the short-term fed funds rate. This is the interest rate that regular banks charge each other for overnight loans, seemingly one of the smallest variables in the economy. Greenspan had come to understand that controlling the fed funds rate was key to the Fed's power over the American economy.
The law gives the Fed power to trade in the bond market. The FOMC can direct the "easing" of credit by having its trading desk in New York buy U.S. Treasury bonds. This pumps money into the banking system and eventually into the larger economy. With more money out there, the fed funds rate drops, making it easier for businesses or consumers to borrow money. Lowering the fed funds rate is the normal strategy for averting or fighting a recession.
On the other hand, the committee can tighten credit by selling Treasury bonds. This withdraws money from the banking system and the economy. With less money out there, the fed funds rate rises, making it more difficult to borrow. Raising the fed funds rate is the normal strategy for fighting inflation.
This buying or selling of U.S. Treasury bonds, so-called open market operations, gives the Fed a brutal tool. Changes in the fed funds rate usually translate into changes in the long-term interest rates on loans paid by consumers, homeowners and businesses. In other words, the FOMC's monopoly on the fed funds rate gives the Fed control over credit conditions, the real engine of capitalism. Though the changes in the rate were not announced in 1987, private market watchers in New York closely monitored the Fed's open market operations and soon figured out the changes. The discount rate was the way that the Fed communicated its intentions publicly; the fed funds rate was the way the Fed actually imposed those intentions.
The FOMC, and now Greenspan, had the full weight of the law and nearly 75 years of history -- and myth -- behind them. They could work their will if they chose.
The committee members spent several hours in a roundtable discussion, reviewing economic conditions. Then Greenspan took the floor.
"We spent all morning, and no one even mentioned the stock market, which I find interesting in itself," Greenspan said casually, looking down the colossal 27-foot-long oval table.
Greenspan's remark was deeply understated. He meant to convey something significantly stronger: For God's sake, he was trying to tell them, there are factors other than the old classical forces moving the economy. There was more to all of this than consumer or government spending, more than business inventories and profits, more than interest rates, national economic growth, savings, unemployment statistics and inflation. There was a whole other world out there -- a world that included the stock market, which had run up 30 percent since the beginning of the year. Wall Street and the financial markets of New York were creating the underlying thrust for a severely overheated economy, the new chairman was certain. The run-up had created more than $1 trillion in additional wealth during the last year. Most of these gains were only on paper, but some people were undoubtedly cashing in and spending more. In any case, many people felt richer -- a powerful psychological force in the economy. On top of that, a stock speculation and corporate takeover frenzy was sweeping Wall Street. And nobody had mentioned it. Was the distance between New York and Washington so great?
None of the committee members seemed interested in Green-span's point about the stock market, but the chairman was convinced of it. By many measures, including earnings, profits and dividends, the stock market was really quite overvalued, he felt. Speculative euphoria was gripping the economy, and the standard economic models and statistics weren't capturing what was happening. Greenspan was concerned about the stability of the entire financial system. During his first week on the job, he had quietly set up a number of crisis management committees, including one on the stock market. The situation, that summer of 1987, had the makings of a potential runaway crisis, he thought.
Greenspan had fully acquainted himself with the law, which requires that the Fed try to maintain stable prices. For practical purposes, that means annual inflation rates -- the annual increase in prices -- of less than 3 percent. For Greenspan, that rate ideally would be even lower, 2 percent or less. The law also directs the Fed to maintain what is called "sustainable economic growth," a rate of increase in overall production in the United States that can continue year after year while maintaining maximum possible employment. The problem, as Greenspan knew too well, was that annual economic growth above 3 percent traditionally triggered a rapid rise in wages and prices. The Fed was charged with finding a balance between growth and inflation. For Greenspan, any imbalances were warning signs.
The economy in August of 1987 was going too strong. There were no measurable signs of inflation yet, but the seeds were there. Greenspan was sure of it. He saw from economic data reports that the lead times on deliveries of goods from manufacturers to suppliers or stores were increasing, just starting to go straight up. Rising lead times meant that demand was increasing and goods were growing more scarce. He had seen this happen too many times in past decades, so he felt that he knew exactly what he was looking at. The pattern in economic history was almost invariably that you got a bang as prices headed up, resulting in 8 or 9 percent annual inflation -- a disaster that would destroy the purchasing power of the dollar. The question now, for Greenspan, was how hard the Federal Reserve could lean against the economy to slow it down, to avoid a drastic series of imbalances. If they tried to put the clamp on with interest rate increases, the system might be so fragile that it would crack under them. The Fed and its new chairman could trigger a recession, defined technically as two quarters, or six months, of negative economic growth.
To Greenspan's mind, they were faced with a challenge similar to trying to walk along a log floating in a river. You sense an imbalance and move slightly to adjust; in the process you may lose your balance, but if you regain it, you end up in a better, more stable place. If you don't, you fall off and crash.
Greenspan contemplated two potential missteps. The first would be to do nothing, which would sanction the overheating. The second would be to take action and raise interest rates. It was quite a bind: acting and not acting each had grave consequences.
The new chairman also felt a mild amount of tension because he didn't want to screw up the formal operating procedures of the FOMC. Before his official arrival at the Fed, Greenspan had met with senior staff members to learn the ropes, to make sure he got it right. A Fed chairman was a symbol, but he was also the discussion group leader. He had to know his stuff. Greenspan's only flub so far had been to mispronounce the name of the president of the Philadelphia Federal Reserve Bank, Edward G. Boehne. It is pronounced "Baney," rhyming with "Janey," and Greenspan had embarrassingly called him "Boney."
Despite Greenspan's apprehension about the economy, he felt confident in his ability to serve as chairman. The key was his private business experience as much as it was his previous government service as chairman of Ford's Council of Economic Advisers from 1974 to 1976. In 1953, at the age of 27, he had founded an economic consulting business in New York City with William Townsend, a bond trader. With a love of mathematics, data and charts, Greenspan had developed models for forecasting based on detailed measurements of real economic activity -- from loans and livestock to mobile home sales, inventories and interest rates. Townsend-Greenspan only had about 35 employees, and Greenspan was a hands-on manager, involved in every facet of the firm's work. In addition to his consulting work, he had served on the boards of Automatic Data Processing, Alcoa, Mobil, Morgan Guaranty and General Foods, among others. He believed that he understood the backbone of the American economy from this experience -- computers, metal, oil, banking and food.
With a somewhat severe face, bespectacled, a bit hunched, narrow eyed and pensive, Greenspan radiated gloom. He spoke in a gravelly monotone, often cloaking his thoughts in indirect constructions reflecting the economist's "on the one hand, on the other hand." It was almost as if his words were scouting parties, sent out less to convey than to probe and explore.
A cautious man, Greenspan didn't want to overstate his fears about the economy to his colleagues at his very first FOMC meeting. The staff report assembled by the Fed's 200 expert economists headed by Michael J. Prell, a small, bearded Fed veteran, forecast "moderate growth."
"While the staff forecast is in a way the most likely forecast," Greenspan told the FOMC, "I'd be inclined to suppose that the risks are clearly on the upside." Growth and inflation were much more likely to be higher than the staff had predicted. "And my last forecast is that that's likely the way Mike will come out the next time around."
One member suggested, at least half-jokingly, that Greenspan was trying to pressure Prell, whose next report would come in six weeks, just before the FOMC's next scheduled meeting.
"In case there's any doubt," Greenspan replied confidently, "I think the real world is going to influence him.
"The risk of snuffing out this expansion at this stage with mild tightening is extraordinarily small," he went on, referring to increasing interest rates that make it more difficult to borrow money. "I just find it rather difficult to perceive a set of forces which can bring this expansion down."
Greenspan could see that the other committee members didn't share the alarm he felt and had somewhat concealed. He realized he didn't know enough yet. And he also didn't think, having been there only a week, that he could walk into the room and expect loyalty and support from everyone. It would not happen. If he had proposed raising the fed funds rate, he could not be sure he would get the votes. It would, he concluded, take quite a while to gain intellectual control of the committee and persuade the members to let him lead them. For Greenspan, it was a sobering moment.
During the next weeks, Greenspan pored over the economic data, attempting to pinpoint the volume in inventories, shipping times, sales and prices that explained the real condition of the economy. He knew where to get the numbers about production and orders for rolled steel, specific kinds of cotton fabric or any other industry he might want to examine. From the data and the charts he could reasonably forecast where the next point on a graph would be plotted, or the general direction and the range of next points. From this, he made his own predictions about how fast the economy was growing. He could see pressures on prices and wages brewing, and he was convinced that momentum in the overall economy was building. It was clear to him that they would have to move interest rates up, sooner rather than later.
Since the FOMC was not scheduled to meet until late September, Greenspan had other options. The seven-member Board of Governors set the other interest rate that the Fed controlled, the so-called discount rate, which is the rate that the Fed charges banks for overnight loans. The economic impact of the discount rate is small compared to that of the fed funds rate controlled by the FOMC, but in 1987 changes in the discount rate were publicly announced and changes in the fed funds rate were not. The discount rate was the Fed's only public announcement vehicle, and changes to it could send a loud public message. It was the equivalent of hitting the gong -- exactly what Greenspan was looking for -- and declaring publicly that the Fed was worried about possible inflation.
All the Fed governors were full-time and had their offices in the main building, set off wide, attractive marble corridors that seemed a strange cross between a European villa and a funeral parlor. Greenspan made an effort to get to know each governor, seeking some out in their offices or inviting them to his office for unhurried but pointed discussion of the economy. He called this "bilateral schmoozing." Over about a week, he sounded out and convinced the governors to support a discount rate increase. A graceful listener, he nonetheless made it clear what he wanted. In private he could convey more of the urgency he felt.
On September 4, two weeks after Greenspan's first FOMC meeting, the Board of Governors met under slightly unusual circumstances. Two were out of town and there was one vacancy on the seven-member board, so only four voting members were present. But Greenspan was in a hurry. The four governors voted unanimously to raise the discount rate 1/2 percent to 6 percent. It was the first increase in over three years. The press release announcing the increase said the rate hike was designed to deal with "potential" inflation.
Greenspan went to his office after the announcement. Okay, now, he told himself as he settled into his chair in his brightly lit office.
It was the most risky time for a sharp rate increase, with stock prices so high and the Dow Jones average over 2,500. There was no way to control the secondary consequences of their decision. He turned to the screen on his computer to see how the markets were going to react -- the stock market, the bond market, the foreign exchange markets. He knew the reaction would be negative. Had they done too much? Greenspan wondered. There was no way to know yet. He felt tension. He scanned the charts and graphs and numbers he had followed for so long -- and suddenly, there before his eyes, he could see the dips he was causing. It was one of the most unusual experiences of his life. As he watched, he felt almost as if an earthquake were occurring and the building were rattling. He didn't know whether the building would collapse, but he hoped the situation would calm down. Finally the markets stabilized, with the Dow Jones down only 38 points on the day.
He got word that Paul Volcker was on the phone.
"Congratulations," Volcker said in his booming voice. "Now that you've raised the discount rate, you're a central banker."
"Thank you," the new chairman said.
Greenspan felt that it was crucial to maintain both the Fed's credibility and his own credibility as an inflation fighter. He did not want to see the unwinding of the Volcker era, when runaway inflation had been effectively slain.
With the discount rate move, Greenspan felt he had put a stamp on his general philosophy of not allowing inflation to take hold. And as he wanted, he had done it earlier rather than later. He felt confident in his knowledge of the markets and the economy, but he was also nervous.
Then he concluded, "If you're not nervous, you shouldn't be here."
Nervousness and doubt were central to the task.
Over the next few weeks, the stock market remained high, with the Dow right around 2500, while long-term interest rates on government and business bonds, which the Fed did not control directly, were also going up. That was rare, Greenspan realized, an unsustainable phenomenon. High interest rates meant higher returns on bonds for investors, which would eventually attract money from the stock market. As investors left stocks for bonds, the stock market should move down accordingly. The higher bond rates or borrowing rates for businesses would also depress business earnings and profits, and that too should have sent the stock market down as investors expected less return. But it wasn't happening. As the prices of stocks went up, their yields in dividends went down. These yields were so low compared to the higher bond yields that it was becoming almost irrational to own stocks.
With the economy running too fast and too hot, Greenspan had little choice but to keep quiet about his concerns. If he talked about the stock market problem in public, he was liable to trigger the very collapse he feared.
What to do?
In 1952, Greenspan met the philosopher and novelist Ayn Rand, a proponent of rational self-interest and radical individualism. The author of The Fountainhead, a popular novel about a libertarian architect, took the young Greenspan, then 26, into her circle. Greenspan was a high-IQ mathematician and economic technician who had adopted the philosophy of "logical positivism," which held that nothing could be known rationally with total certainty. He was an extreme doubter and skeptic. The two got into a long series of debates on the issue of values, ethical systems and the nature and origin of morality.
Young Greenspan, intense, with thick, black, slicked-back hair, thought he could outdo anybody in an intellectual debate, but Rand regularly cornered him. It was like playing chess, and all of a sudden, out of nowhere, she would checkmate him. Rand was compelling, and the young man was enthralled.
Rand and Greenspan argued about the nature of society and the power of the state. She pushed him hard. The matters they disagreed on were those that were not provable one way or the other, Greenspan felt, but he believed that the debates and the intellectual rigor gave him a sense of how to determine what was right and what was wrong in his value system. He felt acutely conscious that he would know when he was compromising the market-oriented, pro-capitalist principles he and Rand shared.
After forming Townsend-Greenspan, Greenspan's skill with numbers and data soon had him advising the chief executive officers of major corporations. He became particularly attuned to addressing the anxieties of the person at the top who wanted to know what was going to happen. Yet even when providing his forecasts for high-paying clients, Greenspan's natural precision and doubt stayed with him. He said often that the future is unknowable, and he did not overstate his conclusions. He spoke in terms of most likely outcomes and probabilities.
In 1968, Greenspan became an economic policy adviser to Republican presidential candidate Richard Nixon. His first prolonged contact with Nixon occurred during a meeting of campaign insiders on Long Island. Nixon opened the meeting by uttering more four-letter words than Greenspan knew existed. He was shocked by the contrast between Nixon's public piety and his private profanity and anger. It was no less, he concluded, than Dr. Jekyll and Mr. Hyde. He was the only member of the senior group not to take a position in the Nixon administration.
A "strict" libertarian, as he termed himself, Greenspan was a believer in the efficacy of free markets. Attempts by government to tamper with them or direct them were folly. He was appalled when President Nixon ordered wage and price controls in his first term -- the ultimate intervention into the markets, a disfiguration of capitalism by government.
In the summer of 1974, Nixon asked Greenspan to become chairman of the President's Council of Economic Advisers, one of the most distinguished posts in government for an economist.
"There's a very good chance I might feel the necessity of resigning in three months," Greenspan warned Nixon's chief of staff, Alexander M. Haig. New wage and price controls would trigger his departure. "I physically would not be able to function and I would have no choice but to resign. And I wouldn't want to do that to you and I wouldn't want to do that to me."
Haig and others assured Greenspan there would be no more forays into wage and price controls.
Greenspan finally accepted the post but took an apartment in Washington on a month-to-month lease, figuratively keeping a packed suitcase by the door. In an unusually graphic comparison, he said coming to Washington to advise a president in a free-market economy that might suddenly shift to one with wage and price controls was like a gynecologist being asked to practice proctology.
He stayed on after Nixon resigned in 1974 and Gerald Ford assumed the presidency. Greenspan thought that Ford was bravest and most correct when he didn't meddle with free markets during the recession of 1974-75, even at the risk of his own political future.
Now, Greenspan's job as Fed chairman made him perhaps the federal government's foremost regulator, and the irony was not lost on him. Still, he didn't want to lose his sense of the virtue of keeping his hands off free markets.
At the next FOMC meeting, September 22, 1987, the chairman remarked that the economy was clearly quite strong. He was uncertain, however, about where they might be in the inevitable ups and downs of the business cycle. "There is always something different; something that does not look like all the previous ones. There is never anything identical, and it is always a puzzlement." But, he said, he had not detected what was unusual about this economic situation, though the main problem of overheating was evident. "We do not yet have any evidence of actual inflation," he said, recommending no change in interest rates. The FOMC agreed unanimously. "The actions we are taking," the chairman said, underscoring the point, "basically would indicate that we did nothing at this meeting."
A month later, over the weekend of October 17-18, Manuel Johnson -- now elevated to the vice chairmanship of the Board of Governors -- spent hours and hours attempting to find a buyer for the largest savings and loan in the United States, the American Savings & Loan Association. American Savings had secretly informed the Fed they were going to have to announce bankruptcy on Monday unless someone took them over. The thrift had a portfolio of so-called junk bonds -- bonds that paid high interest rates -- and they had taken a severe beating. The price of bonds moves the opposite of interest rates, so as interest rates had soared, the value of their bonds had sunk to the point that the thrift was effectively broke.
Johnson was unable to find a buyer, he reported unhappily to Greenspan. To make matters worse, the stock market had been down on Friday. It looked as though it was going to be a rough Monday.
Greenspan took a professorial approach. Great, if a buyer can be found, he said, but if not, market forces will work it out.
On Monday, October 19, the stock market was down in the morning but then started back somewhat. Greenspan decided to stick to his schedule, which included a speech at the American Bankers Association convention in Dallas the next morning. By the time he left for the airport, the stock market was back down again, by several hundred points, and the situation looked awful. He debated whether to back out and stay in Washington, but he concluded that canceling the speech would send the wrong message, a message of crisis. At midafternoon, he boarded American Airlines flight #567 bound for Dallas.
The plane had no phone, so when he got off in Dallas he immediately inquired about the market.
"It was down five oh eight," replied Jim Stull, a senior vice president at the Dallas Fed who had come to meet him.
"Wow, what a terrific rally!" Greenspan said. The market was down only 5.08 points. Whew!
That meant close to $1 trillion in wealth -- more than 20 percent of the stock market's total value -- was wiped out for the moment.
"There has never been a decline in one day over 20 percent," Greenspan said soberly. A serious decline in the stock market did not come as a surprise, but the severity of the one-day drop was a shock because it was without precedent.
He had studied the Black Tuesday crash of October 29, 1929, a critical turning point in history. That crash had triggered bank failures and a recession, which led to the Great Depression of the 1930s. The market crash of 1929 had been 11.7 percent, compared with the 22.6 percent drop that had just been reported.
At the Federal Reserve headquarters in Washington, Johnson was the official crisis manager. He was struck by the tomblike hush in the corridors. He contacted the senior staff. Don't go home, he told them, we need to go over this. Everyone gathered in the small library across from the board and FOMC meeting room. Johnson took out a one-inch-thick binder with a pink cover that had emblazoned diagonally across its front a large bold warning: "RESTRICTED -- CONTROLLED."
He read, "Summary Papers on Risks in the U.S. Financial System." He turned to the tab on the stock market: "STRICTLY CONFIDENTIAL, STOCK MARKET RISKS." The seven-page section stated that the current prices were "probably unsustainable." The options for action, Johnson read, included open market buying of bonds to keep money in the banking system and short-term interest rates from rising. Some options were extreme. "Try to organize stock purchases by major securities firms," he read. That would be an unheard-of market intervention. Was it that bad? Johnson didn't know. Another option, he read, "an off-the-wall suggestion: targeted Fed lending specifically designed to support stock values." Again, another extreme idea. He wondered how it could be done. Still another option included shortening stock market trading hours or even a trading halt. The papers weren't very helpful.
Greenspan finally reached the Adolphus Hotel in downtown Dallas and held a conference call with Johnson and the others. Some were saying, Well, let's wait and see.
"You people have not been around long enough," Greenspan said. He had been around, around money, around the markets, around people on the verge or in panic, for decades. "This is a shock to the system," he said. "You don't assume it's going to wear off." Greenspan knew that a crash of that magnitude was like a gunshot to the entire financial system. The full pain would not be felt right away. There would be ripple effects for a long time, a possible convulsion in the economy and in society.
Someone on the phone said that everything might be okay.
"You know what just happened?" Greenspan said. "We just destroyed a huge chunk of wealth in this country."
Drafts of a possible statement by the Fed or by Greenspan were being cobbled together. Without having made a decision, the chairman and others agreed to regroup on the phone the following morning well before the stock market opened.
Greenspan said he would stay and give his speech the next morning. It was important not to appear panicky, he said. The speech was on bank regulation, and he attempted to graft several reassuring paragraphs onto it about the stock market. He was not happy with the result.
No one knew the answer to the main question of why the market had crashed. Was something fundamentally wrong with the businesses whose stock had suddenly plummeted 20 percent? Had the doubt and overvaluing triggered more doubt, starting a landslide of reactive sellers bailing out in anticipation of more declines and doubt? Had the process just been overwhelmed, some self-reinforcing spiral downward unique to the moment?
It was a crisis, a financial Vietnam, but it had happened over a single day, not years, creating the potential for a major economic catastrophe. If the stock market continued down, the system -- the relationships, rules and theology that Greenspan had built into his head and that had become a part of who he was -- would break apart.
That same day, on the 10th floor of the New York Federal Reserve Bank on the edge of Wall Street, E. Gerald Corrigan, the bank's president, was troubled. Corrigan, a 46-year-old beefy, profane, smart, Jesuit-educated Irishman, was the vice chairman of the FOMC. The open market operations of the Fed -- the buying and selling of U.S. Treasury bonds that caused an increase or decrease in the key fed funds rate -- were conducted through his bank. Corrigan had personal relationships with the heads of the banks, the investment banking firms and the brokerage houses in the nation's financial capital.
Corrigan had spent nearly his entire career at the Fed. He had been Paul Volcker's aide in D.C. for years and had been president of the Minneapolis Fed before taking over the key New York post on January 1, 1985. He knew without a doubt that the crash was going to cause major problems.
Corrigan and Greenspan finally hooked up by phone.
"Alan, you're it," Corrigan said. "Goddammit, it's up to you. This whole thing is on your shoulders." Corrigan, an ally, believed there was no time for procrastination and little for analysis. The availability of money in the system would be critical. In one form or another, Wall Street securities and brokerage firms, and their clients, would need bank credit, their lifeline, to cover their losses.
"Thank you, Dr. Corrigan," Greenspan said.
Greenspan knew how the financial system's plumbing worked -- an elaborate series of networks involving regular banks such as Citibank, investment banks such as Goldman Sachs, and stock brokerage firms such as Merrill Lynch. Payments and credit flowed routinely among them. The New York Fed alone transferred more than $1 trillion a day. If one or several of these components failed to make their payments or to extend credit -- or even just delayed payment in a crisis -- they could trigger a chain reaction and the whole system could freeze up, even blow up.
Before Greenspan hung up with Corrigan, he told himself, I'm going to find out what I'm made of. The first challenge: Could he sleep? He did, for roughly five hours. He was amazed.
"Help!" said a new voice on the phone first thing the next morning, Tuesday, October 20. It was Howard Baker, Reagan's chief of staff.
"Something bothering you, Howard?" Greenspan asked.
Baker was feeling pretty lonely. "You've got to get back here," he said. The other Baker, the treasury secretary, was in Europe on a hunting boondoggle with the king of Sweden. "I looked around and there's nobody in town but me, and I don't know what the hell I'm doing."
Greenspan said he couldn't get a flight until after his speech.
"Alan," Baker said, "we've still got airplanes and I'm going to get you back up here." He promised to send a military jet with continuous secure communications to bring Greenspan back to Washington. A Gulfstream was dispatched at once. Greenspan still wanted to give his speech before leaving Dallas to convey a sense of business as usual. Corrigan and Johnson said he had to go to Washington immediately. A routine speech to bankers in the midst of an obvious crisis would send a signal that the chairman was out of touch with reality. Greenspan canceled his speech.
Corrigan had been in his office at the New York Fed since 5 A.M. that Tuesday morning. The 15 phones in his suite of offices were jumping off the hook with calls from the bankers and players in the financial markets. The immediate and pressing question was who would finance or give credit to the banks, the brokerage houses and others in the financial system that needed money. For practical purposes, the Fed was already giving credit in the hundreds of millions of dollars at the current interest rates in routine overnight loans. What were the limits? Would they pull the plug? Would the Fed's lending system be overwhelmed? There were both technical and policy questions.
In a conference call that morning, Greenspan and his colleagues debated what the Fed should say publicly. The Fed lawyers had come up with a lengthy statement.
Goddammit, Corrigan said emphatically, we don't need a scholarly, legalistic thing. We've just got to say in one sentence, We're going to put a lot of money in the market. In part, they had a plumbing problem. Everyone needed to be assured they could get money -- in other words, liquidity or credit. The Fed also had to address the confidence problem, he urged. They had to show their hand early.
A key question was whether there was a major hole in the system. Was some firm in trouble and maybe insolvent? In the short run, Corrigan argued, there was no way to tell the difference between just short-term liquidity problems and outright insolvency.
They finally agreed on a one-sentence statement. Greenspan issued it in his name at 8:41 A.M., before the markets opened:
"The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system."
"Alan," Corrigan said in a personal follow-up call to Greenspan, "we're going to have to back this up. I just want you to know that I'm going to start making calls." His phones were still going crazy. He had to talk to the heads of the banks and brokerage houses.
What are you going to say? Greenspan asked.
Corrigan said that he was going to have to talk very tough, and he was going to have to talk in code. He couldn't give them orders, and he couldn't beg.
Greenspan wanted the exact words. They couldn't tell banks to lend to bankrupt institutions; they could be sued for huge amounts of money if shareholders in bank stocks could show that the Fed, a key regulatory agency for banks, had improperly directed unsound loans. How would it work?
Corrigan offered a hypothetical call to the head of a big bank. He would say, "You've got to make your own business and credit decisions....But there is this bigger picture out there. If the system becomes unglued, you won't be insulated....If for God's sake there's anything I should know, let me know." In other words, let him know if you're not going to make your payments or aren't getting payments from others, or if you're in trouble. Corrigan needed immediate, high-quality information if he was to discover a hole that might collapse the system. They couldn't plug a hole they didn't know about, so they would have to address everybody.
Greenspan preferred a more subtle approach. The argument should be more calibrated, assuring the banks that the Fed was not trying to force them to lend on an irrational basis or to take extreme risks. The argument should be: Remember that these people who want money have long memories. If you shut off credit to a customer who has been a good customer for a number of years because you're a little nervous, the customer will remember that. Think of the longer-term interests and the customer relationships. Corrigan should clarify to the banks where their self-interest lay.
Corrigan understood, but he would have to speak in his own voice -- and his style was loud and clear. He knew he would have to make sure the payments and credit extensions were voluntary. At the same time, it would be his job to make certain they happened.
Greenspan was aware of how tricky it would be to strike the right balance. With so much power over the banks, they had to be careful about using heavy-handed methods. If they forced actions with implied threats, they could eviscerate the vitality of the banking system, which had to operate freely. At the same time, he knew Corrigan was going to bite off a few earlobes. That was okay. The Federal Reserve needed an enforcer at this moment.
Corrigan, his stomach churning, called Bankers Trust. It was a very tough presentation. Goddammit, you've got to fall in line, you've got no choice.
The bankers on the other end of the phone felt pressured, but they knew that they didn't really have any choice but to do what Corrigan wanted them to do.
Corrigan's call to the Bank of New York was also on the tough side. After some negotiation, they fell in line.
One brokerage house owed some $600 million to $700 million to another brokerage house and was delaying the payment, unsure of the other firm's condition or even its solvency. If they paid, would they in turn be paid what they were owed by other firms?
This was precisely what Corrigan feared -- one firm choking, stopping the flow. Rumors were flying.
He argued that there was no insulation for any one bank or firm. If the system came down, everyone would go with it. Clinging to $700 million would not save the firm. Goddammit, he knew what could happen, he said. He tried to sound calm.
The payment was made.
On his way to Washington, Greenspan considered his options. The entire system could crumble. It could happen in 10 minutes.
He particularly didn't want anyone from the Fed to sound like Herbert Hoover, president in 1929, declaring with historically memorable stupidity after Black Tuesday that everything was terrific. Everything wasn't terrific. They were in a real crisis. Failure to acknowledge even this simple state of reality would cause the knowledgeable players in the market to think the Fed ought to go to the loony bin.
After all, the Fed was in charge of the sovereign credit of the United States. They had the legal power to buy up the entire national and private debt, theoretically infusing the system with billions, even trillions, of dollars, more than would ever be necessary to restore liquidity and credit. Of course, the result of that would be Latin American-style inflation.
In addition, there was an ambiguous provision in Section 13 of the Federal Reserve Act, the lawyers told Greenspan, that would allow the Fed, with the agreement of five out of seven members of its board, to loan to institutions -- brokerage houses and the like -- other than banks. Greenspan was prepared to go further over the line. The Fed might loan money, but only if those institutions agreed to do what the Fed wanted them to do. He was prepared to make deals. It wasn't legal, but he was willing to do it, if necessary. There was that much at stake. At that moment, his job was to do almost anything to keep the system righted, even the previously inconceivable.
Joseph Coyne, the Fed's veteran press officer, was along on the flight. He asked Greenspan how he was able to appear so calm.
"You don't worry about things you can't do anything about," the chairman replied. Until they landed there wasn't much he could do. He returned to his thoughts.* * *
By about 11:30 A.M. on that same day, stock in IBM, one of the big blue chip firms, stopped trading. All the trade orders were to sell. There were no buyers. Soon dozens of other stocks stopped trading. A stock is worth only what someone is willing to pay at a given moment. If no one was willing to buy, the stock was, on a theoretical level, worth nothing or heading to nothing. By 12:30 P.M., any ground gained during the morning trading had been lost, and the whole market had tanked.
Corrigan spoke with Johnson in Washington. This was the moment of direst need.
We can't hold it, Corrigan said with real panic in his voice. It's falling apart. There's not enough trust in the market, and it's going to melt down.
He came up with a desperate contingency plan. Instead of just loaning money -- guaranteeing liquidity to the banks -- the Fed would directly guarantee the payments between brokerage firms. But it would be a last, desperate measure. The plan, and the Fed's willingness to embrace it, had to remain a deeply guarded secret. If word got out, banks and brokerage houses would just seize on the guarantees and use them instead of their own money. It would give everyone an easy way out.
Greenspan's plane had landed at Andrews Air Force Base outside Washington, and the car that was bringing him into town didn't have a secure phone. To hell with it, Greenspan said to himself. He called in to the Fed, even though his conversation might be overheard.
Johnson said that they had just received a call from New York. There was a plan being discussed to shut down the New York Stock Exchange within the hour.
"That would blow it," Greenspan said. The head of the Securities and Exchange Commission, David Ruder, had gone on television and mused that there was a point at which he would favor a "very temporary" trading halt. Ruder later denied that he'd even contemplated a trading halt, but his statement was fact. Awfully dangerous to go on TV, Greenspan thought, if you didn't want to be quoted. Closing the New York Stock Exchange was really not an option in Greenspan's mind. Once it was closed, how would it be opened? What prices would stocks trade at? The Hong Kong exchange had closed once and it had taken a week for it to be reopened. Markets set prices, and if there were no market, there would be no price. It was almost unthinkable.
Johnson worried, if New York shut down, what would happen to the futures market? A futures contract is an agreement to buy or sell something -- wheat, gold, bonds, stocks -- at a future point. With no basic stock market trading, there would be no future. The stock futures market would collapse. That would trigger general panic, he believed. They were truly about to go over the precipice.
Howard Baker didn't have the foggiest notion what was going on. John Phelan, president of the New York Stock Exchange, had been arguing in favor of a suspension of trading. He urged Baker to have President Reagan issue an executive order suspending stock trading. The 1933 Securities Act gave the president the power to do so.
Baker took the proposal to Reagan.
What do you think? Reagan asked.
"What I think is I don't know," the chief of staff replied. He said his instincts told him it would be a lot easier to suspend trading than to resume it. He proposed that the White House counsel draft an order to suspend trading, just in case. "I'm going to put it in my desk drawer," Baker said, "and I'm not going to bring it to you, and we're going to wait and see how this day goes."
That's fine, the president said.
Phelan kept beating the daylights out of Baker on the phone. He was fierce and certain. Suspend trading. Things are out of control. There's a disconnect. The specialists on the stock exchange floor who kept active trading going for the major stocks were starting to go crazy. If they lost the specialists, they would lose the whole place, Phelan said.
Howard Baker took to the phones. He talked with the heads of General Motors, Salomon Brothers and Merrill Lynch. They all opposed a suspension of trading. Baker reached Donald Stone, one of the most prominent floor specialists on the New York Stock Exchange.
"I owe so much money," Stone said, "I can't count it. This place is knee-deep in panic."
At the Fed, Greenspan reached a key executive in the Chicago options exchange, who said the market there was about to collapse as well.
"Calm down," Greenspan said. "It's containable. Don't worry, don't panic." He was fascinated to see how powerful people functioned under stress. It reminded him of the Apollo 13 astronauts who successfully repaired their spacecraft in outer space by manufacturing a replacement part they had not brought along. Does your mind or psyche freeze over? he wondered. He was going to find out.
He also spoke directly with a number of big players from the largest financial institutions. Their voices were shaking. Greenspan knew that scared people had less than perfect judgment.
He didn't pray, and he didn't cry -- though he admitted later that he would have wept if he had thought it would keep the markets from deteriorating further. If he didn't do something, this crash had the potential to devastate the American economy.
Meanwhile, a number of prominent companies had announced that they were entering the market to buy back their own stock at the lower prices, in effect saying that their stock was such a bargain that the company was willing to put up its own cash to purchase the stock. It was a message of confidence.
At 12:30 P.M., there was very little trading, a sign the system might be freezing up.
Then, about 1 P.M., only a half hour later, the Major Market Index futures market staged its largest rally in history. Several major Wall Street firms bought a mere $60 million in future contracts on stocks, and the action sent a shock of brief optimism through the market. Because the buyer of futures contracts had initially to put up only a small portion of the money, the cost of these transactions was only a fraction of that $60 million. But the positive movement apparently triggered a significant number of buy orders in the underlying stocks. Some big institutions or wealthy investors had perhaps decided to gamble in order to stabilize or even save the market. Soon the Dow itself rallied, ending the day up 102 points, a record gain.
Howard Baker had lived through one of the tensest days of his life. He sensed but did not know -- not a soul ever told him -- that some big companies and investors had gone into the market to buy stocks and drive the prices up. By law and tradition, the White House, Treasury, the Securities and Exchange Commission, the free markets, the New York Stock Exchange and the Fed all had a role in solving the problem. There was no single stock market czar, a person or institution fully in charge. Baker was pretty sure it was one of those moments when fractured responsibility made it as dangerous as it ever got.
But the greatest achievement, Baker believed, was Greenspan's one-line press release. The Congress could have met in extraordinary session and passed legislation without hearings to reassure the markets, but that would have had little impact. The president could have suspended trading or acted somehow, but that too would have done little. There was only one part of the government that could have turned it around, and that was the Fed offering unlimited credit. In the end, money talked -- or, at least, the Fed's openly stated willingness to provide it.
Treasury Secretary Jim Baker had flown back to the United States on the Concorde. He too thought the one-sentence statement was brilliant. They were lucky to have Greenspan at the Fed. Baker wasn't sure that Volcker would have been so quick to act.
Corrigan never figured the whole thing out, and part of him didn't want to know. If it was a major miracle rescue of American capitalism, several people or firms might have operated in concert to manipulate the market. That was technically a scheme, and possibly illegal. And if someone in the government or the Fed had given tacit approval, encouragement or even just a wink, that would make it worse. Corrigan decided that he didn't want to pursue the matter.
For all Greenspan knew, it might have been a handful of individuals who made the move. There was no telling whether the transactions were made out of knowledge or desperation, skillful calculation or serendipity. Was it possible that American capitalism was given a reprieve by the strategic -- or accidental -- investment of several million dollars? It was possible, of course. Or perhaps the bottom had been reached and the market had pulled out naturally. Whatever the answer, Greenspan's largest realization was they hadn't known what to do. They could set up a crisis committee, confer, send messages to the financial markets, seek intelligence, talk tough or smart, look at the data until they were blue in the face and try to project, but they were all novices given the problem they faced.
That wonderful, nebulous space between the free markets of capitalism and regulations of government was the land of the unknown. It was Greenspan's first major lesson at the Fed, and he had been chairman only 72 days.
Greenspan set up a crisis command post in his office. He, Johnson and some of the others stayed round the clock for the next several days. They were eating crummy sandwiches and keeping in constant contact with Corrigan in New York, the other bank presidents and market people from around the world.
On Thursday, October 22, the president of the Chicago Fed called with a new crisis. First Options, a subsidiary of Continental Illinois, a giant bank, was broke and could no longer provide loans to the options market.
The Fed, as the regulator of banks, had insisted that Continental keep a firewall between its depositors' money and its subsidiaries, such as First Options. The firewall was there to protect the bank from being drained while supporting a failing subsidiary and to protect depositors from losing their money. Continental now wanted relief from the firewall in order to keep First Options afloat.
William Taylor, head of the Fed's bank supervision enforcement division, rushed into Greenspan's office as the chairman and Johnson were sitting at a small oval coffee table.
"We have to shut them down," Taylor said. They had to follow their own regulations and protect Continental Bank and its depositors. They could not let First Options bleed the bank.
Taylor didn't have the big picture, Johnson knew. The failure of First Options would send the options market into paralysis and perhaps trigger another stock plunge. He looked at Greenspan, who seemed to signal agreement.
"Let them do it," Johnson said to Taylor. "Don't block it. Let the money go. We'll clean this up later."
Greenspan just nodded.
Things weren't fixed, he realized again. There was no mathematical way to figure out what was happening, let alone what had already happened, no way to remove the many elements of uncertainty. It was more sobering than ever.
Copyright © 2000 by Bob Woodward