SERIOUS MONEY:AMELIA EARHART, the world's most famous female aviator, was born on this day in 1897. She became the first woman to fly across the Atlantic in 1928 and made headlines in an era when aviation captured the public's imagination.
Unfortunately, her Lockheed Electra disappeared over the Pacific just three weeks shy of her 40th birthday and the ground- breaking aviator was never heard from again.
Amelia’s story has much in common with Alan Greenspan’s latter years at the helm of the Federal Reserve. The serial bubble-blower appeared to lose his compass and the subsequent hard landing in uncharted territories has thrust his former employer’s independence into the spotlight. His legacy is such that apolitical monetary policy could well disappear from investors’ radar screens; a prospect that would almost certainly have a negative impact on asset valuations.
Greenspan has said that bubbles are difficult if not impossible to identify, a convenient excuse for a man who presided over and nurtured two of the greatest bubbles in US history.
The evidence suggests that the stock market and housing bubbles were not only easy to spot, but difficult to miss even to the untrained eye.
The stock market euphoria during the latter half of the 1990s saw valuations soar to levels unprecedented in all of American financial history. At their peak in the spring of 2000, US equities offered an inferior long-term real return than that available on risk- free Treasury inflation-protected securities. The love affair with real estate that followed the demise of the technology bubble saw the ratio of median prices to median income jump to three standard deviations above the historic norm. It’s hard to argue that these numbers are justifiable.
The notion that bubbles are virtually impossible to identify as put forward by the so-called “maestro” in defence of his record at the Fed does not sit well with his own words at meetings of the Federal Open Market Committee that are a matter of public record.
He warned of market euphoria as early as 1993 and following the monetary tightening cycle that he effected throughout 1994, he observed: “We have taken a lot of bubble out of the market,” even though stocks were no lower than before the interest rate hikes.
The powerful advance in stock prices in 1995 and 1996 saw the so-called seer warn of irrational exuberance but, just seven months later during the summer of 1997, he had an about-turn and embraced the brave new world of technology.
The musings of the most influential advocate of the new economy served as a green light to would-be investors to get on board and participate in the once- in-a-lifetime opportunity to get rich as quickly as possible.
Public participation took off and just one year later the number of equity mutual funds surpassed the number of stocks listed on the New York Stock Exchange while day-trading was rapidly becoming a national pastime.
The love affair with technology saw almost 200 new issues more than double on their first day of trading in 1998 and 1999 as compared with less than 40 over the previous quarter century.
The danger may not have been apparent to Greenspan but it certainly was to his esteemed predecessor, Paul Volcker, who commented in 1999: “The fate of the world economy is now totally dependent . . . on about 50 stocks, half of which have never reported any earnings.
The demise of the technology bubble was not a matter of if, but when, but upon its subsequent deflation, the “maestro” claimed that the tools available to the Fed could not have prevented the mania. However, the same man observed in 1996: “if you want to get rid of the bubble” increasing the requirements on margin debt “will do it”.
He never did raise margin requirements and, as the market neared its peak, margin debt relative to GDP soared to the highest level since 1929.
The recession that inevitably followed betrayed Greenspan’s brave new world but he blamed 9/11 for the economy’s continuing malaise in early-2002.
He lowered interest rates aggressively and held them almost four percentage points below that prescribed by the respected Taylor rule for almost a year. Real interest rates were below the rate of inflation for 2½ years but the former Fed chairman demonstrated no concern in the face of rising home prices, explaining that real estate “was especially ill-suited to develop into a bubble”.
The potential threat to stability was dismissed as Greenspan marvelled at his achievements and observed: “New financial products – including derivatives, asset- backed securities, collateralised loan obligations and collateralised mortgage obligations . . . have contributed to the development of a more flexible and efficient financial system.”
How wrong can one man be?
Amelia Earhart’s childhood was marred by a family history of alcoholism while Greenspan’s latter years at the Fed were sullied by a Wall Street intoxicated on his 100-proof brand of monetary policy. The hangover will be long-lasting.
Perhaps the maestro should have heeded the words of William McChesney Martin, who chaired the Fed during the 1950s and 1960s, when he stated that the central bank was in “the position of the chaperone that has the punch bowl removed just when the party was warming up”.
charliefell@sequoia.ie
