Greenspan Dethroned

March 27, 2001 -- The law that what goes up must come down has lately applied not just to overpriced stocks, but also to reputations.

Case in point: Alan Greenspan, the owlish, likeably jug-eared Fed chiefwhose standing was elevated to absurd heights in the good times by afawning media and Wall Street. "He was revered prior to '98, but he wasanointed in '98," says David Orr, chief economist at First Union CapitalMarkets. "It was a coronation."

The level of adulation for Greenspan was off the scale compared withearlier Fed chairmen, as was the tremendous expansion of the economy,which began 10 years ago.

But lately that invincible image has started to fray around the edgesas companies have retrenched, laying off employees and slashing spending,and the Nasdaq and S&P 500 stock indexes have stumbled into bear market territory.

The Wizard Is Only Human

One analogy compares Greenspan to the Wizard of Oz — right now investors are alot like Dorothy, just discovering that the Wizard is only a human being.

The question, says finance professor Meir Statman of Santa ClaraUniversity, is "whether what is happening now is something that was boundto happen, a wave much too powerful even for Greenspan [to withstand], orwhether he was sluggish in his response."

Critics on Wall Street say the Fed chief deserves blame for the slumping stock markets. Some complain the Fed hiked rates too aggressively last year, contributing to the currenteconomic slowdown. Between June 1999 and the following May, the Fed raisedinterest rates by 1.75 percent, to 6.5 percent.

Since January the Fed has changed its course. It's proceeded to cutrates by almost as much, slashing 150 basis points in less than threemonths.

But even that's not enough to appease some critics. In a Wall StreetJournal editorial last month, Wayne Angell, chief economist at BearSterns and a former governor of the Fed, argued that the times call formore aggressive cuts, given the dramatic drop in annual economic growthfrom 5 percent to 1 percent last year.

From Praise to Reprimand

Even in Washington, the Fed chief has lost points. Only a year ago,during a hearing for Greenspan's re-nomination at the Fed, Senate BankingCommittee head Phil Gramm practically gushed compliments. "Millions ofpeople owe you a deep debt of gratitude for your leadership," he said, "andfor doing more than probably any one else on the planet to produce thestrong economy we have today."

But during testimony before lawmakers in February, Greenspan faced reprimands from those who complained the Fed's rate increases in 2000 worsened current economic problems andsuggested rate cuts should have begun sooner.

To be sure, average Americans still seem pretty satisfied with Greenspan's performance. In a March poll for The Wall StreetJournal/NBC News conducted by Hart-Teeter Research, Greenspan earned apositive rating from 55 percent of respondents, with only 8 percent giving him a negativerating. While 17 percent of those polled gave him credit for economic gains, only4 percent blamed him for problems in the economy.

Still, there's no denying the tide of opinion is changing, withsentiment in some quarters of Wall Street taking a sharp turn toward thecritical.

But is such a swing in opinion fair? Or are investors punishingGreenspan for the simple fact that the market is reverting back to normalafter a long, gleeful joy ride away from economic reality?

Some economists say the latter is true, suggesting investors have cometo embrace impractical ideas about what the Federal Reserve is actuallycapable of doing. Even as powerful an institution as the Fed shouldn't beexpected to shoulder sole responsibility for the economy and the market,they say.

"It's really an unrealistic expectation that the Fed all on itsown, with only monetary policy and jawboning, could effect all thefine-tuning needed to maintain the economy's momentum," says Samuel Hayes,who teaches investment banking at Harvard's business school. Tax policy and government spending form two other legs in the three-legged stool, he says.

Steering Through the Rough Spots

In any case, a government institution can't really be held accountablefor the behavior of millions of Americans who wildly bid up the Nasdaq past5,000, and went on a spending spree that has created staggering levels ofconsumer debt. In the wake of that crazy runup, a cooling-off period may bewarranted to return the economy to some semblance of normalcy.

"I think that we've had a market that's had a lot of froth in it andthat froth was inevitably going to have to be squeezed out," says Hayes,"so this market correction is no more than the engagement of economicgravity that is pulling things back towards a rational price base. The sourgrapes will probably continue as long as the market continues to trenddownward. People are always looking for a scapegoat, and it makes good copyto dump on Greenspan."

Notwithstanding current economic troubles, economists credit Greenspanwith steering the economy through rough spots several times in his 14-yeartenure. The Fed helped stave off recession with rate cuts that bolsteredsentiment after the market crash in 1987 and the emerging markets crisis in1998.

At other times Greenspan went above and beyond the call of duty, lendinghis prestige to outside efforts to keep the economy on an even keel. InOctober 1987, Hayes recalls, Greenspan mobilized banks and other lenders toprovide liquidity for several troubled Wall Street houses that appearedlikely to default.

Again in 1995, he helped muster support in Congress for amassive loan to help Mexico through its devastating peso crisis. And threeyears later, he threw his weight behind a plan to garner support from WallStreet firms for a bailout of massive hedge fund Long-Term CapitalManagement, preventing another crisis.

Proceed with Caution

Even now, some economists acknowledge the Fed has its reasons formoving slowly. First Union's Orr says he thinks interest rates should be atleast 50 basis points lower — and maybe the Fed thinks so too. But thenature of the institution is to be cautious.

"I think a principle Greenspan has operated under is that the future is unknowable, and therefore human beings are going to make mistakes in projecting the future," says Orr. "Soif you know you're going to possibly make a mistake, you should take anaction that will have the least harm if it is a mistake." The worst thingto do would be to act in panic mode — especially given the number ofconflicting economic signals to be deciphered.

Still, Orr has faith the Fed will deliver. Right now the eurodollarfutures contract — which he considers the best proxy for the market'sexpectations — is forecasting a Fed funds rate of about 4.25 percent forSeptember. "I have no doubt they'll get to it if they need to. What theydon't want is to do too much too quickly," he says.