clock menu more-arrow no yes

Filed under:

Can Fed retake bull by horns?

He was the miracle worker, the wizard, the colossus astride the galloping 1990s economy. Journalist Bob Woodward captured his reputation in the title for his biography of Alan Greenspan: "Maestro."

Today, critics of all stripes — new-economy boosters, iron and steel industrialists and millions of investors who were rocked last week by the stock-market tumble — are baying at Greenspan's door.

On CNBC's financial call-in show last week, viewers anxious about what the Federal Reserve chairman might do to their portfolios sought advice.

Manufacturing companies are imploring the Fed to cut interest rates and pluck heavy industry out of its recession.

And Wayne Angell, who for years sat on the Fed's board of governors, recently voiced rare public criticism of Fed policy in The Wall Street Journal, saying the Fed was sending mixed signals that were causing confusion in financial markets.

Could it be, asked Detroit money manager David Sowerby, that "Emperor Greenspan has no clothes?"

As never before in his 14-year tenure, the 75-year-old economist, who runs the nation's central bank and can play swing on a clarinet, is being criticized as though he is single-handedly pushing the economy into recession.

All eyes were on the Federal Reserve on Tuesday, when it was expected to authorize at least another half-percentage-point reduction in interest rates, augmenting the full-point cut approved in January meetings to combat growing fears of a recession.

When Greenspan, widely credited as the principal architect of the nation's decadelong economic boom, appeared before a congressional committee early this month, he found himself in the unusual position of answering a chorus of critics who complained that his January rate reductions, aimed at reinvigorating the economy, came too late. It was a harsh turn of events for a man who had been lavishly praised throughout the past decade for his management of the economy.

"In retrospect, I see nothing that we did that strikes me as inappropriate, as far as policy is concerned," Greenspan said defensively.

Is the criticism warranted?

Millions of investors may think so. But the fact remains that while the longest-running economic expansion in U.S. history has slowed, there is no confirmation yet of a recession. Despite an increasing number of layoffs by technology companies, a record 132 million Americans are still employed, and the inflation tiger set loose 20 years ago has been tamed.

But the fact that Greenspan has had to defend himself at all is a sign of troubling economic times.

With the economy skating on the razor-thin edge of recession, the Fed is in danger of botching the "soft landing" it had hoped to engineer. The nation, and the world, hang on whether Greenspan's Fed can see this through.

"Until this point, people were praising Greenspan's policy decisions, so he could just bask," said William Cheney, senior economist for Boston-based John Hancock Financial Services. "He can't bask anymore."

The drumbeat for an even bigger rate cut intensified last week, as the NASDAQ Composite index plunged and the broader Standard & Poor's index of 500 stocks followed the technology-heavy NASDAQ deep into bear-market territory.

Even though the markets staged a small rally Monday — the Dow Jones industrial average rose 135.70 points, to close at 9,959.11, while the Nasdaq rose 60.28 points, to close at 1,951.19 — many investors are anxiously awaiting Greenspan's decision Tuesday afternoon.

"Investors have little to go on, aside from the hope the Fed will rescue the stock market," said Ned Riley, chief strategist for the investment division of State Street Corp.

Greenspan has made it clear that it's not the Fed's job to bail out the market every time investors lose.

"We are not focusing monetary policy on the stock market," Greenspan said a year ago. "We are focusing on the economy."

Some economists argue that Greenspan has kept the economy growing at a sustainable pace and, based on that, has kept his reputation intact.

"If you take that narrow view of the Fed's responsibility, which I buy into," said Stanford University economics professor Robert Hall, there is no "cause for alteration from the Fed's conservative course, which is to make small interest-rate adjustments with their eye on inflation and recession, neither of which is a big deal right now."

But the slowdown is inflicting real pain, eliciting cries for help from many corners of the economy.

The manufacturing sector, for instance, has lost about 270,000 jobs during the past year. If the Fed does not take action, the National Association of Manufacturers said, capital investments by public companies will keep dropping and sink manufacturers deeper into recession.

In a letter to the Fed's Open Market Committee, the association politely requested a half-point reduction in interest rates this week, said its economist, Gordon Richards, "but we'd be thrilled" with more.

There is no evidence, in current data, that the overall economy is in recession, which is defined as two consecutive quarters of negative growth. However, growth virtually ground to a halt during the first quarter of this year after an abrupt slowdown in the final months of 2000, according to Wall Street estimates.

Wall Street pundits argue that if Greenspan doesn't keep the stock markets from sliding farther, trillions of dollars more in paper losses may cause economic damage as Americans, watching their financial wealth evaporate, cut back the spending that has so far kept the economy out of a full recession.

A new "flow of funds" report by the Federal Reserve showed that plunging stock prices, particularly on the Nasdaq Stock Market, reduced household net worth by $900 billion last year. It was the first decline since 1945. Household stock portfolios shrank by more than $2 trillion.

"The amount of interest-rate reductions necessary to cushion and forestall ever-growing recession risks is much more than they seem to be contemplating," said Allen Sinai, global economist in New York for Boston-based Decision Economics Inc.

A pessimistic Sinai sees a 50-50 chance that the US economy will enter recession this year because of a series of negative developments, including backsliding in Japan, the world's second-biggest economy, a "downwave" in US capital spending by business, and falling consumer confidence.

Greenspan's Fed certainly has raised expectations about his powers on Wall Street, since the central bank has frequently come to the rescue when US financial markets are in trouble.

In 1987, through small adjustments of interest rates, the Fed averted recession and propped up the markets after an October crash. A decade after that, Greenspan reduced rates and prevented a calamity in the United States after a currency meltdown in Asia cascaded around the world and triggered the near-collapse of Long Term Capital Management, a huge New York hedge fund.

And this year, on Jan. 3 — the day after the Nasdaq plunged 7 percent — the Fed in a surprise announcement slashed interest rates by half a percentage point.

Some argue that Greenspan's biggest error may have occurred two years ago, when he allowed the Nasdaq to develop a speculative bubble before raising rates in June 1999 to "talk the market down."

Greenspan was clearly aware of the risks of a soaring market: Months before rates were cut, he coined a term to warn that stock investors were exhibiting "irrational exuberance."

"The mistake was that the Fed didn't get tough enough when the bubble was getting bigger and bigger and bigger," said Nicholas Perna, an economic consultant in Ridgefield, Conn.

The higher the market went, the further it had to fall. That has proved true, particularly in the Nasdaq, which quadrupled in three years and has sacrificed 63 percent of its value since its March 2000 high.

The Standard & Poor's 500 index, now 25 percent below its year-ago high, entered a bear market after losing 83 points last week. And the Dow Jones index of blue-chip stocks sank below 10,000 last week for the first time since October.

While falling stocks are a threat, assessments of the Fed depend on how the economy fares. The economy is at a crossroads that could lead to a rebound, and it may be simply too early to make a judgment. Most economists and some Fed governors forecast that even if the economy goes into recession by midyear, growth for the year will be positive.

John Hancock's Cheney, citing a February jobs report that showed 135,000 new jobs were added, argues that Greenspan has already achieved the "soft landing" he was aiming for.

"Greenspan's judgments have turned out to be good," Cheney said. "There's a combination of skill and luck involved. He still has the skill. The luck could run out, but I don't think it has yet."