Market Still Has Lovin' Feeling for Greenspan

Monday, President Bush talked about the "hangover" from the "economic binge" of the 1990s. Tuesday, the man who presided over that binge spoke before Congress and, for some reason, investors took comfort in his testimony.

For some time now (and long before it was fashionable), this column has been critical of Federal Reserve Chairman Alan Greenspan for having created the environment in which the stock market's bubble erupted; specifically, by engineering the bailout of Long Term Capital Management in 1998 and by turning on the liquidity spigots in late 1999 ahead of the much ballyhooed "Y2K" calendar change.

In 1996 Greenspan famously talked about "irrational exuberance" but uttered nary a cautionary public statement thereafter, despite the stock market's volcanic eruption in the last years of the decade. (In the context of corporate malfeasance, Greenspan talked Tuesday about a "once-in-a-generation frenzy of speculation that is now over," which is as close as he's come to saying publicly: "It was a bubble, it's over.")

Many investors blame Greenspan for killing the golden goose with rate cuts in 1999 and 2000, but such critiques fail to acknowledge that the goose was largely Greenspan's creation and thus his to cook. Others lost faith in the chairman when his 11 rate cuts in 2001 failed to reinspire stocks, as this column suggested might occur.

Regardless of the growing anti-Greenspan sentiment (for whatever reasons), it seems many investors maintain their faith in the chairman, whose comments Tuesday had the complete opposite effect of those of President Bush in recent days.

When Greenspan began his semiannual monetary report to Congress at 10 a.m. EDT, the market was in the midst of a morning swoon. About 30 minutes later, major averages reversed course in notable fashion. As of 1:47 p.m. EDT, the Dow Jones Industrial Average was down 0.5% to 8593.36 vs. its morning low of 8406.45, while the S&P 500 was down 0.4% to 914.40 vs. its earlier low of 897.13. Meanwhile, the Nasdaq Composite was continuing its recent relative outperformance, up 1% to 1396.11 after having traded as low as 1367.

In his prepared statement, Greenspan discussed how the U.S. economy has "withstood a set of blows" -- including the stock market's tumble, a sharp retrenchment in spending by businesses and the Sept. 11 terrorist attacks -- that "almost surely would have induced a severe contraction" in previous business cycles.

"Depressing effects of recent events linger" and "considerable uncertainties ... still confront us," Greenspan conceded. But "the fundamentals are in place for a return to sustained healthy growth." The Fed now expects GDP to grow 3.5% to 3.75% in 2002 (vs. 2.5% to 3% in February) and 3.5% to 4% in 2003. Those gains should be sufficient to bring the unemployment rate down to 5.25% to 5.5% by the end of next year, he testified.

Greenspan acknowledged the Fed's "accommodative stance" of monetary policy "will not prove compatible over time" with that kind of growth. But he argued that inflation's quiescence gives the Fed room to maintain the fed funds rate at its current 1.75% level, "pending evidence that the forces inhibiting economic growth are dissipating enough to allow the strong fundamentals to show through more fully."

Translation: Don't expect a rate hike anytime soon, but neither is the Fed going to ease rates as was rumored yesterday. (Prior to Tuesday's speech, fed fund futures had been forecasting low odds of any change in monetary policy this year, having recently priced out prior expectations for a rate hike. So Greenspan's testimony can be seen as another example of the chairman following the market's recommendation rather than setting it.)

In the Q&A session with senators, Greenspan fretted about the "breakdown of fiscal discipline" in Washington, punted on questions about the dollar, which was resuming its downward course vs. other major currencies today, and equated corporate fraud with violence against the financial markets.

Throughout the chairman's testimony, Senate Banking Committee head Paul Sarbanes commented on how much the market improved during Greenspan's appearance. Arguably, stocks were primed for a rally, as many traders and money managers believed Monday's midday reversal was the start of something constructive. Still, would-be buyers needed a catalyst, and the timing of Tuesday's move suggests all glory goes to Greenspan. Most media outlets will be quick to give it to him.

Still, the bet here is that "the Maestro" is eventually going to have to take the blame for what he helped bring about. If the stock market doesn't generate some kind of sustainable recovery soon and the economy falters rather than flourishes in the second half, that day might come sooner rather than later.