Federal Reserve Chairman Alan Greenspan said Friday that the U.S. central bank couldn't have deflated the stock market bubble during the late 1990s because a sharp rise in interest rates would have pushed the economy into recession. "The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion," Greenspan said in remarks before the Kansas City Fed's annual economic conference in Jackson Hole, Wyo. As evidence of this, Greenspan said the Fed raised interest rates by more than 3 percentage points in the late 1980's and mid-1990's, but that the markets continued to rise after a brief pause. Greenspan's speech came in response to critics who have argued that the Fed didn't take strong enough action to control stock market euphoria in the late 1990s. The Nasdaq surged a whopping 85% in 1999 and an additional 25% between January and March 2000. The S&P 500 jumped 24% from the start of 1999 to March 2000. Since the market peaked, of course, trillions of dollars in wealth have been wiped out and a string of former highflying companies have gone bankrupt or been sold off in parts. Greenspan said Fed policymakers struggled to understand developments in the mid '90s, and that "only history books and musty archives gave us clues to the appropriate stance for policy." Nonetheless, he said there was nothing the Fed could have done to prevent the bubble short of a sharp increase in interest rates "that engenders a significant economic retrenchment."
Speaking on the Margins
Countering arguments that the Fed should have raised margin requirements, Greenspan said the amount of margin debt was so small that any changes would have had little impact on stock market volatility. During the late '90's, investors who wanted to buy more stock borrowed huge amounts of money from their brokers based on the value of their current holdings. Once share prices declined, brokerages sent out margin calls forcing investors to repay the money they had borrowed. In September 1996, Greenspan said that restrictions on these kinds of loans would raise "major concerns" in the market. "I guarantee that if you want to get rid of the bubble, whatever it is, that will do it," he said at the time. A few weeks later, Greenspan issued his famous words of warning that "irrational exuberance" had potentially gripped the market. The stock market rally, of course, continued for over three more years. Bill Fleckenstein, president of Fleckenstein Capital and a contributor to TheStreet.com's sister site RealMoney.com, said Greenspan's speech suggests that the Fed chief is concerned about the possibility of being tagged as the man responsible for the bubble and, more importantly, the economic downturn that investors are currently suffering through. "Now that he's finally admitted we had a bubble, which is a first, he is saying even if we had known it was occurring, there was nothing we could do," Fleckenstein said. Still, Fleckenstein believes the speech will backfire. "I think a lot of people had thought he was doing a good job and that he was the maestro," he said. "He's not going to get away with saying he didn't help cause the bubble." At the same time others, like Brian Gilmartin, the founder and portfolio manager of Trinity Asset Management, defend the chairman. Gilmartin is a contributor to another sister site of TheStreet.com, RealMoneyPro.com. "Kicking Greenspan with the economy down has become fashionable of late, and I can't blame those for delivering at least a little harsh treatment to a man who has been so closely identified with the economic success of the '90's," he wrote on RealMoneyPro. "But the criticism has reached almost extreme levels, particularly today, since his Jackson Hole speech has the tenor of someone who is backpedaling furiously." Gilmartin also said that "what people seem to forget is that Greenspan has only somewhat direct control over the banking system. ... What people also seem to forget is that with the banking system relatively healthy, and no credit or liquidity problems within the system, there isn't much else Greenspan can do. "This 'economy' isn't his fault," Gilmartin continued, "and I would even argue by moving when he did in 2001 he prevented worse decay."