Shaped like a claw grasping at the Atlantic, Walker’s Point is a narrow spit of land that juts southward from the Maine coastline. Cold ocean currents from Nova Scotia slosh past the point’s rocky eastern shore, and the quiet cove to the west teems with striped bass and lobster. A single road connects Walker’s Point to the mainland, leaving the peninsula in the state of isolation that first attracted its namesake—Bert Walker, a Missouri banker who bought the land in 1902, shortly before a small Hungarian girl named Rose Goldsmith arrived at Ellis Island. No doubt Walker would have been gratified to know that his grandson, George Herbert Walker Bush, would one day seek solace at his oceanfront compound, midway through his bid for the U.S. presidency.1
On Memorial Day weekend in 1988, when George H. W. Bush made the pilgrimage to Walker’s Point, he needed to recharge his batteries. His campaign was not going according to plan. Having inherited money, connections, and manners, he was used to doing well: “He had always seemed a little like Scott Fitzgerald made him up,” a friend once remarked of him.2 As Reagan’s sitting vice president, Bush enjoyed the advantage of incumbency as well; he basked in the reflected glory of an economy that was notching up its twenty-third consecutive quarter of expansion, the longest peacetime boom in American history. Yet despite Bush’s advantages, he trailed Massachusetts governor Michael Dukakis, the top Democratic contender, by as much as 10 percentage points; and to make matters worse, the long boom was threatening to stall out on him. After cutting interest rates in the wake of Black Monday, the Federal Reserve was beginning to tighten. Contemplating his prospects in the coming November, Bush could see the central bank hovering like a storm cloud above him.
On Monday, May 30, 1988, Bush ventured out from his compound to watch the Memorial Day parade in the nearby village of Kennebunkport. The skies opened and rain poured down upon him. The next day, as the vice president sat through a marathon of campaign strategy sessions, his advisers kept coming back to the economy. Their counsel was dampening, and screamingly dull—the candidate was bored by economics. “This fellow, George Herbert Walker Bush, with an honors degree from Yale in economics, knew no economics,” recalled Paul MacAvoy, the indignant dean of the Yale School of Management, who went out to advise Bush at Walker’s Point in 1980, during the candidate’s first presidential run. “He was not a Hayekian; he was not a Keynesian, he was nothing, he knew nothing!” MacAvoy had long experience with politicians, but his time with Bush still left him agog. “He sat facing the ocean,” the professor marveled, “and we [advisers] would sit with our backs to the water and we would start in on shoe imports or the classical paradigm and he would look over our shoulders and say, ‘Oh my god, MacAvoy, they’re going out in the pencil boat. They’re going to see the seals! Oh, damn it.’”3
After suffering through the briefing sessions, Bush stepped out to see the press, dressed in a baseball cap and a crisp windbreaker. Even when he was not wearing a suit, he still managed to look dapper.
“There was some expression of concern,” Bush said, recounting for reporters what he had heard from his campaign team. His advisers had assured him that “we were rocking along pretty well on inflation, and making great progress in terms of growth”—he had “a lot of confidence” in Greenspan and the Fed, he stipulated. Then he pulled the trigger.
“As a word of caution, I wouldn’t want to see them step over some [line] that would ratchet down, tighten down on the economic growth,” Bush informed the scrum. “So I think there is more room for the economy to grow without unacceptable increases in inflation.”4 “Watching for signs of inflation is fine,” he conceded. But the Fed “is at the lower end in terms of growth of the money supply.”5
It was a warning, an omen: the Walker’s Point declaration of May 1988 set the tone for Alan Greenspan’s next four years in office. The Bush family retreat in New England might radiate gentility and charm, but when it came to the Fed and interest rates, George H. W. Bush was primed to do ungentle battle.
• • •
A few months into his life as Fed chairman, Greenspan was settling into a smooth rhythm. He would wake each morning at five-thirty or six, conscious that the first hours of the day would be his most intellectually productive. He would lie in bed for several minutes, thinking through the knottiest questions on his plate; and after this period of prone pondering, he would commit his epiphanies to paper before the tide of the day’s business swamped them. Next, he would crack open the old-fashioned leather briefcase with the curled top that he brought home from the office. Not pausing for breakfast—eating would divert his body’s energies from his brain to his stomach, he believed—he would start reviewing draft speeches and poring over technical papers produced by the Fed’s economists. If his back was troubling him, Greenspan would go through the papers while soaking in a hot bath. His staff got used to deciphering steam-smudged marginal notes, the product of the chairman’s morning cogitations.
A bit after seven o’clock in the morning, a driver and a security guard would interrupt Greenspan’s studies. The Fed chairman had been assigned a security detail after Paul Volcker had received threats; but the minders constituted an informal crew, and Greenspan often felt he was being accompanied rather than protected. With his posse downstairs waiting for him, Greenspan would pack up his papers and walk out into the curving corridor of the Watergate building; then he would ride the elevator down to the lobby and board the waiting black limousine. The journey from apartment door to car door constituted almost half of his commute: the drive to the Fed building took less than five minutes.
Arriving at the office, Greenspan would permit himself breakfast, often with a guest: the Treasury secretary, an FOMC colleague, a senior staff economist, a journalist, a politician. Then he would launch into a series of meetings. On days when he was due to chair a board session, Bill Wiles, the secretary of the Board of Governors, would stop by to deliver a pro forma briefing, and Greenspan would proceed into the boardroom to preside over the day’s business. There would be matters regarding financial oversight; decisions about whether a proposed bank merger should be allowed; debates on whether a lender that violated the Fed’s rules should be punished or just cautioned. Greenspan would run the meetings evenhandedly, much as he had done with the Social Security commission; he avoided weighing in too hard on regulatory dilemmas, preferring to preserve his capital for arguments about interest rates, which were conducted mainly in the separate forum of the Federal Open Market Committee. On days when there were no board meetings, Greenspan would hold court to a steady stream of visitors, including figures from his rich past—Kathryn Eickhoff, Marty Anderson, assorted friends from Wall Street.6 The discussions were not confined to economics, not by any means—his guests were often startled to discover that Greenspan could handicap a close-fought Senate primary election or tell you which congressman was likely to cast the swing vote on which House committee. A bit after six o’clock in the evening, the chairman would be on his way out of the door: to a drink or a dinner at the old-line Metropolitan Club; to a private soirée arranged by a powerful hostess; or to an embassy reception. Having made a point of showing up at parties since his days in the Ford White House, Greenspan had now acquired an additional reason to get out: Andrea reveled in it.7
While he was still new to the job, Greenspan’s social appetite flagged just occasionally. Four months into his tenure, Laurence Tisch, the billionaire boss of the CBS television network, invited Alan and Andrea to the Kennedy Center Honors, a grand occasion at which the actress Bette Davis was to be among those feted. Andrea bought a special dress; this would be her biggest evening out since the White House state dinner for the Salvadoran president. But on the morning of the Honors, a Sunday, Alan got cold feet. He had a packed agenda the next day: a Fed board meeting in the morning, a lunch at the conservative American Enterprise Institute, meetings in the afternoon with Treasury Secretary Baker, with the number two at the German central bank, and with no less a figure than President Reagan. He had been up late for a dinner party at Andrea’s on Saturday evening. Now he wanted to stay home and study.
“You what?” Andrea demanded, when Alan explained what he had decided. Quite apart from her own disappointment, Andrea shuddered to think what CBS’s boss would make of his substitute social partner. Alan had passed his tickets for the Kennedy Honors on to Wayne Angell, the peppery Fed governor from Kansas with whom he played tennis. It was an act of social sacrilege, like failing to show up at your friend’s wedding and deputizing a colleague.
“It’s done,” Alan answered. “I need to work. I cannot stay up late.”8
These lulls in sociability were brief, however. That week following the Honors, after getting through his meeting with Reagan, Greenspan was in the swing again, dining with Barbara Walters at Washington’s Madison Hotel on Tuesday and breakfasting with Henry Kissinger the next morning. Most weekends he would go to Manhattan, where he made amends with Laurence Tisch, golfing with him at the Century Club, an exclusive enclave some twenty miles north of the city. Tisch was a billionaire at a time when there were just a handful of billionaires in the entire nation, but he could spend an eternity lining up a twenty-five-cent putt. He had clearly worked hard for every penny he had earned, Greenspan liked to tease him.9
When he was not golfing in the suburbs, Greenspan would eat brunch with Felix Rohatyn, the boss of the investment bank Lazard Frères, and stay in touch with his cousin Wesley Halpert, who had led him on coin hunts on the beaches of Queens during boyhood vacations. Denied the opportunity to become a doctor by anti-Jewish quotas, Wesley had become a dentist, and Alan had become a conscientious patient. On several occasions each year, Greenspan would visit Wesley’s town house at the very end of Fifty-third Street, on the eastern edge of Manhattan—sometimes he would go to the clinic on the lower level to get his teeth cleaned; sometimes he would go to Wesley’s residence on the upper level to eat dinner. It was a case of Say’s law, Greenspan later quipped. Supply creates its own demand, Jean-Baptiste Say had observed, a century before: by selling his wares and earning an income, a supplier becomes a consumer, thus boosting demand—including demand for his own output. In similar fashion, Wesley supplied the food that sullied his cousin’s teeth, thereby ensuring Alan’s continuing demand for his dental services.10
For his first year or two at the Fed, Greenspan maintained his apartment in the United Nations Plaza, which he had owned since he had first grown rich in the mid-1960s. He would stay there for a night or two, using it as a base for his golf games and his social rounds, but never failing to make time for visits to his mother. Now in her mideighties, Rose was a sad shadow of her former self: her mind remained clear, but she suffered from depression. Alan would make his way to her modest apartment on the West Side of Manhattan and sit with her in the living room that she seldom ventured from, struggling to fill the silences. He was still her brilliant son, the grown version of the handsome prodigy of half a century before—the boy with the even features and dark hair who solved math problems in his head to entertain the relatives. But now nothing made her eyes light up, not even her perfect progeny; as she confessed regretfully to him one day, his greatest successes had arrived when she could not take any pleasure in them. Alan would stay with Rose for an hour or so, doing his best to reverse the pattern he had always known. For the first sixty years of his life, she had been the one to illuminate the room with gaiety and chatter; now it was his turn to provide the sunshine, and it did not come easily. Presently he would rise and take his leave. But he expressed his love for her on every morning of her final years, faithfully telephoning her by nine o’clock, even if it meant setting an alarm when he was in a different time zone.11
As he entered his late eighties in his own turn, Greenspan recalled his mother’s fading strength with a rare flicker of emotion. His mother’s incapacity to enjoy his grand success was “pretty awful,” he said, his voice thickening just slightly.12
• • •
Despite Candidate Bush’s outburst at Walker’s Point, Greenspan was in fact a monetary dove during his first year or so in office. He had arrived at the Fed determined to protect Volcker’s inflation-fighting legacy, but the near-death experience of Black Monday altered his priorities.13 Price stability now seemed to matter less than financial stability, at least for the time being, and Greenspan repeatedly resisted hawkish colleagues at the Fed who wanted to raise interest rates. “If we were to indicate that we were tightening, the shock to the markets I think would break the stock market,” he worried to the Federal Open Market Committee in February 1988, explaining why the lowest jobless rate in nine years was not reason enough to raise borrowing costs. Three months later, the specter of financial fragility was still holding him back. “There is a stock market out there that I think could get pretty shabby,” he fretted at the FOMC meeting in May—even though it had been more than half a year since the trauma of Black Monday.
Because of this preoccupation with financial stability, Greenspan committed the opposite error to the one that Bush accused him of. Far from squeezing the economy too much, he was allowing core inflation to accelerate, risking Volcker’s legacy. Thanks to this monetary looseness, real estate prices started to take off—and by an irony apparently lost on Bush, the property mania raged especially fiercely in picturesque New England.14 Describing the vice president at Walker’s Point on that Memorial Day weekend, the Washington Post noted that the quaint little homes around the art galleries and seafood restaurants were fetching astronomical prices.15 The Fed’s loose monetary policy, aimed at managing the risks from fragile equities, was perversely encouraging New England’s mortgage lenders to foment a new source of fragility.
With inflation showing up in consumer prices and housing, Greenspan came under pressure from his Fed colleagues. At the FOMC meeting following Memorial Day, Boston Fed president Frank Morris warned him bluntly about a “kind of euphoria in commercial building” in New England; and many of the other regional Fed presidents, who were less closely allied to the Reagan administration than the Fed governors in Washington, shared Morris’s frustration with Greenspan’s loose policy. After all, the economy had grown at a sizzling rate of 5.4 percent in the second quarter of 1988, and unemployment was now at its lowest level since the Nixon era. Another few months of rapid growth seemed certain to stoke even higher inflation. What was Greenspan waiting for?16 A month later, at the start of August 1988, the discontent with Greenspan burst out into the open. The New York Times quoted a chorus of private economists who accused Greenspan of outright cowardice. “I think he’s gun-shy,” one critic said bluntly.17
Greenspan had won plaudits for his handling of the crash. But now, a year into his Fed chairmanship, his credibility was at stake. If the gun-shy label stuck, it could take years to unstick it.
• • •
Two days after the Times’s broadside, on Friday, August 5, 1988, Manley Johnson attended a parade at one of the capital’s oldest landmarks, the Marine Barracks in southeast Washington. The ceremony honored James Baker, a former marine officer, who was resigning from the helm of the Treasury to take over Bush’s campaign for election. Johnson made his way through the security check, past the young, white-gloved marines, and readied himself to watch the eerie, floating, ceremonial stride that these young warriors performed so earnestly.18
Johnson spotted one of Baker’s deputies at the parade and approached him. He had a message to deliver. In the past forty-eight hours, the mood at the Fed had shifted. The chairman had held off on tightening for a surprisingly long time, but now Wall Street economists were accusing him of being chicken. That very morning, the critics had been fortified: strong data on employment had appeared, confirming that the economy was overheating.19 The pressure for a rate hike was building, Johnson warned Baker’s aide. The Treasury should brace itself.
The message should not have come as a surprise; by any objective measure, it was indeed time to tighten. But in keeping with the spirit of the Walker’s Point declaration, the man from the Treasury pronounced himself aghast.20 A rate hike now, three months ahead of the election, was exactly what the Bush camp was most dreading.
Two days later, on Sunday morning, Baker appeared on NBC’s Meet the Press. The Treasury secretary wanted to discuss Bush’s run for the White House, but the interviewer kept bringing up the Fed. How would the Bush campaign fare if Alan Greenspan chose this moment to tighten monetary policy?
“I think the Federal Reserve has done an extraordinarily good job of maintaining the balance between preserving growth on the one hand and being vigilant against inflation on the other,” Baker hedged.
“But if they nudge interest rates upward because they feel it’s necessary to control inflation—”
“You’re asking me to talk with you about a hypothetical,” interrupted Baker. “They have not said that they’re going to do that.”
Two days later, on Tuesday, August 9, the hypothetical became actual. The Fed marked the end of its post–Black Monday monetary looseness by hiking the publicly announced discount rate by half a percentage point. Greenspan had responded to his critics: he was not shy of his gun. But he had confirmed the Bush team’s darkest fears. The Republican National Convention was a week away, and Bush was still trailing Michael Dukakis.
After the board meeting Greenspan went over to Baker’s office at the Treasury.21 If he was going to manage the political fallout from the rate hike, he had to warn Baker face to face, before the news of the Fed’s move hit the newswires.
“I’m sure you’re not going to be happy about this,” Greenspan began after the two men sat down in Baker’s office. “But after a long discussion of all the factors,” he continued, “we arrived at a decision to raise the discount rate.”22
“You just hit me right here,” the Treasury secretary said, gesturing at his stomach.
“I’m sorry, Jim,” Greenspan answered simply.
Baker began to roar and shout, but the Fed chairman stood his ground stoically.23 There was a paradox about his personality: polite, soft-spoken, Greenspan hated to confront others; but when he found himself on the receiving end, he reacted perfectly serenely. His confidence in his own powers of judgment allowed him to shrug off abuse—to dismiss it as a pitiful symptom of his assailant’s vulnerability. Perhaps, Greenspan reflected in this case, Baker was screaming so as to cover his own back; he needed to be in a position to assure Bush that he had protested the Fed’s move with maximum ferocity. After more than a decade in and out of Washington, Baker had emerged as the ultimate pro. He never lost control, except in a controlled fashion.24
The following Sunday, Greenspan’s guess was vindicated. Baker made another appearance on one of the morning TV shows, purring with professional composure. A higher discount rate was not so bad, he now maintained.25 However much he might pressure the Fed behind the scenes, Baker evidently understood the case for cooling the economy.
• • •
Greenspan’s interest-rate hike in the summer of 1988 ended up helping the vice president. The tightening was too mild to dampen the economy—after a slight deceleration in the third quarter of the year, growth roared back in the fourth one.26 But the tightening did contribute to a turn in New England. The housing market cooled off at last: for the first time in five years, New England home prices lagged the national average. Happily for Bush, his opponent, Michael Dukakis, was the governor of Massachusetts; and Dukakis had made the prosperity of his home state a central theme of his campaign, so that the end of the New England boom ripped the core out of his message. Bush seized the opportunity to deride the vaunted “Massachusetts Miracle” as the “Massachusetts Mirage.” By the middle of October, polls put the vice president comfortably ahead. Bush won the election in a landslide, aided by a Fed move that he had vehemently resisted.
It did not necessarily follow that Bush or his team would stop attacking Greenspan. Jim Baker understood enough to keep criticism private, but he was heading off to serve as secretary of state, where he would have nothing to do with monetary policy. His successor as Treasury secretary, Nicholas Brady, was a Wall Street executive with far less experience of Washington; he was high on courtesy and low on analytical rigor, and he had an Irish temper, like Greenspan’s old antagonist Don Regan. A few days after the election, on November 18, Brady appeared on NBC’s Today show, brimming with unsolicited monetary advice. “I don’t see anything in the figures right now that would indicate that interest rates are going to rise,” he said, brazenly ignoring the clear signs that growth was too high to be sustainable.27
Brady was not the only Bush adviser who promised trouble for Greenspan. The Fed chairman was also worried about his old supply-side adversary, Representative Jack Kemp, now frequently described as a future Republican president. Handsome, ebullient, and famous since his days as a young football pro, Kemp was seen as a youthful version of Reagan—another sunny crowd-pleaser from the entertainment industry. Kemp had no patience whatever with austerity of any kind, whether it arrived courtesy of higher taxes or higher interest rates. Awkwardly for Greenspan, he seemed set to take a job in the Bush cabinet.
On Thursday, December 1, 1988, Greenspan walked into Manley Johnson’s office. He was looking a bit flustered.
“There must be some mistake,” Greenspan began. That evening, Kemp’s retirement from the House of Representatives was to be marked by a grand reception at the Omni Shoreham Hotel in northwest Washington. A thousand guests would be on hand, including President Ronald Reagan and President-elect George Bush. Greenspan had not received an invitation.
Johnson had a good relationship with Kemp, and Greenspan wanted his assistance. “Can you do me a favor and call up Jack and just make sure, you know, I know where my table is?” Greenspan asked Johnson.
Johnson did not see why Greenspan was so keen to go. Rubber-chicken dinners in cavernous ballrooms were nothing much to lust after. In fact, Johnson himself had been invited to the event but was thinking of skipping it.
“Why do you want to go?” Johnson asked. He suggested to Greenspan that he could show up in his place—there would be a free seat at his table.
Greenspan was not going to be left out of a power gathering like this one. He insisted to Johnson that he must have been invited in his own right. The address on the card must have been wrong; there had to be some error somewhere. But it was now already the midafternoon. He needed Johnson to call his buddy and straighten out the confusion.
Johnson tracked down Kemp in a suite at the hotel, where the honoree was getting ready.
“Jack, Alan thinks that there’s been some kind of administrative screw-up, you know, about his table, about his invitation to your event tonight and everything like that.”
“There’s no screwup; I didn’t invite him,” Kemp answered.
Johnson tried to humor his old friend. It was a mistake to exclude Greenspan.
Kemp pushed back. He didn’t like Greenspan’s economic views. The man was an enemy of supply-side tax cuts.
“That’s petty, Jack,” Johnson protested. “You know he wants to be at your event, and everybody in the administration is going to be there. He’s the chairman of the Fed. You cannot not include him.”
Kemp went around in circles a bit more, then eventually relented. “All right, tell him he can come.”
“I’m not going to tell him that he can come. He’s the chairman of the Fed. You tell him.”
Kemp agreed, and that night Greenspan took his place among the throng at the Omni Shoreham.28 The event raised big dollars for two conservative think tanks—tickets had sold at $1,000 a pop—and Kemp amused the crowd by passing a football to Reagan: the rising standard-bearer of tax-cut conservatism was linking up with the older one. The veteran conservative intellectual William F. Buckley Jr. stood up and compared Kemp’s departure from Congress to “the retirement of Niagara Falls from Niagara.”29 Speaker after speaker paid tribute to Kemp’s supply-side views. Jim Baker hailed Kemp as “the idea man behind the Reagan Revolution.”
Surrounded by members of his own political party with whom he had little in common, Greenspan must have reflected on the challenges ahead. Thanks to Manley Johnson, he was physically inside the room. But he was intellectually estranged from it.
• • •
Two weeks later, on December 13 and 14, Greenspan chaired an FOMC meeting. The news was not good—it was too good. The staff’s Greenbook, the briefing prepared ahead of each meeting, stressed that the economy was growing rapidly; inflation, already up to 4.2 percent, was set to continue rising. Greenspan’s rate hike in August had evidently not been enough. Contrary to what Treasury Secretary Brady seemed to believe, interest rates might have to rise as much as two full percentage points to keep the lid on prices.30
Earlier that year, Greenspan had resisted rate hikes because of his fear for financial stability. Now the same dilemma raised its head again—although by now financial stability was about more than just the stock market.
“There is a whole set of risks that everybody around this table is familiar with—mostly in the financial area, thrifts, LDCs, LBOs, etc., etc.,” observed Ed Boehne, the president of the Philadelphia Fed. He was referring to the bogeymen who had spooked the monetary establishment for some years: LDCs (or less developed countries) had yet to crawl out from under their collapsing debts, while LBOs (or leveraged buyouts) were still propping up the stock market. Raising interest rates might be the right policy to combat inflation, but American corporations and consumers had piled up mountains of debt.31 If the Fed tightened abruptly, there would be an epidemic of bankruptcies.
John LaWare, the Fed governor who took the lead on financial regulation, echoed Boehne’s anxieties. “I’ve got a metallic taste in my mouth when I start trying to quantify—and this is the difficult part—the implications on these fragile elements in our financial system of a 200 basis point rise in interest rates,” he said. “More recently, we’ve had the question of real estate overhang. A higher set of interest rates is obviously going to at least prolong the resolution of that overhang.” If New England mortgage lenders had behaved recklessly during the boom, a higher cost of funds was the last thing they needed.
Greenspan listened to his colleagues’ concerns—and more or less ignored them. It was a striking turnaround: financial fragility now mattered less to him than controlling inflation. More than a year had passed since Black Monday, and the sustained tranquility of the stock market had taught him a lesson: if the imperatives of financial stability and price stability were pulling him in different ways, he could prioritize stable prices, knowing that if markets crashed he had the power to contain the damage. Moreover, the warning of the previous August stuck in his mind: if Wall Street came to believe that he was gun-shy, inflation expectations would rise, and it would take enormous effort to force them back down again. The future central-bank consensus—that price stability trumped other objectives—was not yet entrenched. But it was taking shape beneath the surface.
After some back-and-forth around the table, Greenspan prevailed upon his FOMC colleagues to set their financial-stability concerns aside and raise the federal funds rate.32 A month later, on January 24, 1989, the chairman defended his move in testimony before the House of Representatives, and his tone made it clear that more tightening was coming.33 But the day after that testimony, Greenspan reaped the inevitable whirlwind. No less a figure than the newly inaugurated president went out of his way to slap him: “I haven’t talked to Alan lately, but I don’t want to see us move so strongly against fear of inflation that we impede growth,” Bush told the New York Times. “We have to keep expanding opportunities for the working men and women of this country.”34
It was the Walker’s Point declaration, all over again. No matter how low unemployment went, it could never fall enough in Bush’s eyes. If Greenspan was going to emulate the Churchillian Volcker, the new president would retaliate by emulating Nixon’s Fed bashing.
• • •
On Sunday, February 5, 1989, Greenspan made his way over to the White House for an evening meeting. The president’s economic advisers were waiting for him in the Roosevelt Room to discuss a secret contingency plan. Their boss was getting ready to unveil a savings-and-loan rescue the next day—the stresses at the S&Ls had finally triggered federal action. At a cost of $90 billion, the S&L bailout would be the largest financial rescue in American history, and there was a risk it could go wrong: the announcement might ignite panic, alerting customers to the weakness of the thrifts, and trigger a run on deposits. The president’s advisers wanted Greenspan’s assurance that if the worst happened, the Fed would prop up the S&Ls with emergency loans, even though the thrifts were technically outside the Fed’s safety net.35 They also wanted Greenspan to sit behind Bush when he announced the plan. He would not have to speak, but they needed him in the camera shot.36
Greenspan assented on both counts. He was willing to backstop the S&Ls, and he was willing to be photographed. His libertarian rejection of bailouts was long gone; what he wanted above all was the space to fight inflation. If the Fed chairman could help the administration deal with the thrifts, perhaps it would cut him slack on monetary policy.
The day after the bailout was announced, the FOMC convened for its next meeting. The tension between the Fed’s inflation-fighting objective and its financial-stability objective was even more acute than usual. One governor noted that raising interest rates would have the effect of “taking some of the modestly solvent and profitable thrifts and throwing them over on the other pile.”37 A regional Fed president chimed in that an increase in borrowing costs of just half a percent would saddle S&Ls with additional losses of about $1 billion—losses that taxpayers would be forced to swallow.38 Moreover, if tighter monetary policy led to a recession, newly unemployed homeowners would default on their mortgages, compounding the S&Ls’ problems.39 Black Monday had been scary because it had happened so fast, but the remedy had proved relatively simple. By contrast, the slow-burning S&L mess could be far more expensive to taxpayers.
If the S&L crisis presented one obstacle to higher interest rates, the Fed was also hamstrung by its own internal confusion. Paul Volcker’s early tenure had coincided with the ascendancy of monetarism, which simplified and clarified the FOMC’s mission—to deliver stable growth of money. Now, in the Greenspan era, the Fed found itself in a doctrinal no-man’s-land.40 Officially, the Fed still operated in a monetarist fashion: it steered the economy by tinkering with the supply of credit. Unofficially, the Fed’s attention was shifting from the quantity of credit to its price—from the money supply to the interest rate. Legally, the Fed was supposed to target full employment as well as stable prices. Practically, it had decided that its priority should be to bring down inflation—but nobody was sure how far or how quickly. The committee was also uncertain about its stance on exchange rates. In the late 1980s, some major central banks used monetary policy to manage their currencies rather than domestic economic conditions. The Fed, for the most part, was not in the currency-targeting camp, but Greenspan and his colleagues sometimes felt they should react to the level of the dollar.
Midway through the February 1989 meeting, Lee Hoskins, the president of the Cleveland Fed, hinted at a way out of this fog. The Fed should be clearer about its intentions—both to itself and to the public. Monetary policy, to be successful, needed an anchor—for a long time the Fed had been guided by its promise to maintain the dollar-gold link; later, following a disastrous period of confusion that had opened the door to stagflation, the Fed had been guided by its promise to maintain stable growth of money. Now, if it was not returning to the earlier anchors, the Fed needed a new one. It should announce an explicit inflation target.
Hoskins was airing an idea that would come to be embraced by central banks the world over. Only a few months later, at the end of 1989, New Zealand became the first convert, enshrining an inflation target in law and granting the central bank the independence from political interference that would make the target achievable.41 Given the pressure on the Fed from the Bush administration, the attractions of a New Zealand–style bargain were obvious: if the Fed formally committed to an inflation target, it would have a potent excuse to ignore White House demands for lower interest rates. But when Hoskins raised the idea of an inflation target in February 1989, he did not win the argument.
Don Kohn, the head of the Fed’s Division of Monetary Affairs, pushed back. Speaking with the implicit backing of Greenspan, he cautioned, “It’s what we do more than what we say—read our actions rather than our lips.” Besides, there was a risk in announcing a formal inflation target, Kohn pointed out. The Fed might miss the target through no fault of its own—a drought or a war could push inflation up, even if monetary policy was perfect. If the Fed committed to a target and then missed, it would squander credibility.42
With confusion as to its monetary tools, no clarity about its inflation target, and with the competing objectives of financial stability and exchange-rate management threatening to encroach, the Fed seemed to be adrift, laying itself open to a humiliating repeat of the inflationary 1970s. As Arthur Burns had argued in Belgrade in 1979, intellectual uncertainty among monetary experts made it harder for a central bank to stand up to pressure from the politicians. But precisely when the Fed appeared most vulnerable, Greenspan proved himself most resolute. In the two weeks after the February 1989 meeting, he raised the federal funds target no fewer than three times, delivering a cumulative jolt of three quarters of a percentage point. On February 24, the Fed hiked the publicly disclosed discount rate for good measure, and instructed bank examiners to discourage certain types of loans—a measure that would restrict real estate lending, exacerbating the crash in New England. Ignoring the warning contained in the Walker’s Point declaration, and discounting his colleagues’ anxiety about precarious S&Ls, Greenspan leaped from low-key, incremental tightening to an aggressive show of force. Unlike his mentor Arthur Burns, he was not going to be intimidated.
The paradox of February 1989 went unremarked by contemporaries. The Greenspan Fed had rejected a proposal to impose clarity on its doctrinal confusion—to replace gold targeting and money targeting with inflation targeting. But even as it rejected inflation targeting in theory, it was inching toward it in practice. At a time of maximum danger for the S&Ls, Greenspan was ready to raise interest rates. Price stability trumped financial stability.
• • •
George Bush swallowed the shock of three successive interest-rate hikes as calmly as he could, masking his annoyance behind jocular teasing. On March 6, 1989, when Greenspan celebrated his sixty-third birthday, he received a card embossed with the presidential seal. “Dear Alan, Happy Birthday!” it began. “May you have many happy returns and may all your days ahead be full of low inflation and yes low interest rates—long and short term.”43 Pressure applied jokingly could be jokingly shrugged off; and Greenspan kept the card appreciatively, filing it with various letters from Presidents Ford and Reagan. But if the Fed’s February tightening had its intended effect, the economy would cool and more S&Ls would fail. The message from the White House was likely to get sharper.
Two days after his birthday, on March 8, Alan flew with Andrea to London. They checked into one of the Marriott hotels—Alan’s commitment to upholding the integrity of the dollar extended to buying American. On Thursday and Friday, the couple fitted in a little time together between meetings, but the highlight came on Saturday. Alan was to see Margaret Thatcher, the bracing free-market icon he had met during the Ford years. When his audience with the prime minister was over, Alan and Andrea were to stay at the country home of Robin Leigh-Pemberton, the governor of the Bank of England.
A limousine arrived to fetch Greenspan and Leigh-Pemberton on Saturday morning. It headed northwest out of London, into the exurban countryside, arriving at the prime minister’s sixteenth-century country residence in time for lunch. Then entering her final eighteen months in office, Mrs. Thatcher was in the mature stage of her public life; and whereas Greenspan remained modest in his manner and increasingly moderate in his opinions, power had only magnified the prime minister’s Napoleonic demeanor. Over lunch and afterward, Mrs. Thatcher congratulated Greenspan for the Fed’s record on inflation, repeatedly turning to her own central bank chief to demand why he had failed to perform as competently. The hectoring continued well into the afternoon, and somewhere in the English countryside, Andrea sat imprisoned in a Bank of England car, circling aimlessly. Her driver was under instructions not to deliver Ms. Mitchell to the Leigh-Pemberton estate until the governor was in a position to receive her; and as the afternoon progressed, her hapless host evidently remained stuck in the prime minister’s clutches. Eventually, word came that Ms. Mitchell would be received by Mrs. Leigh-Pemberton alone, and Andrea was given tea and shown to her room—a room exclusively for her, as her nonhusband would sleep elsewhere. It was early evening by the time Greenspan and Leigh-Pemberton arrived. The Englishman headed straight to the drinks cabinet and poured himself a neat whiskey.44
In the second quarter of 1989, the Fed’s February tightening began to have its intended effect on the economy. Growth began at last to slow—in some places, abruptly. New England’s bubbly economy was hit hardest: with real estate prices no longer rising, construction workers could not find jobs, and debt-laden firms began to miss their payments. The Boston Globe detailed a dramatic rise in New England’s bankruptcy filings, and a go-go mortgage lender named Eliot Savings Bank, which had boasted during the boom years that it did “deals the other banks thought were crazy,” collapsed ignominiously.45 New Hampshire’s bankruptcy court was so overwhelmed that torrents of paperwork piled up in cardboard boxes stacked around the floors of the courthouse.
At first the blowback appeared limited. In early May, following the news that unemployment had risen, the CEA chairman, Michael Boskin, wrote to the president: “We need to be prepared to (quietly) nudge the Fed to ease if this slowdown is other than temporary.”46 The administration refrained from public attacks on the Fed; and thanks to the resolute February rate hikes, Wall Street commentators who had deplored the gun-shy chairman now sounded respectful. “I think Alan Greenspan is the best Federal Reserve chairman we have had in the postwar period, bar none,” one gushed. “If he gets us through this [period] with a soft landing—that is, with a slowdown in growth without a recession—I’ll underscore my comment.”47 Hoping to achieve such a soft landing, Greenspan cut the federal funds rate slightly in June and again in July. He had squeezed the economy enough to slow it down. Now he felt ready to resume easing.
On Friday, August 11, Greenspan headed off for a long weekend on Nantucket, where he stayed at the home of Senator John Heinz, ketchup heir and moderate Republican. Turning on the television to watch the Sunday morning talk shows, Greenspan saw Dick Darman, Bush’s budget director, on NBC’s Meet the Press. Darman had been James Baker’s deputy at the Reagan White House and later at Treasury; he was one of the smartest operatives in Washington, but not one of the most modest. By force of personality and intellect, he frequently eclipsed the amiable Treasury secretary, Nicholas Brady, whom one commentator dismissed as “the nice man serving as Treasury secretary until Dick Darman takes over.”48 Darman’s fans—foremost among them, Darman himself—agreed that he was shrewd, charming, and extremely funny. He was also lethal to be on the wrong side of.49
On this particular morning, Darman was gunning for Greenspan. The Fed, he suggested, “may have been a little bit too tight.” Then he added a warning. “If we do have a recession, I think it will be because they erred on the side of caution.”50
Greenspan was shocked. “What!?” he protested at the television screen.51 Raising the bogeyman of a recession seemed gratuitous; despite the slowdown in New England and the trouble at the S&Ls, nationwide growth was still running at a healthy rate of 3 percent or so. Nor did Greenspan need a lecture about high interest rates; he had already begun cutting them. Perversely, Darman was going to achieve the opposite of what he claimed to want. By agitating for a cut in interest rates, he would make it impossible for Greenspan to deliver without compromising the Fed’s independence.
Jack Kemp, by now installed as Bush’s secretary for Housing and Urban Development, scribbled a felt-tipped message to Darman. “D.D. You are the 1st ever to take them on! You’re right & I (we) thank you—J.K.”52 Then, realizing he had missed an opportunity for a football metaphor, Kemp fired off another note. “Dick—You’re the Q.B. who can lead us to victory! Don’t give up—Your ‘right tackle’ Jack.”53
Fearing that Darman’s example might encourage copycat attacks, Greenspan opened a correspondence with him, flattering the budget director by appearing to take his monetary ideas seriously. If Darman felt he had a private line to the Fed chief, he might be less likely to go public with his criticisms. But the challenge posed by Darman was not so easily contained. Greenspan soon found himself confronted by a fresh round of attacks—this time from inside his committee.
Nine days after Darman’s outburst, on August 22, Boston Fed president Richard Syron confronted his colleagues with more trouble from New England.54 The losses at the S&Ls were now spreading to the larger banks, setting off a vicious cycle. As New England’s lenders faltered, they extended fewer loans; fewer loans meant lower growth; lower growth meant yet more bankruptcies, which weakened the lenders further. The region was suffering the full force of a real estate hangover.55
“I may be stretching a point, but I think there may be a little lesson from the region,” Syron suggested in his strong Boston accent.56 Once New England’s bubble had burst, it had set off a chain reaction that no policy could halt. If this sequence repeated itself across the country, Greenspan’s hopes for a national soft landing could look quaint in hindsight. Cleaning up after an equity bubble was one thing. Cleaning up after a housing bubble might be quite another.
• • •
Two months after Syron sounded the alarm about housing, the Fed confronted another shock from the financial system. With the growth slowdown that summer, investors had begun to worry about junk bonds, the high-yielding debt used to finance corporate takeovers. On Friday, October 13, 1989, the jitters came to a head with the collapse of one of the largest leveraged deals of the decade, the $6.75 billion buyout of United Airlines. The collapse screamed out that the buyout boom was over. The Dow Jones Industrial Average ended the day down nearly 7 percent—a far bigger drop than it had registered on the Friday before Black Monday.
Wall Street’s warriors went home for the weekend, asking themselves what the next Monday would be like. The answer arrived sooner than expected. On Sunday morning the Washington Post and the New York Times quoted an anonymous “senior Fed official” who pledged, “Markets will be able to count on us to make sure the financial system stays liquid.” The Fed had apparently decided to rerun its old playbook from 1987. The markets would not be permitted to freeze up. There was no reason to panic.
Greenspan had no difficulty guessing the source of the news stories. On Saturday, Manley Johnson had suggested a liquidity pledge, arguing that the Fed should get out ahead of stock market instability rather than waiting for a meltdown, as it had in 1987. Greenspan had rejected Johnson’s pitch, objecting that there was no need to promise a safety net preemptively. Staging a rescue when all other options had been exhausted was one thing; conditioning investors to expect support at the first sign of trouble was quite another. Johnson had evidently ignored Greenspan and taken his case to the newspapers.57
Gerald Corrigan read the Sunday newspapers and called Greenspan from New York. As a veteran Fed official, Corrigan pronounced himself outraged; the leak shattered the Fed’s tradition of vigorous internal debate and limited external communication. Of course, the anonymous senior official was correct: if Monday brought a full-blown crash, the New York Fed stood ready to supply the markets with liquidity. But Corrigan did not like having his hand forced by news stories.
Greenspan overcame his normal aversion to confrontation, and let Johnson know that he was angry. He never heated up enough to raise his voice; he turned cold and icy. The Fed’s firepower was limited, he told Johnson; it was not to be wasted on panicky leaks to the newspapers. Besides, no central bank should train markets to assume there was a floor under equity prices; if speculators thought that the Fed had their backs, their bets would only grow wilder.58 By the end of his tenure, Greenspan would come to be remembered as the creator of the “Greenspan put”—a reference to the put options that traders buy to limit their potential losses. But in 1989, Greenspan was furious with Johnson for announcing such a put in public.
• • •
On the Monday following the minicrash, tourists and camera crews clustered outside the stock exchange like rubbernecking witnesses at some motorway disaster. “I feel like I’m watching a car accident,” said a twenty-four-year-old New Yorker waiting to get into the visitors gallery.59 Tan-coated sentries guarded the entrances to the stock exchange. Across the street, anarchist squatters from a nearby park carried placards that read: SELL TODAY, JUMP TOMORROW.
Greenspan watched the clock tick down to the market’s 9:30 a.m. opening. On the phone with him were the rest of the FOMC members, whom he had convened by conference call.
“One gets the impression of looking at a Cape Canaveral blastoff,” Greenspan joked. Then he turned serious.
“Those articles in the Washington Post and the New York Times yesterday were not authorized releases,” he said pointedly. “They were not done by myself nor anyone I’m aware of.”
Corrigan weighed in. The leaks were “undermining discipline in the marketplace.” They were “amateurish.” They “cut right at the very heart of the Federal Reserve,” he said menacingly.
Manley Johnson kept quiet, grateful that nobody was calling him out by name. Greenspan might have little stomach for confrontation, he reflected grimly to himself, but the pit bull from New York took care of that department for him. Still, Johnson could at least console himself that his policy would prevail. By speaking to the newspapers, he had created a fait accompli—thanks to the expectations he had stoked, the Fed felt compelled to supply more money to the markets.60 When the stock market opened, Fed intervention duly calmed investors’ nerves. Buoyed by the Manley Johnson put, Wall Street recovered.
Later that day, Greenspan went over to the Washington Post building, where he was met in the lobby by the newspaper’s Fed reporter, John Berry. Greenspan knew Berry well: of all the journalists covering the Fed, Greenspan gave the uncomplicated Berry most access, finding in him a useful means to get his message out to Congress and the markets. The two men rode the elevator to the executive dining room, where they were greeted by the Post’s proprietor, Katharine Graham. The grande dame of Washington society had befriended Greenspan, introducing him to Meg Greenfield, the Post’s editorial page editor, and to Warren Buffett, the famed investor and Post shareholder. Greenspan would sometimes go over to Greenfield’s house on the northern edge of Georgetown for parties; and every year after the Gridiron Club dinner—an elite Washington ritual that brought together media barons and public figures—he would team up with Warren Buffett to present his views on the economy to a select group of Post guests and advertisers. For a man who deplored his colleague’s leaks to reporters, Greenspan was remarkably cozy with the media.61
Sitting in the Post’s executive reception room, Greenspan assured Berry and his colleagues that the minicrash was behind them. But over the next months, the challenge of financial fragility persisted. Investors’ withdrawal from junk bonds exacerbated a larger problem: creditors of all kinds were scared of lending. Regional Fed presidents swapped stories of small businesses stymied by tightfisted banks; home builders were scrambling for funding; in February 1990, Drexel Burnham Lambert, the investment house that had pioneered junk bonds, collapsed, with the Fed resisting entreaties to save it. Amid this drying-up of credit, growth slipped to under 1 percent. The recession predicted by Darman began to seem all too possible.
• • •
By the spring of 1990, Greenspan’s record at the Fed was the mirror of his reputation later. After a brief period as the gun-shy chairman in the wake of Black Monday, he had emerged as the hard man who stood up to the White House and to the doves within his own monetary policy committee who wanted to cut interest rates. Greenspan had shown he could be hard on Wall Street, too, opposing the Manley Johnson put and allowing Drexel to go down without assistance. Critics who later scolded Greenspan for a monetary policy that enabled bubbles, and for a regulatory stance that permitted Wall Street to run wild, seldom reckoned with this early part of his tenure. Given the pressure from the Bush administration, the intellectual confusions about monetary policy, and the scary fragility of finance, Greenspan might have been expected to go soft—especially because the public had lost its appetite for the fight against inflation.62 But instead of buckling, Greenspan hung tough. He raised the discount rate on the eve of the Republican convention in the summer of 1988. He brushed off warnings from a popular new president by hiking the federal funds rate after Bush’s inauguration in 1989. And the following August, when the formidable White House budget director came after him on television, Greenspan adamantly declined to budge, even as New England’s bubble imploded and S&Ls failed across the nation.63
Seven years earlier, when Paul Volcker had been in the thick of the inflation fight, the Reagan administration had repaid him with whispers that he would not be reappointed. In March 1990, the Bush White House dealt with Greenspan the same way: an anonymous White House source confided to the Los Angeles Times that the Fed chairman would be gone when his term expired the next summer. Greenspan’s offense, the anonymous source specified, was his obstinate failure to cut rates—a failure that cruelly undermined a president who deserved better. The way the White House saw things, Bush had made the tough decision to clean up the S&Ls, a mess that he had not created. He did not deserve a monetary policy that drove more S&Ls under and raised the cost of the bailout, thereby expanding the budget deficit and forcing Bush to contemplate a tax hike that would undo the central pledge of his campaign—“Read my lips, no new taxes,” the candidate had promised famously. The LA Times quoted a “longtime” Bush adviser who confided that the president was “mad as hell” with the chairman. “I can’t believe he will reappoint him and I don’t know a soul in the White House who thinks he will,” the adviser declared bluntly.64
During the weeks after the press leak, Greenspan stood his ground firmly. Because he refused to bend on monetary policy, the cost of the S&L cleanup increased, and the budget deficit ballooned alarmingly. At the end of June 1990, the president invited congressional leaders to a breakfast in the White House family dining room; and after some intensive horse-trading, the outline of a deficit-reduction strategy emerged—some of the gap would be closed by cutting government spending, but there was no way around the need to raise more revenues from citizens. An aide scratched out a summary of the agreement on a yellow legal pad; soon the president’s three-word campaign centerpiece of “no new taxes” had fallen victim to 130 words posted on a bulletin board outside the White House press room.65 The president had been forced into a U-turn. He was ready to raise taxes after all.
The backlash was not long in coming. The Republican faithful who had worked for Bush’s election felt betrayed: “Read my lips: Bush blew it,” seethed a prominent conservative in the Washington Post. “This essentially guarantees a conservative challenge to Bush in 1992,” he added, anticipating a bruising contest in the upcoming Republican primaries.66 But Bush’s policy climbdown was momentous for another reason, too. Since the time of the Walker’s Point declaration, he had made a public show of taking on the Fed; yet now he was retreating ignominiously. Arthur Burns’s Belgrade lecture had been turned upon its head. Rather than the president’s forcing compliance from the central bank, the central bank had stood its ground, obliging the president to abandon his campaign promise.