The Market Shaker

MacNeil/Lehrer NewsHour

December 6, 1996


"Irrational exuberance and unduly escalating stock prices." These seven simple words describing the stock market in a speech by the Chairman of the Federal Reserve, Alan Greenspan, sent markets around the world into a sharp downward spiral. Jim Lehrer takes a look at how this happened and the power that Greenspan wields.

KWAME HOLMAN: Last night in Washington, Federal Reserve Chairman Alan Greenspan gave a speech to the American Enterprise Institute, a Washington research organization. Two sentences sent the world’s stock and bond markets into an overnight downward spiral.

ALAN GREENSPAN, Chairman, Federal Reserve Board: How do we know when irrational exuberance has unduly escalated asset values which then become the subject of unexpected and prolonged contractions as they have in Japan over the past decade. And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy.

KWAME HOLMAN: Greenspan’s comments about irrational exuberance and unduly escalating stock prices came after the New York stock exchange had closed, but traders around the world were just starting their day. In Japan’s market, the first to open, traders interpreted the Federal Reserve Chairman’s comments to mean that stocks in the U.S. market were overvalued and that, in response, the Federal Reserve might raise U.S. interest rates, thus affecting markets everywhere.

STEVE HANNAH, Global Markets Economist: Certainly, the Japanese markets took his comments with a vengeance. We saw very aggressive selling of markets in the Asian centers, and that continued into Europe, where we saw very steep falls in the equity and bond markets there, but, nonetheless, the atmosphere remains very nervous.

KWAME HOLMAN: The Japanese stock market plunged 3.2 percent, its largest drop this year, and the tailspin didn’t stop there. Hong Kong’s market fell almost 3 percent. In Frankfurt, the German market fell 4 percent. In London, traders finished the day losing 2 percent of their market value. And when the New York Stock Exchange opened at 9:30 this morning, the market plunged 145 points, or about 2 percent, within 30 minutes. But by the end of the day, the Dow Industrial Average recovered substantially, regaining 2/3 of its lost value but still down 55 points.

JIM LEHRER: Now two perspectives on all of this. Owen Ullmann is a senior news editor in the Washington bureau of “Business Week” Magazine. He’s been reporting on the Federal Reserve for 18 years. David Jones is the chief economist at Aubrey Lanston & Company, a securities firm in New York. He wrote a book about Alan Greenspan and the Federal Reserve. Owen Ullmann, how in the world does something like this happen, just--Alan Greenspan makes a speech here in Washington and a few hours later, those folks are selling stocks and all hell is breaking loose in Tokyo. How does that happen?

OWEN ULLMANN, Business Week: It’s really in a matter of minutes, Jim, not hours. We have instantaneous communication. We have markets that are open around the world constantly some place. Alan Greenspan’s words are followed very closely by everyone. He makes a comment. There are plenty of financial news wires that report it immediately. There is a stock market immediately that picks it up in Tokyo or Singapore and Hong Kong. Traders panic; they say something important has happened, the Fed Chairman spoke, and they act on it, often irrationally.

JIM LEHRER: Who told them this was bad news? I mean, how did they know--how did they know to interpret what Greenspan said as a reason for selling stocks?

OWEN ULLMANN: Well, I’m not sure they interpreted it properly. If you listened to the chairman, who likes to be very obtuse and not really say what he means or he thinks, he asked a question. He didn’t answer the question. He simply asked, basically he asked a question that’s been on everyone’s mind for the last month. Has the U.S. stock market risen too fast, too far? Is it headed for a fall? But he didn’t answer it. But what he did say is, should the market correct, and fall somewhat, there’s no need for the Fed to step right in. So I think he was doing two things. I think, one, he was trying to suggest that maybe the market is running too far ahead. On the other hand, he said, don’t look for us to raise interest rates or do something about it right away. But I think people are so quick to act on the information, Jim, that without really stopping to think what he might have said and meant, they wanted to trade and make some money.

JIM LEHRER: And how do they make money, if the market’s gone down?

OWEN ULLMANN: Well, traders make money on the change. It doesn’t matter whether the market goes up or down. It’s the transactions, as one trader used to tell me. There’s always a buyer. There’s always a seller, and the bigger the spread and the more the action, the more the traders make money. So they want volatility. The investor obviously wants stability and wants the market to always go up, but the traders want something else.

JIM LEHRER: They don’t care either. As long as people are buying and selling, they’re happy.

OWEN ULLMANN: They get their commission.

JIM LEHRER: All right. Now, it started in Tokyo. Then there was a chain--nobody made an independent judgment on what Greenspan said. They were reacting to the first reaction, then to the second and the third, is that essentially what happened?

OWEN ULLMANN: Well, I think as it sank in, you could almost say that as they moved toward time zones, to market zoning up in the U.S., they started to stop and think what happened, because in Tokyo and in Hong Kong, the market fell much more than in London or the U.S. I can’t explain the big fall in the German stock market, but the U.S., after the market fell about 2 percent, as your reporter noted, by the end of the close, it had fallen less than 1 percent, because people realized that the U.S. economy is fundamentally sound, that the Fed is not going to raise interest rates right now any time in the near-term, and that the stock market, while it has been rising rapidly lately, has not gotten into a speculative fever, at least not yet.

JIM LEHRER: Now, David Jones, you are experienced at watching Alan Greenspan and listening and parsing his words. He’s known as a man who doesn’t say anything accidentally. Do you think he intended this exact result when he spoke last night?

DAVID JONES, Wall Street Economist: (New York City) I certainly think so, Jim. Those key words that were eluded to earlier in the show--irrationally exuberant--are two classic Greenspan words--admit he’s worried about speculation in the stock market. He didn’t have to convince himself that it was actually here and actually I don’t think anyone knows exactly at any given moment precisely how much of the stock market is based on pure speculation, how much of the stock market is based on fundamentals of moderate growth, with inflation in check and a lot of savers buying stocks which, in essence, have been major factors driving the market. But I would simply say, if you look back over the last six or eight weeks and look at any stock market chart, those prices looked like they were going up to and into orbit. They were going straight up. And I think Chairman Greenspan felt that--he was actually looking ahead---he felt that if the stock market did move into a period of a speculative binge, we might end up with stock prices so high that it would close off Greenspan’s options let’s say six to twelve months from now if he has to, for example, tighten to cool off inflation next year. No one knows for sure whether he’ll have to, but if he would have to, if the stock market were subject to excessive speculation at the time, it could crash. And so what he wanted to do was keep his options open, looking ahead into next year.

JIM LEHRER: But I’m intrigued by the idea, David Jones, that the chairman of the Federal Reserve would choose some words, and are you suggesting that he thought, okay, a few minutes from now they’re going to react in Tokyo, and then they’re going to react in Hong Kong, and then they’re going to react in Frankfurt and London, and then the Dow Jones is going to do all--I mean, he--he--I won’t say plotted this--but he expected this?

DAVID JONES: Well, he certainly was trying to change psychology. Actually, I don’t think even he knew how much speculation was built into the market, but, by the way, I would observe on the basis of today’s action that we really had somewhat more speculation in those foreign markets, both stocks and bonds, too much money moving in too fast, than we had in the U.S. markets, and I think in some ways, this was a test of those markets. We’ve had a lot of money created by the Bank of Japan, a lot of money created by the German Bundesbank in Europe. And that money has moved into some speculative action. So what he wanted to do, what Chairman Greenspan was really trying to do, was change psychology. He said, look, we’re getting a little bit one-sided in the market, prices are only going up in stocks, I just want to cool it off, make it a two-sided market, where people are a little bit uncertain as to which way it’s going to go for a while.

JIM LEHRER: But what I’m trying to get at is this, David, that it’s one thing for the Federal Reserve to lower interest rates, raise interest rates, do things. Now, here he took action with words. What I’m trying to get at is: Was he consciously taking action? I mean, he wasn’t changing psychology. He was also doing something by saying a few things last night in a speech in Washington, D.C..

DAVID JONES: But it was halfway action. I would call it jawboning. I agree with Owen. Chairman Greenspan is in no way ready to start tightening. The economy is in basically good shape, but the one thing he’s worried about is the markets were getting overheated both in the U.S. and elsewhere, and what he wanted to do was to use rhetoric, in a sense. It’s a halfway action. Let’s call it that, Jim, and sort of--not cause a crash--not cause the markets to collapse, but just cool them down a little bit, so that--so that we can keep this expansion going, and if inflation does pick up a bit next year, the chairman still has the option, if he has to, to give us a mid-course correction, which is a tightening move, without causing a crash in markets that were too speculative.

JIM LEHRER: Not more words but then in that case, it would be action. Owen Ullmann, you agree that Alan Greenspan knew exactly he was doing last night?

OWEN ULLMANN: I think he thought he knew exactly what he was doing, but I’m not sure that Alan Greenspan is quite as adept at trying to manage the stock market--

JIM LEHRER: All over the world.

OWEN ULLMANN: --as he is at monetary policy. We actually found out this evening in some reporting, what might have led up to this comment, which is two days ago, Greenspan and the rest of the Fed board met with some outside advisers in preparation for one of their interest rate meetings, and they included three major brokerage houses from Wall Street, and they asked a question that’s not usually on the agenda: Is the stock market overvalued? And what’s interesting is among the three major houses, there was disagreement about whether stocks in the U.S. really are overvalued, but there was complete agreement that if there was a correction, say a 10 percent or more drop, they do not think it would harm the U.S. economy. So I think Alan Greenspan chose his words very carefully and didn’t make a statement but raised, again, the rhetorical question, are we seeing a rational behavior here as a way, as David pointed out, to gently jawbone the markets to say hey, we’re keeping an eye on you, we’re getting concerned, we’re not saying we’re concerned yet, but you might be getting, you know, too high, too fast, but the markets also know that he is not prepared to back up that action by taking moves to raise interest rates.

JIM LEHRER: Is it correct to say, David Jones, that there are--there are no words from any other individual possibly in the world that mean more to people like you and others who work on Wall Street than the chairman of the Federal Reserve?

DAVID JONES: I was thinking about that today, Jim. I don’t think even the President could have shaken the markets. Obviously, he’s more worried about foreign policy at the moment. But Chairman Greenspan in this regard is clearly the second most powerful person in our government, and the reason is that the Federal Reserve has the flexibility in terms of changing policy, the independence, in essence, to move fairly quickly, if it feels it’s appropriate.

JIM LEHRER: Unlike the President who has to go to Congress and get a law passed and do all that sort of business and worry about public opinion, the Federal Reserve can just do it?

DAVID JONES: Precisely. The Fed does have to worry over time about Congress and public opinion, but if Alan Greenspan got up on the wrong side of the bed on Monday morning and decided to tighten credit and push interest rates up, he has the power, assuming he can bring along his fellow policy makers, which I certainly would assume, to make a difference. And I think it’s that kind of power--and I also think in global markets as soon as any central bank leader starts talking about tighter labor markets or irrationally exuberant stock market, there’s almost a presumption that he will at some point do something. As I say, I think he’ll wait a while before he does

JIM LEHRER: Owen, has there ever been a case quite like this before--you’ve been covering the Federal Reserve for 18 years--where a Federal Reserve chairman said something in a speech--I’m not talking about action now, just made some comments, and there was this kind of reaction all over the world so quickly?

OWEN ULLMANN: Not quite with a Fed Chairman, but if you go back to 1987, the stock market crash then, it was triggered by comments that then Treasury Secretary James Baker made about the value of the dollar versus the mark. And a lot of people thought that that statement--

JIM LEHRER: Refresh our memory on that.

OWEN ULLMANN: Well, that’s when back in 1987, the stock market fell I think over two days about 25 percent. Now compare that to less than 1 percent today. That was a panic. And people looking back believe it was triggered by comments that the Treasury Secretary made about the value of the dollar versus the mark. The market had been rising very rapidly, and that caused a full scale panic. What’s interesting is it never seemed to have a major impact on the U.S. economy at the time, and, in fact, the market soon--I think within about six months or so--recovered that ground. Alan Greenspan made a statement at the time, saying, we’re prepared to do whatever necessary to prevent any major financial crisis, and that helped provide some reassurance. I’d say that that is closest to where policy makers, if not the Fed chairman, had a major impact through their words on financial markets.

JIM LEHRER: Well, thank you very much, Owen Ullmann and David Jones, for being with us.

Copyright 1996 MacNeil/Lehrer Productions. All Rights Reserved.