Like the statues of dictators, investment icons have been toppled one by one since the stock market peaked in 2000. Chief executives, once lionized by their shareholders, are now often viewed withmistrust. Stock analysts who were once Wall Street’s equivalent of rock stars are now seen as carnival barkers. But through it all, Alan Greenspan, the chairman of the Federal Reserve Board,generally kept his deity status. Not long ago, one lawmaker predicted that Greenspan would be remembered as the greatest central banker of all time. Even after years of falling stock prices, the Fedchairman was a man many investors still found worthy of worship. But last week, the bowing and scraping seemed to have stopped. From Washington to Wall Street, deep skepticism was emerging instead.When Greenspan visited Capitol Hill for his regular testimony on monetary policy, it was not the usual lovefest. He was questioned sharply by some lawmakers apparently tired of waiting for theeconomic recovery that he has regarded as imminent for almost two years now. Some of the hostility was politically motivated. Most of the toughest questioning came from Democrats and an independent;they expressed concerns about burgeoning deficits, rising unemployment and low interest rates for savers. But the hectoring, nonetheless, represented a significant shift. On Wall Street, Greenspan’scomments prompted a sell-off in Treasury securities, pushing up interest rates significantly. Stocks also fell. Bond traders did not like his tepid promise, made in his first day of testimony, tokeep monetary policy accommodating as long as necessary. Indirectly, he made it clear that the minute the economy picks up, rates will rise. And some traders noted how odd it seemed that he hadmentioned nothing about deflation, a popular Fed topic recently. Jawboning about deflation by Fed officials helped propel interest rates to their lows in mid-June. Doug Kass, a hedge fund manager atSeabreeze Partners in Florida, said the reactions from both Washington and Wall Street were a watershed.
Greenspan has now officially lost the confidence of the bond market, Kass said. Market participants are now going to begin questioning past-cycle and current-cycle policies by the Fed.
Greenspan said the bond market’s move indicated that traders, too, saw signs of an economic recovery. But some bond traders disputed this assessment and said the move showed the market’s concern over rising trade and budget deficits and the inflation risks that will result from the Fed’s ballooning of the money supply. By driving rates so low, Greenspan has created two manias, one in bonds and one in real estate, Kass said.
The Fed has been unwilling to accept a normal business cycle, he said. It’s relying on extending overvalued assets in order for consumption to be continued at very high levels.
Now, interest rates are rising, threatening an economy kept moving only by heavily leveraged consumers. For example, homeowners’ equity as a percentage of their real estate holdings is at 55.2 percent, according to Federal Reserve figures. In 1982, homeowners’ equity stood at 69.9 percent. Homeowners have been taking equity out of their homes and spending it. If mortgage rates rise, home prices will fall, driving down this equity stake even further.
Once you start down this path of not letting the destructive side of capitalism work, you build a bigger and bigger edifice so each time you’ve got to bet the ranch to make sure it doesn’t collapse. said Bill Fleckenstein, head of Fleckenstein Capital in Seattle. Everyone has believed for at least 5 or 10 years that Greenspan could wave his magic wand and fix any problem. When people start to turn on him, that’s when the music finally stops.
