President Bush yesterday renominated Alan Greenspan for a fifth term as head of the Federal Reserve's Board of Governors. The news that the 78-year-old patron saint of the 1990s bull market, whose current term expires in June, will have another 18 months at the helm didn't cause much of a ripple on Wall Street.
In fact, the pre-appointment hoopla was much more of a Washington than a Wall Street story. Would Bush fils exact revenge by not appointing the man who was allegedly not sufficiently accommodating during Bush père's 1992 re-election campaign? By waiting until the last minute, Bush seemed to be playing a game of chicken with the central banker. Were Bush operatives subtly leaning on the insecure central banker to keep interest rates low by withholding renomination? The theory of such political gamesmanship is weak. It would require an economic team that has difficulty with simple arithmetic outmaneuvering the infinitely wily Greenspan.
What's more, Greenspan has never required much pressure to do the administration's bidding. First, he abandoned his long-term stance as a deficit hawk to endorse tax cuts based on surpluses that he had to know were nonexistent. He has made only the most perfunctory complaints when the administration and its congressional allies systematically destroyed the nation's balance sheet. And he proved enormously accommodating by slashing the Federal Funds Rate to historically low levels—it's been at 1 percent since June 2003.
Indeed, Greenspan's stubborn insistence on keeping the interest rates he controls ultra-low explains why the market largely shrugged at his reappointment. In recent months, the Maestro has lost a lot of his juice with investors. A central banker who can no longer cut interest rates—the gift for which investors and financial service companies are always hoping—carries less weight and inspires less affection on Wall Street.
Many of those worried about the long-term direction of the economy have also turned on Greenspan—not because he's going to raise rates, but because he has failed to do so. CNBC talk-show host and National Review columnist Larry Kudlow wrote last week that supply-siders "have every reason to be concerned that the Fed has waited too long to rein in unusually easy money." Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., took to the Wall Street Journal op-ed page to complain that Greenspan's Fed is behind the curve because it uses the wrong data to assess inflation risks.
The market seems to agree. The Federal Reserve controls interest rates by manipulating the Federal Funds Rate, the rate at which banks can borrow money from each other overnight. These short-term rates influence long-term rates, which dictate what people pay for mortgages, car loans, and longer-maturity bonds. But the daily activity of investors placing bets, and of consumers, companies, and governments borrowing money, also heavily influence long-term rates. Greenspan, fearing deflation despite signs of inflation, has kept the short-term rate he controls static for nearly a year. Meanwhile, the market, fearing inflation amid signs of inflation, has pushed long-term rates sharply higher. The rate on the 10-year Treasury bond has risen from 3.65 percent in mid-March to 4.78 percent today—an increase of more than 30 percent. Greenspan will almost certainly raise rates in June by 25 or 50 basis points. But because the markets have already raised longer-term rates substantially, his move will be anticlimactic. And Greenspan's move will likely be the first of several—the market is predicting a Federal Funds Rate of about 2 percent by the end of 2004.
For much of his tenure, Greenspan has been credited with an Olympian mastery over the markets, a preternaturally superior understanding of the economy, and an ability to engineer soft landings. (See under: Woodward, Bob, The Maestro.) But in the past few years, Greenspan has received a lot of ex post facto criticism for not doing more to choke off the speculative frenzy in stocks earlier than 2000. And in what may be a manifestation of the Feiler Faster Thesis, some observers are already indicting Greenspan as the villain of the housing bubble, even though that hasn't popped yet.
Greenspan's commitment to low interest rates ushered in an era of cheap money, in which Americans took on massive amounts of new debt to buy houses, cars, and vacations. And many believe the reckoning—a credit bust—is just around the corner. James Grant, the acerbic editor of Grant's Interest Rate Observer, wrote in the New York Times on Sunday that the Fed has a "guilty conscience" because "It knows that its 1 percent rate drove many risk-averse people into stocks and bonds because they could no longer afford to live on the meager returns of their savings." Peter Eavis, a sharpcolumnist at TheStreet.com,agrees. He relishes the prospect of extending Greenspan's reign only because "there is a very high chance that the 78-year-old Greenspan will be around to deal with his own mess."