The Greenspan Put

Alan Greenspan became Chair of the Federal Reserve System in August 1987, beginning an eighteen-year reign. Two months after he took over, on October 19, the Dow Jones suffered a one-day crash of 22.6 per cent; the largest one-day loss in history. The Federal Reserve took unprecedented action on Tuesday, October 20. Those interventions came to be known as the Greenspan “put”.

As central bankers and economists meet in Jackson Hole this week watch the speeches for a hint that the thirty-year legacy of the Greenspan “put” has run its course.

I remember coming into work very early on Tuesday morning, October 20, after a sleepless night, wondering if the market would open. The previous day stockbrokers had handled a flood of calls from clients who wondered if they’d lost everything. Most investors took no action on the Monday as markets were swamped with sell orders and traders were frozen with fear.

And selling would have been a big mistake.

Early Tuesday, before the market opened, the Federal Reserve called the banks and told them to lend money freely to the brokerage firms. This stopped brokerage firms from selling shares into a falling market.

And Chair Greenspan issued this press release, at 8:41 a.m.:

“The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

This support was the start of the Greenspan “put”, referring to the central bank’s new role as supporter of stock market prices. Participants came to believe that if their losses were too large, the Fed would ride to their rescue. After Greenspan left the Fed in 2005 it became the Bernanke “put” and survives to this day as the Yellen “put”.

But it was out-of-character for Greenspan to act this way, based on past views. According to biographies he was a devout follower of free-market principles and regular attendee at weekly gatherings held by Russian-born philosopher/novelist Alisa Rosenbaum, known as Ayn Rand. Rand is famous as the founder of the “objectivism” school of thought and writer of novels like “Atlas Shrugged”.

Here’s an example of her beliefs:

“According to objectivist precepts, taxation was immoral because it allowed for government appropriation of private property by force”

President Gerry Ford, Alan Greenspan (centre) and Ayn Rand (second from right) circa 1975 – Photo Source: Gerald R. Ford Presidential Library

Most observers feel that Rand’s opinions were too radical for a mainstream central banker like Greenspan. And apparently he overcame that early indoctrination, acting quickly and forcefully as a neophyte Fed Chair on behalf of big government. Markets are still enjoying the effect of his precedent-setting actions today.

Here’s how the Federal Reserve historical record describes it:

“Black Monday led to a number of noteworthy reforms, including exchanges developing provisions to pause trading temporarily in the event of rapid market sell-offs. In addition, the Federal Reserve’s response set a precedent for the central bank’s use of “liquidity” to stem financial crises.” (Emphasis added)

That quote refers to “financial crises” but there was no evidence that the 1987 rout would have resulted in a financial crisis.

On that dark October day in 1987 Greenspan saved the stock market from a nasty spell of declining prices but he might have accidentally triggered an attitude among speculators means that governments are going to be responsible forever for rescuing speculators from the consequences of their own greed.

If Ayn Rand hadn’t passed away in 1982 it seems likely that she would have been disappointed by the big government intrusion into the “free” market.

 

Hilliard MacBeth

 

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