Stop Putting Words in Greenspan's Mouth
Among the many factors that sent the stock market
tumbling last week was Fed Chairman Alan Greenspan's speech Thursday night to a
conference sponsored by the Office of the Comptroller of the Currency. (I'm
assuming that's the United States' Comptroller of the Currency, though I'm not
really sure what the comptroller of the currency, as opposed to a comptroller
of a company, does.)
Greenspan's speech, which dealt with the "fundamental
sources of risk" and the limitations of the traditional risk-management models
financial institutions use, did not spook an already nervous stock market
because anyone actually read or listened to the speech. It spooked the market
because Greenspan mentioned the reality of market panics, and because he linked
"Dutch tulip bulbs" with "Russian equities." God only knows what would have
happened had he mentioned "tulip bulbs" and "Internet stocks" in the same
phrase.
Greenspan didn't make that connection, but a lot of
outside observers did, leading to the inevitable conclusion that, in his
typically oblique way, the Fed chairman was trying to talk down stock prices in
general and Internet stock prices--which, though not quite as gaudy as they
were back in April, are still pretty hefty--in particular.
This is the wrong conclusion. Although Greenspan did
speak to the idea that investors are starting to see stocks as not much more
risky than bonds (an idea associated with the authors of Dow 36,000 --see
Slate
's "Crapshoot" for a critique of this idea), the real focus of his
speech was something much broader, namely the way financial panics tend to
eradicate the delicate distinctions between different classes of assets,
distinctions that any market system needs in order to invest for the
future.
The two most striking things about financial panics, at
least in the modern economic world, are that they happen more often than one
would expect in a normal (bell-curve-shaped) distribution of events, and that
when they happen, they tend to spread rather than remain localized. What
Greenspan was arguing was that we have to take these considerations into effect
when we think about managing risk in the future. Specifically, he said, banks
have to set aside "higher contingency resources--reserves or capital," and
recognize the limits of the models they're using. Panics can't be anticipated,
after all. That's what makes them panics.
Now, you might say that this speech should have spooked the stock market, since the Fed chairman was
saying that sudden crises of investor confidence can descend without warning.
But that is something we all knew already. More to the point, saying a crisis
can descend without warning is not the same as saying that it can descend
without causes. Talking about the current stock market as a bubble without
taking into account the extraordinary performance of corporate America--which
Greenspan himself cited in his speech--is to treat all episodes of investor
confidence as identical. They aren't.
More important, Greenspan's real point was that there
are few safe havens once a financial crisis starts. Last year, for example,
during global crisis, investors flocked to the 30-year Treasury bond but were
totally unwilling to buy the 29-year bond, even though the difference in risk
between the two assets was presumably minimal. In that sense, saying that
stocks are riskier than bonds because the stock market could crash is wrong. If
crashes determine risk, then there are very few assets that you can really call
safe. In that sense, if Greenspan was trying to talk down the stock market, he
was trying to talk down all markets. Which I think tells us that he wasn't
trying to do anything of the sort. His message was a simpler one: Be more
careful than you think you have to be.
