Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market"(Aucontrarian.com, 2009)
On January 7, 2011, Kelly Evans of the Wall Street Journal interviewed former Federal Reserve Chairman Alan Greenspan. He rooted for the stock market.
Greenspan's circular logic was unenlightening: "Stocks are cheap if earnings are to continue higher." Taken as a whole, this does not mean much, akin to prophesizing: "The Red Sox will win if they score more runs than the Tigers." Greenspan's successful impoverishment of the American people often hinged on the suppression of his dependent clauses: "Stocks are cheap," was all we needed to know.
Greenspan also revealed the (purported) economic recovery is hostage to a bigger and better stock market bubble. He did not put it that way. Interviewer Evans pestered the deaccessioned relic into a defense of the current Fed's market-rigging policy. The former central banker denied any such collusion, but did claim: "The stock market overall is the only type of stimulus that you can get into the economy that doesn't have any debt associated with it." There may never have been greater debt associated with the stock market than in 2011. That, after all, is how it stays up.
Gluskin, Sheff economist David Rosenberg celebrated the new year by publishing some unnerving charts. Margin debt at U.S. broker/dealers has risen 24% over the past year. The hand wringing about atrophied bank lending is a narrow view. A broader investigation shows that commercial banks' trading assets surged $64 billion in December, 2010. UBS Prime Brokerage Services reported on January 12, 2011, that hedge funds have increased their leverage to within 10% of the peak in 2008. Since the bottom (when Lehman Brothers surrendered), gross leverage at hedge funds is up 43%.
A favorite destination for releveraging is stock mutual funds and ETFs - they received $24 billion in net flows in December, 2010. This does not even account for the far greater leverage during buying sprees of S&P 500 futures contracts, the domain of the banks and hedge funds. The institutions have plenty at stake. They took the Fed at its word. ("[H]igher stock prices will boost consumer wealth and help increase confidence..." - Fed Chairman Ben S. Bernanke, November 4, 2010)
The Fed is doing its best to fulfill institutional confidence with its current money-pumping program (QE2). The bulge-bracket brokers compensate for Federal Reserve lapses by raising S&P 500 futures prices when the market flags.
It is this symbiotic relationship that lies beneath Greenspan's confident stock market forecast, an inevitable conclusion after listening to his other reasons to buy stocks, all of which are often associated with an impending crash:
GREENSPAN: "We've had an extraordinary rise in profit margins. This is coming to an end." That may seem to contradict the rationale for his "stocks are cheap" analysis, and it does. Greenspan was never a model of cogency.
The following exchange was of the same quality:
GREENSPAN: "[W]e are going on the assumption that long-term interest rates will stay down. We don't know that...We are in the position we were in 1979....There were no inflation fears, then, within three to four months, we went up 400 basis points [i.e., 4 percent].
EVANS: "Do you think something like that could happen again?"
GREENSPAN: "I think it's a danger."
Inflation had been 12% in 1974 and 9% in 1978, so the leap to 13% inflation in 1979 was not difficult to imagine, except, apparently, to the man who had led the President's Counsel of Economic Advisers from September, 1974 to January, 1977.
My own view is in accord with Greenspan's. Interest rates could very well jump 4%, but, this time it could take 15 seconds. The government-sanctioned machinery that now operates the stock, bond, commodity, futures, foreign exchange, and executive-pay markets is even more susceptible to a miscue than was true when the Greenspan Put assured investors the Nasdaq would never fall below 5,000. (That great unwinding receives its due in Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession.) Should interest rates revert to a proper level, it may take an additional 15 seconds for the stock market to follow.
It is no wonder that after the interview, Business Insider choose as its headline: "Alan Greenspan Sees a Huge Chance of a Bond Collapse, While Lashing Out at His Critics." As to the second half of Business Insider's headline, the incoherent scolding of his critics was pathetic. The less said about it the better.