To understand why Greenspan seems to have changed from investors’ guardian angel into a financial devil of sorts, you’ve got to understand what he’s saying–and what he’s not saying. He says his problem with soaring stock prices is that they’ve generated a “wealth effect” that has increased consumer spending at a faster clip than production has risen, threatening to set off an inflationary spiral. His unspoken intent, I think, is to prick what he considers a stock-price bubble caused by excessive speculation. And bubble busters know that the earlier you get out your little needle, the less damage the collapse of the bubble causes. The horrible example is Japan’s “bubble economy” of the 1980s. When regulators finally pricked the bubble of insanely high land and stock prices, the economy tanked and still hasn’t recovered. Greenspan doesn’t want to go down in history as America’s bubble boy.
But Greenspan has no direct control over stock prices. He controls short-term interest rates, which influence the economy. But this affects stock prices only indirectly, by raising companies’ borrowing costs and holding profits below where they’d otherwise be. The lower profits, in turn, are awarded a lower valuation by analysts, who discount projected future profits to today’s value. Do the math: at 5 percent interest, a dollar of profit three years from now is worth 86.4 cents today. At 7 percent, it’s worth only 81.6 cents.
But the companies whose wildly speculative stocks are driving the Nasdaq market and causing the bubble–if one exists–don’t borrow much money. They raise their money by selling stock. And their stock prices aren’t based on profits, actual or projected. They’re based on hype, perceived potential and momentum. It would take massive economic pain to drive these puppies down.
The great mystery is why Greenspan hasn’t attacked speculation directly by raising initial margin requirements. Margin is the amount of money you can borrow from a brokerage house to add stock to your portfolio. Currently it’s 50 percent, which means you can borrow $500 for each $1,000 of stock, although some brokerage houses have more stringent rules. The Fed, which controls margin rates because of a historical accident, hasn’t changed them since 1974. Increasing the margin rate to 100 percent, which would completely eliminate borrowing to finance new purchases, would send a powerful message. Not to mention trashing some ultraspeculative stocks whose price moves are influenced by day traders, who typically borrow heavily.
Greenspan has said repeatedly that raising margin rates would hurt only small investors, because big investors have plenty of ways to get around margin requirements, such as dealing in stock options or futures rather than owning stock directly. My feeling, though, is that Greenspan is also looking out for the well-being of brokerage houses, which make huge profits on margin loans. And imagine the weeping and wailing if he trashed a bunch of Nasdaq stocks by changing margin requirements.
There’s now speculation in Washington that the Fed may change margin requirements. But even if it doesn’t, expect Greenspan’s war on stock prices to continue. This will make the market more perilous–and interesting–for the next few months. And remember, there’s no such thing as a safe stock. As witness last week’s collapse of Procter & Gamble, whose stock value fell $36 billion–31 percent–in a single day when it announced profits far lower than it had led Wall Street to expect. And remember that even as Nasdaq soars, former leaders like Microsoft and MCI WorldCom are down substantially for the year.
So put not your faith in Alan Greenspan. He will step up to bail out the financial system of the United States or the world, as he’s done any number of times since becoming the head Fed in 1987. But if your stocks go bad, he’s not going to bail you out.
