Sunday, March 13, 2005

Greenspan should have removed the punch bowl

By Richard Siklos

The US Federal Reserve Board has a nifty policy of releasing minutes of its internal committee meetings five years after they happen. And so it was with tingles of nostalgia that I read through last week's release of the Federal Open Market Committee meeting chaired by Fed chairman Alan Greenspan and held on December 21, 1999.

What really stood out from the document were the comments of Fed staff economist Mike Prell, who voiced some alarm over the quality of companies that were then raising money in the scorching initial public offering market of the day.

In particular, he describes how the company VA Linux disclosed in its filings that it might never make any money, yet had just gained roughly 700 per cent on its first session of trading en route to a $9bn market capitalization.

"Not bad for a company that some analysts say has no hold on any significant technology," Prell tells the meeting. "The warning language I've just read is at least an improvement in disclosure compared to the classic prospectus of the South Sea Bubble era, in which someone offered shares in 'a company for carrying on an undertaking of great advantage, but nobody to know what it is'. But, I wonder whether the spirit of the times isn't becoming similar to that of the earlier period."

The meeting moved on with little comment from Greenspan on the subject. After all, at that point there were other matters of concern to discuss, like the looming Y2K bug. Besides, there was a New Economy at work, and the dotcom era was only beginning. It was around this time that the online brokerage E-Trade ran a TV ad depicting a doctor standing over a patient and declaring: "He's got money coming out the wazoo!"

We all know what soon happened. Five years ago this past Thursday, on March 10, 2000, the Nasdaq market zoomed to an all-time high at closing of 5,048.62. It had begun its ascent at less than 1,500 in 1997. Then the sell-off began, and continued for some two years. By June of 2002, the Nasdaq had deflated back down below 1,500 again, resulting in the evaporation of more than $9 trillion in value.

Today, the Nasdaq index has rebounded a little, nearly doubling from its lowest point to just above the 2,000 mark, but the glory days have faded into the distance. Tellingly, more than two dozen internet and telecommunications mutual funds tracked by Bloomberg have posted an average 19 per cent annual loss over the last five years.

Many of the biggest names of the bubble days - Cisco, JD Uniphase, Lucent and CMGI among them - can be bought for a fraction of what they once commanded. (In fact, Cisco was momentarily the world's biggest company by market value with a capitalization of $586bn. Today, Cisco is worth $119bn and the world's biggest company, having recently surpassed General Electric, is ExxonMobil with a value of nearly $388bn.)

A couple of the after-effects of the bubble's end remain curious. One is that it did not lead to any significant or lasting economic malaise in the US - even after the double-whammy of the September 2001 terrorist attacks. Rather, there was a slight recession and a slow recovery. This was of course the much-debated handiwork of Greenspan, whose decision to drop interest rates, from 6.5 per cent in May 2000 to 1 per cent by June 2003, flew wildly in the face of the tactics of previous Fed chieftains.

William McChesney Martin, the Federal Reserve chairman from 1951 to 1970, once famously said the central bank's role was to "take away the punch bowl just when the party gets going".

Greenspan's recipe called for more, tangier, punch. As a result, rather than feeling stung by the bubble's declines, Americans have been on a borrowing frenzy for the past few years. But instead of just buying unproven technology stocks, they've been pumping money into real estate, in a boom not unlike what the UK has experienced.

Indeed, what's notable in the US context is the degree to which housing prices are being driven by speculators - second homes now account for 36 per cent of all housing transactions in the US.

The second curious thing is that even the face of what happened, investors are not shy about pumping money into hot internet stocks; witness the meteoric valuations of such companies as Google, Yahoo, and Ebay, even after hitting some recent road bumps.

Although some economists now fret about the declining dollar the way they used to about soaring dotcoms, America's mood remains strangely upbeat.

The country may not be completely in denial. One big difference between 2000 and 2005 is the come-uppance that has been meted out on the CEOs, bankers and accountants who took unfair advantage of the mania.

Most recently, disgraced former Worldcom CEO Bernie Ebbers spent the week in a Manhattan courtroom waiting for the jury to return a verdict in his fraud case. It's not hard to shake the feeling that for all the blood and ink spilt in the bubble's aftermath, we're still trying to work out exactly what happened and whether it really, truly ended.

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