Inside the Mind of Alan Greenspan

How Do You Get To Be a Guru?

On Jan. 31, 2006, Greenspan, 79, plans to retire. That day will mark the end of his 14-year term as a Fed governor and the midpoint of his fifth four-year term as chairman. Soon after President Reagan nominated him in August 1987, the stock market suffered a 508-point drop in a single day. It was the worst one-day fall since the crash that led to the Great Depression in 1929.

Fed watchers say Greenspans savvy engineering of interest rates and the money supply limited the damage caused by the crisis. He went on to preside over the longest modern-day surge in the U.S. economy, which lasted most of the 1990s.

But some critics complain that Greenspan failed to prevent the "irrational exuberance," in his famous words, that led to the dot-com bubble and its collapse in March 2000.

With the GDP barreling ahead at 4% in the first quarter of 2005, and Greenspan raising the Funds Rate by just another .25% on March 22, some Fed watchers are questioning whether Greenspan is once again letting the economy grow too fast. And last month, Senate Minority Leader Harry Reid (D-Nev.) called Greenspan "one of the biggest political hacks" for backing President Bushs recent economic initiatives such as the privatization of Social Security.

The next Fed chairman, nonetheless, will be judged against Greenspans insights and instincts. Though the successor wont share Greenspans brain, he or she will have the same intelligence system: a network of some 500 economists at the Fed and its 12 reserve districts who will continue to analyze more than 1.5 million points of economic data via Sun Microsystems Solaris and Red Hat Linux servers.

Its a hard-to-replicate knowledge management system involving both humans and computers. Corporate leaders can only dream of having such an asset at their disposal.

Congress created the Federal Reserve in 1913 as a fail-safe bank to the banks. Its job was to accept other banks deposits, make overnight loans to them and issue coin and currency. Today, it also processes 18 billion inter-bank checks each year.

Its most public role—Greenspans role—is to set monetary policy.

The chairman regulates the supply and price of money to achieve three primary goals: maximize economic growth, advance employment and control inflation.

To achieve those objectives, he has a powerful set of tools. For starters, he can raise or lower interest rates, by ripple effect, throughout the country by adjusting either the Federal Funds Rate or the Discount Rate.

The Federal Funds Rate is the price commercial banks charge each other to borrow federal money overnight. The Discount Rate is the price the 12 reserve banks charge commercial banks to borrow funds on a daily basis.

By directive, Greenspan also can increase or decrease the amount of money banks lend by raising or lowering the amount of money they are required to hold in reserve against outstanding loans and investments, something known as the "reserve requirement." In effect, if a bank is required to hold $20 of each $100 it receives in a deposit, it can lend 80% of its deposits. If it must hold only $10, it can lend $90, which increases the amount of money in use.

Separately, Greenspan can manipulate the supply of money in the economy by selling or buying government securities such as Treasury bills.

Greenspan decides which tools to wield from an elaborate two-story boardroom in the center of the Federal Reserve building on Washingtons Constitution Avenue.

On meeting mornings, like Feb. 1, Greenspan enters this room from his attached office and seats himself at the side of the 27-foot mahogany table. He prefers to be seen as participating in the discussion rather than leading it.

Still, attendees know who is in charge.

Greenspan arrives at these meetings with his mind largely made up, according to Laurence Meyer, vice chairman of private forecasting firm Macroeconomic Advisers and a Fed governor from 1996 to 2002.

The chairman knows what he wants to do, such as raise the Funds Rate, and has already drafted the statement the Fed will issue after the meeting.

Greenspan is guided by the advice of six governors, named to 14-year terms by the presiding U.S. president. The governors and the 12 reserve bank presidents each get an opportunity to speak, usually for about five minutes. But unless the majority strongly disagrees with the chairmans views, Greenspans plan will be approved.

Meyer says Fed board members do debate. But the assumption is that everyone will vote with Greenspan at the end of the meeting. Perceived dissension at the Fed could shake confidence and set off financial-market chaos, he explains. A split vote would cause uncertainty in the markets about exactly where the Fed was headed—to higher or lower rates.

"The committee doesnt want to fracture consensus," he says. "You never like to surprise markets."

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Indeed, the Fed chairman does not give interviews, fearing his words could affect stock markets worldwide.

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