"Greenspan Is Highly Overrated"

BusinessWeek economist Bill Wolman says the Fed chairman was right to warn of irrational exuberance -- and dead wrong to ignore it

If the U.S. were a weak South American country, the International Monetary Fund "would be here beating us over the head and recommending that nobody lend us any money until we cut our government deficit." And Federal Reserve Chairman Alan Greenspan is "highly overrated."

Those are two of the more provocative statements from William Wolman, longtime economist for BusinessWeek. Wolman worries about the impact of both the federal budget and trade deficits on the economy and the markets -- especially in view of the out-year tax cuts in the Bush tax bill. And he thinks that Greenspan is at fault for not doing something to control the market bubble after his warning of "irrational exuberance" in 1998.

Wolman sees a stagnant market and slow economic growth ahead. For now, he urges conservative investing in high-dividend stocks, utilities, regional banks, REITs, and particularly TIPS -- Treasury inflation-indexed securities.

These were among many comments Wolman made in a chat presented Aug. 6 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. A complete transcript is available on AOL at keyword: BW Talk.

Q: Even in only a week, there have been wild movements up and down -- happily, up today. Can we relax for a minute?


It's hard to say. But the fact is that it was a reversal on low volume, seemingly tied to the expectation that the Federal Reserve will cut the fed funds rate. I think that expectation is probably legitimate. But don't get too excited. The Fed already has cut rates by 4.75 percentage points. And they don't have much room to repeat the trick without Japan-ing the American economy.

I think that the hopes for a revival sparked by easier money are, at best, weak hopes. The U.S. is a country that spends $1 billion a day more abroad than foreigners spend in the U.S. That means that there are pressures on the Fed to moderate its rate cut. I noticed, for example, that Canada has raised its federal bank rate over the past month. And Europe is still reluctant to cut. So there are definitely limits here.

Q: Why so much volatility in the last two weeks? When do you foresee this market volatility ending?


The volatility is a common characteristic of bear markets, and particularly during periods when bear markets are trying to rally. As compared to the past, volatility is high right now because of the role of derivatives and the activities of hedge funds. The bulls get all excited when volatility increases, because historically that has been a sign of a market bottom. And though I'm a great believer, with Mark Twain, that although history does not repeat, it does rhyme, I think that volatility tells us a lot less now than it used to in the past, before the hedge funds and the derivatives were so prominent.

Q: Here's the multibillion-dollar question: Have we bottomed out?


My general position is that the market will be relatively stagnant this year, not moving much from current levels, except in a trading range.... However, if I had to choose between a strong rally and a further decline, I'd go in the latter direction. To me there's about a 20% chance that the Dow will look 6000 in the face sometime later this year.

Q: What sectors do you like for the balance of this year?


I like high-dividend stocks. I like utilities, I like regional banks. And I like REITs. As you see, my taste is for conservative stocks that pay high dividends.

Q: Is 4000 a reasonable target for the Dow in the next five years, considering that we are in a secular bear market?


I sure hope not. Professor Robert Shiller of Yale, author of Irrational Exuberance and the guy who's really gotten the market right, thinks that 6000 is where the market is going. That's why I say there's a substantial possibility that the market will go to 6000. But even Shiller is not talking about 4000.

Q: Given deficit spending for the foreseeable future, how do you see it affecting monetary policy and markets?


In the short run, it doesn't bother me much. But I associate myself with the view, not popular in Republican circles, that the out-year tax cuts in the Bush tax bill pose a substantial danger to the economy.

The potential deficit in the long run is a potential problem. The real issue for the U.S. is the twin deficit -- in the government budget and in the balance of trade. If the U.S. were a weak South American country, the IMF would be here beating us over the head and recommending that nobody lend us any money until we cut our government deficit. As has often been said, we are lucky to be Americans.

Q: Do you think Greenspan is likely to stay at the Fed? If not, is there a good replacement in sight?


I think Greenspan is highly overrated. The dumbest thing he ever did -- and there's lots of competition -- was not to follow up on the "irrational exuberance" warning that he stole from Shiller in 1998, when the Dow was at 6400.

Even Paul Volcker would have recognized that it is the role of a central banker to warn of financial excesses before they get out of control. So I think that Greenspan bears part of the responsibility for the bubble that is now causing so much pain. As for a replacement, anybody's guess is as good as mine. This Administration being what it is, my guess is that it would be John McTeer, now president of the Dallas Fed.

Q: What is the effect of the "401(k) hoax" on the private accounts for Social Security?


First, let me express my heartfelt thanks for mentioning the book, The Great 401(k) Hoax [of which Bill is coauthor with his wife, Anne Colamosca]. My own guess is that the recent performance of the market makes it highly unlikely that we will see private Social Security accounts over the next few years. That suits me just fine.

There's a lot of ferment in Washington now, in which I'm quite frankly participating, about needed pension reforms. There are a couple of things in Senator Sarbanes' bill limiting the use of company stock in pension plans. But reform must go a lot further than that.

Q: Do you attribute the [market] downturn to the economy or to corporate fraud?


Take one from group A and one from group B, and also add in international tensions, which are a real problem. It's kind of interesting that periods that have followed stock market bubbles in the past have been associated with international tension and war. We all know what happened after the 1929 crash in Europe. But we sometimes forget that there was a stock market bubble in the U.S. that broke in 1966 and was followed by almost 20 years of stock market stagnation. And the breaking of that bubble, of course, was associated with the escalation of the war in Vietnam...

Q: Comment on this, Bill? Some so-called market strategists suggested that bear markets have lasted some 14 years after bubbles break.


That's right. One of my most vivid memories of my years as a journalist was a story I wrote in the Jan. 26, 1966, issue of BusinessWeek, which was entitled The Market Seeks a New Millennium, meaning that the Dow was looking as though it would break 1000. It took me 16 years to be right. The point, of course, which I didn't recognize at the time, is that once a bubble breaks, the effect historically has been very long-lasting in limiting stock market gains.

Q: Here's another multibillion-dollar question -- are we heading into a double-dip recession?


I don't think so. But I do think that economic growth will be very slow, at least until the middle of next year. I would also make a point, which makes me very unpopular, that it is not clear to me that we're really out of the original recession because most of the swing in GDP has been an inventory swing.

Q: Bill, is it true that an economist can be wrong for 30 years and still keep his job?


The answer to that question is that I've been wrong for a lot more than 30 years, and I've kept my job for a lot more than 30 years.

Q: Do you think there is going to be a movement to go back to the old-type pensions?


That is really interesting. I've been doing a lot of reading of things that have been sent to me since I co-authored The Great 401(k) Hoax. Interestingly, there is already some slight movement back to the defined-benefit pension plans. There also is a movement toward certain kinds of hybrid plans, which combine features of both defined-benefit and defined-contribution pension plans. And perhaps most interesting of all, there is a movement in some states, particularly the state of Washington, to have 401(k)s administered by a state government agency, which would give them some of the advantages of defined-benefit plans. There is something of the same kind going on in Nebraska.

Q: Hey! Nobody is answering the question about how long this downturn will last and what to do NOW.


The answer is to invest very conservatively. One thing I really like are the inflation-indexed bonds, issued by the government [TIPS, or Treasury inflation-indexed securities], which pay a little under 4%, plus a cost-of-living adjustment. That means you can get over 6% on your money on a federally guaranteed bond.

Q: Bill, are you still a member of the Flat Market Society?


The answer is yes! Unfortunately, the flat market will now occur deep in a volcano. I will defend my flat market forecast of the turn of the year by simply saying that it was way better than the forecasts of most other people, who were very bullish at that time.

Q: What do you think GDP will be next year? For that matter, for the rest of this year?


Well, as a member of the Flat Market Society, I must contemplate a flat economy. So I would guess the growth rate will be somewhere between 1% and 2% in the second half.... I think that growth will accelerate some, maybe to 2.5%, from the fourth quarter of 2002 to the fourth quarter of 2003. There just is not enough energy in the tech sector for me to expect much more. It's also extremely important to realize that one effect of the accounting woes is to change the kinds of rate-of-return calculations that go into capital-spending decisions for the worse....