Appointed chairman of the nation's central bank just two months before the stock market crash of 1987, American economist Alan Greenspan (born 1926) acted quickly to avert a general financial collapse.
Alan Greenspan was born in New York City on March 6, 1926, to Herman H. and Rose G. Greenspan. His Bachelor's (1948), Master's (1950), and Ph.D. (1977) degrees in economics were all earned at New York University. For three decades, 1954-1974 and 1977-1987, he was chairman and president of an economic consulting firm in New York City, Townsend-Greenspan & Co., Inc. His distinguished record during this time is reflected by his elections as chairman of the Conference of Business Economists, president of the National Association of Business Economists, and director of the National Economists Club.
His career in the private sector was interrupted by calls to public service, first as chairman of President Ford's Council of Economic Advisors (1974-1977), then as chairman of President Reagan's Commission on Social Security Reform (1981-1983), as well as several other presidential boards and commissions. These included President Reagan's Economic Policy Advisory Board, and a consultant to the Congressional Budget Office.
Career With the Federal Reserve System
Greenspan assumed his most important public position on August 11, 1987, replacing Paul A. Volcker as chairman of the Board of Governors of the Federal Reserve System (the Fed). The Fed seeks to control the creation of money and to influence key interest rates, thereby controlling fluctuations in prices of financial market assets, such as stocks and bonds. Perhaps most important among the Fed's responsibilities is to provide temporary loans (through the so-called "discount window") to banks and other financial institutions in times of need. This "lender of last resort" function was the primary reason the Fed was created by Congress in 1913, since individual bank failure had often spread to other banks, leading to a general financial market collapse.
Less than two months after assuming office, Greenspan was faced with such a financial market crisis. After peaking at 2,722 in August of 1987, the Dow Jones industrial average (an index of 30 major industrial stock prices) floated downward by 17 percent over the next month and a half. Suddenly, on "Black Monday," October 19, the market collapsed by more than 500 points as terrified sellers dumped millions of shares. Falling stock prices automatically triggered millions of additional sale orders owing to computerized program trading. Buyers that had previously bought stocks "on margin"—borrowing some portion of the purchase price using the stock as collateral—were then subject to margin calls and forced to provide additional collateral when these stock prices fell. Many of these stock holders were thus also forced to sell.
What consequently resulted was the largest one-day drop in stock prices in U.S. history, with over 20 percent of the New York Stock Exchange wealth evaporating overnight. The securities firms (brokerage firms and dealer-brokers) that as middlemen provide for orderly trading in stocks on the New York Exchange were hard-pressed to find operating capital as Black Monday wore on, particularly when major domestic and foreign banks withdrew their loans as the alarm spread. The financial system neared collapse from a lack of ready cash (a "liquidity" crisis). Many other financial institutions would have faced insolvency had the market continued to drop the following day.
Acting quickly, Greenspan met with top Fed officials and mapped a strategy for easing the cash crunch, using the Fed's virtually unlimited reserves to bolster the troubled financial institutions. Before the market opened on Tuesday, October 20, Greenspan announced the Fed's "readiness to serve as a source of liquidity to support the economic and financial systems." With the full force and power of the Fed backing these institutions, fear of a general collapse receded and the Dow-Jones industrial average rebounded with a rally of over 100 points on that day.
Incidentally, the bull market of the "Roaring Twenties" had collapsed on October 29, 1929, with again the Fed, acting through the New York Regional Federal Reserve Bank, providing needed short-term liquidity to stop the financial panic from spreading to other sectors of the economy. In contrast to 1987, however, the Crash of 1929 foretold and contributed to a long-term economy-wide collapse. This was partially due to infighting over monetary policy at the Fed, which allowed the money supply to fall by a third over the period from 1929-1933 and which contributed to banking panics that led more than a fifth of the nation's banks to suspend operation.
Yet Greenspan's worries were far from over. On the inflation front, he found cause for considerable alarm. The federal budget deficit had swollen to $221 billion by 1986 and was exerting a powerful inflationary effect on the macroeconomy. While the deficit stabilized at around $150 billion for the remainder of the decade, the collapse of many federally-insured savings and loan institutions was obligating the government to pay out many hundreds of billions of dollars more in the future. The overall effect was to raise interest rates, thereby supplanting spending for capital investment in the private sector. Thus future supply productivity might be hampered at the very time demand was increasing.
Reappointed Despite Differences
Having weathered the financial market panic of 1987, Greenspan sought to send a clear signal that the fight against inflation was now his top priority. This meant slowing the growth of financial reserves that add to the money supply, which, when spent, put upward pressure on prices. Thus the Fed is faced with the dubious task of fighting unemployment (by expanding reserves) and simultaneously fighting inflation. His four-year term as chairman expired in 1991. However, President Bush announced that he would reappoint Greenspan to another term, although the recession caused tension between them.
In 1996, Clinton also reappointed him, despite different financial policies. Greenspan has been criticized for raising interest rates at the first sign of inflation even when the economy has been slow and unemployment high, whereas Clinton believed in strong economic growth, even if it meant a small rise in inflation. Since interest rate hikes mean fewer businesses take out loans to expand, and therefore fewer jobs, the 1996 reappointment surprised many. On April 6, 1997 Greenspan married NBC reporter Andrea Mitchell.
He had also served previously as a member of TIME magazine's Board of Economists and senior advisor to the Brookings Institution Panel on Economic Activity. In addition, Greenspan served as corporate director to numerous banks and manufacturing companies, including J. P. Morgan (the nation's fourth-largest commercial bank) and Alcoa (the nation's largest aluminum company). His honorary degrees were numerous, including those from Wake Forest, Colgate, Hofstra, and Pace, and he was the joint recipient with Arthur Burns (a Fed chairman in the 1970s) and William Simon (a former treasury secretary) of the Thomas Jefferson Award for the Greatest Public Service Performed by an appointed official, presented by the American Institute for Public Service (1976).
Further Reading on Alan Greenspan
General discussion of the Fed's operating procedures are outlined in U.S. Board of Governors, The Federal Reserve System: Purposes and Functions. For an inside look at the workings of the Fed, see William Greider, Secrets of the Temple: How the Federal Reserve Runs the Country (1987). Greenspan's views on inflation are given in Weapons Against Inflation (1979). As Greenspan is always making new decisions regarding interest rates, there are numerous articles to be found in periodicals such as Business Week and Money. For a good comprehensive work on his career, see Robert Sherrill "The Inflation of Alan Greenspan", The Nation (March 11, 1996). For a brief look at the differences in the philosophies of Greenspan and Clinton, see Owen Ullmann "Clinton and Greenspan: Is an Explosion Coming?", Business Week (June 6, 1994).
Fascinating discussions of the Crash of 1987 are found in" Terrible Tuesday: How the Stock Market Almost Disintegrated a Day After the Crash," Wall Street Journal (November 20, 1987) and Frederic S. Mishkin, Money, Banking, and Financial Markets (1989). The most famous monetary scholars of the Great Depression are Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (1963), but for a more readable classic account, see John Kenneth Galbraith, The Great Crash, 1929 (1955).