Greenspan History via WSJ

Here’s a fascinating look at "The Maestro" via the lens of the WSJ, circa 1987:

·

Fed Jolt: Nominee Greenspan Shares Volcker’s Goals But Not Yet His Clout 

· On the Spot: Stock Market’s Frenzy Puts Fed’s Greenspan In a Crucial Position

· Fed’s New Chairman Wins a Lot of Praise On Handling the Crash

 

Change at the Fed

Fed Jolt: Nominee Greenspan Shares Volcker’s Goals But Not Yet His Clout

Reagan Choice Is Stout Foe Of Inflation and Deficits, Skilled Political Operator
No Cheering by Supply-Siders
PAUL BLUSTEIN
THE WALL STREET JOURNAL, June 3, 1987
http://online.wsj.com/article/SB112403855089412600.html

WASHINGTON — In a surprise move, President Reagan announced yesterday that Paul Volcker had declined a third term as the chairman of the Federal Reserve Board and that he would nominate Alan Greenspan to replace him as the chief of the nation’s central bank.

By picking Mr. Greenspan, who headed the Council of Economic Advisers under President Ford, Mr. Reagan signed on a man who comes as close as anyone to enjoying Mr. Volcker’s credibility in financial markets. The 61-year-old economist is expected to generally pursue policies on inflation, interest rates and economic growth that may appear almost indistinguishable from Mr. Volcker’s.

Even so, Mr. Greenspan faces a daunting challenge in proving to the financial markets that he is a worthy replacement for the outgoing Fed chief. The bond market, reacting to the news that Mr. Volcker won’t stay on, took its worst pounding in years. The dollar also plunged yesterday against all major currencies. The stock market, however, ended only modestly lower, apparently banking on the notion that the Fed’s policies won’t change significantly. The commodity markets, sensing a possible resurgence of inflation, rose sharply.

"Volcker is sort of a financial demigod, and it’s hard for anybody who’s new to develop that stature," notes Robert Hormats, a vice president of Goldman, Sachs & Co. As for Mr. Greenspan, Mr. Hormats adds, "The markets are going to feel him out."

The new Fed chief also will face political pressures. Some Republicans think that Mr. Greenspan may be more accommodating politically during next year’s presidential campaign. A former top Reagan administration official says Mr. Greenspan will probably be "a shade" less likely than the 59-year-old Mr. Volcker to tighten credit and drive up interest rates while the Republicans are trying to retain the White House.

Moreover, Mr. Greenspan, who currently heads the New York economic consulting firm of Townsend-Greenspan & Co., will head a diverse seven-member board that has shown it no longer automatically follows the chairman’s lead.

But Mr. Greenspan is known as a skilled political operator — even more so than Mr. Volcker, who is widely admired for his political acumen. In 1983, Mr. Greenspan gained praise for his role in helping forge a compromise to shore up the Social Security system. He was also one of two men — the other was Henry Kissinger — who negotiated on former President Ford’s behalf at the 1980 Republican Convention when Mr. Ford was seeking the No. 2 spot on the GOP ticket.

Mr. Greenspan undoubtedly recognizes that his worst political mistake would be to appear a lackey of the White House. Jerry Jasinowski, the chief economist of the National Association of Manufacturers, says Mr. Greenspan may be forced "to out-Volcker Volcker," at least at first, by adopting a tough anti-inflation policy aimed at bolstering the dollar and his own credibility. Volcker associates, predicting that Mr. Greenspan will try to mold himself in the Volcker image, hailed the nomination.

"I think it’s an excellent appointment, and I think there will be very little change in direction as a result of this," says Frederick Schultz, who was the Fed vice chairman from 1979 to 1982 and remains a close friend of Mr. Volcker’s. At the Fed, a senior official says that despite disappointment over Mr. Volcker’s pending departure, "I think the reaction is that Greenspan is probably the best choice outside the Federal Reserve System that could have been made."

Traditional Republican politicians also praise the choice. Senate Minority Leader Robert Dole says the "country is very fortunate to have a man of Alan Greenspan’s character" to replace Mr. Volcker. But supply-siders, who oppose high interest rates because they would slow economic growth, are considerably less enthusiastic. GOP Rep. Jack Kemp of New York says he was "disappointed" that Fed Vice Chairman Manuel Johnson wasn’t picked. And supply-side publicist Jude Wanniski calls the Greenspan appointment "the worst decision to come out of the Ronald Reagan White House," saying that Mr. Greenspan "is one of the ringleaders of the austerity gang."

And Mr. Greenspan does have a reputation as a stern foe of inflation. In the Ford administration, he strongly supported the Fed’s tight-credit policies despite the deep recession those policies helped engender in 1974 and 1975. He told this newspaper in March 1976: "The cost of being wrong in overstimulating the economy is far greater than the costs of being wrong in understimulating."

More recently, Mr. Greenspan has been an outspoken backer of Mr. Volcker, often echoing the Fed chief’s warnings about the dangers of a precipitous decline in the dollar. Speaking of Mr. Volcker at the White House yesterday, Mr. Greenspan said: "Under Paul’s chairmanship, inflation has been effectively subdued. It will be up to those of us who follow him to be certain that those very hard-won gains are not lost. Assuring that will be one of my primary goals."

In a striking endorsement of Mr. Volcker’s policies, Mr. Greenspan added: "There are very few people in this profession who are more impressive than he and who seem to do the right thing at the right time almost every time."

And Mr. Volcker, in turn, lavishly praised his designated successor, saying that he was "very happy" that Mr. Greenspan was going to take over the board.

The announcement of a change of leadership at the Fed comes at a delicate time. The plunge in the dollar earlier this year is forcing the Fed to put a high priority on defending the greenback lest foreign investors pull their funds out of the U.S. and precipitate a financial crisis. To attract foreign funds, the Fed has nudged up interest rates in recent weeks despite continued weakness in the domestic economy.

Mr. Greenspan has publicly supported some of the remedies that Mr. Volcker favors — especially cutting the federal budget deficit, an action that both men believe would reduce U.S. reliance on foreign funds. In fact, Mr. Greenspan was quoted as saying on Feb. 11 that "the long-run solution is almost surely going to mean increasing taxes." President Reagan hotly disputes that view.

But although Mr. Volcker and his successor see eye to eye on most issues, some of Mr. Greenspan’s recent statements have diverged from the Fed chief’s. On one sensitive matter, for example, Mr. Greenspan was quoted on May 27 as predicting that the dollar "will be significantly lower" in the long run. That assertion contrasts with the statements of Mr. Volcker, who has avoided saying anything that might depress the dollar.

Analysts speculate that Mr. Greenspan is likely to change his tune on the dollar now that he is headed back to an official capacity. Asked yesterday at the White House whether the dollar has bottomed out, Mr. Greenspan replied: "There’s certainly evidence in that direction." He declined to answer further questions about monetary policy, noting that he expects to be quizzed closely at his Senate confirmation hearing. (Democratic members of the Senate Banking Committee vowed yesterday to question Mr. Greenspan extensively at his confirmation hearing, but it seems unlikely that the Senate will block his nomination.)

On monetary policy generally, Mr. Greenspan clearly shares Mr. Volcker’s pragmatic approach of tightening and easing credit based on a variety of factors — the money supply, interest rates, foreign-exchange rates and other indicators of growth and inflation. Under Mr. Volcker, this approach came to be known as "the Volcker standard" because its credibility — unlike other approaches, such as the gold standard — depended heavily on the Fed chief’s personal stature and judgment.

Now, the question is whether a "Greenspan standard" will prove as successful. One problem that Mr. Greenspan will face will be to unite the other Fed governors around his policies. Mr. Reagan has appointed several supply-siders to the seven-member board, and they have loosened Mr. Volcker’s once-iron grip over Fed policy. Mr. Greenspan might be even less able to control the other Reagan appointees and will have to take time to gain their confidence, as Mr. Volcker has done.

Mr. Greenspan, who speaks with assurance and possesses a dry sense of humor, has excellent relations with the press. He is a bachelor and has dated several female journalists, including, in past years, Barbara Walters. In contrast to the aloof Mr. Volcker, Mr. Greenspan enjoys socializing and has been known to relax at parties by playing the piano; he also played tenor sax and clarinet in the Henry Jerome orchestra, sitting next to Leonard Garment, who later became White House counsel and who now is a Washington lawyer.

Although he is a follower of Ayn Rand, the late philosopher who fervently advocated freeing capitalism from government constraints, Mr. Greenspan gets along well with politicians of both parties. In 1979, for example, Mr. Greenspan was one of the first people consulted by Sen. Edward Kennedy as the Massachusetts Democrat was launching his unsuccessful bid for the presidency.

By all accounts his consulting business has been very successful, although not all his private ventures have gone well. Mr. Greenspan was a principal at Greenspan O’Neil Associates, a pension fund management concern founded with $2 million of Hollywood talent-agent Marvin Josephson’s money back in September 1984, but the firm folded earlier this year.

Mr. Greenspan will be able to draw authority from his popularity in financial markets — which, though clearly not as great as Mr. Volcker’s, is considerable.

Richard Hoey, a Drexel Burnham Lambert Inc. economist who frequently conducts polls about the Fed, says Mr. Greenspan "has always been No. 1 or No. 2 since 1983" in surveys asking Wall Streeters who could best replace Mr. Volcker. The one person who sometimes ranked higher in the surveys was E. Gerald Corrigan, the president of the Federal Reserve Bank of New York and widely considered a Volcker protege, "and the general view was that Corrigan didn’t have a serious chance," Mr. Hoey says. "So Greenspan was No. 1 among those believed to have a reasonable chance."

But in global monetary affairs, "Greenspan is a totally unknown quantity," says Dimitri Balatsos, a London-based economist with Kidder, Peabody & Co. "Volcker also has a good rapport with his central-bank counterparts around the globe, which Greenspan clearly lacks."

Treasury Secretary James Baker dismissed the markets’ sour reaction to yesterday’s announcement. "I really believe that when the market focuses on . . . the outstanding qualifications of the successor to Chairman Volcker that you won’t see that kind of activity continue for a sustained period of time," Mr. Baker said.

On Capitol Hill, reaction was mixed. House Speaker James Wright, a Texas Democrat, said Mr. Greenspan "would not have been my choice. One day, we’ll have a Federal Reserve chairman whose primary interest is in keeping interest rates low." Democratic Sen. William Proxmire of Wisconsin, the chairman of the Senate Banking Committee, lamented the loss of Mr. Volcker, saying, "We’re going to miss him, miss him very much," and adding that he needs "to take a long, careful look at Alan Greenspan" before deciding whether to support his nomination.

But Senate Majority Leader Robert Byrd, a West Virginia Democrat, said Mr. Greenspan "is a man of considerable knowledge and experience." And Senate Finance Chairman Lloyd Bentsen, a Texas Democrat, said the president had made "a good appointment."

At the White House yesterday, Mr. Greenspan acknowledged that he faces a tough task. "Trying to fill Paul Volcker’s shoes," he said, "is going to be an extraordinary challenge."

~~~~~~~~~~~~~~~~~~~

After the Crash
On the Spot:
Stock Market’s Frenzy Puts Fed’s Greenspan In a Crucial Position
He Must Aid the Economy But Not Fuel Inflation;
Is Tax Rise Now Possible? Reagan’s Bipartisan Stance
ALAN MURRAY
THE WALL STREET JOURNAL, October 21, 1987

WASHINGTON — The stock market’s Monday collapse has put
Federal Reserve Chairman Alan Greenspan on the front line in the fight to
prevent a market panic from turning into a general economic slump.

Just a few days ago, Mr. Greenspan was under pressure from
the financial markets to increase interest rates and prove his willingness to
fight inflation. But by yesterday, the focus had changed dramatically. After
Monday’s unprecedented market crash, traders and analysts were calling on the
central bank to ease credit to avoid recession.

"I think Greenspan is the only candidate for restoring
the confidence of the markets," said Jerry Jordan, the chief economist at
First Interstate Bank Corp. "It’s the chairman of the Fed, when it comes
down to it, who pulls the levers."

Whether Mr. Greenspan is up to that task remains to be seen.
He tried to calm markets yesterday with a one-sentence statement signaling the
Fed’s switch from an anti-inflation to an anti-recession policy. It said:
"The Federal Reserve, consistent with its responsibilities as the nation’s
central bank, affirmed today its readiness to serve as a source of liquidity to
support the economic and financial system."

The Federal Reserve quickly backed up its statement with
action, driving the federal funds rate down to about 6 3/4% late in the day
from more than 7 1/2% Monday. "I think that speaks for itself," said
a senior administration official when asked if the Fed had eased credit. The
federal funds rate, the interest rate banks charge on loans to each other, is a
sensitive measure of the tightness of monetary policy.

The central bank’s response seemed to soothe the worst fears
troubling the markets. After swinging around wildly all yesterday, stocks ended
higher. The Dow Jones Industrial Average ended with a record gain of more than
100 points — a sharp contrast with its record 508-point plunge on Monday. And
for the second day in a row, the bond market surged, largely fueled by money
drained out of stocks. The higher bond prices meant lower interest rates, of
course, because the two move inversely to each other.

The Fed’s statement "was the most calming thing that
was said yesterday," said James E. Annable, the chief economist of the
First National Bank of Chicago. "The Fed is aggressively creating
liquidity in the market, and that’s what you want now."

Although an adequate supply of funds in the market and the
economy is important, the challenges facing the Fed over the coming weeks are
immense. If the Fed doesn’t do enough to bolster the economy, the stock-market
collapse could quickly drag down other areas of the economy. And if the Fed
primes the pump with too much money, it risks a collapse of the dollar and
renewed fears of inflation.

"We know how to prevent economic downturns," says
Benjamin Friedman, a Harvard economist. "But I’m not sure we know how to
prevent them without causing inflation."

Mr. Greenspan, who had been scheduled to make a speech in
Dallas yesterday, canceled it and rushed back to Washington. He spent much of
the afternoon closeted with Treasury Secretary James Baker and White House
Chief of Staff Howard Baker, discussing how the administration should respond
to the market collapse.

But the administration’s ability to respond is limited. Even
White House officials acknowledge that public confidence in President Reagan
has been severely eroded in recent months and won’t easily be restored.

"The Bork defeat showed markets very clearly that
President Reagan is a total lame duck who doesn’t have the power to control
events," one White House aide admits. "It’s hard to see what Reagan
can do, unless he can come up with something pretty dramatic."

Most analysts believe that a concerted effort by the
president and Congress to attack the federal budget deficit could calm market
fears. The president opened the door to such a grand compromise yesterday. In
an announcement made after conferring with Mr. Greenspan and the two Mr.
Bakers, the president abandoned his harsh anti-tax rhetoric and called for
"bipartisan" negotiations with Congress.

Nevertheless, continued partisan squabbling leaves the
outcome of any such talks in doubt. And meanwhile, the monkey is on Mr.
Greenspan’s back. "I think the response is going to have to come from the
Federal Reserve," says Sen. Nancy Kassebaum, a Kansas Republican.
"It’s unfortunate. We let the Fed solve our inflation problem in the early
1980s. Now, we’re going to be looking to the Fed again."

But it isn’t clear just how much the Fed can do in the face
of huge budget and trade imbalances, which require the U.S. to keep its
interest rates high enough to finance the twin deficits. "People have been
trying for years to tell Congress and the administration that eventually the
budget deficit will put the Fed in a position where it doesn’t have any options
left," says former Fed Governor Lyle Gramley. "Well, it’s there now.
It’s a no-win game."

In the efforts to restore market confidence, administration
officials have emphasized that the economy’s "fundamentals" remain
sound. That was certainly true last week. Employment looked strong, inflation
was low, and consumer spending and investment were holding up reasonably well.

But the market’s nose dive could change those fundamentals
substantially. In just a week, the market has wiped out — on paper — nearly a
trillion dollars of wealth. Among those who were hard hit, that is likely to
damp enthusiasm for spending money on houses, cars, furniture and appliances.
And lower stock prices will hobble businesses trying to raise the money needed
for capital investment.

More important, the plunge in stocks could produce a severe
psychological effect. "Even if you’re not directly affected, it may make
you hesitant, cautious, pessimistic," says Thomas Juster, a University of
Michigan economist and an expert in consumer spending. "If you were on the
edge of making a decision to buy something, you are likely to say, ‘Maybe I
should wait and see where the dust settles.’"

And Harvard’s Lawrence Summers notes that any businessman
"thinking about starting a building project or ordering an expensive
machine has to think to himself: ‘Let’s wait and see how things shake
out.’"

To counter those forces, "the Fed should be
easing," Mr. Summers says. The mistake made in 1929, many economists note,
was that the central bank held its tight grip on credit for too long and thus
turned market panic into depression.

"The next move on the part of the Fed should be a
lowering of the discount rate, when the opportunity is right," agrees
Irving Auerbach of Aubrey G. Langston & Co. Last month, the Fed raised its
discount rate — its rate on loans to member banks — to 6% from 5 1/2%.

Fed Governor Wayne Angell acknowledged yesterday that the
stock-market plunge could suggest the need for an easier Fed policy.
"Declining stock markets tend to add to people’s preferences for
liquidity," Mr. Angell said. "That can move quite easily into a
deflationary force. What’s appropriate for us to do is make certain we supply
the amount of money people may wish to hold in such an environment."

But an easier credit policy carries serious risks. With
unemployment below 6% and many businesses operating near capacity, inflation
could easily accelerate. Moreover, easier credit in the U.S. — if not matched
by easier monetary policies abroad — could depress the dollar and threaten the
administration’s dollar-stabilization agreement with other industrialized
countries.

"The effects of this decline in stock prices are going
to be negative, and perhaps sizably so," Mr. Gramley says. "But if
the Fed were to begin anticipating negative effects and start easing monetary
policy, it risks being misunderstood and thus worsening the crisis of
confidence. The Fed has to sit tight, let the smoke clear, assess what the
damage is and then respond as conditions become more clear."

Harvard’s Mr. Friedman contends that the stock-market drop
could force the Fed to abandon efforts to defend the dollar. "The point
is, the dollar is going to have to come down sooner or later," he argues.
"To resist that in a climate in which the economy might be weak would be
especially foolish."

Robert Hormats of Goldman, Sachs & Co. agrees. "I
think we have gotten ourselves locked into a syndrome where everybody thinks
that any fall in the dollar is a catastrophe," he says. "But it’s not
highly inflationary if the dollar falls a little bit in a controlled manner. In
fact, with the stock market falling, that creates a deflationary climate, so a
dollar drop would certainly not be inflationary."

Despite the pitfalls, Fed officials hope to negotiate the
risky waters ahead without slowing growth or sparking inflation.

"When you go back through U.S. history, you find there
are some kinds of market volatility that have less impact and some that have
long-lasting effects," Governor Angell says. "Certainly, we’ve had
stock-market movements that did not have deep or long-lasting effects on the
real economy. That’s our job — to insulate the economy from these
forces."

Ultimately, the Fed’s ability to hold the economy together
in coming months could depend on Mr. Greenspan’s skill in instilling confidence
in the markets. "We lost our great man at the Federal Reserve," says
Mr. Jordan, referring to former Fed Chief Paul Volcker. "His was a purely
judgmental monetary policy, but the truth is people trusted his judgment."

Whether Mr. Greenspan can engender the same respect remains
to be seen. "We have these twin fears that inflation is going out of
control or that we are heading into recession," Mr. Jordan says. To allay
those fears, Mr. Greenspan must walk a very narrow line, he adds. "Not too
much, not too little, just the right amount."

~~~~~~~~~~~~~~~~

 

Fed’s New
Chairman Wins a Lot of Praise On Handling the Crash
Alan Greenspan Was Aided By His Ability to Foresee Problems
and by Planning
His Independence Still at Issue
ALAN MURRAY
THE WALL STREET JOURNAL, November 25, 1987
http://online.wsj.com/article/SB112404015636012610.html

WASHINGTON — On Oct. 19, Federal Reserve Board Chairman
Alan Greenspan arrived in Dallas at 5:45 p.m., and his first question for the
official meeting him at the airport was: "How did the market close?"

"Down five-oh-eight," came the reply. For a
moment, Mr. Greenspan felt relieved. The Dow Jones Industrial Average had been
off a staggering 200 points when he had left Washington four hours earlier. But
it had rallied, he thought, to end "down five-point-oh-eight."

The relief faded quickly. Mr. Greenspan found out that he
had a problem with a decimal point — and that the stock market had had a
horrendous problem. It had crashed a record 508 points in a single day.
Moreover, it had left him with much of the responsibility for cleaning up the
mess.

In the month since, Alan Greenspan has proved his mettle. He
and other top Fed officials responded coolly and quickly to the stock-market
collapse and helped keep it from spiraling out of control. "They handled
the market crisis very, very well," says Stephen Axilrod, a former Fed
staff director and now vice chairman of Nikko Securities Company International
Inc.

One reason: Mr. Greenspan was prepared. Weeks before the
crash, he had launched a secret study of how the Fed could respond to a variety
of potential catastrophes, including a stock-market collapse. Fed officials say
that effort helped them react quickly to the events on and after Oct. 19.

Before the market collapsed, some traders and analysts had
expressed doubts about Mr. Greenspan’s leadership. His public insistence that
he saw no signs of inflation in the economy worried many, who thought the
usually gloomy economist had turned Pollyannaish in his new job. Alan Abelson,
the Barron’s magazine columnist, jokingly blamed Mr. Greenspan’s optometrist,
who "obviously somehow fitted the new chairman of the Federal Reserve with
faulty eyeglasses."

The new Fed chief still hasn’t achieved the heroic public
stature of his predecessor, Paul Volcker, and he continues to face nagging
questions about his independence from the Reagan administration. If these
questions persist, they could damage the Fed’s standing with Congress and the
financial markets.

But since the crash, the reviews have been generally
positive. "Alan did what a Fed chairman should do," says Irwin
Kellner, the chief economist at Manufacturers Hanover Trust Co. "He
reassured the markets, and he provided liquidity."

In addition, he has been more adept than Mr. Volcker at
pushing the Reagan administration toward a budget agreement with Congress and
at melding a consensus among the diverse personalities on the Fed board.

The events before and after the stock-market crash show how
Mr. Greenspan’s temperament and training have prepared him to guide the Fed
through a crisis. His reputation as an economist was built upon an ability to
foresee potential problems — a skill now useful at the Fed as well.

Shortly after taking office, Mr. Greenspan quietly created a
crisis-management team, which included Fed Vice Chairman Manuel Johnson, New
York Federal Reserve Bank President Gerald Corrigan and a few top Fed staffers.
After the crash, Mr. Corrigan, a street-tough operator trained by Mr. Volcker,
played a crucial role in restoring calm. Other government officials, including
Treasury Secretary James Baker, and leaders of stock and options exchanges also
helped. In the end, planning, cooperation and luck came together to prevent the
market crash from turning into a financial calamity.

Mr. Greenspan started with planning. He told his
crisis-management team to look at possible problems, to pinpoint the weak spots
in the U.S. economy and financial system and to compile a book of options for
the Fed to follow in any crisis. The book contained a section on how to deal
with major bank failures; one on how to respond to a free fall of the dollar,
and, most important as it turned out, one on how to handle a stock-market
collapse.

Fed officials remain reluctant to talk publicly about the
secret effort. Word that the Fed is looking into the possibility of any kind of
crisis could set one off.

But privately they acknowledge that Chairman Greenspan urged
them to think about all the "flash points" that could cause a
breakdown. The various scenarios and options were compiled in notebooks, with a
pink cover sheet marked: "Highly confidential; restricted;
controlled." Only a few high officials had access to them.

Paul MacAvoy, who served with Mr. Greenspan on President
Ford’s Council of Economic Advisers, says Mr. Greenspan has always shown skill
and imagination in discerning troubles that may lie ahead. "He has an
amazing ability to anticipate a variety of outcomes from a policy initiative or
from changing circumstances in the world economy," Mr. MacAvoy says.
"He would sit in a room with policy makers and come up with a scenario
that made everybody else uncomfortable. They would all want to ignore it."

That Cassandra complex paid off on Oct. 19. As the markets
began diving that Monday morning, Chairman Greenspan and the Fed board
conducted a telephone conference with the presidents of the regional Fed banks.
After some discussion, Mr. Greenspan decided to go ahead with a scheduled trip
to the American Bankers Association meeting in Dallas. At the time, the market
seemed to be leveling off, and his failure to arrive in Dallas might spark
panic.

As the market continued to plummet, Vice Chairman Johnson
called together a small group of senior Fed staff officials and established a
crisis center in the mahogany-paneled library across the hall from his office.
Included were Donald Kohn, the director of the division of monetary affairs;
Edwin Truman, the staff director of the division for international finance;
William Taylor, the staff director for bank regulation and supervision; and
General Counsel Michael Bradfield. Mr. Johnson had with him the crisis notebook
prepared weeks earlier, and he turned to the stock-market section.

All afternoon, Mr. Johnson worked the telephones, collecting
information from Mr. Corrigan in New York and keeping in close touch with the
Treasury Department. When Chairman Greenspan finally phoned from Dallas, Mr.
Johnson reported on the day’s devastation in the stock market.

The Fed officials knew that "liquidity" might
prove a problem the next day. They needed to ensure that the banking system
would have enough money to keep credit flowing in the New York and Chicago
markets. Otherwise, panicked lenders might pull back, causing a shortage of
credit, a rise in short-term interest rates and a full-fledged financial
disaster.

Messrs. Greenspan, Johnson and Corrigan discussed whether
the chairman should stay in Dallas and, the next day, deliver a much-shortened
speech in which he would pledge to provide liquidity for the markets. Mr.
Johnson and the Fed staff drafted a statement; Messrs. Greenspan and Corrigan
reviewed it. The crisis team worked through the night, monitoring first the
financial markets in Tokyo as they opened that evening (Washington time), and
then the European markets when they opened early the next day.

Early Tuesday, Mr. Greenspan decided to cancel his speech
and return to Washington. There, the Fed issued a brief statement: "The
Federal Reserve, consistent with its responsibilities as the nation’s central
bank, affirmed today its readiness to serve as a source of liquidity to support
the economic and financial system."

The Fed began flooding the banking system with funds in an
effort to drive down interest rates. On Tuesday, Oct. 20, a market collapse was
narrowly averted.

But another near-crisis struck that week on the Chicago
Board Options Exchange. The market plunge had caused huge losses at First
Options of Chicago Inc., a subsidiary of Continental Illinois National Bank
& Trust Co. First Options clears, trades and lends money to more than 20%
of market makers in listed options and, on a typical day, uses bank loans of
about $2.5 billion to finance that business. When First Options faced large
financing requirements on Oct. 21, Mr. Greenspan acted quickly to enable
Continental Illinois Corp., the bank’s holding company, to inject funds into
the options subsidiary. Without that action, one official says, "the options
exchange would have shut down."

For the next two weeks, the Fed chairman ran a crisis center
in his office, with Mr. Johnson and Monetary Affairs Director Kohn close at
hand. Surviving on club sandwiches, they monitored markets world-wide for
almost 24 hours a day.

Another aftershock hit on Nov. 10, when the dollar began to
plunge. For the first time since the Oct. 19 crash, the stock, bond and
foreign-exchange markets all were slumping, and U.S. officials began to worry
about an uncontrolled fall of the dollar. Then, in late morning, President
Reagan said he didn’t want a further decline in the dollar, causing it to
stabilize and then rise slightly. At the time, Mr. Reagan’s comment — made in
response to a reporter’s question during a photo session with the president of
Israel — seemed casual. But later, officials suggested that the remark had
been planned, apparently after consultations between the Treasury and the Fed.

The Fed still isn’t out of the woods. Before the
stock-market crash, it had been worrying primarily about squelching inflation
fears, which were driving up interest rates. Since Oct. 19, it has concentrated
on providing enough liquidity to prevent a contraction in credit and a
recession. As the markets continue to settle down, Fed officials are worrying
about recalibrating their policies to avoid providing too much liquidity, which
could reignite fear of inflation.

Perhaps the biggest challenge still facing the Fed chairman,
however, will be to prove to financial markets that he can act independently of
the Reagan administration. The independence issue is critical: With an election
year approaching, many observers fear that the administration will push the Fed
toward promoting short-term growth at the expense of long-term progress against
inflation.

Treasury Secretary Baker renewed the doubts about Mr.
Greenspan’s independence in an interview with The Wall Street Journal on Nov.
4, when he stressed the need for an easy monetary policy to avoid recession.
The same article quoted administration officials as saying that, in retrospect,
the Fed’s Sept. 4 increase in its discount rate — the rate it charges on loans
to member banks — was a mistake.

Those comments angered Mr. Greenspan, who phoned the
Treasury secretary to complain early on the morning the article appeared. In
recent testimony on Capitol Hill, the chairman has reasserted his independence.

"I know of no Federal Reserve policy actions which are
affected by the Treasury Department," he said in response to a question
from Rep. Stephen L. Neal, a North Carolina Democrat. "We do not solicit
their views in policy questions. We obviously try to coordinate with them in
the sense that we are part of the United States government . . . but the one
thing I can assure you is that the presumption that the Treasury Department is
in control of monetary policy is false."

Mr. Greenspan isn’t the only Fed official whose independence
is questioned by market analysts. Vice Chairman Johnson, who had worked at the
Treasury under Mr. Baker, also raises suspicions. But Mr. Johnson has tried
hard since joining the Fed to bolster his credibility with the financial
markets. And he knows that becoming linked to inflationary policies would
surely kill his chances of ever being named Fed chairman.

Mr. Greenspan’s deft political sense has helped at the Fed
as well as in his dealings with the administration. Unlike Mr. Volcker, he has
worked hard to court other board members, sometimes socializing with them after
hours. The five other members tend to be fiercely independent, and they differ
in their economic views. On the crucial issue of the dollar, for instance,
Governor Wayne Angell argues strongly for supporting it in the currency
markets, while Governor Robert Heller makes the case for letting it fall
unimpeded.

The new chairman has also improved relations with the
presidents of the regional Fed banks. During the crisis, he took the unusual
step of holding telephone conferences every day for nearly two weeks with the
board and all the presidents to discuss the situation.

"The one thing that stands out about Chairman Greenspan
is that he has gone to some lengths to include all potential sources of
information," says Gary Stern, the Minneapolis Fed’s president. Boston Fed
President Frank Morris agrees. "He did extremely well" during the
crisis, he says. "He displayed a great deal of concern to get everybody’s
views."