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Greenspan Is Boggled, but Are the Rest of Us?

October 11, 1998|TOM PETRUNO

Federal Reserve Board chairmen usually are masters of the dull understatement. That's one reason why, when their terms are up, they never go on to be hosts of TV home shopping shows.

So it was more than a bit surprising last week when Fed chief Alan Greenspan, speaking to a meeting of economists, described the current state of U.S. financial markets as something he has "never seen anything like" before.

Hmmmm. Now, Mark McGwire, with his 70 home runs this baseball season, is something we haven't seen before. The explosion of the Internet is something we haven't seen before. But this year's market turbulence?

The 72-year-old Greenspan was speaking specifically about the speed with which investors have run away from risk recently, dumping stocks, junk corporate bonds, emerging-market bonds and nearly every other security in which some magnitude of risk is present--which is, of course, most of them.

Granted, the volatility in markets has been spectacular. The Dow Jones industrials are routinely swinging 200 points or more in a day. Many individual stocks have lost 40% or more of their value in a matter of days, sometimes hours. The dollar--still the world's primary currency--nonetheless last week was beaten down 14% against the hapless Japanese yen.

And in the Treasury bond market, which had been the place where many risk-averse investors had taken refuge, the panic buying of September suddenly has turned into panic selling. The yield on five-year Treasury notes, for example, rocketed from 4.09% to 4.47% last week, after diving to 4.09% from 4.37% the week before.

By late last week, mortgage lenders were quoting sharply higher rates to borrowers than they had just a few days earlier, wreaking havoc with the housing market.

This is the kind of market volatility, and resultant economic uncertainty, that we used to derisively ascribe to poor little banana republics. Are we living in the United States of America--or the Republic of Paradour?

Maybe that's the frustration Greenspan was voicing last week, in somewhat more polite terms. Still, was he using hyperbole in saying that he has never seen markets like this before?

The year 1990, after all, was no picnic: The corporate junk bond market collapsed with the economy and the demise of kingpin junk bond broker Drexel Burnham Lambert. Fearful of risk, investors fled junk securities and the stocks of any financial companies with even a minor connection to junk.

In the course of that year, shares of Los Angeles-based insurance company SunAmerica Inc. (then called Broad Inc.) lost 70% of their value, simply because the firm had a small portion of its investment portfolio in junk bonds.

Was it an overreaction? Apparently. SunAmerica, which soon will merge with American International Group, has seen its shares rocket from split-adjusted 77 cents a share in 1990 to nearly $56 today.

The year 1982 also was harrowing. Mexico and other Latin American governments were in effect bankrupt, and the U.S. was in a deep recession. The resulting financial system crisis blasted shares of banks and other industry players.

That was the last time--prior to recent months--that I remember eminent economists talking openly about the potential for a global depression. Of course, the depression never came. And many of the pummeled financial industry stocks were great bargains in retrospect.

Will that turn out to be true again this time, with stocks like Chase Manhattan, Merrill Lynch and Washington Mutual all down 40% to 60% from their 1998 peaks?

If so, that will be the positive side of this dramatic volatility, whether or not it truly is unprecedented, as Greenspan suggested: Many patient investors will have been given a gift in the panic reaction of those less patient.

Greenspan, in describing investors' unwillingness to take on risk today, put it this way: "What is occurring is a broad area of uncertainty or fear, and when human beings are confronted with uncertainty--meaning they do not understand the rules or the terms of a particular type of engagement they're having in the real world--they disengage. . . . [They] are basically saying, 'I want out.' "

That has certainly been true in the case of many so-called hedge funds, which have been fingered as the culprits in many of the world's backlashing markets this year.

Big-money hedge fund players don't look much beyond the next 10 minutes: If a market trend is going against them--which was the case last week, when the Japanese yen suddenly started to rise, confounding hedge funds that had bet it would sink further--they exit in a flash. They don't care a whit what effect their actions have on other investors, or on the economy.

But Greenspan, making his point about how many such investors have opted to "disengage" from markets, may be forgetting the mass of stock mutual fund investors--most of whom have in fact sat tight in recent months, opting not to sell even though they probably perceive that the risk of staying in the market has risen sharply.

"Maybe it's naivete--or maybe it's cool logic," says Doug Cliggott, investment strategist at J.P. Morgan Securities in New York, referring to most stock fund investors' willingness to stay put.

Cliggott figures it comes down to this: Most small investors with long-term time horizons "are going to stay in the U.S. equity market until a clear alternative comes along." So far, despite the Fed chairman's wide-eyed worry over volatility, most individual investors still don't see a good alternative to stocks. And that's not so dumb.


Tom Petruno can be reached by e-mail at

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