One good market regurgitation, and the 911 call goes out: Alan Greenspan, where are you when we need you?

For the past few months, the US stock market has suffered periodic episodes of vertigo—about one per week—usually on news of something foul in the subprime market, after which it goes back to scale new heights.

Last week something happened. The stock market had three bad days, one of which was really bad, as investors abandoned all sorts of risky assets for the safety of US Treasury securities.

What was most interesting about Thursday’s 312-point dive in the Dow Jones Industrial Average—the Dow was off 450 points at its lows—was how quickly financial futures markets started to entertain the notion that the Federal Reserve might ride to the rescue with an interest-rate cut in the fourth quarter of this year.

“In the last 48 hours, the fed funds futures had the biggest change in outlook for Fed policy in months,” Jim Bianco, president of Bianco Research in Chicago, said in a phone interview Friday. “Two weeks ago, there was no ease priced in until September 2008, the last contract that trades.”

It was two weeks ago that Fed Chairman Ben Bernanke presented the central bank’s semiannual monetary policy report to Congress and reiterated the long-held view that inflation remains the predominant policy concern.

What happened in the interim to change that risk, at least in the eyes of those who traffic in interest-rate futures? 

Missing link

The stock market took a dive.

“It’s right out of the Greenspan playbook,” Bianco said. “In addition to all the other wonderful things the Fed does, such as promoting stable prices and maximum employment, under Greenspan the Fed set out to make sure that brokerage statements had the highest return possible.”

This is not the Greenspan Fed. The “Greenspan put” retired with the former chairman in January 2006.

A put option gives the buyer the right to sell a security, commodity, index or futures contract at a specific price by a specific date. Buying a put protects the holder against a decline in prices.

The “Greenspan put” entered the lexicon after several stock-market rescue efforts: Greenspan cut the overnight federal funds rate in 1995 following the Mexican peso crisis and Orange County, California, blowup; and again in 1998 in response to the near-collapse of hedge fund Long-Term Capital Management.

Investors came to refer to, and rely on, the Greenspan put as an implicit guarantee that the Fed would cut rates if things got too dicey in the stock market, which had become the national pastime in the late 1990s.  

Means to an end 

Greenspan inherited a 4.2-percent inflation rate (using the core consumer price index) from Paul Volcker in August 1987 and cut it in half in 18 years. Volcker had already done the heavy lifting, cutting core inflation from its 1980 peak of 13.6 percent.

While Greenspan was considered an inflation fighter, in reality he placed more emphasis on achieving maximum sustainable employment than the Fed’s other mandate, price stability, according to Joe Carson, director of global economic research at AllianceBernstein.

“Greenspan was much more willing [than Bernanke] to move official rates up or down if changes in current or prospective economic conditions were perceived as a threat to the quest for maximum employment [or growth], and ultimately to price stability,” Carson wrote in a recent report for clients.

Rather than speed limits for growth or ceilings for inflation, Greenspan “focused instead on the imbalances that would engender economic and price strains,” he said. 

Dogs at bay

For example, core inflation has been above the Fed’s comfort zone of 1 percent to 2 percent for some time. Bernanke has given no sign that he is contemplating a rate cut, even in the face of a housing recession and below-trend growth last year.

The core CPI rose 2.2 percent in the 12 months ended in June, down from a recent peak of 2.9 percent in September 2006.

That inflation rate didn’t pose a hurdle to Greenspan, who cut rates 16 times in the last decade of his tenure with core inflation at 2.2 percent or higher “because other economic or financial imbalances were more pressing at the time,” Carson said.

Cut to the chase: If Greenspan were Fed chairman, would he be cutting rates now? Probably not, Carson said, but he’d be leaning in that direction. One can imagine him making an elaborate argument that the only reason the core CPI is above 2 percent is “because CPI housing costs are based on imputed rents, not actual prices,” Carson said.

Greenspan was nothing if not flexible. 

P&L crisis

The Pavlovian response in interest-rate futures markets last week—stocks down, Eurodollar and fed funds futures prices up—demonstrates how hard it is for traders and investors to let go of expectations that the Fed will respond to any and all crises.

“The definition of a crisis in the Greenspan era was any market environment preventing a trader from getting 100 percent of his bonus potential,” Bianco said. “We still operate like that.”

Bernanke is trying to wean the market from that form of life support. It’s a slow process, and during times of stress, old habits reassert themselves.

At times like these, it’s important to remember that “Greenspan is no longer Fed chairman,” Bianco said. “It’s a dirty little secret that not too many people know.”

Caroline Baum, author of Just What I Said, is a columnist for Bloomberg News. The opinions expressed are her own.

IF the President still thinks of her legacy in the last three years of her administration, she had better heed the call of her colleagues from the University of the Philippines’ School of Economics.

Debt watch

There was great rejoicing in the Department of Finance when national government outstanding debt went down at the end of 2006. The media closely followed the bold steps of the Bureau of Treasury as it successively prepaid expensive dates when interest rates were favorable and cash was available.

Which of these is correct?

Is it: “The drop in share prices on the Philippine Stock Exchange [PSE] last week was an appropriate reaction to the threat of a slow down in the US economy, reducing earnings of locally listed firms”; or “The drop in share prices on the [PSE] last week was driven by investor mentality that the Philippines is a financial colony of the US”?

When the peso strengthened from P56 to P53, there was much rejoicing, with exporters willing to reset their planning targets within that range.

When asked on television why Carlito Puno has been replaced by Romulo Neri as the new chairman of the Commission on Higher Education (CHED), Neri hesitated a bit, then offered this one-liner quote: “I, too, was surprised.”

One good market regurgitation, and the 911 call goes out: Alan Greenspan, where are you when we need you?