sent a military executive jet to pick me up.
The markets that morning gyrated wildly—Manley Johnson sat in our
makeshift operations center giving me the play-by-play while I was airborne.
After I got in a car at Andrews Air Force Base, he told me the New
York Stock Exchange had called to notify us it was planning to shut down
in one hour—trading on key stocks had stalled for lack of buyers. "That'll
blow it for everybody," I said. "If they close, we've got a real catastrophe on
our hands." Shutting down a market during a crash only compounds investors'
pain. As scary as their losses on paper may seem, as long as the market
stays open investors always know that they can get out. But take away the
exit and you exacerbate the fear. To restore trading afterward is extraordinarily
hard—because no one knows what prices should be, no one wants to
be the first to bid. The resuscitation process can take many days, and the
risk is that in the meantime the entire financial system will stall, and the
economy will suffer a crippling shock. There wouldn't have been much we
could do to stop the executives at the exchange, but the marketplace saved
us by itself. Within those sixty minutes enough buyers materialized that the
NYSE decided to shelve its plan.
The next thirty-six hours were intense. I joked that I felt like a seven-
armed paperhanger, going from one phone to another, talking to the stock
exchange, the Chicago futures exchanges, and the various Federal Reserve
presidents. My most harrowing conversations were with financiers and
bankers I'd known for years, major players from very large companies
around the country, whose voices were tightened by fear. These were men
who had built up wealth and social status over long careers and now found
themselves looking into the abyss. Your judgment is less than perfect when
you're scared. "Calm down," I kept telling them, "it's containable." And I
would remind them to look beyond the emergency to where their long-
term business interest might lie.
The Fed attacked the crisis on two fronts. Our first challenge was Wall
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Street: we had to persuade giant trading firms and investment banks, many of
which were reeling from losses, not to pull back from doing business. Our
public statement early that morning had been painstakingly worded to hint
that the Fed would provide a safety net for banks, in the expectation that
they, in turn, would help support other financial companies. It was as short
and concise as the Gettysburg Address, I thought, although possibly not as
stirring: "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." But as long as the markets
continued to function, we had no wish to prop up companies with cash.
Gerry Corrigan was the hero in this effort. It was his job as head of the
New York Fed to convince the players on Wall Street to keep lending and
trading—to stay in the game. A Jesuit-educated protege of Volcker's, he'd
been a central banker for his entire career; there was no one more streetwise
or better suited to be the Fed's chief enforcer. Gerry had the dominant
personality necessary to jawbone financiers, yet he understood that even in
a crisis, the Fed must exercise restraint. Simply ordering a bank to make a
loan, say, would be an abuse of government power and would damage the
functioning of the market. Instead, the gist of Gerry's message to the banker
had to be: "We're not telling you to lend; all we ask is that you consider the
overall interests of your business. Just remember that people have long
memories, and if you shut off credit to a customer just because you're a little
nervous about him, but with no concrete reason, he's going to remember
that." That week Corrigan had dozens of conversations along these
lines, and though I never knew the details, some of those phone calls must
have been very tough. I'm sure he bit off a few earlobes.
As all this was going on, we were careful to keep supplying liquidity to
the system. The FOMC ordered the traders at the New York Fed to buy
billions of dollars of treasury securities on the open market. This had the
effect of putting more money into circulation and lowering short-term
rates. Though we'd been tightening interest rates before the crash, we were
now easing them to help keep the economy moving.
Despite our best efforts, there were a half dozen near disasters, mostly
involving the payment system. A lot of transactions during the business day
on Wall Street aren't made simultaneously: companies will do business with
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BLACK MON DAY
one another's customers, for instance, and then settle up at day's end. On
Wednesday morning Goldman Sachs was scheduled to make a $700 million
payment to Continental Illinois Bank in Chicago, but initially withheld
payment pending receipt of expected funds from other sources. Then Goldman
thought better of it, and made the payment. Had Goldman withheld
such a large sum, it would have set off a cascade of defaults across the market.
Subsequently, a senior Goldman official confided to me that had the
firm anticipated the difficulties of the ensuing weeks, it would not have
paid. And in future such crises, he suspected, Goldman would have second
thoughts about making such unrequited payments.
We also went to work on the political front. I spent an hour Tuesday at
the Treasury Department as soon as Jim Baker returned (he'd been able to
catch the Concorde). We huddled in his office with Howard Baker and
other officials. President Reagan's initial reaction to Wall Street's calamity
on Monday had been to speak optimistically about the economy. "Steady as
she goes," he'd said, later adding, "I don't think anyone should panic, because
all the economic indicators are solid." This was meant to be reassuring,
but in the light of events sounded disturbingly like Herbert Hoover
declaring after Black Friday that the economy was "sound and prosperous."
Tuesday afternoon we met with Reagan at the White House to suggest he
try a different tack. The most constructive response, Jim Baker and I argued,
would be to offer to cooperate with Congress on cutting the deficit,
since that was one of the long-term economic risks upsetting Wall Street.
Even though Reagan had been at loggerheads with the Democratic majority,
he agreed that this made sense. That afternoon he told reporters that he
would consider any budget proposal Congress put forward, short of cutting
Social Security. Though this overture never led to anything, it did help
calm the markets.
We manned the operations center around the clock. We tracked markets
in Japan and Europe; early each morning we'd collect stock quotes on
U.S. companies trading on European bourses and synthesize our own Dow
Jones Industrial Average to get a preview of what the New York markets
were likely to do when they opened. It took well over a week for all the crises
to play out, though most of them were hidden from public view. Days after
the crash, for example, the Chicago options market nearly collapsed when
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THE AGE OF TURBULENCE
its biggest trading firm ran short of cash. The Chicago Fed helped engineer
a solution to that one. Gradually, though, prices in the various markets sta
bilized, and by the start of November the members of the crisis manage
ment team returned to their regular work.
Contrary to everyone's fears, the economy held firm, actually growing
at a 2 percent annual rate in the first quarter of 1988 and at an accelerated
5 percent rate in the second quarter. By early 1988 the Dow had stabilized
at around 2,000, back where it had been at the beginning of 1987, and
stocks resumed a much more modest, and more sustainable, upward path.
Economic growth entered its fifth consecutive year. This was no consola
tion to the speculators who had lost their shirts, or to the scores of small
brokerage houses that failed, but ordinary people hadn't been hurt.
In retrospect, it was an early manifestation of the economic resilience
that would figure so prominently in the coming years.
T
T
he Federal Reserve and the White House are not automatically allies.
In giving the Fed its modern mandate in 1935, Congress took great care
to shield it from the influence of the political process. While the governors
are all appointed by the president, their positions are semipermanent—
Board members serve terms of fourteen years, longer than any appointees
except the justices of the Supreme Court. The chairmanship itself is a four-
year appointment, but the chairman can do little without the votes of the
other Board members. And while the Fed must report twice a year to Con
gress, it controls its own purse strings by funding itself with interest income
from the treasury securities and other assets it holds. All this frees the Fed
to focus on its statutory mission: putting in place the monetary conditions
needed for maximum sustainable long-term growth and employment. In
the view of the Federal Reserve and most economists, a necessary condition
for maximum sustainable economic growth is stable prices. In practice, this
means Federal Reserve policies that contain inflationary pressures beyond
the current election cycle.
No wonder politicians often find the Fed a hindrance. Their better
selves may want to focus on America's long-term prosperity, but they are
far more subject to constituents' immediate demands. That's inevitably re
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BLACK MON DAY
fleeted in their economic policy preferences. If the economy is expanding,
they want it to expand faster; if they see an interest rate, they want it to be
lower—and the Fed's monetary discipline interferes. As William McChesney
Martin Jr., a legendary chairman in the 1950s and 1960s, is alleged to have
put it, the Fed's role is to order "the punch bowl removed just when the
party was really warming up."
You could hear that frustration in the voice of Vice President George
Herbert Walker Bush in spring 1988 as he campaigned for the Republican
presidential nomination. He told reporters that he had "a word of caution"
for the Fed: "I wouldn't want to see them step over some [line] that would
ratchet down, tighten down on the economic growth."
In fact, tightening was just what we were doing. Once it became clear
that the stock-market crash had not seriously damaged the economy, the
FOMC had started inching up the fed funds rate in March. We'd done
so because again signs were accumulating that inflation pressures were
rising and the long Reagan-era boom had maxed out: factories were full,
and joblessness was at its lowest level in eight years. This tightening proceeded
into the summer, and by August it was necessary to raise the discount
rate too.
Since the discount rate, unlike the fed funds rate, was publicly announced,
raising it was much more politically explosive—Fed officials called
such a move "ringing the gong." The timing for the Bush campaign could
not have been worse. Bush wanted to piggyback on Reagan's success, and
he was trailing the Democratic contender, Michael Dukakis, by as much as
17 points in the polls. The vice president's campaign staff was hypersensitive
to any news that might point to a slowing economy or otherwise dim
the luster of the administration. So when we voted to raise the rate just a
few days before the Republican convention, we understood that people
were going to be upset.
I'm a believer in delivering bad news in person, privately, and in advance—
especially in Washington, where officials hate to be blindsided and
need time to decide what they want to say publicly. I don't enjoy doing it,
but there's no alternative if you want to have a relationship thereafter. So
as soon as we voted, I left the office and drove over to the Treasury Department
to see Jim Baker. He had just announced he was leaving his job as
///
THE AGE OF TURBULENCE
secretary of the treasury to become chief of staff of the Bush campaign. Jim
was an old friend, and as treasury secretary he needed to be told.
As we sat down in his office, I caught his eye and said, "I'm sure you're
not going to be happy about this, but after a long discussion of all the
factors"—I listed a few—"we arrived at a decision to raise the discount rate.
It's going to be announced in an hour." The increase, I added, was not the
usual one-quarter of a percentage point, but twice that, from 6 percent to
6.5 percent.
Baker sat back in his chair and jabbed his fist into his stomach. "You've
hit me right here," he growled.
"I'm sorry, Jim," I said.
Then he cut loose and lambasted me and the Fed for not being responsive
to the real needs of the country, and expressed whatever other angry
thoughts came into his head. Having been friends for a while, I knew this
tirade was just an act. So after a minute, when he paused for air, I smiled at
him. Then he laughed. "I know you had to do it," he said. A few days later,
he publicly endorsed the rate increase as essential for the long-term stability
of the system. "In the medium and long term it will be a very good thing
for the economy," he added.
W
W
hen George Bush won that fall, I hoped the Fed and his administra
tion would get along. Everybody knew that whoever came in after
Reagan would face big economic challenges: not just an eventual downturn
in the business cycle, but whopping deficits and the rapidly mounting na
tional debt. I thought Bush had upped the ante substantially when he'd de
