Supermoney, p.7
Supermoney, page 7
There were some other very large American corporations also in a state of gasping illiquidity. It is not polite to name names, but you could start with Lockheed, Chrysler, TWA, Pan American, and LTV. In particular, two finance companies, Chrysler Financial and Commercial Credit, had commercial paper out far in excess of their approved credit at banks.
The worriers began to see the following script: the holders of the Penn Central’s commercial paper would be busy papering the bathroom and calling their lawyers. Like Mark Twain’s cat, who sat on a hot stove, and then would not sit on any kind of stove, hot or cold, investors would not exactly be reaching for more commercial paper. The commercial paper from other companies had short maturity: some would come up Monday, some Tuesday, and so on.
There was $40 billion of commercial paper outstanding, and if nobody was to sit on that particular stove again, where would $40 billion come from as the notes matured, day by day? Not from the stock market: the stock market was flat on its back, and anyway, it takes time to register to sell stock. Not from the bond market: the bond market was in disarray, and the bond dealers were still working off inventories from weeks previous. Not from the banks: the banks were all loaned out.
“I was on a summer weekend in Cape Cod,” says the economist of a major New York bank. “I went to town to get the paper, and I just stood there reading it in the grocery store. I could see the U.S. banking system might have to pick up an extra fifteen billion dollars, and it just didn’t have it to give. I remember thinking to myself, This could be another Credit Anstalt.”
The Credit Anstalt was the Austrian bank that failed in 1931, and turned out to be the first domino to fall; it triggered a whole series of bank failures and helped to bring on the world-wide depression.
Wasn’t that a bit extreme? I asked the senior economist.
“The sixth biggest enterprise in the United States goes broke,” he said, “but it’s a railroad. There are special provisions for railroads, left from the 1930’s; they keep operating. But you let half a dozen major U.S. companies default on their short-term debts, their creditors throw them into the courts, their suppliers and contractors are afraid they won’t get paid and they rush for the courts, and meanwhile everybody tightens up and cuts operations and starts laying off people. You could have a real panic that would snowball, a panic that would feed on itself. It’s happened in this country before.”
But, I said, in this day and age, that wasn’t likely.
“You’ve never lived through a panic,” he said.
But there is a lender of last resort; that is why we have a Federal Reserve system. Congress, by the Constitution, can create money, and Congress gave that money-printing function to the Federal Reserve in 1913, when that agency was created. The Fed reports to Congress once a year; it is an independent agency; its seven governors are appointed by the President for terms of fourteen years apiece. This is not the place for the college-freshman-economics-course explanation for the mechanics of the working of the Fed. Suffice it to say it can turn money on and off. By the way it turns the faucet, the Fed hopes to speed up the economy when it slows down, and slow down the economy when it gets overheated. It used to believe that if the cost of money went up, buyers would drop away. At this point, however, the Fed was working more with monetary aggregates, which one Fed official described as “roller-skating on three wheels—it will work, but you need new body movements.”
There is a philosophy that the way to cure inflation is to get everybody to stop reaching out. You want them to curl up in a fetal position and stop breathing for a while; that cures enthusiasm. Then things cool off. The Fed had had the money valve largely off, because inflation was certainly roaring. The Fed itself had been criticized: for cutting off money too abruptly in 1966, for increasing it too fast in 1967 and early 1968.
Fed meetings are not public, but the two possible positions were fairly clear. The first position said thus: only we can print money. Once we print it, we can’t control how it is used. Printing money has to be part of an overall plan, involving foreign balances, taxes and so on. Our Official Policy is one of restraint, and if we depart from it, not only are we not able to control where the money goes, but the news of a sudden change might have a reverse effect and scare everybody to death.
The second possible position for a Fed governor was to worry about Monday morning, and to treat the weekend as something special in history. The issuers of commercial paper would not be able to sell any more; they would go to their banks; the banks would say, sorry; the issuers would be brought into the courts by the people to whom they owed money; the issuers would start to lay off people and cut back operations; everybody could stake out a corner for an apple stand, if the corner wasn’t already occupied by a fried-chicken stand. The notes of a Fed official to a Fed meeting later that summer uses this language: “inability of the issuers to pay their paper at maturity would have dire consequences for the issuers, the commercial paper market, other financial markets, and the banking system.” Dire consequences is a phrase not used lightly.
The Monday morning worriers won.
Alfred Hayes, the president of the Federal Reserve Bank of New York, was in London; acting for him was a sixty-three-year-old former Wall Street lawyer, William Treiber, now the executive vice-president of the New York Fed. Treiber is a pleasant, white-haired type, given to conservative three-piece suits, just as you would expect from a Columbia College, Columbia Law, Sullivan and Cromwell executive vice-president of a Federal Reserve bank. Treiber left the massive Federal Reserve building, modeled after the Strozzi Palace in Florence, at the same time the shell-shocked bankers went up to the First National City’s offices. Treiber drove to his weekend home, a two-hundred-year-old farmhouse in East Winchester, Connecticut. He called the First National City Bank; at 10:30 P.M., he reported later, the bankers were all still there and still in a state of shock.
Treiber got on the phone. Over the weekend, that was all he did. He moved a card table with a phone on it into the dining room of his farmhouse. He talked to Arthur Burns, chairman of the Board of Governors and captain of the Monday-morning worriers. He called the head of every major bank in New York at home, or the next in command if the chief executive couldn’t be found. (David Rockefeller of the Chase Manhattan was on his boat, off Bar Harbor, Maine.) Treiber couldn’t leave his card table, except briefly, because the farmhouse only had one line, and frequently he had to leave word. His daughter took a picture of “Daddy’s weekend office.” In the dry language in which these things are reported, it was said the bankers were told that “the use of the discount window would be appropriate,” which does not mean everyone got a cut rate.
Sunday night Treiber flew to Washington; the Fed’s Board of Governors met Monday at 9 A.M. By Monday night, phone calls had gone out through the twelve Federal Reserve banks to every bank in the system—not just to big city banks, but to small-town banks all over the country. The Fed’s index finger was beginning to bleed from all the dialing. The message was the same: if anybody comes into your bank and wants a loan, give it to him. Then if you’re all loaned out, come to us and we’ll see that you have the money.
I began to speculate: What would have happened if teenagers tied up the home phones? Or if the Fed’s own Paul Revere were unable to get through? The Penn Central’s lawyers are driving through suburban Philadelphia looking for the judge’s house, nervously thumbing the paper, and the line is busy.
I could see the following scene. After all, school was out.
“Hello, Mr. , please.”
“This is Timmy.”
“Hello, Timmy, can I speak to your father.”
“No.”
“Please, Timmy, it’s important.”
“No.”
“Why can’t I speak to your father?”
“He’s not here.”
“Where is he?”
“He’s outside practicing his golf swing.”
“Could you go get him?”
“No.”
“Why can’t you go get him?”
“I’m not allowed to leave the kitchen until I finish my lunch.”
“This time it’s all right. I’ll fix it for you, I promise.”
“I have to finish my lunch.”
“How long will it take to finish your lunch?”
“I don’t know. I don’t like carrots. But I have to eat them.”
“Could you call him from where you are?”
“No.”
“Is anybody else home?”
“Yes.”
“Who? Let me talk to them.”
“Arthur can’t talk.”
“Who can’t talk? Why can’t they talk?”
“He’s a dog.”
“Timmy, listen closely. I want you to put the carrots in Arthur’s dish, and then go get your father.”
“They’ll find out. Arthur doesn’t eat carrots.”
“Just do it. Listen, Timmy, would you like a new football helmet? Would you like an autographed picture of Arthur Burns. In uniform?”
“Yes.”
“Good boy. Just do what I say.”
After an appropriate interval, the banker makes it to the phone.
“Hello.”
“Rodney, this is the Federal Reserve calling. I’m sure you know why.”
“Uh, I think my kid got the message garbled, he said you said to put the carrots in the dog’s dish.”
The Fed official says, sorry to call him at home, but that if anybody wanders into his bank, dispense money. Rodney thanks him and reminds him: “Don’t forget the autographed picture of Arthur Burns.”
On Monday, June 22, Arthur Burns, the Fed’s pipe-smoking chairman, pressed not only for the additional reserves but to do away with Regulation Q, which would permit the banks to take in large short-term time deposits. The Fed had taken those large time deposits away from the banks as an anti-inflation move. Now it decided to worry about inflation some other time, and gave them back. After an all-day debate, Burns won his point.
From that point on, events followed the script. The Penn Central went broke, but no one else did. Six billion dollars fell away from the commercial paper market, as buyers recoiled in horror. The companies that were going to sell the commercial paper and were unable to do so went to their banks and begged for money. The banks went to the Fed, the Fed loaned them the money, and the banks reloaned the money to the would-be insurers of IOU’s. In one July week alone, the banks lined up for $1,700,000,000 at the Fed window. More than $2,000,000,000 in bank money went to companies whose commercial paper was coming due. Not only that, with Regulation Q wafted away, the banks took in $10,000,000,000—ten billion dollars—in time deposits, just in case anybody needed more money. Some of the bankers who had stayed awake that summer, fretting that if anybody added up the losses in their bond portfolios they might think the bank was busted, were stunned to find that they were having a very good year.
The Fed was pleased. Not only had there not been a crisis, but the money had been recycled. It had been there as debts before and it was still there; now, however, it was owed to banks, not to individual borrowers, and with the banks, the borrowers could have some breathing room to sit down and work repayments out in an orderly way. And there was no great inflationary addition to the supply of money.
Gradually, there began to be faint, faint cheers for the Fed’s actions from all of the seventeen people who understood them. A New York banker said the Fed had done “a classic job.” Business Week said “a wrong move by the Fed could have allowed Penn Central’s financial distress to infect the nation’s financial system . . . touching off a chain reaction of corporate failures.”
As the Crunch abated, the bankers and the Fed performed the equivalent of the pro football touchdown ritual: lots of fanny-patting, jumping up and down, and hugging the ball-carrier. I can see it all in a ghostly, silent instant replay, except that the stadium is empty. It is empty because nobody knows it happened—not only Mr. and Mrs. America, who think that the Fed is the FBI, but all the readers of those papers that carry financial pages. It is all too abstract, and too hard to explain. A 105-yard razzle-dazzle touchdown in absolute stony silence.
William Treiber’s September 10 report to New York Fed directors contained some sense of satisfaction. “The commercial paper market was in a near crisis situation,” he said. “The banks stepped into the breach promptly to provide credit . . . aided, of course, by . . . the expressed desire of the Federal Reserve to assist the banks in avoiding a crisis. The commercial paper market is now calm.”
Treiber had to add a final sentence. “It was an interesting,” he said, “at times, a highly exciting experience.”
I have to figure the crisis of June 19-23, 1970, as a very near miss, because the normal language of banks—and especially of the Fed, is dry, abstract, full of passive tenses, and unemotional. Things are not supposed to be “interesting” in the banking business, and when they become highly exciting for the participants, I begin to hold my breath. When it was over, the Fed returned to its nice, dry language. Here is some of its description of the events transpired, from the Monthly Review (August 1970) of the Federal Reserve Bank of New York. Never mind the phrases that are strange; keep going, and get the feel:Fears of a general liquidity crisis rose to a peak late in the second quarter after the Penn Central Company filed a petition for reorganization on Sunday, June 21. These worries were exaggerated . . . nevertheless, concern during the second quarter over the possible widening of liquidity problems aggravated the uneasy atmosphere in the money and bond markets . . . these pressures were most evident in the commercial paper market, where participants became apprehensive that some borrowers would be unable to refinance a large volume of existing debt, some of which was of very short maturity. The Federal Reserve System acted to facilitate refinancing of these debts by the banking system, by suspending Regulation Q ceilings on large short-term time deposits, and by using the discount window and open market operations to guard against liquidity pressures. These actions had a salutary effect on most financial markets, tensions subsided . . .
and everybody lived happily ever after. Just that easy.
Yet something bothered me. It was in the phrase, “the lender of last resort.” Why was everybody cheering the Fed? Did not some people say that the Fed’s stop-go policies had helped cause the Crunch? Was it not their job to do just what they did? I asked the Fed.
“It seems to me,” I said, “that the Fed did just what it should. That is why we have a Fed, so we do not have the panics that we had in 1873 and 1893 and 1907, with banks failing and markets collapsing and everybody out of work. It’s like having a fire. You call the fire department.”
The Fed officer leapt at the metaphor. I guess Fed officers are so used to saying, “The discount window might be appropriate,” that a metaphor has seductive charm for them.
“Exactly!” said the Fed officer. “Exactly! The fire department! This never happened before! And it worked! The engines, and the hoses, and the water pressure, and the foam—it works! It all works!”
In time, as nobody else went busted, some confidence crept back into the commercial paper market. The demand for funds abated. The banks reduced their prime rate to 8 percent, then to 7½, then to 7 percent, and they built up their own liquidity. What could have been a crisis was over.
And why is this drama relevant to understanding what went wrong in the stock market?
Any investor has a choice: he can buy a stock or he can buy a bond. If bonds are yielding 2 percent, he may well figure he can do better in the stock market. If bonds are yielding 10 percent, he may just settle for that. If you are running a pension fund, and all you need to supply the pensions is a return of 4½ percent, and you can buy a telephone bond at 9 percent, you buy the telephone bond and play golf until you retire, for your job is over. When there isn’t enough credit, people will bid up the price of money, and telephone bonds will sell at 9 percent.
Then the money that could go into stocks will go into bonds instead. Or stockholders—professional and individual—will sell their stocks and buy bonds. And that means that everybody who bought an 8 percent telephone bond at 100 finds it marked down to 97 when there is a new telephone bond at 100 that yields 9 percent. When there is a 9 percent telephone bond, everybody that owns an old bond, even a week old, has a loss.
That is a description of an uneasy bond market, and why it is bad for the stock market. If you add to that a real Crunch, with the possibility of major companies not paying their bills and their payrolls, nobody will buy stocks. Maybe some other time, maybe they will be cheaper later: maybe we will get a chance to buy Chrysler at the 1933 prices, if there still is a Chrysler. If you add to that just a few rumors of a bank holiday—well, it does something to the atmosphere. A bank holiday is a misnomer. Everybody else gets the holiday; the bankers have to stay till midnight figuring out which companies to save and how to keep the bank going.
By historical standards, American business is still not enormously liquid, but the summer of the Crunch created a great thirst. The first order of business was to get a cushion back into the balance sheet. According to Tilford Gaines, senior economist of the Manufacturers Hanover, business needed more than $50 billion—over and beyond any needs for new money—just to get back to the relative stability of the early 1960’s. Within a year, that was down to $35 billion, and it is still going. Secondary borrowers have a much harder time than the big boys, but once more there is money for everybody. The prime rate for bank lending has come down three percentage points, which doesn’t sound dramatic enough, so they say “three hundred basis points,” which is dizzying.
