The Greenspan Put
Global equity markets dropped drastically on Jerome Powell’s first day at the Federal Reserve. When markets quiver a question you’ll hear analysts and journalists bring up is, “Will the Chair use the Greenspan Put?” On today’s episode, a brief primer on the Greenspan Put. As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com.
I am Alexander Bagehot and you’re listening to The Bankster Podcast, the only podcast dedicated to the fascinating and ever more consequential world of central banking.
Global equity markets dropped drastically on Jerome Powell’s first day at the Federal Reserve. When markets quiver a question you’ll hear analysts and journalists bring up is, “Will the Chair use the Greenspan Put?” On today’s episode, a brief primer on the Greenspan Put.
A quick definition first and then a breakdown of each part.
Definition Greenspan Put
The Fed will ease monetary policy conditions to help prevent financial market downturns. In even simpler terms, the Fed will save the stock market whenever it starts to go down.
Who is Greenspan?
Chairman of the Federal Reserve 1987-2006
During the time while Greenspan was Chairman, the US economy grew at a historically remarkable, consistent, healthy pace. In fact economic historians refer to the time period from the mid-80’s to 2007 as “The Great Moderation”. This extended stable growth turned Greenspan and the position of Chair of the Federal Reserve from a quite technocrat position to the ever press worthy position it is today, spurred on by the new 24 hour cable news recently introduced at the time.
Sebastian Mallaby, in his excellent book The Man Who Knew, describes it this way, “As American prosperity advanced, the cable business-news network CNBC gained traction with a fetching gimmick. On mornings when the FOMC was due to meet, a camera crew would lie in wait outside the Fed building. When the powerful figure of the Fed chairman hove into view—pin-striped, proceeding purposefully, curled-top briefcase in one hand—a telephoto close-up would interrogate his face. If Greenspan looked tense, the network would couple the footage with the suspenseful theme tune from Mission Impossible, the old CBS TV series recently remade as a shoot-’em-up movie. If Greenspan looked carefree, the producers might roll out Jean Knight’s jaunty soul hit, “Mr. Big Stuff.” Then the camera lens would home in on that briefcase, swinging lightly in the Fed chairman’s hand.” Head back to the episode on communication to hear more about the briefcase theory. Anyways, one more relevant comment to make about Greenspan that was also noted in Mallaby’s book.
““How many central bankers does it take to screw in a lightbulb?” went a joke of the time. “One,” the answer went: “Greenspan holds the bulb and the world revolves around him.”
So that’s who Greenspan was, the namesake of the Greenspan Put. Now onto the next part, what is a put?
What is a put?
An option: Financial instrument used to make bets about the future price of something. There are two types of options: (1) for if you think the price will go up PUT and (2) for if you think the price will go down CALL.
Here’s an example of a simple put. You believe that Amazon stock, currently worth about $1,500 will go up to $2,000 by July, but you don’t want to actually buy the stock, wait until the price goes up, and then sell it (which would be the normal way you’d think of making money from investing). Instead you could buy a put, which would give you the option to buy Amazon stock for say $1,800 at any time before July. You pay a fee at the beginning and then you can buy Amazon whenever you want. So what you would do is you would wait until you the price of Amazon got to $2,000 then you’d exercise your option and buy it at $1,800 and then you could immediately turn around and sell it on the market for $2,00 and take home the $200. Now this is an oversimplification but hopefully it helps you understand that a put option can be used to make bets that the price of something will go up.
Putting them together: The Greenspan Put
The success of the financial market expansion of the US economy was often associated with the leadership of Alan Greenspan. It was viewed that he would rescue the stock market if anything bad happened. This came mostly from an experience in 1998 when an incredibly massive hedge fund called Long-Term Capital Management almost imploded. Greenspan organized a private recapitalization and announced a lowering of interest rates in response.
The idea that formed was that Greenspan and the Federal Reserve would act like they had bought a put option on the US stock market. They were betting that the US stock market would continue to grow. And a bet from the most powerful financial institution in the world is a bet worth mimicking.
In summary, you’ll hear the term Greenspan Put used anytime there is a downturn in the stock market. I’ve seen it a number of times in the last few weeks as market turmoil has been much higher than it has been for a few years. And now you know that they are simply referring to the idea that the Fed is going to do something to keep stocks from going down.
To end today’s episode, I want to emphasize that keeping the stock market going up and up is not a direct goal of the Federal Reserve or any central bank. Their very high level goal is to keep economies healthy. Sometimes the economy and the stock market are moving in the same direction and sometimes they are not. In fact the underlying numbers of the economy have been very solid recently even as the stock market has gone down. But now you’ll understand the background when you see or hear the Greenspan Put.
If you have questions you’d like answered on the podcast send them in. As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com. Don’t forget on the website you can sign up to receive my short email newsletter accompanying each biweekly episode.
Today’s episode was written, edited, and produced by me, Alexander Bagehot. Thanks to all of you for listening, and I’ll see you next time on The Bankster Podcast!