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<text> <title> (1987) Panic Grips The Globe </title> <history> TIME--The Weekly Newsmagazine--1987 Highlights </history> <article> <source>Time Magazine</source> <hdr> November 2, 1987 THE CRASH Panic Grips The Globe </hdr> <body> A crisis spotlights Washington's failures First came a vague foreboding, a kind of free-floating anxiety. The U.S., said worriers, could not go on forever spending more than it would tax itself to pay for, buying more overseas than it could earn from foreign sales, and borrowing more abroad than it could easily repay. There had to be a day of reckoning, and it could unhinge the whole world economy. But when might it come? What form would it take? How bad might it be? No one could say, and so the forebodings could be pushed to the back of the mind. But then, slowly at first, the anxiety began to take on a shape that could be sensed if not exactly foreseen. On all the world's stock exchanges, prices had leaped up too far, too fast, to be sustained. The mood in the markets shifted from fantasy about instant wealth to nervousness about an inevitable "correction" (a wonderful euphemism). By Monday morning the concern was no longer vague but had taken on physical form--piles of papers littering brokers' desks, each representing a hastily scribbled order to sell stock; rows of numbers flashing on computer screens, bring news of alarming price breaks in all the early-opening markets: Tokyo, Hong Kong, London, Paris, Zurich... Then trading began in New York, and the unimaginable happened: a collapse on a scale never before--no, not even in 1929. Prices went down, down, down, swiftly wiping out an entire year's spectacular gains. "I just can't believe that this is happening," moaned one trader, as he took nonstop sell orders at Donaldson, Lufkin & Jenrette. At lunchtime, brokers across the U.S. went hungry or ate sandwiches at their desks while trying to keep phone receivers pressed to both ears. "This is going to make '29 look like a kiddie party," shouted a trader on the Los Angeles floor of the Pacific Stock Exchange. Almost an entire nation become paralyzed with curiosity and concern. Crowds gathered to watch the electronic tickers in brokers' offices or stare at television monitors through plate-glass windows. In downtown Boston, police ordered a Fidelity Investments branch to turn off its ticker because a throng of nervous investors had spilled out onto Congress Street and was blocking traffic. George Finch, 66, a retired businessman in San Francisco, summed up the bewilderment: "I don't know what the hell is going on." By the time the 4 p.m. closing bell rang at the New York Stock Exchange on what instantly became known as Black Monday, the Dow Jones industrial average had plunged 508 points, or an incredible 22.6%, to close for the day at 1738.74. Some $500 billion in paper value, a sum equal to the entire gross national product of France, vanished into thin air. Volume on the New York exchange topped 600 million shares, nearly doubling the all-time record. Brokers could find only one word to describe the rout, an old word long gone out of fashion but resurrected because no other would do: panic. The frenzy rose as it spread once again around the globe. On Tuesday stock prices fell by 12.2% in London, 15% in Tokyo, 6% in Paris and 6.7% in Toronto, on top of huge losses Monday. Then, since blind panic is no more sustainable than unthinking euphoria, came a crazy whipsawing that continued virtually all week and in markets all around the world. Up, down, up, down, with trends reversing in hours, and then reversing again. And always the questions: Would the stock crisis cause a recession? Or even a global depression like the one ushered in by the 1929 Crash? What would happen to the dollar, to interest rates, to world trade? What might Ronald Reagan do to calm the markets? Could a President who was so weakened by the Iran-contra affair and the impending defeat on the Bork nomination, and who was distracted by war in the Persian Gulf and his wife's cancer operation, possibly quell the financial turmoil? Did he even understand that he faced a first-class crisis of confidence in his leadership? At first the President gave no sign that he did. He spoke only in comments shouted to reporters over the roar of helicopter rotors on the White House lawn and in brief formal remarks issued through his spokesman, marlin Fitzwater. On Black Monday, he blithely attributed the crash to "some people grabbing profits" accumulated during the market's long rise. In a statement after the close of trading, he said that "the underlying economy remains sound"--unwittingly drawing another parallel to 1929, when Herbert Hoover said almost exactly the same thing. On Wednesday, Reagan remarked that the midweek rally indicated the Monday collapse had been "some kind of a correction"--a statement that would have been reassuring only if he had intended it ironically, as he obviously had not. Some critics began speaking of the President in tones of contempt. Said a Wall Street money manager during the midst of the crash: "You sell and get what you can and never again listen to Ronald Reagan." M.I.T. Professor Robert Solow, who was awarded the Nobel Prize for Economics last week, took the occasion to criticize Reagan's long, obstinate resistance to tax increases thought necessary by many to trim the budget deficit and thus restore confidence. The President, said Solow, "is holding the Congress back from slow access of intelligence." By Thursday night, however, Reagan at last showed that he recognized the seriousness of the situation--and the need for action. "We shouldn't assume that the stock market's excess volatility is over," he asserted at a White House press conference, and he acknowledged that public fear spread by those gyrations "could possibly bring about a recession." More important, he announced that he was summoning the leaders of Congress to a bipartisan deficit-cutting conference at which, through his top aides, he was "putting everything on the table with the exception of Social Security, with no other preconditions." Including a tax increase? Though he could not quite bring himself to pronounce those words, Reagan clearly indicated that, well, yes, he would at least discuss the subject. Reminded again and again by reporters of his many previous pledges to veto anything resembling a tax increase, he refused to repeat any such pledge; he merely said both spending and taxes should be kept "as low as possible." It was, however, anything but an inspiring performance. The President repeatedly stumbled and seemed unsure of just what he wanted to say. Several times he slipped into well-worn denunciations of congressional Democrats before remembering that this time he was supposed to sound conciliatory. In his Saturday radio speech, Reagan once again called on Democrats to "remember that lower taxes mean higher growth," even while acknowledging that "all sides must contribute" to a budget-cutting package. The net impression was that in countenancing discussion of a tax increase he was doing something he felt he must, without an conviction. The impact of the President's words was hard to gauge. Exchanges in Asia and Europe suffered additional heavy losses Friday, but that might have been more a response to a bad Thursday on Wall Street. Despite a lukewarm reaction in the New York financial community to the President's statements, prices on the Big Board steadied, perhaps from exhaustion. The Dow average eked out a .33 gain to close the week at 1950.76. Tow bits of news helped: the Consumer Price Index rose at an annual rate of only 2.1% in September, less than half the 5.8% pace in August; the GNP grew at an annual rate of 3.8%, after adjustment for inflation, in the third quarter, up from 2.5% in the second quarter. Those figures seemed to indicate that the American economy, if not exactly sound in its fundamentals, was at least not deteriorating as drastically as the Black Monday stock-price collapse might have led an unsophisticated observer to believe. Nonetheless, the week as a whole will go down as the worst in financial history. The Dow's Black Monday plunge of 22.6% was almost double the record 12.8% fall on Oct. 28, 1929. Despite a spirited rally on Tuesday and Wednesday, the Dow was still down an unprecedented 295.98 points, or 13.2%, for the week. That immediately eclipsed the record 235.48-point decline the market had suffered the previous week. From its peak of 2722 in August to its Friday close, the average has fallen 28.3%, burning up an estimated $870 billion in equity values. Volume for the week was inconceivably greater than ever before, totaling 2.3 billion shares on the Big Board; the four heaviest trading days in New York exchange history all occurred last week. The turnover strained the exchange's computer network to the limit, and the Big Board decided to knock off trading two hours early on Friday and this Monday and Tuesday to allow exhausted brokers time to catch up on their paperwork. At best, the President may have bought some time for the WHite House and Congress to come up with a program to convince investors that something worthwhile will be done to bring budget and trade deficits under control. Probably not much time, either Wildly gyrating markets are better than those that plunge straight down, but they are hard on the nerves of stockholders who have already proved they are ready to jump at the first sign of trouble. The continued drop on the foreign exchanges Friday cannot be brushed off. If the wild week proved anything, it was that in an era when the U.S. is dependent on foreign goods and capital, no exchange is an island. Price breaks overseas can tough off panic in the U.S., which can then hammer prices down further abroad; that, in fact, is roughly what happened Monday and Tuesday. Moreover, even if prices stabilize--a gargantuan if, given the extreme jumpiness of the markets--the bust that has already occurred darkens prospects for business. Even in an economy the size of the U.S.'s, the nearly $385 billion in asset values that vanished last week alone is a sum large enough to have a strong impact. Not all those losses are theoretical; for many people who sold on Monday, the damage is painfully real. And investors who sat tight and saw the value of their stocks recover a bit at midweek have had an unforgettable demonstration that they cannot count on eventually being as rich in reality as they once looked on paper. To be sure, hardly anyone expects a rerun of the Great Depression that followed the 1929 Crash. Main reasons: the economy has developed many safeguards, and the Government, if it cannot yet be trusted to resolve the nation's fundamental financial problems, at least knows enough to avoid making the situation drastically worse. The banking system collapsed in the wake of the 1929 debacle, but it is much sounder today, shored up by federal deposit insurance, among other things. Says James Wilcox, an economist at the University of California, Berkeley: "In the 1930s when things looked bad, people ran from the banks out of fear. In 1987 people run to the banks to put their money in, because this time the banks are among the safest things around." The Federal Reserve Board, in hindsight, is widely considered to have played a role in converting the 1929 Crash into the 1930s Depression by allowing the U.S. supply of money and credit to shrink substantially at the worst possible time. Last week the Fed took exactly the opposite tack. Chairman Alan Greenspan on Monday was denounced by some critics for having inadvertently helped trigger the stock-market break by pushing up interest rates in early September. But on Tuesday morning he became something of an instant hero by reversing policy: just before the markets opened, he announced that the Federal Reserve, "consistent with its responsibilities as a central bank," would make as much money available as might be needed--for example, to banks that might be hurt by suddenly uncollectible loans to stockbrokers. Greenspan seemed to be as good as his word; by week's end the Fed was apparently pumping enough money into banks to bring interest rates down again slightly. Led by Citicorp, the major U.S. banks dropped the benchmark prime rate that they charge corporate customers from 9.25% to 9%. The move came only two weeks after the banks had boosted the prime from 8.75% to 9.25%. But if no depression is in the cards, the market crack could cause a recession all by itself. Economists last week were quoting odds like so many Las Vegas bookies. Some guessed the chances of a recession had gone from 1 in 4 to 1 in 2, others from 15% to 35%, but few doubted that the odds had increased. If a recession does not come, most agreed, the economy probably is in for at least a slowdown that might knock a percentage point or two off its growth rate. Frank Korth, senior vice president of Shearson Lehman, explains the mechanism by which market cracks get translated into slowdowns or recessions: "If you lose $4,000 in the stock market, you don't go out and spend $1,200 on a new color TV or $4,000 on a new motorboat. As a result, the man on the street whose job is in the boat plant is out of a job because there is no market for his company's product. Boatbuilders don't want to build inventory, so they close down their plants. Everybody loses: the plant workers, the suppliers, the corner grocer, the shoe store." This is, of course, a highly simplified scheme, and there is nothing inevitable about it; it could be averted by Government action that would restore confidence. But what kind of action? An answer must begin with an analysis of what trigger the market crash. Superficially, the bust might seem, to put it bluntly, insane. By no rational calculation could the asset value and earning power of American corporations be 22.6% less on Monday night than they had been the previous Friday. But that statement assumes that their values on Friday were realistic, and in hindsight there is widespread agreement that they were not. In other words, the crash to some extent really was--ho, all right--a correction, though one on a scale to make that word seem ludicrously inadequate. Says Korth of Shearson Lehman: "The market should not have reached 2700 [on the Dow Jones average] in the first place. We probably should have been trading around 1900 or 2100; maybe 2000 would have been the right number based on interest rates, corporate earnings and other fundamentals. We were 700 points ahead on sheer greed." As early as August, when the American bull market celebrated its fifth birthday, some investing pros were noting apprehensively that stock prices were getting out of line with expected corporate earnings, and dividend yields had fallen well below the interest return on bonds, making the fixed-income securities potentially a better investment. But the general feeling then was that the Dow might go as high as 3000, on pure momentum if nothing else, so why not stick around for the end of the ride? A similar psychology ruled overseas,according to Nils Lundgren, chief economist of Sweden's PK banken. Says he: "The market was really overspeculated, with people saying to themselves, `I won't get out now, but as soon as stocks start to fall, I will sell.' When you have that mentality operating, you are ready for a big fall." When markets get into such a state, almost anything can start a smashup. In the event, last week's explosion did not lack for triggers. Interest rates were pushing higher: the yield on U.S. Treasury bonds rocketed briefly above 10%. That seemed likely to pull money out of stocks into the bond market. In fact, something of the sort seems to have happened. While the stock market suffered through its collapse Monday, the bond market began a brisk rally, presumably propelled by money fleeing the stock exchanges and looking for a safe haven. The biggest immediate blow of all was a report two weeks ago showing that the monthly U.S. trade deficit in August had declined only slightly, to $15.7 billion. Investors who had been hoping for a large reduction took that as a sign that U.S. finances were out of control and that the Reagan Administration did not know how to fix them. They began dumping stocks. Moneymen in the U.S. and Europe found a personal villain: U.S. Secretary of the Treasury James Baker. Some came close to implying that he turned a serious stock-price decline into an all-out crash single-handedly. That would be a wild exaggeration, but he surely did not help. What Baker did was get into a complicated but unnerving spat with West German financial authorities, who two weeks ago permitted the fourth rise in German interest rates in three months. What was so bad about that? Washington would like West Germany, Japan and other major countries to reduce interest rates for two reasons: 1) to avoid competing against the U.S. for international capital needed to cover the federal budget deficit; 2) to stimulate their domestic economies so they will import more U.S. products and not be so dependent on export sales that swell the American trade deficit. Baker might have been justified in criticizing the German interest-rate boost; he was not the only moneyman to consider it unnecessary as well as unwise. The boost was supposed to combat inflation, but West Germany is a country with almost no inflation. Baker, however, went much further than merely criticizing the Germans. In a series of statements beginning Thursday, Oct. 15, and continuing through a TV interview on Sunday, he repeatedly asserted that the U.S. would not accept the German interest-rate boost quietly. Moneymen immediately read his comments to mean that Washington would no longer abide by the February Louvre accord under which the U.S., West Germany, Japan and four other nations try to keep the values of their currencies within a narrow trading range. Indeed, the New York Times quoted an unnamed "senior Administration official" as announcing an "abrupt shift in policy," implying the U.S. would seek to retaliate against the Germans not just by letting the dollar fall but by actively driving it down. For investors around the world, many of whom assumed the unnamed official must have been Baker, that raised horrifying specters: chaos in the currency markets and a breakdown of the slender degree of international financial cooperation achieved under the Louvre agreement (named after the Paris museum, which also house the French Finance Ministry offices in which the accord was negotiated). U.S. Economist Pierre Reinfrew accuses Baker of "initiating economic warfare against the Germans and then threatening to bomb his own currency." Treasury sources vehemently deny that Baker intended any such thing. All he want to say, they insist, was that Washington would not let the West Germans push the U.S. into raising its own interest rates; they point out that his statements never even mentioned the dollar specifically. And the unnamed senior official? It was not Baker, Treasury people insist; in fact, Baker would like to get his hands on whoever it was. Perhaps, but such statements cannot inspire confidence in the degree of policy coordination within the Reagan Administration. Ironically, Baker in a sense won his campaign. Flying to Europe for a scheduled visit Monday, he persuaded the West Germans to roll back the interest-rate increase he had assailed, and they together specifically reaffirmed the Louvre agreement. But it was much too late to calm the unrest Baker's previous statements has intensified. Well before he patched things up with the Germans, selling on the world's stock exchanges had accelerated into an all-out crash. One factor behind the speed of the market's descent was the almost complete computerization of the New York exchange and other markets. There is immense dispute, even days after the fact, as to what part computers that make trades semiautomatically played in touching off the gigantic volume of sell orders. Taking no chances, however, the Big Board after the Monday debacle instituted restrictions on so-called program trades of large portfolios of stock carried out by computer, in order to damp down price swings. In a broader sense, computers unquestionably had an all-important role. They enable the exchanges to execute trades swiftly, in volume that would have been inconceivable a few years ago. So at times of market excitement, the volume that would once have been stretched over a week or so gets squeezed into a day. When the orders are predominantly on one side, prices run up or down violently. But never so violently as on Black Monday. Tickers and news reports flashed the story of huge price declines on heavy volume. With each sale, more investors became convinced that a collapse had begun and they had better get out while they still could. Mutual-fund managers tried to hold on but could not: they had to dump stock to get cash to pay off investors who clamored to redeem their fund shares. Margin calls to investors who had bought stock on credit aggravated the frenzy. Some could not put up additional collateral and were sold out. Why, then, did the rout give way to a rally? Traditionally, that happens after every so-called selling climax (even in 1929), because most investors who were thinking of selling have been cleaned out in one grand sweep and buyers start looking for newly cheap shares. The rally in the middle of last week was given particularly powerful support by some 200 major corporations that started buying up their own stock at bargain prices, in part of keep it out of the hands of would-be raiders. The rush put at least a temporary damper on mergers and acquisitions anyway. Several deals fell through because the bids made for the target companies suddenly looked unrealistically high after the general decline in stock prices. But it is anyone's guess whether the small degree of stability so painfully achieved on Friday--volume dwindled as the Dow average stood almost still-will hold even for days or hours. Alan Meltzer, professor of political economy at Pittsburgh's Carnegie-Mellon University, thinks the "markets will remain volatile because there are still too many unanswered questions." The most fundamental questions, economists agree with the closest approach to unanimity they ever achieve, are: How long will the U.S. try to live it up on borrowed money? And can it summon the will to start the painful readjustment necessary to kick the habit--a readjustment that grows more painful the longer it is put off? The problem is hideously complicated in detail but simple enough in outline. Ever since the giant tax cuts of 1981, the U.S. has been running deficits on a scale never seen before. True. Reagan announced at his press conference that the deficit in fiscal 1987, which ended on Sept. 30, dropped to $148 billion, from $221 billion the prior fiscal year. But the new figure is still far too high, and it is likely to rise again soon; much of the 1987 reduction was due to one-shot effects of the tax-reform law. Concurrently, the U.S. has swung from a surplus of exports over imports of $3 billion as recently as 1975 to a trade deficit of $156 billion last year. One result is that America has run up a foreign debt of about $250 billion. Economists across a broad spectrum of ideological positions warn almost with one voice that this situation is precarious in the extreme. Foreigners will not continue forever to finance American profligacy, and the stock-market crash was a relatively mild foretaste of what could happen if they pull their money out. The nation would then face a grim choice of financing the deficit by ruinous printing-press inflation or a sudden, brutal cutback in spending that might trigger a real economic bust. No wonder, then, that stock investors have been nervous. Whatever the precise mix of emotions and events that triggered last week's collapse--and to establish that mix would require probing into millions of minds around the world--its root cause was a dim but accurate perception that U.S. prosperity was not sustainable with present policy. And with Congress and the President perpetually wrangling over the most modest proposals to reduce the budget deficit, they could see no sign that policy was about to change. In truth, even with the most brilliant policy, the passage to a sounder prosperity is likely to be tricky, dangerous and painful. Lowering the trade deficit will take years, and will probably require a cut in American consumption--meaning, in other words, at least a temporary reduction in the standard of living. Many economists think the dollar will have to fall further too, reluctant as both U.S. and foreign moneymen are to see that happen. The reluctance is understandable. Unless a decline is carefully managed, it will raise two dangers: a renewal of inflation and a panic flight of foreign capital from the U.S. (since foreigners would not be eager to hold dollar-denominated investments that shrank in value against their own currencies). But there is an impressive consensus, in the U.S. and abroad, on how to begin to correct the imbalances in the American economy. The President and the Democratic-controlled Congress must agree, right away, on a package of measures that hold some real promise of reducing the budget deficit steadily and substantially. Certainly these must include painful spending cuts. But they must also include tax increases, much as Reagan hates the thought. Not because they are any panacea; indeed they carry a serious risk. Higher taxes might reduce consumer spending just when a recession is beginning, and deepen the slump. But no significant budget cut is possible without at least some sort of modest tax increase, and no progress toward solving the nation's fundamental economic problems is possible without a real deficit reduction. That was the theme, implicit or explicit, of comments around the world last week. Foreign government and financial leaders have an all-important stake in U.s. economic policy. The worldwide market crack is already hurting their economies; for example, it has delayed European programs to privatize industry by selling chunks of government-owned companies to individual investors. An American recession, should that be the result of a continued stock slump, could quickly travel abroad. French President Francois Mitterrand, speaking at a financial forum Thursday, complained about a "world that constantly moves the carpet under your feet, pulling it out and threatening to trip you up." The market bust, he said, "is the disorder of a non-system. There is no system. It has been broken." Others left no doubt about who must bear responsibility for fixing it. Says a senior Canadian government economist: "Everyone, all around the world, has been keeping an eye on the U.S. economy and wondering how long it could continue to survive without dealing with things like its trade imbalance and its huge federal deficit. When people became convinced that the U.S. lacked the will (we know it has the ability) to deal with these problems, they lost confidence in the U.S. market." Guido Carli, former head of the Bank of Italy, is specific about what needs to be done: "The only way out is to reduce the U.S. deficit. Otherwise there is a risk of recession." Does Reagan now understand the necessity? Just before Black Monday, Treasury Secretary Baker in a TV interview restated the President's opposition to any sort of tax boost. But he and other insiders were already monitoring the stock market apprehensively. The previously Friday, White House Chief of Staff Howard Baker had pulled together an informal group consisting of himself, the Treasury Secretary, Council of Economic Advisers Chairman Beryl Sprinkel, Federal Reserve Chairman Greenspan and White House Aide Kenneth Duberstein. They met with the President after the market had closed with a then record loss of 108.36 points (shortly to be vastly eclipsed). Their message: basic economic indicators were good, but the markets were very nervous. On Monday, Howard Baker was on the telephone almost all day long, keeping in touch with old colleagues on Capitol Hill, where he had once been Republican Senate leader, and phoning people on Wall Street, including New York Stock Exchange Chairman John Phelan, to get market reports. At 3:40 p.m., 20 minutes before the close of trading,the chief of staff and Duberstein called at the Oval Office to give Reagan a market status report. But prices were tumbling too rapidly for anyone to keep track of them. Reagan, as his later statements indicated, simply did not know what to make of the crash. The decisive meeting occurred Tuesday after the market close. James Baker, by then back in his Treasury office after having cut short his trip to Europe, first called in Howard Baker, Greenspan and Sprinkel to coordinate what they would tell the PResident. Then, joined by Duberstein, they went upstairs in the White House to the brightly colored West Sitting Room, which the Reagans use as a living room. James Baker opened by telling Reagan that the world seemed to be looking for some movement on the President's part, and the quickest way he could display leadership was by reaching a compromise with Congress on reducing the budget deficit. Everyone knew that would have to include a tax increase. Greenspan, who had been an informal economic adviser to Reagan before the President chose him to head the Federal Reserve, voiced a somewhat perverse but effective argument: in effect, the only way to keep taxes low was to agree to raise them a bit. If there was no budget compromise with Congress, he said, the financial markets might continue to weaken and the economy might take a real turn for the worse. That, he continued, might give the Democrats enough political clout to shove through a big increase severely trimming back Reagan's cherished tax cuts, either by ramming one through over the President's veto or by winning the 1988 election and enacting a stiff boost after Reagan left office. The President showed great reluctance to accept the advice that he should compromise on a modest boost now. But, says one participant, eventually the "President bought the [Greenspan] argument that if the economy goes down the tubes you lose the whole thing, the whole legacy." Even so, the two Bakers had to argue further on Thursday to cement Reagan's agreement to state in his press conference that night that he would put everything on the table in budget discussions with congressional leaders. But as the President began speaking, advisers who had coached him were concerned that he would take back that pledge almost immediately after making it. Their fear was that once Reagan got past his prepared statement and started answering reporters' questions, he would go on automatic pilot and repeat all his standard denunciations of taxes. In fact, Reagan once or twice started to do exactly that but caught himself before going too far. Said an adviser the next day: "He almost blew it. He came very close." But he did not blow it, and the budget negotiations were set to begin early this week. It should not take long to find out whether some agreement can be reached. Even if a renewed market decline does not force a quick resolution--and one very well might--the talks will be racing a deadline of sorts. if a budget compromise is not worked out and enacted by Nov. 20, some $20 billion of automatic spending cuts go into effect under a modified version of the Gramm-Rudman Act. They would slash away with idiot impartiality at defense and social spending, at good programs and bad. And that would just about end any chance that Washington would give the stock markets the signal they yearn for. What if the negotiations break down and the market gets the opposite signal: that the U.S. is unable or unwilling even to start working out some long-range solution to its gargantuan budget and trade deficits? As last week's wild price whipsawing demonstrated, no one can predict stock prices and volume for even a few hours. But if the U.S. continues to float on a sea of red ink and foreign debt--well then, many financial experts suggest, sooner or later the markets can expect the real crash. How it could be much worse than Black Monday is as difficult to imagine as was Black Monday itself just days before. But the world had better hope it never finds out what the ultimate bust would be like. -- By George J. Church. Reported by Rosemary Byrnes and Barrett Seaman/Washington and Frederick Ungeheuer/New York, with other bureaus Greenspan's Big Test If any one man can decide how last week's market turmoil will affect the U.S. economy, and indeed that of the entire world, he is Alan Greenspan, 61. As chairman of the Federal Reserve Board, the soft-spoken economic forecaster is the ultimate arbiter of the nation's credit supply and thus of the interest rates at which money is lent throughout the U.S. banking system. On the job less than three months, Greenspan is suddenly being forced to make rapid and delicate decisions to prevent the market crash from turning into a mushrooming financial collapse and to stave off a steep recession. Says Charles Schultze, who was chairman of President Jimmy Carter's council of Economic Advisers: "Greenspan is in a very difficult period in which he is truly being tested." Following Black Monday, Greenspan moved quickly to avert further disaster. The day after the market's plunge, the new Fed chairman cut short a speaking trip to Dallas and hurried back to his ornate second-floor office in Washington's Eccles Building. He had already issued a terse announcement that the nation's central bank would "serve as a source of liquidity to support the economic and financial system." That was a signal that banks would have no difficulty obtaining additional credit as needed to provide for the huge losses sustained by shell-shocked brokerages. Greenspan's announcement produced an immediate decline in interest rates, as the banking system moved in effect to replace some of the $500 billion in stock values that vanished on Black Monday. Greenspan also began moving behind the scenes to bolster the Reagan Administration's political response to the crash. Within an hour of Treasury James Baker's return from West Germany to Washington on Tuesday, Greenspan was huddling with him to plan the Administration's response to the market crash. Later that day the Fed chairman helped persuade Reagan to offer Congress a summit meeting to negotiate a federal-deficit reduction program. People like Lyle Gramley, a former Federal Reserve governor who is now chief economist for the Mortgage Bankers Association, praised the Fed chairman for his decisive actions. But critics like Paul Craig Roberts of Washington's Center for Strategic and International Studies charge that Greenspan also helped cause last week's market disaster. They note that back on Sept. 4, Greenspan's first important move as Fed chief was to push successfully for a hike in the bellwether discount rate, the interest that the Fed charges on funds lent to financial institutions, from 5 1/2% to 6%. It was the first such increase in nearly 3 1/2 years. Greenspan justified the rate hike as a move against potential inflationary pressures, which indeed it was. But for investors, any increase in interest rates makes stocks less attractive, since higher returns become available for bonds, Treasury bills and other fixed-income securities. During the two trading days after the Fed announced its decision, the Dow Jones industrial average dropped 54 points. Admits Gramley: "A common problem is the markets do not understand Alan Greenspan's statements. He needed to express [the Fed's decision] more clearly." Greenspan's task is especially difficult because he follows Paul Volcker, who left the Fed last August after eight years as chairman. Volcker was legendary for his ability to inspire confidence at home and abroad. Greenspan's experience is also grounds for reassurance. In 2 1/2 years as Gerald Ford's chief economic adviser, he had some success in combatting inflation,then the nation's main economic woe. But, unfortunately, the progress was temporary, and inflation was not decisively licked until a severe credit squeeze was imposed in the early 1980s by Volcker and the Fed. </body> </article> </text>