James K. Galbraith

We Cannot Have Discipline, So We Must Have Pain


I have two friends – divorced women in their fifties, intellectuals, with literary and cultural interests – who put their nest eggs into NASDAQ stocks earlier this year. Ouch. Neither of them was rich, nor ever destined to be. Now they will be somewhat less so.

In the long history of manias and speculations, the info-tech boom was far from being the worst to come along. Past frenzies have centered on real estate in swamps and suburbs (Florida, Texas), on ephemera (tulips), or on the pursuit of the world’s most useless metal (gold). In most cases, fraud was a dominant motive force.

In the tech boom, the beneficiaries were mainly small companies staffed by nerds and b-school grads. Most of them were trying to make a product; and some of them succeeded. Fraud there was, but most of it was of the genial, optimistic, borderline sort that characterizes every long shot – who knows if this stuff will work? Not a bad way, all in all, for bright and ambitious young people to spend their time. They weren’t building nukes, after all, or dealing drugs, or running numbers.

And could they have succeeded? In many cases, they might have, given time, money and reasonable expectations. Stock offerings raised cash, which was then used to fund operations. The NASDAQ was a machine that converted naive hopes and blind optimism into payrolls, the payrolls were placed as bets on gadgets and lines of code. Not all of those bets were honest, and not all of the honest ones were any good. But some of them were.

Alas, tech companies can only absorb so much cash at a time. Beyond a certain point, there was much more money available than could be used. The time to payoff grows longer, necessarily, as the bets grow more exotic. Good management of the tech boom would have required measuring out the financial injections, stretching them through time, and keeping a lid on unrealistic expectations of gain.

This was Mr. Alan Greenspan’s responsibility. And he blew it.

For the financial markets, it’s give an inch, take a mile. If a twenty percent gain is possible, why not forty percent? Margin lending is a device for doubling your bets. But only for a limited time; if the inflows do not continually accelerate, a reckoning must come. Everyone buying on margin knows this; they all calculate that they can get out before the crash. In the meantime, more and more of the money flows to projects less and less likely to succeed before the bills come due.

This is why Henry Reuss (former Chair of the House Banking and Joint Economic Committees of Congress) and I were calling last autumn for a sharp rise in the margin requirement. We saw the danger, and we said so. The Federal Reserve ignored us. They made excuses, citing “academic studies” on the ineffectiveness of the margin rules. No such studies on raising interest rates were ever commissioned. Interest rates went up, margin requirements did not: a formula for disaster. Margin loans exploded.

The Federal Reserve knew this. It did nothing. As an institution, it deliberately and willfully took the speculators’ part.

And now, the crash has come – sooner than I expected, but for reasons both predictable and predicted. It was all perfectly needless, and perfectly avoidable, even up to the past few weeks. Mr. Greenspan’s motto is: We Cannot Have Discipline So We Must Have Pain.

I don’t think – I could be wrong – that the rest of the economy will go down. At least not right away. But the tech sector, an innocent and largely cheerful creation of a hopeful moment in our economic history, is deeply wounded. It is a casualty of the Feckless Fed, a blot on Greenspan’s reputation, and a sign that when the chips are down, the brokers and the bankers win out over the nerds and the b-school graduates every time.

Not to mention the financial innocents who piled into the NASDAQ at the top.

James K. Galbraith is a professor at the LBJ School of Public Affairs, U.T.—Austin, and chair of Economists Allied for Arms Reduction. He warned against rising interest rates and neglect of margin requirements in his speech at the White House on April 5. He is author of CreatedUnequal: The Crisis in American Pay, and co-editor of “Inequality and Industrial Change: A Global View” (forthcoming). He directs the U.T. Inequality Project, whose work may be viewed at http://utip.gov.utexas.edu.