Greenspan put

Based on Wikipedia: Greenspan put

In 2009, Lloyd Blankfein, the chief executive of Goldman Sachs, described his bank's use of Federal Reserve lending facilities as "doing God's work." The remark was meant to be clever. It landed as something else entirely—a window into how Wall Street had come to view its relationship with the central bank: not as a lender of last resort, but as an inexhaustible patron of speculation.

This story begins in 1987, when a man named Alan Greenspan had been Federal Reserve chair for barely two months before markets handed him a crisis. On October 19th—Black Monday—the Dow Jones Industrial Average dropped twenty-two percent in a single day. It remains the largest one-day percentage decline in the index's history.

Greenspan's response was swift and consequential. The Fed flooded the financial system with money, signaling that it stood ready to provide whatever liquidity banks needed. Markets stabilized. The crisis passed. And a precedent was born.

The Insurance Policy Nobody Bought

To understand what came next, you need to understand what a "put option" is. In financial markets, a put is a contract that gives you the right to sell something at a predetermined price, no matter how far the actual market price falls. It's insurance against disaster. If you own stock and buy a put, you've capped your downside. The stock could go to zero and you'd still be able to sell at the strike price.

Puts cost money. You pay a premium for that protection.

The Greenspan put was different. It was free insurance that nobody explicitly purchased but everyone learned to expect. After Black Monday, and then after the savings and loan crisis, and then after the Gulf War selloff, and then after Mexico's peso crisis—after each successive shock—the pattern became unmistakable. When markets fell sharply, the Federal Reserve would intervene. Asset prices would recover. Those who had held their nerve, or doubled down, would be rewarded.

"Don't fight the Fed" became the mantra. It meant something specific: when the Federal Reserve is actively pushing asset prices higher, betting against that tide is foolish.

The Mechanics of Market Support

How does a central bank actually push asset prices up? The Federal Reserve doesn't buy stocks directly. But it has tools that achieve similar effects through less direct channels.

The first tool is interest rates. The Fed controls the federal funds rate—the interest rate at which banks lend reserves to each other overnight. When the Fed cuts this rate, borrowing becomes cheaper throughout the economy. Corporations can refinance debt at lower costs, which improves their profitability. Investors looking for returns move out of safe assets like Treasury bonds (which now pay less) and into riskier assets like stocks. The math of discounted cash flows makes future corporate earnings worth more in present-value terms. All of these forces push stock prices up.

The second tool is bond buying. When the Fed purchases Treasury bonds in large volumes, it accomplishes several things. It pushes bond prices up (and yields down, since prices and yields move inversely). Banks that hold Treasury bonds see profits on their books. And the money the Fed pays for those bonds enters the financial system, available for deployment elsewhere.

The third tool—and this one would prove fateful—is the repurchase agreement. A "repo" works like this: a bank sells securities to the Fed with an agreement to buy them back at a slightly higher price the next day, or the next week, or in some cases with rolling agreements that stretch indefinitely. It's essentially a collateralized loan from the Fed to the bank, with the securities serving as collateral.

What makes repos powerful is that the bank can use the borrowed money to buy assets. If those assets rise in price, the bank profits from both the capital gain and whatever dividends or interest the assets pay—minus the minimal cost of the repo loan. It's leverage, provided by the central bank.

When Free Insurance Encourages Recklessness

Economists have a term for what happens when you're protected from the consequences of your risks: moral hazard. The classic example is fire insurance that's so generous it actually encourages arson. The Greenspan put created moral hazard on a civilizational scale.

Consider the psychology. If you're a Wall Street trader in the 1990s and you've watched the Fed rescue markets repeatedly, what's the rational response? Take bigger risks. Use more leverage. If your bets pay off, you keep the gains. If your bets blow up badly enough, the Fed will intervene to prevent catastrophe. One veteran trader described the environment bluntly: "You can't lose in that market. It's like a slot machine that always pays out."

Economist John Makin called it "free insurance for aggressive risk-taking."

The culmination of this dynamic was the collapse of Long-Term Capital Management in 1998. LTCM was a hedge fund run by some of the most credentialed people in finance, including two Nobel laureates in economics. They used sophisticated mathematical models to identify tiny mispricings in bond markets, then leveraged those positions enormously—at their peak, they had over a trillion dollars in positions backed by less than five billion dollars in equity.

When the Russian government defaulted on its debt in August 1998 and markets moved in ways the models hadn't anticipated, LTCM faced ruin. The fund's interconnections with major banks meant its failure could cascade through the financial system. The New York Fed orchestrated a private bailout by LTCM's creditors, but the episode prompted the most dramatic expansion of the Greenspan put yet.

Interest rates fell. Money flowed. And investors piled into the most speculative corner of the market they could find: internet stocks.

Bubbles as a Feature, Not a Bug

The dot-com bubble that followed is well remembered. Companies with no revenue, no clear business model, and names ending in ".com" achieved valuations in the billions. Pets.com, which sold pet supplies online, went public in February 2000 and was bankrupt by November. The NASDAQ composite index rose from about 1,300 in early 1995 to over 5,000 in March 2000, then crashed to below 1,200 by late 2002.

When the bubble burst, Greenspan's Fed cut interest rates aggressively—from six and a half percent down to one percent by 2003. But this time, Greenspan adjusted the tools of his put. Rather than relying primarily on Treasury purchases, the Fed began buying mortgage-backed securities.

The logic was straightforward: if you want to stimulate the economy by making people feel wealthier, home prices are a more direct route than stock prices. Most Americans don't own meaningful stock portfolios, but most middle-class Americans own homes. Make mortgages cheaper, and home prices will rise. Rising home prices make homeowners feel rich. Feeling rich, they spend more.

It worked, until it didn't. Home prices rose steadily through the 2000s. Cheap mortgages made housing affordable even as prices climbed, at least as measured by monthly payments. The financial industry obliged the demand for mortgage debt by relaxing lending standards dramatically, packaging increasingly questionable loans into securities, and selling those securities worldwide with the blessing of credit rating agencies.

By 2006, the system had become absurd. "NINJA" loans—no income, no job, no assets—were a real category of mortgage product. The assumption underlying the entire structure was that home prices would continue rising indefinitely.

The Limits of the Put

When U.S. home prices began falling in 2006, the Greenspan put faced its existential test. Greenspan himself had retired in early 2006, handing the Fed chairmanship to Ben Bernanke. But the tools remained the same. Cut rates. Buy bonds. Provide repos.

This time, it wasn't enough.

The problem was that Wall Street had used the Greenspan put's tools too enthusiastically. Investment banks had gorged themselves on repos, leveraging their balance sheets to buy mortgage-backed securities. When those securities began declining in value, the banks needed more collateral for their repos. But their collateral was the same mortgage-backed securities that were falling. A death spiral had begun.

By September 2008, Lehman Brothers had failed—the largest bankruptcy in American history. The entire financial system stood at the edge of collapse. Bernanke's Fed had to do something the Greenspan put had never required: bypass the banks entirely.

This was direct quantitative easing—the Bernanke put. Rather than lending money to banks through repos and letting the banks buy assets, the Fed would print money and buy the assets directly for its own balance sheet. Treasury bonds, yes. But also mortgage-backed securities by the hundreds of billions. The Fed's balance sheet, which had been around eight hundred billion dollars for decades, would eventually swell to over four trillion.

The Addiction Deepens

Bernanke announced the end of the first quantitative easing program (QE1) in June 2010. Markets promptly collapsed again. He was forced to announce a second program (QE2) in November 2010. When that ended, markets struggled. A third program (QE3) began in September 2012 and continued for years.

The pattern was unmistakable. Markets had become dependent on Fed intervention to sustain their valuations. Each attempt to withdraw support triggered selloffs severe enough to force a reversal.

Janet Yellen succeeded Bernanke in 2014 and largely continued his approach—perpetual monetary looseness, interest rates held near zero, quantitative easing maintained or expanded as needed. During her tenure, a new term emerged: the everything bubble.

In 2015, Bloomberg captured the concern: "The danger isn't that we're in a tech bubble. The danger is that we're in an Everything Bubble—that valuations across the board are simply too high." Stocks, bonds, real estate, commodities—prices across multiple asset classes had risen to levels that historically preceded crashes.

Jerome Powell took over as Fed chair in 2018 and initially attempted what his predecessors had failed to do: normalize monetary policy. He raised interest rates modestly and began "quantitative tightening"—letting the Fed's bond holdings shrink by not reinvesting the proceeds when bonds matured. The plan was to reduce the Fed's balance sheet from four and a half trillion dollars to something like two and a half to three trillion over four years.

Markets collapsed in the fourth quarter of 2018. Powell abandoned the plan.

By mid-2019, even without an obvious crisis, Powell was providing large-scale repos to Wall Street banks. The everything bubble had become too large to deflate safely. Asset prices could only go higher, or the system would break.

The Pandemic Puts Everything to the Test

Then came COVID-19. In March 2020, as the pandemic spread globally and economies locked down, markets experienced one of the fastest crashes in history. Powell's response was the largest monetary intervention ever attempted. Interest rates went to zero. Quantitative easing resumed at unprecedented scale. The Fed began buying not just Treasury bonds and mortgage-backed securities but corporate bonds—something it had never done before. It even bought shares of bond exchange-traded funds.

The Fed's balance sheet, which had been around four trillion when Powell took over, roughly doubled to nearly nine trillion.

Markets recovered with stunning speed. By August 2020, the S&P 500 had erased all its pandemic losses. By year end, despite a global pandemic, economic shutdowns, and millions of job losses, stock markets reached all-time highs. Housing prices soared. Cryptocurrency speculation exploded. Assets of all kinds appreciated together.

Time magazine noted that the scale of Powell's intervention "is changing the Fed forever." Bloomberg called the Powell put stronger than either the Greenspan or Bernanke puts.

Nancy Pelosi, the Speaker of the House, offered a remarkably candid assessment during a television interview: "We know that the Fed is shoring up the markets so that the stock market can do well. I don't complain about that. I want the market to do well."

The Bill Comes Due

Throughout the decades of the Fed put, one warning had been consistently dismissed: that creating money to buy assets would eventually cause inflation. For years, this prediction seemed wrong. Consumer prices rose slowly if at all through the 2010s, even as asset prices soared.

The pandemic changed that. The combination of disrupted supply chains, massive government stimulus payments, and the Fed's unprecedented money creation finally produced the inflation that skeptics had long predicted. By mid-2022, consumer price inflation had reached nine percent—levels not seen since the early 1980s.

Powell faced a choice that none of his predecessors had confronted so starkly. Continue the put and watch inflation potentially spiral out of control. Or reverse course and deliberately prick the everything bubble he had helped inflate.

He chose to prick it. Interest rates rose rapidly through 2022 and 2023. Quantitative easing became quantitative tightening. The Fed put became what financial commentators called the Fed call—using the same tools in reverse to bring prices down rather than push them up. (A call option, the opposite of a put, increases in value when prices rise. Reversing a put is, conceptually, imposing a call.)

The cryptocurrency market crashed. Housing prices declined in many markets. Technology stocks suffered their worst year since 2008. Several regional banks failed when their bond portfolios, bought at high prices during the everything bubble, collapsed in value.

The Side Effects of Free Insurance

Beyond the immediate market gyrations, the decades of the Fed put produced consequences that are still playing out.

Wealth inequality widened dramatically. The Fed put primarily benefits those who own financial assets—stocks, bonds, real estate. The top ten percent of Americans own roughly ninety percent of stocks. The bottom half own almost none. Each iteration of the Fed put transferred wealth upward. Various economists have traced the rise in American wealth inequality from its low point in the 1980s to levels not seen since the late 1920s directly to Fed policy. The Fed disputes this characterization.

When asked directly whether Fed policy had increased inequality, one economist responded with unusual bluntness: "That's one of the things that's actually really not in contention. I don't think there's really anyone on the other side of that issue saying 'No, no, no, the Fed's policies have not driven or increased wealth and income inequality.' Except for maybe Fed chair Jerome Powell himself."

Political dynamics shifted as well. When asset prices become instruments of policy, they become political prizes. Donald Trump made the stock market an explicit measure of his presidency's success, tweeting about market highs and criticizing the Fed whenever it showed any inclination to tighten policy. Economist Mohamed El-Erian observed that Trump "believed and repeatedly stated publicly that the stock market validated his policies as president. The more the market rose, the greater the affirmation of his agenda."

This created a feedback loop. Politicians pressured the Fed to maintain high asset prices. The Fed obliged. Markets rose. Politicians pointed to rising markets as validation. The Fed faced even more pressure not to allow declines.

Steven Pearlstein of The Washington Post captured the dynamic precisely: "In essence, the Fed has adopted a strategy that works like a one-way ratchet, providing a floor for stock and bond prices but never a ceiling. The result in part has been a series of financial crises, each requiring a bigger bailout than the last."

Where We Are Now

The Fed put, in its various forms, has been a fixture of American financial life for nearly four decades. It has prevented some crashes and cushioned others. It has made some people very rich. It has created epic speculative bubbles and then dealt with their aftermath by creating conditions for even more epic bubbles.

Whether it has made the financial system more stable or simply deferred and magnified inevitable reckonings remains deeply contested. Historian Edward Chancellor, in his 2022 book "The Price of Time: The Real Story of Interest," argued that the everything bubble and its inflationary aftermath represented a "hangover" from decades of central bank overreach.

What seems clear is that the relationship between central banks and financial markets has been fundamentally altered. Markets now expect intervention. They price in intervention. They become addicted to intervention. And each intervention must be larger than the last to achieve the same effect.

The Substack article that prompted this exploration carried a warning in its title: "The Fed Can't Rescue AI." The implication is clear. Whatever bubble forms around artificial intelligence—and the valuations of AI companies suggest one is well underway—market participants shouldn't assume that the Fed put will bail them out.

They probably will anyway. That's what forty years of Greenspan puts, Bernanke puts, Yellen puts, and Powell puts have taught them. Don't fight the Fed. The slot machine always pays out.

Until, someday, it doesn't.