EMPORIUM
J.C. Penney Gains From Precedent-Setting Deal for Eckerd Drugs
by Isadore Barmash
When J.C. Penney Co. (NYSE: JCP) bought Eckerd Drug Stores in February
1997, the reaction was very mixed. Some professional pundits thought it
was an odd but potentially synergistic deal. Others viewed it as a gamble
to latch on to and keep the older customer crowd that is more and more
frequenting pharmacies. Still others thought that the acquisition was an
act of desperation by a company that had decided it had done the utmost as
a department-store operator.
After a year or so, the general attitude is much more unified. In
essence, it is that Penney pulled off one of the wiliest stunts in the
department store business in years. In fact, it may well be that Penney's,
long considered one of the most conservative of retailers, showed
uncharacteristic, dazzling speed and more alacrity than its peers in buying
the 1,800-store Eckerd to add to its own 1,100 drug stores.
In these days of fickle but better-heeled, middle-income customers, the
big question is, how can a self-respecting department store chain improve its
bottom line and return on investment? Stores like Penney's, Macy's, Dillard
(NYSE: DDS), Marshall Field's are under the gun. On one hand, they are
constantly losing market share to the ever-pushy discounters like Wal-Mart
(NYSE: WMT) and Target while the smarter specialty store operators like the
Gap (NYSE: GPS), Crate and Barrel, Finish Line (Nasdaq: FINL), Abercrombie &
Fitch (NYSE: AFS) and others keep biting off pieces of business that always
belonged to department stores.
Recently writing about department stores Jeffrey Edelman, analyst for
PaineWebber, New York, said, "Shopping center growth has slowed
substantially, with very few units being added over the past several
years. Store expansion opportunities continue to diminish, as do further
acquisition possibilities. Asset productivity is becoming more important
and instrumental, as department stores increase their emphasis on return
on investment."
But Penney's had a little edge. It was already in the retail drug-store
field with its Thrift and two smaller chains. No doubt its management realized
how important critical mass would be as the nation's health-care business
continued to grow. As Frank Newman, president and chief executive officer of
Eckerd, told a Merrill Lynch meeting in February, "This is an industry that
has been going through rapid consolidation. The four top players, Eckerd,
Walgreen (NYSE: WAG), CVS (NYSE: CVS) and Rite Aid (NYSE: RAD), generate about
60% of total segment volume. Each of us are in the $10 billion to $13 billion
annual sales range. This consolidation has been driven in large part by the
growth in managed care plans which, by reducing margins, have created the need
for more throughput in order to amortize the significant infrastructure costs
related to managed care. It also rewarded those operators who were able to
put together large networks of stores."
Since buying Eckerd's, comments are very positive. Merrill Lynch's Dan
Barry says, "Eckerd has boosted Penney's multiple and market performance.
Eckerd provides a growth vehicle for Penney. Synergies through the
combination of drug-store chains should result in cost savings of 14 cents
a share in 1997 and 23 cents a share in 1998. Eckerd is a strong
competitor in the drug-store industry with strength in key markets. We
believe that Eckerd is the low-cost operator in the industry and tight
cost controls should continue to result in leverage." What does Penney say
about it? Speaking in March at a Merrill Lynch meeting, Penney's
chairman-chief executive, James Oesterreicher, said, "In our drug store
business, we added significant growth by expanding our presence through
the purchase of Eckerd. This took Penney from $23 billion in revenue in
1996 to about $30 billion in 1997. The physical conversion of 1,100 former
Thrift, Fay and Kerr drug stores to the Eckerd nameplate is now complete.
This division, with 2,800 drugstores, is positioned to deliver synergies
from this consolidation."
Although he did not break down Eckerd's contribution to the recent
fourth-quarter results, he said, "We're proud of our performance. Our
operating profits were up 42%. Our operating margins were 9.4% which gets
us back to our margin levels of the mid-1990s." Then he added, "Eckerd,
with $9.7 billion in sales, now represents 30% of our company's revenues. Our
drug store division is number one or two in 34 of the 42 major markets in
which we operate. Our drug stores are also located in 10 of the 12
fastest-growing markets of the country. This year, we can focus on the
fundamentals of the drug-store business and on achieving the synergies
that we believe are available."
In fact, it may be -- can it be unthinkable? -- that the Eckerd drug-store
chain might eventually do better, at least in long-range, percentage terms,
than Penney's department stores? In fact, that happened in February. In a
month when department stores like Penney's had same-store sales which were
only 1.1% ahead of last year's, Federated Department Stores (NYSE: FD) were up
1.5% and both Dillard and May Department Stores (NYSE: MAY) had 5% rises,
Eckerd's same-store revenues rose 7.5%. Of course, that was only one month.
So -- can it all point in the direction of more drug-store
acquisitions by department-store chains? Clothes-furniture-pharmaceuticals
-- is it the next step after food-and-nonfood store combinations? Hence,
will Federated Department Stores go after, say, Walgreen's or Rite Aid?
How about May Department Stores striking out for a real go-go drug-store
player like CVS? Or will we see Dillard's or Proffitt's (NYSE: PFT) or
Dayton Hudson (NYSE: DH) making come-hither eyes at the New York chain of
Duane Reade and combine that fine regional chain with others like, say,
Genovese Drug Stores (AMEX: GDX.A), in the New York area? These deals are
probably already being mapped out in theory by more than one or two
investment bankers. Don't be too surprised when it happens.
###
LIFE IN THE 20s
Sitting Ducks -- Not Supermom, Just a Mom who Works
by Melissa Metz
(Melissa Metz received her B.A. and M.S. in Computer Science from
Columbia University, and works there as a system administrator. When not
at Columbia, she works (and learns) at home as a new mother. Most of her
previous professional writing has been in C and Perl, though she has
written in English for ;login:, Computing News, and The Wecagram. She is
a member of the System Administrators' Guild (SAGE), as well as USENIX,
the Advanced Computing Systems Association.)
In my last weeks at work before my daughter was born, my sense of the
future became strangely warped. We would have meetings at the office
about what we were doing in the next month or two, and it all seemed so
silly. As I told my co-workers, "but that will happen after the End,"
meaning the end of this life, and the beginning of a whole new life. But
my plans for my new life still included work.
I tried everything in my search for a babysitter for my first-born. In
that I've been there, done that -- if you'll pardon the cliche -- let me
save you the trouble of hitting a lot of dead-ends; the agony of following
a lot of paths to nowhere.
A friend of mine who was also expecting her first was giving up her
job teaching. She offered to watch both babies once I returned to work.
In more formal circumstances, this is known as Family Care: You leave
your child in the home of a woman with children of her own. Family care
providers are registered and are limited in how many children they can
bring in.
To have such an arrangement on an informal basis with a friend was
great: someone I knew and trusted would be watching my baby.
Unfortunately, it didn't work out. She had not realized how much attention
her own baby would demand.
Lesson one: even if you don't think you need to find childcare, you
may. Remember, this is a whole new life, you don't know how much you, your
friends or your mother-in-law will really take to providing full-time
childcare.
Finding good childcare is not a quick process, so get started soon.
And try to figure out how you will do it before that baby is actually
sitting in your lap, wanting to eat, play or be helped to sleep.
Hopefully, you haven't skipped over those chapters in the baby books
and parenting magazines. (You did subscribe to at least one free or paid
parenting magazine, didn't you?) I went back and reviewed the magazines,
and got the 800 numbers for finding child care -- I started with Child
Care Aware and looked for family care near my work. (Having the baby near
work is recommended for those who want to continue breastfeeding, or just
for a chance to see baby during the day.)
I pored over the lists I got with the 800 number and made dozens of
calls, but with little success. The magazines had all made it sound very
straightforward, but it turned out the list I received was simply everyone
registered in the zip code I gave. Some of them had done family care
previously, but were no longer doing it. Some of them were from a very
different neighborhood nearby, and didn't speak English.
I got a sinking feeling every time a woman would call for her daughter
to come to the phone and translate for her. Having baby learn a second
language was fine, but getting an answer to "How did Jenny do today?"
seemed like it could be important to me. We interviewed one woman, who
sounded good until we asked where Jenny would play, and she said she would
move the playpen from room to room. So much for house arrest.
End of Lesson Two: Family Care sounds great, but, depending on your
needs and your neighborhood, you may not be able to find what you want.
After the first few phone calls I started a log sheet. I called
literally dozens of caregivers, there was no way to keep them all straight
without taking notes. I made up sheets with 5-6 entries per page, where I
could write the caregiver's name, the phone number and address (or general
location), the type of care, and a log of calls -- whether I reached them
and/or when I was supposed to call back. For those that answered the phone
and were actually interested in watching my baby, I made other longer
sheets with more detailed questions.
The magazines also told me that even very young babies could do well
in a day care center, where I would drop off my daughter each day with a
large number of other babies and a few adults. This had the advantage of
more constant availability, since they would cover for a caregiver who
couldn't make it one day. But multiple caregivers seemed to offer a less
stable emotional set up for my baby. As it turned out, all of the day care
centers in my area were full. Besides, none of them took babies as young
as my newborn.
Flyers came next. I wrote up and posted flyers for a nanny near home
or for family care near work. I posted a note on a computer bulletin
board. I also started reading flyers from other people -- wherever they
were posted. My husband clipped ads from the local newspaper. I made more
calls. I talked to parents I knew at work, and asked them how they found
someone. We talked to several nice women, the best of whom canceled their
interviews because they had already been hired.
Tip: To childcare seekers and providers: set up the interview as soon
as possible or you will miss your chance to impress them. The opportunity
will be history. Our search was a success, or so it seemed. We wound up
choosing between two women: one was very organized, with a printed
information sheet listing her references. The other was more interested
in getting down and playing with the baby. We picked the latter, but
first I dutifully called her references. A lesson I learned later about
references: really talk to the people the sitter has worked for.
Tip: Remember, they don't want to be mean so they are likely to answer
simple questions positively. Don't ask "was she good?" Ask "how often
was she late?" or "In what ways did she play with your child?" And don't
expect them to call back if you leave a message. Call again. A good
babysitter's references are more likely to want to call and encourage you
to hire her. If someone was disappointed with their babysitter, they
don't want to call and tell you about it.
We hired the get-down-and-play-with-baby sitter. She lasted three
months, with frequent absences. When she came, she was great, and a joy
to our daughter. But there were too many times she didn't come and she
didn't call either. Until one day when she didn't come, I called and was
told her phone was disconnected. Help! Her life was simply too out of
control. My friends at work shook their heads and told me "when you hire
a babysitter, it's like you're now her parent too," you have to worry
about everything that can go wrong in her life.
By this time, I was running out of vacation days, and looking pretty
flaky to my boss at work. I couldn't afford to go through this sort of
babysitter again. We decided to lay down the money and go with a nanny
referral agency. Agencies do things that would be hard or impossible for
you to do yourself, and the time-consuming things have been done before
you even meet the nanny.
They run background checks; they get written reviews from previous
employers; they filter through hundreds of applicants to find one who is
suited to your needs. Find out what their guarantee period is in case
things don't work out. A good agency will provide you with a suggested
agreement form, so you and the nanny clearly understand what her
responsibilities are -- and yours.
But they are pricey, charging around four weeks' the sitter's salary
just to find you an employee. Then you have to pay the babysitter
besides. You look at your paycheck, and there is more money going out
than coming in. At least after the first month, you get to keep a
little. (No one said kids were cheap.)
But don't forget the benefits (insurance, retirement fund) that come
with your paycheck. Health costs alone are worth 25% of your pay. And
remember, your baby will only be small for a few years. If you like what
you do, it will be worth it three years from now when your child goes to
school and you still have your job. It will be worth it each night when
you come home happy instead of being home all day resenting the loss of
your old life. And it is worth it to get the best sitter you can find and
afford, so your child will be happy too. And by the way, through a local
agency, we soon found a warm, reliable sitter who is still with us.
Tip: The bottom line: do what feels right. What's right for someone
else may not be right for you. It won't be easy, but the rewards of your
new life will be worth it.
-- The National Child Care Information Center gives tips for finding
child care at http://nccic.org/findcare.html.
-- Zero to Three, the National Center for Infants, Toddlers, and
Families, also gives hints on choosing child care, which can be found at
http://www.zerotothree.org/parent.html.
-- Child Care Aware can give you the name of a referral agency in your
area, and will also send some leaflets that will help you in your search.
You can reach them at 1-800-424-2246 or at hn6125@handsnet.org. According
to the search engines, they seem to have a web site at
http://www.targetstores.com/TargetWWW/html/child01.htm, though I haven't
been able to reach that site from my computer.
-- Community Connection for Child Care at http://www.kern.org/cccc/ is
based in Kern County, Calif., but provides lots of good tips for your
child care search.
-- If you decide to go with a Nanny Agency, you'll probably do best to
find them in the yellow pages -- on the web, go to
http://www.switchboard.com/ select "Find business" and look for category
"Child Care Service" in your area. Most agencies are accredited with the
International Nanny Association, http://www.nanny.org.
-- Click on "Kids & Family" at http://www.enews.com/ for a list of
magazines that might be helpful to you now, including Working Mother at
http://womweb.com/wmlife.htm.
-- Not strictly child care, but you would do well to contact your
local La Leche League group, http://www.lalecheleague.org/.
###
MEDICINE MAN
Sepracor Opens the Door
by George Stasen
The last two articles reviewed stocks that either doubled or tripled in
price in the past 12 months. This week's stock, Sepracor Inc. (Nasdaq: SEPR),
more than doubled in the same time period. But that's not all. Sepracor
stock in the past 36 months rose from $4 per share to $40. Awesome. That
makes Sepracor a future stock in retrospect, but what counts for future stocks
is performance over the next 10 years.
The Sepracor story is similar to the final game of a championship
basketball tournament where the heavy favorite has a comfortable lead. Then,
in the last minutes, the underdog puts on a display of virtuosity that dazzles
their opponents, and the underdogs come out the winner.
Ethical drug companies by virtue of their vast resources would be
considered the odds-on favorites in any competition with a small emerging
company. To achieve their present stature, they had to overcome tremendous
obstacles. Consider that the cost of developing a new ethical drug ranges
between $50 million and $100 million. Only one prospective drug in 10 clears
all the regulatory hurdles, and the average development time from discovery to
the point of market entry is about 12 years. Furthermore, some new drugs
manifest side effects serious enough that they have to be withdrawn from the
market.
Given all that, what did Merck, Pfizer, Schering-Plough, etc. miss in
their multi-billion dollar drug research programs that made it possible for
Sepracor to come out a winner? The answer lies in strategy and proprietary
drug chemistry.
Sepracor wisely chose not to meet its potential competition head on.
Instead, the company decided to use its expertise to develop improvements in
widely prescribed drugs whose safety and efficacy profiles were well known.
The improvements sought were the elimination of side effects, increased
therapeutic efficacy, reduced dosage, greater potency and expanded
indications.
A key element in Sepracor's strategy was that the FDA did not require
the company to reproduce the lengthy and very costly early-stage trials
required of a drug discovery company. This dramatically slashed
Sepracor's product cycle time from 12 years to three and at about
one-tenth the cost, thus dramatically lowering the company's development
risk.
So much for strategy. On to chemistry and a question that nags for an
answer. How could Sepracor gain such a tremendous technological
advantage over the major drug firms?
Chiral chemistry has been the foundation of Sepracor's research and
development strategy. Chiral molecules exist in mirror-image forms called
optical isomers. Often only one optical isomer of the pair in a chiral
drug is responsible for the drug's efficacy. The other may be inert or
cause undesirable side effects. Many established drugs on the market
today are mixtures with equal amounts of two isomers. By separating the
two isomers and eliminating the unnecessary or harmful isomer, the company
can produce a drug that offers superior benefits to the patient than
existing therapy. Sepracor's proprietary expertise in isomer separation
grew out of the company's prior interest in developing products for
separating and purifying chemicals and proteins from biological sources.
Optical isomer pairs have very closely matched properties. They are
identical in melting point, boiling point, and density. They are also
indistinguishable from each other under classical spectroscopic analyses,
and they react with a chemical reagent in the same way and the same
speed. The only difference between mirror image isomers is in the
relative spatial arrangement of the atoms, which results in the isomers
having distinctly different three-dimensional shapes. The three-dimensional
shape of a drug is an important determinant of activity and potency.
Consequently, virtually all classical organic chemical synthesis, i.e., drug
research, gives rise to an equal mixture of optical isomers which are very
difficult, if not impossible, to separate by standard methods. That explains
why chiral separations technology went unexploited for so long.
Next. It's one thing to capitalize on opportunity that is being
overlooked, but once revealed to competitors, how do you protect
yourself? Sepracor has opened the door as its patents and product
development testify. With the prompting of the FDA, about 80% of drugs
now in the pipelines of major pharmaceutical firms are single isomer
compounds. Although single isomer versions of existing drugs should
continue to provide opportunities for Sepracor in the near to medium term,
that window of opportunity may be closing. Nevertheless, the proprietary
nature of Sepracor's drug discoveries is well established, and the company
has erected a sound patent position around its developmental products. To
date, Sepracor has been issued 25 patents and has 25 more pending.
Sepracor's response to the competitive challenge has been to shift
focus to active metabolites which hold more long-term promise.
Pharmaceuticals which do not effect a therapeutic benefit until they have been
modified by the body's metabolism are called prodrugs. The actual therapeutic
entities are formed by the metabolism of prodrugs by enzymes in the liver or
elsewhere in the body and are called active metabolites. Prodrugs do not
exhibit any beneficial pharmaceutical activity in advance of their conversion
to active metabolites. There is often a considerable delay associated with
this conversion. Active metabolites, including Sepracor's, can improve on
prodrug-based therapies by offering reduced times to onset of action and
benign side effect profiles compared to their parent prodrugs. Sepracor's
success will depend on its ability to demonstrate the clinical advantages of
an active metabolite and to obtain patent protection on the improved chemical
entity.
This brief background on chiral chemistry and active metabolites
hopefully establishes a solid basis for appreciating Sepracor's excellent
outlook. There is much to justify your further research on this future stock.
Major pharmaceutical companies have in effect validated Sepracor's proprietary
expertise through strategic partnering arrangements with the company.
Sepracor has six pharmaceuticals in human trials and 13 additional
active-metabolite or single-isomer drugs are undergoing preclinical
investigation. Sepracor is using its expertise and technology in chiral
chemistry and metabolic formulation to create new entities in three of the
fastest growing pharmaceutical markets, i.e., respiratory disease, urology
and pain management. Annual world markets in these areas total nearly $12
billion, and they are growing rapidly. For example, worldwide sales of ant
ihistamines to treat allergies exceeded $3 billion in 1997, and the
antihistamine market is expected to grow to $6 billion over the next five
years.
It's worth remembering that it has not always been a bed of roses for
Sepracor stockholders. Prior to its three-year meteoric rise, the stock
had dropped from $14 per share to $4. There is a large institutional
following in the stock which could lead to extraordinary volatility.
However, the door appears open to unusual capital appreciation.
###
PORTFOLIO
Fed Hunts Inflation By Targeting Bull Market
by John Tompkins
The jittery stock market this week demonstrated once again that the
only thing it has to fear is the Federal Reserve. Ever since Allan
Greesnpan said investors were displaying "irrational exuberance," we've
been aware that the market was a target, indeed, the only target of
Washington's inflation fighters. Three weeks ago, Fed Governor Laurence
H. Meyer warned that unless there was a near-term slowdown in the economy,
monetary tightening will be required. Last week he was joined by Governor
Roger Furgeson who tossed another brick bat by saying
either Asia would slow our economy or "there will have to be some Fed
action that will do that." You can expect more of this in the near future.
Upset by the lack of market reaction to these warnings, the Fed still
got what it wanted last Monday when The Wall Street Journal published a
story saying that the Fed had abandoned its "neutral" stance at the March
31 meeting in favor of "leaning toward" higher interest rates. We won't
know if this is true until later this month when the minutes of that
meeting are released, but the report knocked the Dow Industrials for a
147-point loop. The change in wording is largely symbolic and doesn't
signal any immediate rate hike. We don't know if the story was leaked or
not, but it demonstrates the market's nervousness over interest rates. It
isn't that Greenspan & Company have a special dislike for people who buy
stocks. They'll tell you that among the economic indicators the Fed
watches are housing starts, the value of the dollar, the purchasing
manager's index -- and "equity prices."
From the Fed's viewpoint, the stock market is ideal: soaring stock
prices raise consumer confidence, impel people to buy things, and make
businessmen feel like expanding, all of which traditionally produce
inflation. Even better, the stock market is the only indicator that the
Fed can control. No amount of threats will cut unfilled factory orders or
the price of wheat but, as Greenspan knows all too well, a couple of angry
warnings about higher interest rates can knock hundreds of points off the
Dow almost before he finishes speaking.
And when stocks go into a tailspin so does the public's free-spending
ways -- an almost instant blow against inflation. Aside from the fact
that the Fed's mandate doesn't include meddling with stocks, it's rather
unsettling to learn from Professor Harold Bierman of Cornell University
that this kind of harassment in the 1920s was probably the main cause of
the Great Crash of 1929. Dr. Bierman published his second book on the
causes of that Crash last month. He states flatly, "Was the crash of '29
inevitable? The answer is No!" He explains:
"The shocking thing is that the panic was preceded and accompanied by
an awful lot of negative PR out of Washington." In September and October
1929 there was no hint that a crash was coming, says Bierman. He charges
that popular historians of the event, such as John Kenneth Galbraith in
"The Great Crash," don't go back and look at the raw data but relate myths
and mistaken conclusions. For example, Galbraith calls RCA "the
speculation symbol of the time," because its stock doubled between 1927
and 1928. But he omits an important fact: RCA earnings between those two
years went from $6.15 a share to $15.98. For a stock to double while
earnings triple hardly reflects wild speculation. Professor Bierman says
that few stocks were overpriced by any measure at the top of the 1929
market, though most popular histories of the period say they all were.
A few days ago The New York Times editorialized about our so-called
"bubble economy," the idea that markets have been swelled by speculative
excess, and at the first pinprick in investor confidence they will
collapse. A week ago both The Financial Times and The Economist warned
that a big U.S. stock market crash was very likely and blamed the Fed for
not raising interest rates to prick the bubble. The fascinating and
frightening thing about these media worries is that they are an uncanny
reprise of what the same media said in 1929.
England's chancellor of the exchequer, Phillip Snowden, lashed out
angrily against the "speculative orgy" taking place in America and both
British publications were pleased to report that Snowden's remarks on
speculation were being widely quoted here. President Hoover wrote in his
memoirs that he had called individual editors and publishers of major
newspapers and magazines to the White House and asked them "to warn the
country against speculation and the unduly high prices of stocks." And
many of them did so during the summer and fall of 1929. Hoover then
pressured Secretary of the Treasury Andrew Mellon and Roy Young, governor
of the Federal Reserve Board, "to strangle the speculative movement."
Bankers, academics, chief executives, and congressmen took up the cry
and, as Professor Bierman says, the public was constantly bombarded with
statements of outrage over the mad speculation on the New York Stock
Exchange. The Senate adopted a resolution supporting legislation to
prevent "illegitimate and harmful speculation." The Federal Reserve hiked
the rediscount rate to 6% from 5% and told member banks they could not
borrow from the Fed if they were financing the purchase of stocks.
Bierman believes that the sheer volume of these reckless warnings
about "the exaggerated balloon of American stock values," and
"extraordinary speculation on Wall Street," from highly placed sources
finally persuaded the public that the situation was indeed dangerous.
Investors took the official advice, fled the market, and turned what would
have been a normal correction into The Great Crash. When you brush aside
the frantic hyperbole of the time, it's obvious that stocks were not too
high priced and that the booming American economy justified the bull
market. Contrary to popular history, the 1920s were a period of real
growth and prosperity, says Bierman. Real income and the gross national
product soared through the decade and 1929 was the best year ever for the
American economy up to that time. Farming, mining, transportation,
communications and public utilities all did well. The business news just
prior to the Crash was extremely positive. Stock prices went up not
because of speculation but because of economic facts. Prospering
companies paid good dividends. In 1928, total dividends on common stock
were $3.44 billion and the following year they rose to $4.46 billion, a
staggering increase of 30%. As Professor Bierman puts it, "It is not
surprising that stocks went up in 1929. It is surprising the market
crashed."
After the Crash there was a hunt for scapegoats. Since it was "common
knowledge" that wicked speculators and evil bankers were to blame, they
were investigated by the Senate and several later indicted. The four
chief villains: Charles E. Mitchell, chairman of National City Bank,
Albert H. Wiggin, chairman of Chase National Bank, Samuel Insull, head of
a public utility empire, and J.P. Morgan & Co., a large investment banking
and commercial banking firm.
Lengthy hearings absolved two from any serious wrongdoing. Two others
were tried and acquitted. Transcripts of the hearings and trials show
that the witch hunters were economically and financially clueless with no
understanding of why stock prices rise or fall. Bierman thinks that these
widely publicized "show trials" were simply an attack on the establishment
by the left end of the political spectrum. Many Fed watchers, including
me, have been in the habit of using Greesnpan as a synonym for the Federal
Reserve Board. The reality is more complex.
Alan Greenspan is the loudest and most respected voice on the Board,
but he's often admitted that not all the members agree with him.
Greenspan is one of the few inflationary doves among the governors. Many
of the rest are hawkish vis-a-vis inflation. One, Governor Broaddus,
president of the Richmond Fed, dissented from the rest of the Board last
November and December because he wanted interest rates raised
immediately. In effect, Greenspan acts as a wise ringmaster trying to
keep the others from voting for precipitate action. It appears that the
chairman has been able to do this through several clever devices: first
he began to question the traditional model of inflation by saying that the
accepted economic yardsticks didn't seem to work anymore. He may actually
have begun to toy with the notion that we're in a new era with
globalization, productivity, and the information explosion all working to
keep inflation at bay. Whatever his real beliefs, the chairman's musings
about why the traditional economic measures didn't seem to work anymore
forced the governors to consider the new era possibility. Greenspan also
hammered away in testimony to congress and in speeches that the numbers
the Fed uses to make decisions are notoriously inaccurate and probably
overstate the rate of inflation. He's also raised the "D word" -- by
lately suggesting that the Asian currency crisis makes it necessary for us
to be as vigilant against deflation as we are against inflation. All
these views were, we think, designed to make the Board consider that
maybe, just maybe, inflation wasn't lurking around the corner and to give
them an excuse not to vote for tight money.
In 1929 the authorities in Washington tried to stop what they thought
was foolish speculation in a way that the cure turned out to be worse than
the disease. Seventy-odd years later, the Fed is again faced with what it
thinks are unreasonably high stock prices. They may very well be too
high, but valuation is in the eye of the beholder. When you buy or sell
stock there are always sellers and buyers on the other side of the fence
with opinions different from yours. Why should the Fed pretend any spec
ial insight into stock prices? In a capitalist economy, markets correct
themselves, which they will do if Washington stops meddling. There's some
evidence that the Fed has meddled with the stock market not only on the
upside but the downside as well.
The day after the crash of 1987, liquidity dried up and the
specialists could not afford to keep an orderly market. That afternoon it
seemed that a second leg of the crash would bring stock prices down
hundreds of Dow points lower. Then, a large anonymous buyer bought a
bundle of Major Market Index futures -- and the Fed announced it would
provide money to banks who lent to specialists. The market stabilized and
the crash of 1987 was over. The action has never been officially
admitted, but Chairman Greenspan came close on Jan. 14, 1997 in a
little-known speech in Leuven, Belgium. He referred vaguely to
"situations like that which followed the crash of stock markets around the
world in 1987 ..."
Then, a few sentences later, Greenspan said, "We have the
responsibility to prevent major financial market disruptions ... if
necessary in rare circumstances, through direct intervention in market
events."
As always, we fear that the inflation fighters on Constitution Avenue
will misjudge and kill a fly with a shotgun. They have done so many times
in the past. But, perhaps the worst aspect of the war of nerves is that
the Fed really wants to curb the stock market. In this desire, it mirrors
exactly the mission it took on in 1929. We pray it doesn't repeat the
mistakes of that era.
Professor Bierman concludes his study of the Great Crash by saying:
"My position is that the efforts to stop the speculation created a climate
that merely required a slight push or a spark to set off the selling
panic. Thus, the smoking gun starting the crash might be events
relatively minor in themselves but major in their consequences."
Two weeks ago, the Federal Reserve Bank of Chicago launched "The Fed
Challenge," a contest among high school students in the middle west.
Teams of students were to analyze current economic data, develop monetary
policy recommendations and defend them to a panel of economists. The
national championship competition will be held on Monday, May 4. Final
recommendations to raise or lower interest rates will be made to a Fed
governor. Besides the usual T-shirts and plaques, the national champs
will get a trophy from the Federal Reserve Board. It will be interesting
to see how the teenagers' grasp of today's economy compares with that of
the Fed.
SOURCE: PR Newswire
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