The Libertarian Who Ruined the Free Market


On this day in economic and business history ...

The Federal Reserve of the 1980s was known primarily for its role in combating the inflation that had riddled the previous decade. Under the leadership of Chairman Paul Volcker, the Fed pushed inflation rates down from a peak of 15% in early 1980 to a far more moderate rate of approximately 4% by the latter half of the decade. His most important work finished, Volcker unexpectedly resigned on June 2, 1987. That same day, President Reagan announced the selection of a successor whose name would later become synonymous with booming stock markets and asset bubbles: Alan Greenspan.

Volcker's resignation shocked the international financial community, according to the Los Angeles Times. The former Fed chairman's aggressive inflation-fighting policies, which became highly unpopular when the U.S. economy fell into a damaging recession in the early '80s, had become widely respected by 1987 as markets soared to new records with nearly every passing day. Greenspan was deferential toward his predecessor, saying that "filling Paul Volcker's shoes will be a major challenge," but promised to serve in the Volcker mold when confirmed to the post. However, the selection of Greenspan, a staunch Republican whose close ties to Ayn Rand's Objectivism were already well known, drew sharp rebukes from politicians across the aisle. One Democratic representative said that "Greenspan is such an ideologue that he will more than likely cave in to ideological pressures."

Greenspan sailed to an easy confirmation two months later, beginning his second stint as a public servant since his four-year tenure as the chairman of President Ford's Council of Economic Advisors. He was quickly beset by a major market problem, as two months after his confirmation, the Dow Jones Industrial Average suffered the worst one-day percentage drop in its century-plus history. Immediately after the crash, the Greenspan Fed issued a press release promising to "serve as a source of liquidity to support the economic and financial system." Thus the Greenspan Put was born. This term refers to Greenspan's consistent willingness to backstop the financial system and the stock market -- a "put," for those investors unaware, is an option that grants the buyer the right to sell a certain asset to the seller of the put when values drop below a certain price.

Greenspan's loose monetary policy led the Dow to the greatest period of growth since the Roaring '20s. From the day after 1987's Black Monday -- when the Greenspan Put first reassured the investing world that the Fed would always be there for them -- to the peak of the dot-com bubble just over 12 years later, the Dow grew at an annualized rate of 17.2%, a rate approaching the annualized 25% growth of the Roaring '20s from trough to peak.

However, Greenspan would later receive intense criticism for his role in inflating both the dot-com bubble and the far more disastrous housing bubble that popped shortly after his retirement in 2006. Nearly three years after his retirement, Greenspan admitted to being in "a state of shocked disbelief" over the market's complete inability to self-correct the egregiously damaging mortgage-lending policies that created a financial crisis. It was the first time Greenspan admitted to finding flaw in his formerly ironclad faith in the unrestrained free market. Greenspan's legacy has thus been damaged -- perhaps irreparably -- by the consequences of his policies. That hasn't stopped his successor, Ben Bernanke, from following a similar path. The current Fed chairman's looser monetary policy has given rise to the notion of a "Bernanke Put," the consequences of which have yet to be fully realized.

Something that wasn't born every minute
Phineas Taylor Barnum began his first circus tour of the United States on June 2, 1835. The legendary showman built a career out of the grotesque, absurd, and extravagant, attracting the curiosity of millions to his three-ring circuses over the years. More than four decades later, Barnum combined with Anthony Bailey's circus to form Barnum & Bailey, the predecessor to today's Ringling Bros. and Barnum & Bailey Circus. Barnum is often credited with the phrase "there's a sucker born every minute," which has been spoken more than a few times in the financial industry. Barnum never actually spoke this quote -- it was uttered by a freak-show competitor frustrated by Barnum's ability to continue drawing customers even after a hoax was revealed -- but it certainly is a good expression of a showman's cunning exploitation of the gullible masses, isn't it?

Barbarians (soon to be) at the gate
Cigarette maker R.J. Reynolds acquired Nabisco for $4.9 billion on June 2. 1985. The deal would create the largest consumer-products company in America, with combined annual sales of more than $19 billion. It beat the size of other major food-company mergers completed the year earlier, and it also came close to becoming the largest non-energy merger in history up to that time. Nabisco's popular Oreos and Ritz crackers would gain access to a deeper advertising budget flowing from high-margin cigarette sales and would also add depth to R.J. Reynolds' stable of food brands, which already included Del Monte and Kentucky Fried Chicken. R.J. Reynolds financed 49% of the buyout with corporate bond issues, continuing the trend of leveraged buyouts pioneered by junk-bond king Michael Milken.

RJR Nabisco would soon fall prey to a far larger leveraged buyout -- four years later, Kohlberg Kravitz Roberts spent a record-setting $25 billion to acquire the company, providing post-merger RJR Nabisco shareholders an impressive 50% annualized rate of return. This event was the high-water mark of the leveraged-buyout era, and it occurred shortly after a federal jury indicted Milken on racketeering charges. KKR's buyout of RJR Nabisco later became the subject of the era-defining book (and later TV movie) Barbarians at the Gate.

The deal took 16 years for KKR to digest, and RJR Nabisco soon split back into its component parts. Today, R.J. Reynolds has become Reynolds American , and Nabisco's brands were shuttled from one tobacco company to another, becoming part of the Kraft food empire before spinning off into the hard-to-pronounce food conglomerate Mondelez International . Nabisco's Oreo was an important part of that spinoff -- it's been the world's most popular cookie for decades.

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