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　　budget, so tough cuts could be presented to incoming cabinet members as a fait accompli. Stockman was a brilliant, hungry thirty-four-year-old congressman from rural Michigan who relished being the point man for what came to be called the Reagan Revolution. In speeches Reagan had compared downsizing the government to applying fatherly discipline: "You know ,we can lecture our children about extravagance until we run out of breath. Or we can cure their extravagance by simply reducing their allowance." In Stockman's version this philosophy had a fiercer name: it was called "starving the beast."

　　I worked closely with Stockman during the transition as he fashioned a budget that was tough as nails. And I was there the day shortly before the inauguration when he presented it to Reagan. The president said, "Just tell me, David. Do we treat everyone the same? You have to cut everybody equally nastily." Stockman assured him he had, and Reagan gave his okay.

　　The Economic Policy Board found itself called into action more quickly than anyone expected. The cornerstone of the Reagan tax cuts was a bill that had been proposed by Congressman Jack Kemp and Senator William Roth. It called for a dramatic three-year, 30 percent rollback of taxes on both businesses and individuals, and was designed to jolt the economy out of its slump, which was now entering its second year. I believed that if spending was restrained as much as Reagan proposed, and as long as the Federal Reserve continued to enforce strict control of the money supply, the plan was credible, though it would be a hard sell. That was the consensus of the rest of the economic board as well.

　　But Stockman and Don Regan, the incoming treasury secretary, were having doubts. They were leery of the growing federal deficit, already more than $50 billion a year, and they began quietly telling the president he ought to hold off on any tax cuts. Instead, they wanted him to try getting Congress to cut spending first, then see whether the resulting savings would allow for tax reductions.

　　Whenever this talk of postponement would get intense, George Shultz would summon the economics advisory board to Washington. This happened five or six times during Reagan's first year. We'd meet in the Roosevelt Room from 9:00 a.m. to 11:00 a.m. and compare our assessments of the economic outlook. Promptly at 11:00, the door would open, and in would come Reagan. Our group reported directly to him. And we'd tell him, "Under no circumstances should you delay the tax cut." He'd smile and joke; Shultz and Friedman and others were old friends of his. Regan and Stockman, who were permitted to attend the meetings but were not allowed to take seats at the conference table or to vote, would sit along the wall and smolder. Presently the session would end and Reagan would leave, fortified in his resolve to press for his tax cuts. Ultimately, of course, Congress approved a version of his economic plan. But since Congress shied away from the necessary restraints on spending, the deficit remained a huge and growing problem.

　　I played a small role in another presidential decision that first year: not to meddle with the Fed. Reagan was being urged to do so by many people in both parties, including some of his top aides. With double-digit interest rates now entering their third year, people wanted the Fed to expand money supply growth. Not that Reagan could command the chairman of the Fed to do this. But, the theory went, if he were to criticize the Fed publicly, Volcker might feel obliged to ease up.

　　Whenever the question arose, I would tell the president, "Don't pressure the Fed." For one thing, Volcker's policy seemed right—inflation did seem to be slowly coming under control. For another thing, open disagreement between the White House and the Fed could only shake investors' confidence, slowing the recovery.

　　Volcker didn't make things easy for the new president. The two men had never met, and a few weeks after taking office, Reagan wanted to get acquainted. In order to avoid the appearance of summoning the Fed chairman to the White House, he asked if he could come see Volcker at the Fed—only to have Volcker send back word that such a visit would be "inappropriate." I was perplexed: I did not see how a visit by the president could compromise the Fed's independence.

　　Nevertheless, Reagan persisted, and finally Volcker allowed that he would be willing to meet at the Treasury Department. The president's opening line at their lunch in Don Regan's office became part of the Reagan legend. He said mildly to Volcker, "I'm curious. People are asking why we need a Fed at all." I am told Volcker's jaw dropped; he had to regroup before coming back with a persuasive defense of the institution. This evidently satisfied Reagan, who went back to being his amiable self. He had communicated that the Federal Reserve Act was subject to change. The two men cooperated quietly from then on. Reagan gave Volcker the political cover he needed; no matter how much people complained, the president made it his practice never to criticize the Fed. And though Volcker was a Democrat, when his term ended in 1983, Reagan reappointed him.

　　In late 1981, Reagan asked me to take the lead in dealing with a colossal headache that had been building for years: Social Security was running out of money. During the Nixon administration, when the program had seemed flush with reserves, Congress had taken the fateful step of indexing benefits to inflation. As inflation soared through the 1970s, so did the costof-living increases in people's Social Security checks. The system was in such financial straits that an added $200 billion was going to be needed as early as 1983 to keep the program afloat. The long-term prospects looked even worse.

　　Reagan had shied away from talking in any detail about Social Security during his campaign—when the question came up, he'd pledged simply to preserve the system. And no wonder. Social Security is truly the third rail of American politics. There was nothing more explosive than Social Security reform: everybody knew that no matter how you dressed it up, any solution was in the end going to involve either raising taxes or cutting benefits for a huge and powerful bloc of voters, or both.

　　Yet the problem was serious, and leaders in both parties understood that something needed to be done—either that, or face the likelihood of not being able to mail checks to thirty-six million senior citizens and disabled Americans. We were getting down to the wire. Reagan's opening gambit, in his first budget, was to propose a $2.3 billion reduction in Social Security outlays. That raised such a storm of protest that he was forced to back down. Three months later he came back harder, with a reform proposal that would cut $46 billion in benefits over five years. But it was clear that a bipartisan compromise was the only hope. Thus the Greenspan Commission was born.

　　Most commissions, of course, don't do anything. But Jim Baker, the architect of this one; believed passionately that government could be made to work. The commission he built was a virtuoso demonstration of how to get things done in Washington. It was a bipartisan group, with five members chosen by the White House, five by the Senate majority leader, and five by the Speaker of the House. Virtually every commissioner was an all-star in his or her field. There were congressional heavy hitters like Bob Dole, the chairman of the Senate Finance Committee; Pat Moynihan, the brilliant maverick senator from New York; and Claude Pepper, the outspoken eighty-one-year-old congressman from Florida who was a senior citizens' icon.Lane Kirkland, the head of the AFL-CIO, was a member and became a close friend; so was Alexander Trowbridge, the head of the National Association of Manufacturers. House SpeakerTip O'Neill appointed the top Democrat—Bob Ball, who had run the Social Security Administration for LB J. And the president appointed me as chairman.

　　I won't go into the intricacies of demographics and finance we mastered, or the policy debates and hearings that ate up more than a year. I ran the commission in the spirit that Jim Baker had envisioned, aiming for an effective bipartisan compromise. We took four key steps to make the whole thing work, which I'll mention because I've used variations of them ever since.

　　The first was to limit the problem. In this case, it meant not taking up the issue of the future funding of Medicare—while technically part of Social Security, Medicare was a far more complex problem, and trying to solve both could mean we would do neither.

　　The second was to get everyone to agree on the problem's numerical dimensions. As Pat Moynihan later put it, "You're entitled to your own opinion, but you're not entitled to your own facts." When it was clear that a long-term shortfall was real, commission members lost their ability to demagogue. They had to support cuts in benefits and/or support a rise in revenues. Reverting to the cop-out of financing Social Security from the federal government's "general revenues" was adamantly ruled out early by Pepper, who worried it would cause Social Security to become a welfare program.

　　The third smart tactic came from Baker. If we wanted a compromise to succeed, he argued, we had to bring everybody along. So we made a point of keeping both Reagan and O'Neill in the loop as we worked. It became Bob Ball's job to inform O'Neill, and my job and Baker's to inform the president.

　　Our fourth move was to agree among the commissioners that once a compromise was reached, we would stand firm against any amendments being imposed by either party. I later told reporters, "If you take pieces out of the package, you will lose the consensus, and the whole agreement starts to unravel." We published our report in January 1983; when it was finally time to present the reform proposals to Congress, Ball and I resolved to testify side by side. Whenever a Republican asked a question, I would answer it. And whenever a Democrat asked a question, he would answer it. Which is just what we tried to do, though the senators didn't entirely cooperate.

　　Diverse as our commission was, we found ways to agree. What brought together men like Claude Pepper and the head of the manufacturers was the care we took to spread the burden. The Social Security Amendments, which Reagan ultimately signed into law in 1983, involved pain for everyone. Employers had to absorb further increases in the payroll tax; employees faced higher taxes too and in some cases saw the date when they could anticipate receiving benefits pushed further into the future; retirees had to accept postponement of cost-of-living increases, and wealthier retirees began having their benefits taxed. But by doing all this, we succeeded in funding Social Security over the seventy-five-year planning period that is conventional for social insurance programs. Moynihan, with his usual eloquence, declared: "I have the strongest feeling that we all have won. What we have won is a resolution of the terrible fear in this country, that the Social Security system was, like a chain letter, something of a fraud."

　　As all this was still unfolding in 1983,1 was in my office one day in New York poring over demographic projections when the telephone rang. It was Andrea Mitchell, a reporter for NBC. "I've got some questions about the president's budget proposals/' she said. She explained that she'd been trying to figure out whether the Reagan administration's latest fiscal-policy assumptions were credible, and that David Gergen, the assistant to the White House communications chief, had suggested my name. She told me Gergen had said, "If you really want to know about the economy, why don't you call Alan Greenspan? He knows more than anybody."

　　"I'll bet you say that to all the economists/' I replied, "but sure, let's talk." I'd noticed Andrea on NBC newscasts. She was a White House correspondent. I thought she was very articulate and that her voice had the nicest authoritative resonance. Also, I'd noted, she was a very good-looking woman.

　　We talked that day and a few more times, and soon I became a regular source. Over the next two years, Andrea would phone whenever she had a big economics story in the works. I liked the way she handled the material on TV; even when the issues were too complex to present in their full technical detail, she would find the crux of the story. And she was accurate with the facts.

　　In 1984 Andrea asked if I'd come with her to the White House Correspondents' Dinner, where reporters invite their sources. I had to tell her that I'd already agreed to go with Barbara Walters. But I added, "Do you ever get to New York? Maybe we could have dinner."

　　It took another eight months before we could connect—it was an election year, and Andrea was extremely busy through November, when Reagan defeated Mondale in a landslide. Finally when the holidays arrived, we scheduled a date, and I made a reservation at Le Perigord, my favorite restaurant in New York, for December 28. It was a snowy night and Andrea rushed in late, looking very beautiful if a bit disheveled after a day of reporting the news and trying to hail cabs in the snow.

　　That night I discovered she was a former musician like me; she'd played violin in the Westchester Symphony. We loved the same music—her record collection was similar to mine. She liked baseball. But mainly we shared an intense interest in current affairs—strategic, political, military, diplomatic. There was no shortage of things to talk about.

　　It might not be everybody's idea of first-date conversation, but at the restaurant we ended up discussing monopolies. I told her I'd written an essay on the subject and invited her back to my apartment to read it. She teases me about that now, saying, "What, you didn't have any etchings?" But we did go to my apartment and I showed her this essay I'd written on antitrust for Ayn Rand. She read it and we discussed it. To this day, Andrea claims I was giving her a test. But it wasn't that; I was doing everything I could think of to keep her around.

　　For much of Reagan's second term, Andrea was my main reason to go to Washington. I stayed in touch with people in the government, but my focus was almost entirely in the business and economics world of New York. As business economics matured as a profession, I'd gotten deeply involved in its organizations. I'd served as president of the National Association of Business Economists and as chairman of the Conference of Business Economists, and was slated to become chairman of the Economic Club of New York, the financial and business world's equivalent of the Council on Foreign Relations.

　　Townsend-Greenspan itself had changed. Large economics firms with names like DRI and Wharton Econometrics had grown up to supply much of the basic data needed by business planners. Computer modeling had become much more widespread, and many corporations had economists of their own. I'd experimented with diversifying into investment and pension-fund consulting, but while those ventures made money, they weren't as lucrative as corporate consulting. Also, more projects meant more employees, which meant more of my time had to be spent managing the business.

　　Ultimately I concluded that the best course was to focus exclusively on what I did best: solve interesting analytical puzzles for sophisticated clients who needed answers and couldpay high-end fees. So in the second half of the Reagan administration I planned to scale back Townsend-Greenspan. But before I could implement those plans, in March 1987, I received a phone call from Jim Baker. Baker was by this time treasury secretary—after an intense four years as White House chief of staff, he'd made an unusual job swap, trading posts in 1985 with Don Regan. Jim and I had been friends since the Ford days, and I'd helped him prepare for his Senate confirmation hearing the spring he took over at Treasury. He had his assistant call to ask if I could come to Washington for a meeting at his house. This struck me as odd—why not meet at his office? But I agreed.

　　The next morning a Washington driver delivered me to Baker's nice old Georgian colonial on an elegant stretch of Foxhall Road. I was surprised to find waiting for me not only Jim but also Howard Baker, President Reagan's current chief of staff. Howard got right to the point. "Paul Volcker may be leaving this summer when his term runs out/' he began. "We're not in a position to offer you the job, but we'd like to know—if it were to be offered, would you accept?"

　　I was briefly at a loss for words. Until a few years before, I'd never thought of myself as a potential Fed chairman. In 1983, as Volcker's first term was ending, I'd been startled when one of the Wall Street firms conducted a straw poll of who might replace Volcker if he were to leave and my name turned up on top of the list.

　　As close as I was to Arthur Burns, the Fed had always been a black box to me. Having watched him struggle, I did not feel equipped to do the job; setting interest rates for an entire economy seemed to involve so much more than I knew. The job seemed amorphous, the type of task in which it is very easy to be wrong even if you have virtually full knowledge. Forecasting a complex economy such as ours is not a ninety-ten proposition. You're very fortunate if you can do sixty-forty. All the same, the challenge was too great to turn down. I told the Bakers that if the job were offered, I would accept.

　　I had plenty of time to get cold feet. Over the next two months, Jim Baker would phone to say things like "It's still under discussion" or "Volcker is thinking about whether he wants to stay." I felt alternately fascinated by the possibility and a little unsettled. It wasn't until just before Memorial Day that Baker phoned and said, "Paul has decided to leave." He asked if I was still interested and I said yes. He said, "You'll be getting a call from the president in a few days."

　　Two days later I was at my orthopedist's office and the nurse came in to say the White House was on the line. It had taken the call a few minutes to get through because the receptionist had thought it was a prank. They let me use the doctor's private office to take the call. I picked up the phone and heard that familiar, easy voice. Ronald Reagan said, "Alan, I want you to be my chairman of the Federal Reserve Board."

　　I told him I would be honored to do so. Then we chatted a bit. I thanked him and hung up.

　　As I stepped back into the hall, the nurse seemed very concerned. "Are you all right?" she asked. "You look like you've gotten bad news."

　　FIVE BLACK MONDAY

　　I'd scrutinized the economy every working day for decades and had visited the Fed scores of times. Nevertheless, when I was appointed chairman, I knew I'd have a lot to learn. That was reinforced the minute I walked in the door. The first person to greet me was Dennis Buckley, a security agent who would stay with me throughout my tenure. He addressed me as "Mr. Chairman."

　　Without thinking, I said, "Don't be silly. Everybody calls me Alan."

　　He gently explained that calling the chairman by his first name was just not the way things were done at the Fed.

　　So Alan became Mr. Chairman.

　　The staff, I next learned, had prepared a series of intensive tutorials diplomatically labeled "one-person seminars," in which I was the student. This meant that for the next ten days, senior people from the professional staff gathered in the Board's fourth-floor conference room and taught me my job. I learned about sections of the Federal Reserve Act I never knew existed—and for which I was now responsible. The staff taught me arcana about banking regulation that, having been a director of both JPMorgan and Bowery Savings, I was amazed I'd never encountered. Of course, the Fed had experts in every dimension of domestic and international economics as well as the capability to call in data from everywhere—privileged access that I was eager to explore.

　　Though I'd been a corporate director, the Board of Governors of the Federal Reserve System, as it is formally known, was an order of magnitude larger than anything I'd ever run—today the Federal Reserve Board staff includes some two thousand employees and has an annual budget of nearly $300 million. Fortunately, running it wasn't my job—the long-standing practice is to designate one of the other Board members as the administrative governor to oversee day-to-day operations. There is also a staff director for management who acts as a chief of staff This way, only issues that are out of the ordinary or that might spark public or congressional interest are brought to the chairman, such as the massive challenge of upgrading the international payments system for the turn of the millennium. Otherwise

　　he is free to concentrate on the economy—just what I was eager to do.

　　The Fed chairman has less unilateral power than the title might suggest. By statute I controlled only the agenda for the Board of Governors meetings—the Board decided all other matters by majority rule, and the chairman was just one vote among seven. Also, I was not automatically the chairman of the Federal Open Market Committee, the powerful group that controls the federal funds rate, the primary lever of U.S. monetary policy* The FOMC is made up of the seven Board governors and the presidents of the twelve regional Federal Reserve banks (only five can vote at any one time), and it too makes decisions by majority rule. While the Board chairman is traditionally the chair of the FOMC, he or she must be elected each year by the members, and they are free to choose someone else. I expected precedent to prevail. But I was always aware that a revolt of the six other governors could remove all of my authority, except writing the Board agendas. [*When the FOMC changes this rate, the committee directs the Fed's so-called open market desk in New York to either buy or sell treasury securities—often billions of dollars' worth in a day Selling by the Fed acts as a brake, withdrawing from the economy the money received in the transaction and pushing short-term interest rates higher, while buying does the reverse. Today the fed funds rate that the FOMC is seeking is publicly announced, but in those days it wasn't. So Wall Street firms would assign "Fed watchers" to divine changes in monetary policy from the actions of our traders or changes in our weekly reported balance sheet. ]

　　I quickly got hold of Don Kohn; the FOMC secretary and had him walk me through the protocols of a meeting. (Don; who would prove to be the most effective policy adviser in the Fed system during my eighteen years, is now vice chairman of the Board.) The FOMC held its meetings in secret, so I had no idea what the standard agenda or timetable was, who spoke first, who deferred to whom, how to conduct a vote, and so on. The committee also had its own lingo that I needed to get comfortable with. For example, when the FOMC wanted to authorize the chairman to notch up the fed funds rate if necessary before the next regular meeting, it did not say, "You may raise interest rates if you decide you have to"; instead it voted to give an "asymmetric directive toward tightening."* I was scheduled to run one of those meetings the following week, on August 18, so I was a highly motivated student. Andrea still jokes about my coming over to her house that weekend to curl up with Robert's Rules of Order.

　　I felt a real need to hit the ground running because I knew the Fed would soon face big decisions. The Reagan-era expansion was well into its fourth year, and while the economy was thriving, it was also showing clear signs of instability. Since the beginning of the year, when the Dow Jones Industrial Average had risen through 2,000 for the first time, the stock market had run up more than 40 percent—now it stood at more than 2,700 and Wall Street was in a speculative froth. Something similar was happening in commercial real estate.

　　The economic indicators, meanwhile, were far from encouraging. Huge government deficits under Reagan had caused the national debt to the public to almost triple, from just over $700 billion at the start of his presidency to more than $2 trillion at the end of fiscal year 1988. The dollar was falling, and people were worried about America losing its competitive edge— the media were full of alarmist talk about the growing "Japanese threat." Consumer prices, which had gone up just 1.9 percent in 1986, were rising at nearly double that rate in my first days in office. Though 3.6 percent inflation was far milder than the double-digit nightmare people remembered from the 1970s, once inflation begins, it usually grows. We were in danger.[*For the record, even as I learned "Fedspeak," I would joke to the staff, "Whatever happened to the English language?" ]of forfeiting the victory that had been gained at such great misery and cost under Paul Volcker.

　　These were vast economic issues, of course, far beyond the power of the Fed alone to resolve. Yet the worst course would be to sit idly by. I thought a rate increase would be prudent, but the Fed hadn't raised interest rates for three years. Hiking them now would be a big deal. Any time the Fed changes direction, it can rattle the markets. The risk in clamping down during a stock-market surge is especially acute—it can pop the bubble of investor confidence, and if that scares people enough, can trigger a severe economic contraction.

　　Though I was friendly with many of the committee members, I knew better than to think that a chairman who had been around for a week could walk into a meeting and shape a consensus on such a risky decision. So I did not propose a rate increase; I simply listened to what the others had to say. The eighteen committee members* were all seasoned central bankers and economists, and as we went around the table comparing assessments of the economy, it was apparent that they, too, were concerned. Gerry Corrigan, the gruff president of the New York Fed, said we ought to raise rates; Bob Parry, the Fed president from San Francisco, reported that his district was seeing good growth, high optimism, and full employment—all reasons to be leery of inflation; Si Keehn from Chicago agreed, reporting that the Midwest's factories were running near full capacity and that even the farm outlook had improved; Tom Melzer of the St. Louis Fed told of how even the shoe factories in that district were operating at 100 percent; Bob Forrestal from Atlanta described how his staff had been surprised at the strength of employment figures even in chronically depressed sections of

　　the South. I think everyone walked away persuaded that the Fed would have to raise rates soon.

　　The next opportunity to do so was two weeks later, on September 4, at a meeting of the Board of Governors. The Board controls the other main lever of monetary policy, the "discount rate" at which the Federal Reserve lends to depository institutions. This rate generally moves in lockstep with the rate on fed funds. Prior to the scheduled Board meeting, I spent a few [*There was one vacancy on the Federal Reserve Board. ]days working my way up and down the corridor seeking out the governors in their offices, building consensus. The meeting, when it came, moved quickly to a vote—the rate increase, from 5.5 percent to 6 percent, was approved by the governors unanimously.

　　To subdue inflationary pressures, we were trying to slow the economy by making money more expensive to borrow. There's no way to predict how severely the markets will respond to such a move, especially when investors are gripped with speculative fervor. I couldn't help but remember accounts I'd read of the physicists at Alamogordo the first time they detonated an atom bomb: Would the bomb fizzle? Would it work the way they hoped? Or would the chain reaction somehow go out of control and set the earth's atmosphere on fire? After the meeting ended, I had to fly to New York; from there I was scheduled to leave that weekend for Switzerland, where I was attending my first meeting of the central bankers of the ten leading industrialized nations. The Fed's hope was that the key markets— stocks, futures, currency, bonds—would take the change in stride, maybe with stocks cooling off slightly and the dollar strengthening. I kept calling back to the office to check how the markets were responding.

　　The sky did not catch fire that day. Stocks dipped, banks upped their prime lending rates in line with our move, and the financial world, as we'd hoped, noted that the Fed had begun acting to quell inflation. Perhaps the most dramatic impact was reflected in a New York Times headline a few days later: "Wall Street's Sharpest Rise: Anxiety." I was finally allowing myself to breathe a sigh of relief when a message reached me from Paul Volcker. He knew exactly what I'd been going through. "Congratulations," it read. "You are now a central banker."

　　I did not for a minute think we were out of the woods. Signs of trouble in the economy continued to mount. Slowing growth and a further weakening of the dollar put Wall Street on edge, as investors and institutions began confronting the likelihood that billions of dollars in speculative bets would never pay off. In early October, that fear turned to near panic. The stock market skidded, by 6 percent the first week, then another 12 percent the second week. The worst loss was on Friday, October 16, when the Dow Jones average dropped by 108 points. Since the end of September nearly half a trillion dollars of paper wealth had evaporated in the stock market alone—not to mention the losses in currency and other markets. The decline was so stunning that Time magazine devoted two full pages to the stock market that week under the headline "Wall Street's October Massacre."

　　I knew that from a historical perspective this "correction" was not nearly the most severe. The market slump in 1970 had been proportionally twice as large, and the Great Depression had wiped out fully 80 percent of the market's value. But given how poorly the week had ended, everyone was worried about what might happen when the markets opened again on Monday.

　　I was supposed to fly on Monday afternoon to Dallas, where on Tuesday I was to speak at the American Bankers' Association convention—my first major speech as chairman. Monday morning I conferred with the Board of Governors, and we agreed that I should make the trip, lest it seem that the Fed was in a panic. The market that morning opened weakly, and by the time I had to leave it looked awful—down by more than 200 points. There was no telephone on the airplane. So the first thing I did when I arrived was to ask one of the people who greeted me from the Federal Reserve Bank of Dallas, "How did the stock market finally go?"

　　He said, "It was down five oh eight."

　　Usually when someone says "five oh eight," he means 5.08. So the market had dropped only 5 points. "Great," I said, "what a terrific rally." But as I said it, I saw that the expression on his face was not shared relief. In fact, the market had crashed by 508 points—a 22.5 percent drop, the biggest one-day loss in history, bigger even than the one on the day that started the Great Depression, Black Friday 1929.

　　I went straight to the hotel, where I stayed on the phone into the night. Manley Johnson, the vice chairman of the Fed's Board, had set up a crisis desk in my office in Washington, and we held a series of calls and teleconferences to map out plans. Gerry Corrigan filled me in on conversations he'd had in New York with Wall Street executives and officials at the stock exchange; Si Keehn had talked to the heads of the Chicago commodities futures exchanges and trading firms; Bob Parry in San Francisco reported what he was hearing from the chiefs of the savings and loan industry, who were mainly based on the West Coast.

　　The Fed's job during a stock-market panic is to ward off financial paralysis—a chaotic state in which businesses and banks stop making the payments they owe each other and the economy grinds to a halt. To the senior people on the phone with me that night, the urgency and gravity of the situation was apparent—even if the markets got no worse, the system would be reeling for weeks. We started exploring ways we might have to supply liquidity if major institutions ran short of cash. Not all of our younger people understood the seriousness of the crisis, however. As we discussed what public statement the Fed should make, one of them suggested, "Maybe we're overreacting. Why not wait a few days and see what happens?"

　　Though I was new at this job, I'd been a student of financial history for too long to think that made any sense. It was the one moment I spoke sharply to anybody that night. "We don't need to wait to see what happens," I told him. "We know what's going to happen." Then I backed up a little and explained. "You know what people say about getting shot? You feel like you've been punched, but the trauma is such that you don't feel the pain right away? In twenty-four or forty-eight hours, we're going to be feeling a lot of pain."

　　As the discussion ended, it was clear that the next day would be full of major decisions. Gerry Corrigan made a point of telling me solemnly, "Alan, you're it. The whole thing is on your shoulders." Gerry is a tough character and I couldn't tell whether he meant this as encouragement or as a challenge for the new chairman. I merely said, "Thank you, Dr. Corrigan."

　　I was not inclined to panic, because I understood the nature of the problems we would face. Still, when I hung up the phone around midnight, I wondered if I'd be able to sleep. That would be the real test. "Now we're going to see what you're made of," I told myself. I went to bed, and, I'm proud to say, I slept for a good five hours.

　　Early the next morning, as we were honing the language of the Fed's public statement, the hotel operator interrupted with a call from the White House. It was Howard Baker, President Reagan's chief of staff. Having known Howard a long time, I acted as though nothing unusual were going on. "Good morning, Senator," I said. "What can I do for you?" "Help!" he said in mock plaintiveness. "Where are you?"

　　"In Dallas," I said. "Is something bothering you?" Handling the administration's response to a Wall Street crisis is normally the job of the treasury secretary. But Jim Baker was in Europe trying to make his way back; and Howard didn't want to deal with this one on his own. I agreed to cancel my speech and return to Washington—I'd been inclined to do so anyway, because in light of the 508-point market drop, going back seemed the best way to assure the bankers that the Fed was taking matters seriously. Baker sent a military executive jet to pick me up.

　　The markets that morning gyrated wildly—Manley Johnson sat in our makeshift operations center giving me the play-by-play while I was airborne. After I got in a car at Andrews Air Force Base, he told me the New York Stock Exchange had called to notify us it was planning to shut down in one hour—trading on key stocks had stalled for lack of buyers. "That'll blow it for everybody," I said. "If they close, we've got a real catastrophe on our hands." Shutting down a market during a crash only compounds investors' pain. As scary as their losses on paper may seem, as long as the market stays open investors always know that they can get out. But take away the exit and you exacerbate the fear. To restore trading afterward is extraordinarily hard—because no one knows what prices should be, no one wants to be the first to bid. The resuscitation process can take many days, and the risk is that in the meantime the entire financial system will stall, and the economy will suffer a crippling shock. There wouldn't have been much we could do to stop the executives at the exchange, but the marketplace saved us by itself. Within those sixty minutes enough buyers materialized that the

　　NYSE decided to shelve its plan.

　　The next thirty-six hours were intense. I joked that I felt like a seven-armed paperhanger, going from one phone to another, talking to the stock exchange, the Chicago futures exchanges, and the various Federal Reserve presidents. My most harrowing conversations were with financiers and bankers I'd known for years, major players from very large companies around the country, whose voices were tightened by fear. These were men who had built up wealth and social status over long careers and now found themselves looking into the abyss. Your judgment is less than perfect when you're scared. "Calm down," I kept telling them, "it's containable." And I would remind them to look beyond the emergency to where their long-term business interest might lie.

　　The Fed attacked the crisis on two fronts. Our first challenge was Wall Street: we had to persuade giant trading firms and investment banks, many of which were reeling from losses, not to pull back from doing business. Our public statement early that morning had been painstakingly worded to hint that the Fed would provide a safety net for banks, in the expectation that they, in turn, would help support other financial companies. It was as short and concise as the Gettysburg Address, I thought, although possibly not as stirring: "The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." But as long as the markets continued to function, we had no wish to prop up companies with cash.

　　Gerry Corrigan was the hero in this effort. It was his job as head of the New York Fed to convince the players on Wall Street to keep lending and trading—to stay in the game. A Jesuit-educated protege of Volcker's, he'd been a central banker for his entire career; there was no one more streetwise or better suited to be the Fed's chief enforcer. Gerry had the dominant personality necessary to jawbone financiers, yet he understood that even in a crisis, the Fed must exercise restraint. Simply ordering a bank to make a loan, say, would be an abuse of government power and would damage the functioning of the market. Instead, the gist of Gerry's message to the banker had to be: "We're not telling you to lend; all we ask is that you consider the overall interests of your business. Just remember that people have long memories, and if you shut off credit to a customer just because you're a little nervous about him, but with no concrete reason, he's going to remember that." That week Corrigan had dozens of conversations along these lines, and though I never knew the details, some of those phone calls must have been very tough. I'm sure he bit off a few earlobes.

　　As all this was going on, we were careful to keep supplying liquidity to the system. The FOMC ordered the traders at the New York Fed to buy billions of dollars of treasury securities on the open market. This had the effect of putting more money into circulation and lowering short-term rates. Though we'd been tightening interest rates before the crash, we were now easing them to help keep the economy moving.

　　Despite our best efforts, there were a half dozen near disasters, mostly involving the payment system. A lot of transactions during the business day on Wall Street aren't made simultaneously: companies will do business with one another's customers, for instance, and then settle up at day's end. On Wednesday morning Goldman Sachs was scheduled to make a $700 million payment to Continental Illinois Bank in Chicago, but initially withheld payment pending receipt of expected funds from other sources. Then Goldman thought better of it, and made the payment. Had Goldman withheld such a large sum, it would have set off a cascade of defaults across the market. Subsequently, a senior Goldman official confided to me that had the firm anticipated the difficulties of the ensuing weeks, it would not have paid. And in future such crises, he suspected, Goldman would have second thoughts about making such unrequited payments.

　　We also went to work on the political front. I spent an hour Tuesday at the Treasury Department as soon as Jim Baker returned (he'd been able to catch the Concorde). We huddled in his office with Howard Baker and other officials. President Reagan's initial reaction to Wall Street's calamity on Monday had been to speak optimistically about the economy. "Steady as she goes," he'd said, later adding, "I don't think anyone should panic, because all the economic indicators are solid." This was meant to be reassuring, but in the light of events sounded disturbingly like Herbert Hoover declaring after Black Friday that the economy was "sound and prosperous." Tuesday afternoon we met with Reagan at the White House to suggest he try a different tack. The most constructive response, Jim Baker and I argued, would be to offer to cooperate with Congress on cutting the deficit, since that was one of the long-term economic risks upsetting Wall Street. Even though Reagan had been at loggerheads with the Democratic majority, he agreed that this made sense. That afternoon he told reporters that he would consider any budget proposal Congress put forward, short of cutting Social Security. Though this overture never led to anything, it did help calm the markets.

　　We manned the operations center around the clock. We tracked markets in Japan and Europe; early each morning we'd collect stock quotes on U.S. companies trading on European bourses and synthesize our own Dow Jones Industrial Average to get a preview of what the New York markets were likely to do when they opened. It took well over a week for all the crises to play out, though most of them were hidden from public view. Days after the crash, for example, the Chicago options market nearly collapsed when its biggest trading firm ran short of cash. The Chicago Fed helped engineer a solution to that one. Gradually, though, prices in the various markets stabilized, and by the start of November the members of the crisis management team returned to their regular work.

　　Contrary to everyone's fears, the economy held firm, actually growing at a 2 percent annual rate in the first quarter of 1988 and at an accelerated 5 percent rate in the second quarter. By early 1988 the Dow had stabilized at around 2,000, back where it had been at the beginning of 1987, and stocks resumed a much more modest, and more sustainable, upward path. Economic growth entered its fifth consecutive year. This was no consolation to the speculators who had lost their shirts, or to the scores of small brokerage houses that failed, but ordinary people hadn't been hurt. In retrospect, it was an early manifestation of the economic resilience that would figure so prominently in the coming years.

　　The Federal Reserve and the White House are not automatically allies. In giving the Fed its modern mandate in 1935, Congress took great care to shield it from the influence of the political process. While the governors are all appointed by the president, their positions are semipermanent— Board members serve terms of fourteen years, longer than any appointees except the justices of the Supreme Court. The chairmanship itself is a four-year appointment, but the chairman can do little without the votes of the other Board members. And while the Fed must report twice a year to Congress, it controls its own purse strings by funding itself with interest income from the treasury securities and other assets it holds. All this frees the Fed to focus on its statutory mission: putting in place the monetary conditions needed for maximum sustainable long-term growth and employment. In the view of the Federal Reserve and most economists, a necessary condition for maximum sustainable economic growth is stable prices. In practice, this means Federal Reserve policies that contain inflationary pressures beyond the current election cycle.

　　No wonder politicians often find the Fed a hindrance. Their better selves may want to focus on America's long-term prosperity, but they are far more subject to constituents' immediate demands. That's inevitably refleeted in their economic policy preferences. If the economy is expanding, they want it to expand faster; if they see an interest rate, they want it to be lower—and the Fed's monetary discipline interferes. As William McChesney Martin Jr., a legendary chairman in the 1950s and 1960s, is alleged to have put it, the Fed's role is to order "the punch bowl removed just when the party was really warming up."

　　You could hear that frustration in the voice of Vice President George Herbert Walker Bush in spring 1988 as he campaigned for the Republican presidential nomination. He told reporters that he had "a word of caution" for the Fed: "I wouldn't want to see them step over some [line] that would ratchet down, tighten down on the economic growth."

　　In fact, tightening was just what we were doing. Once it became clear that the stock-market crash had not seriously damaged the economy, the FOMC had started inching up the fed funds rate in March. We'd done so because again signs were accumulating that inflation pressures were rising and the long Reagan-era boom had maxed out: factories were full, and joblessness was at its lowest level in eight years. This tightening proceeded into the summer, and by August it was necessary to raise the discount rate too.

　　Since the discount rate, unlike the fed funds rate, was publicly announced, raising it was much more politically explosive—Fed officials called such a move "ringing the gong." The timing for the Bush campaign could not have been worse. Bush wanted to piggyback on Reagan's success, and he was trailing the Democratic contender, Michael Dukakis, by as much as 17 points in the polls. The vice president's campaign staff was hypersensitive to any news that might point to a slowing economy or otherwise dim the luster of the administration. So when we voted to raise the rate just afew days before the Republican convention, we understood that people were going to be upset.

　　I'm a believer in delivering bad news in person, privately, and in advance—especially in Washington, where officials hate to be blindsided and need time to decide what they want to say publicly. I don't enjoy doing it, but there's no alternative if you want to have a relationship thereafter. So as soon as we voted, I left the office and drove over to the Treasury Department to see Jim Baker. He had just announced he was leaving his job as secretary of the treasury to become chief of staff of the Bush campaign. Jim was an old friend, and as treasury secretary he needed to be told.

　　As we sat down in his office, I caught his eye and said, "I'm sure you're not going to be happy about this, but after a long discussion of all the factors"—I listed a few—"we arrived at a decision to raise the discount rate. It's going to be announced in an hour." The increase, I added, was not the usual one-quarter of a percentage point, but twice that, from 6 percent to 6.5 percent.

　　Baker sat back in his chair and jabbed his fist into his stomach. "You've hit me right here," he growled.

　　"I'm sorry, Jim," I said.

　　Then he cut loose and lambasted me and the Fed for not being responsive to the real needs of the country, and expressed whatever other angry thoughts came into his head. Having been friends for a while, I knew this tirade was just an act. So after a minute, when he paused for air, I smiled at him. Then he laughed. "I know you had to do it," he said. A few days later, he publicly endorsed the rate increase as essential for the long-term stability of the system. "In the medium and long term it will be a very good thing for the economy," he added.

　　When George Bush won that fall, I hoped the Fed and his administration would get along. Everybody knew that whoever came in after Reagan would face big economic challenges: not just an eventual downturn in the business cycle, but whopping deficits and the rapidly mounting national debt. I thought Bush had upped the ante substantially when he'd declared in his acceptance speech at the Republican convention: "Read my lips: no new taxes." It was a memorable line, but at some point he was going to have to tackle the deficit—and he'd tied one hand behind his back.

　　People were surprised by the thoroughness with which the new administration replaced Reagan appointees. My friend Martin Anderson, who had long since shifted out of Washington back to the Hoover Institution in California, joked that Bush fired more Republicans than Dukakis would have. But I told him it didn't bother me. It was a new president's prerogative, and the moves did not affect the Fed. Besides, the senior economic team coming in—Treasury Secretary Nicholas Brady Budget Director Richard Darman, CEA chairman Michael Boskin, and others—were longtime professional acquaintances and friends of mine. (Jim Baker, of course, moved up to become secretary of state.)

　　My main concern, shared by many senior people within the Fed, was that the new administration attack the deficit right away, while the economy was still strong enough to absorb the shock of cuts in federal spending. Big deficits have an insidious effect. When the government overspends, it must borrow to balance its books. It borrows by selling treasury securities, which siphons away capital that could otherwise be invested in the private economy. Our deficits had been running so high—well over $150 billion a year on average for five years—that we were undermining the economy I highlighted this problem just after the election, testifying before the National Economic Commission, a bipartisan group Reagan had set up in the wake of the 1987 crash. The deficit was no longer a manana problem, I told them: "The long run is rapidly becoming the short run. If we do not act promptly, the effects will be increasingly felt and with some immediacy." Unsurprisingly, because of Bush's no-new-taxes pledge, the commission ended in a stalemate, with the Republicans arguing that spending should be cut and the Democrats arguing to raise taxes, and it never had any effect.

　　I quickly found myself in the same public conflict with President Bush that we'd had during the campaign. In January, I testified to the House Banking Committee that inflation risks were still high enough that Fed policy would be to "err more on the side of restrictiveness rather than stimulus." The next day with reporters, the president challenged this approach. "I do not want to see us move so strongly against inflation that we impede growth," he said. Normally such differences would get aired and resolved behind the scenes. I'd been looking toward building the same collaborative relationship with the White House that I'd seen during the Ford administration and that I knew had existed at times between Reagan and Paul Volcker. It was not to be. Great things happened on George Bush's watch: the fall of the Berlin Wall, the end of the cold war, a clear victory in the Persian Gulf, and the negotiation of the NAFTA agreement to free North American trade. But the economy was his Achilles' heel, and as a result we ended up with a terrible relationship.

　　He faced a worsening trade deficit and the politically damaging phenomenon of factories moving overseas. The pressure to cut the federal deficit finally forced him; in July 1990, to accept a budget compromise in which he broke his no-new-taxes pledge. Just days later came Iraq's invasion of Kuwait. The ensuing Gulf War proved to be great for his approval ratings. But the crisis also threw the economy into the recession we'd been worried about, as oil prices rose and uncertainty hurt consumer confidence. Worse still, the recovery, which began in early 1991, was unusually slow and anemic. Most of these events were beyond anyone's control, but they still made "the economy, stupid" an effective way for Bill Clinton to beat Bush in the 1992 election, despite the fact that the economy during that year had grown by 4.1 percent.

　　Two factors greatly complicated the economic picture. The first was the collapse of America's thrift industry, which put a big, unexpected drain on the federal budget. Savings and loans, which had been instituted in their modern form to finance the building of the suburbs after World War II, had been failing in waves for a decade. The inflation of the seventies—compounded by mismanaged deregulation and, ultimately, fraud—did hundreds of them in. As originally conceived, an S&L was a simple mortgage machine, not much different from the Bailey Building and Loan run by Jimmy Stewart in It's a Wonderful Life. Typically, customers would deposit money in passbook savings accounts, which paid only 3 percent interest but were federally insured; then the S&L would lend out those funds in the form of thirty-year mortgages at 6 percent interest. As a result, S&Ls for decades were dependable moneymakers—and the thrift industry grew huge, with more than 3,600 institutions and $1.5 trillion in assets by 1987.

　　But inflation spelled doom for this tidy state of affairs. It drove both short-term and long-term interest rates sharply higher, putting the S&Ls in a terrible squeeze. For the typical S&L, the cost of deposits soared immediately, but because the mortgage portfolios turned over only slowly, revenues lagged. Soon many S&Ls were in the red, and by 1989 the great majority were technically insolvent: if they'd sold all their loans, they wouldn't have had enough money to pay off all their depositors.

　　Congress tried repeatedly to prop up the industry but mainly succeeded in making the problem worse. Just in time for the building boom of the Reagan era, it increased the level of taxpayer-funded deposit insurance (from $40,000 to $100,000 per account) and relaxed the restrictions on the kinds of loans S&Ls could make. Before long, emboldened S&L executives were financing skyscrapers and resorts and thousands of other projects that in many cases they barely understood, and they were often losing their shirts.

　　Others took advantage of the loosened rules to commit fraud—most notoriously Charles Keating, a West Coast entrepreneur who was ultimately sent to prison for racketeering and fraud for having misled investors through sham real estate transactions and the sale of worthless junk bonds. Salesmen at Keating's Lincoln Savings were also said to have talked unsophisticated people into shifting their savings from passbook accounts into risky, uninsured ventures controlled by him. When the business collapsed, cleaning up the mess cost taxpayers $3.4 billion, and as many as twenty-five thousand bond buyers lost an estimated $250 million. The revelation in 1990 that Keating and other S&L executives were major contributors to Senate campaigns made for a full-blown Washington drama.

　　I had a complicated involvement in this mess not only because of my job but also because of a study I'd done while still a private consultant. Years before, at Townsend-Greenspan, a major law firm representing Keating had hired me to evaluate whether Lincoln was financially healthy enough to be allowed to invest directly in real estate. I'd concluded that with its then highly liquid balance sheet, it could do so safely. This was before Keating undertook dangerous increases in the leveraging of his balance sheet and long before he was exposed as a scoundrel. To this day I don't know whether he'd started committing crimes by the time I began my research. My report surfaced when the Senate Ethics Committee opened hearings into Keating's connections to five senators, who came to be known as the Keating Five. John McCain, one of those being investigated, testified that my assessment had helped reassure him about Keating. I told the New York Times that I was embarrassed by my failure to foresee what the company would do, and added, "I was wrong about Lincoln."

　　The incident was doubly painful for me because it caused trouble for Andrea. By this time she had become her network's chief congressional correspondent, and she was covering the Keating scandal. Andrea had always taken extreme care to keep what she called a firewall between my work and hers as our relationship deepened. For example, she never attended any of my congressional testimonies; she strove to avoid even the appearance of a conflict of interest. The Keating hearings put this to the test. Reluctantly, Andrea decided to take herself off the story while the news media explored my connection to the case.

　　No one knew how much the final cleanup of the thrift industry would cost taxpayers—the estimates were in the hundreds of billions of dollars. As the work proceeded, the drain on the Treasury was perceptible, worsening the fiscal challenge for President Bush. The job of trying to recoup some of the losses fell to the Resolution Trust Corporation, which Congress had created in 1989 to sell off the assets of the ruined companies. I was on its oversight board, which was chaired by Treasury Secretary Brady and included Jack Kemp, then the secretary of housing and urban development; real estate developer Robert Larson; and former Fed governor Philip Jackson. The RTC had a professional staff, but for me by early 1991 being on the oversight board was almost like having a second job. I spent large amounts of time poring over detailed documents and attending meetings. The vast numbers of uninhabited properties we managed were deteriorating rapidly from lack of maintenance, and unless we moved quickly to get rid of them, we would end up with one huge write-off. Moreover, we would probably have been saddled with a bill to tear a lot of them down. I kept adding up the cost in my mind. It was not a pretty thought.

　　S&L mortgages that were still paying interest had sold off readily in the market. But now the RTC had gotten down to the assets nobody seemed to want: half-built malls in the desert, marinas, golf courses, tacky new condo complexes in overbuilt residential markets, repossessed half-empty office buildings, uranium mines. The scope of the problem beggared the imagination: Bill Seidman, who chaired both the RTC and the Federal Deposit Insurance Corporation, calculated that if the RTC sold off $1 million of assets a day, it would need three hundred years to sell them all. Clearly, we needed a different approach.

　　I'm not sure who came up with the creative sales idea. As we finally presented it, the plan was to group the properties into $ 1 billion blocks. For the first package, which we offered at auction, we especially solicited the bids of a few dozen qualified buyers, mostly businesses with track records of turning around sick properties. "Qualified" doesn't necessarily mean "savory"—the groups we approached included so-called vulture funds and speculators whose reputations could have used a face-lift.

　　Only a few bids materialized, and the package went for a comparative song—just over $500 million. What's more, the winning bidder had to make a down payment of only a fraction of the price, and then pay installments based on how much cash the properties generated. The deal looked like a giveaway, and as we'd expected, public watchdogs and Congress were outraged. But there's nothing like a bargain to stimulate demand. Large numbers of greedy investors rushed to get in on the action, the prices of the remaining blocks of property soared, and within a few months the RTC's shelves were stripped bare. By the time it disbanded in 1995, the RTC had liquidated 744 S&Ls—more than a quarter of the industry. But thanks in part to the asset sales, the total bill to taxpayers was $87 billion, far less than originally feared.

　　Commercial banks also were in serious trouble. This was an even bigger headache than the S&Ls because banks represent a far larger and more important sector of the economy. The late 1980s was their worst period since the Depression; hundreds of small and medium-size banks failed, and giants like Citibank and Chase Manhattan were in distress. Their problem, as with the S&Ls, was too much speculative lending: in the early eighties, the major banks had gambled on Latin American debt, and then, as those loans went bad, like amateur gamblers trying to get square they'd bet even more by leading the whole industry into a binge of commercial real estate lending.

　　The inevitable collapse of the real estate boom really shook the banks. Uncertainty about the value of the real estate collateral securing their loans made bankers unsure how much capital they actually had—leaving many of them paralyzed, frightened, and reluctant to lend further. Big businesses were able to tap other sources of funds, such as innovative debt markets that had sprung up on Wall Street—a phenomenon that helped keep the 1990 recession shallow. But small and midsize manufacturers and merchants all over America were finding it hard to get even routine business loans approved. And that, in turn, made the recession unusually difficult to snap out of.

　　Nothing we did at the Fed seemed to work. We'd begun easing interest rates well before the recession hit, but the economy had stopped responding. Even though we lowered the fed funds rate no fewer than twenty-three times in the three-year period between July 1989 and July 1992, the recovery was one of the most sluggish on record. "The U.S. economy is best described as moving forward, but in the teeth of a fifty-mile-an-hour headwind" was how I explained the situation to an audience of worried New England businessmen in October 1991.1 couldn't be very encouraging, because I didn't know when the credit crunch would end.

　　Iwould see President Bush every six or seven weeks, usually in the context of a meeting with others but sometimes one-on-one. We had known each other since the Ford years. He'd even had me over to Langley for lunch when he was director of Central Intelligence in 1976. During the early months of the 1980 campaign, he often called me on economic policy issues. While Bush was vice president, I would join him every so often at the White House. He was intelligent and in person we always got along well. I was particularly taken with his wife, Barbara, a spunky and formidable presence. But during his presidency, he was far less focused on the economy than on foreign affairs.

　　Though his father had worked on Wall Street and he'd majored in economics at Yale, he had never experienced the markets firsthand. He didn't think of interest rates as being set mainly by market forces; he seemed to believe that they were matters of preference. It was not a thoughtful view. He preferred to delegate economic policy to his top aides. This meant that I dealt mainly with Nick Brady, Dick Darman, and Mike Boskin.

　　Darman, the budget director, was in many ways similar to David Stockman—a major-league policy intellectual and a believer in sound fiscal management. Unlike Stockman, though, Dick was often less than direct with people and was more driven by political expediency. Over time I learned to keep my distance. Darman wrote years later that behind closed doors at the White House, he'd strenuously opposed keeping the no-new-taxes pledge. Instead he tried to persuade the president to attack the deficit early on, when they might have put the issue quickly behind them. But the president wasn't convinced. As 1989 progressed, the White House found itself at loggerheads with the Democratic Congress. So much debt continued to hang over the budget that when the recession came, the administration didn't have the fiscal flexibility to address it.

　　Before long, the administration began blaming its troubles on the Fed. Supposedly we were choking the economy by keeping the money supply too tight. I got my first taste of this in August 1989, while Andrea and I were visiting Senator John Heinz and his wife, Teresa, at their Nantucket summerhouse. We put on the Sunday morning talk shows and there was Dick Darman on Meet the Press, I was only half paying attention when I heard him say, "It's important to not merely Chairman Greenspan but the other members of the Board and the FOMC ... that they be more attentive to the need to avoid tipping this economy into recession. I'm not sure they're quite there yet." I nearly spilled my coffee. "What!" I said. Listening to his argument, I thought it made no economic sense. But then I realized it didn't have to: it was political rhetoric.

　　Treasury Secretary Brady didn't like the Fed either. He and the president were friends and had a lot in common—both were wealthy, Yale-educated patricians and members of Skull and Bones. Nick had spent more than three decades on Wall Street, rising to become chairman of a major investment house. He brought with him to Washington a depth of real-world trading experience and the habit of command.

　　Throughout the Bush administration, Nick and I cooperated on many major issues—we traveled to Moscow in 1991 and worked closely and effectively on complex matters of bank regulation and foreign exchange. Not only did he and I work together, but he even invited me down to Augusta National to play golf, and Andrea and I socialized with him and his wife, Kitty.

　　But he reinforced President Bush's instrumental view of monetary policy. To Nick, slashing short-term interest rates seemed a no-risk proposition: if the Fed flooded the economy with money, the economy would grow faster. We would have to stay on the lookout for a flare-up of inflation, of course, but if that happened, the Fed could rein it back in. If I had done what they wanted, I'd have pushed for faster, steeper cuts, and no doubt have had my head handed to me by the market—deservedly.

　　The treasury secretary, however, was not receptive to debate. Like many traders, he'd had great success going by his gut; in matters like exchange rate policy, I found his sense of the markets quite acute. But he was not a conceptualize^ and was not inclined to take the long-term view. Nick and I would meet for a working breakfast once a week, and whenever the subject of monetary policy came up, we would simply go round and round.

　　This impasse made coping with the deficit and the recession doubly difficult, because it meant the administration was always looking for a quid pro quo from the Fed. When the 1990 budget bill was on the table—and President Bush finally faced the necessity of breaking his no-new-taxes pledge—Nick asked me for a commitment that if the budget went through, the Fed would lower interest rates.

　　In fact, the budget package impressed me. It included a couple of Darman innovations that I thought were very promising, such as a "pay-go" rule that any new spending program had to have some offsetting source of funding, either a new tax or a budget cut ("pay-go" was Washington shorthand for "pay as you go"). The proposed budget did not cut the deficit as deeply as it might have, but the consensus at the Fed, with which I agreed, was that it was a big step in the right direction. In a congressional hearing in October when the budget was finally up for approval, I pronounced the plan "credible"—which might sound like faint praise, but it was enough to make the stock market jump, as traders bet that the Fed would instantly cut interest rates. Of course, we had no such intention: before easing credit, we needed to see first whether the budget cuts actually became law, and most important, whether they had any real economic effect.

　　So I was always very careful in what I privately told Nick. I said, "A sound budget will bring long-term rates down because inflation expectations will fall. Monetary policy, appropriately, should respond to that by lowering short-term rates." This was standard Fed policy, but it frustrated Nick because it was not the promise he was looking for..

　　When the recession hit that fall, the friction only got worse. "There has been too much pessimism," President Bush declared in his 1991 State of the Union address. "Sound banks should be making sound loans now, and interest rates should be lower, now." The Fed, of course, had been lowering rates for over a year, but the White House wanted more, faster cuts.

　　PHOTOGRAPHIC INSERT 1

　　Age five, Washington Heights, New York City, 1931. The collection of Alan Greenspan

　　With three cousins on the Greenspan side, circa 1934 (I'm on the left). The collection of Alan Greenspan

　　Sixteen years old, Lake Hiawatha, New Jersey. The collection of Alan Greenspan

　　My father, who sold stocks on Wall Street, left my mother when I was two. When I was nine, he gave me a copy of his book, Recovery Ahead!, which confidently predicted the end of the Depression and included this affectionate, if somewhat mystifying, inscription: "To my son Alan: May this my initial effort with constant thought of you branch out into an endless chain of similar efforts so that at your maturity youmay look back and endeavor to interpret the reasoning behind these logical forecasts and begin a like work of your own. Photograph by Darren Haggar

　　After a year at the Juilliard School, I toured the country as a sideman with the Henry Jerome dance band, playing saxophone and clarinet (I'm sitting at far left). I also did tax returns for the band members. Courtesy of Henry Jerome Music

　　With my mother, Rose Goldsmith, a brave and lively woman who gave me my love of music.

　　The collection of Alan Greenspan

　　By 1950,1 was earning enough as an economist to think about leaving New York City for the suburbs, which I did just over a year later. The collection of Alan Greenspan

　　Of all my teachers, Arthur Burns and Ayn Rand had the greatest impact on my life. An economist who did groundbreaking work on business cycles, Burns was my faculty adviser and mentor during my first year of graduate school at Columbia, and years later persuaded me to finish my Ph.D. He served before me as head of the Council of Economic Advisors and chairman of the Federal Reserve Board. Ayn Rand expanded my intellectual horizons, challenging me to look beyond economics to understand the behavior of individuals and societies. LEFT: Bettmann/Corbis; RIGHT: The New York Times/Getty Images

　　Adam Smith's Enlightenment ideas of individual initiative and the power of markets came back from near eclipse in the 1930s to their current dominance of the global economy. Smith (above left) remains among my deepest intellectual influences. I was also influenced by the thinking of John Locke (above right), the great British moral philosopher who articulated fundamental notions of life, liberty, and property, and Joseph Schumpeter, the twentieth-century economist whose concept of creative destruction gets to the heart of the role of technological change in a modern capitalist society. TOP LEFT: Hulton Archive/Getty Images; TOP RIGHT: Bettman/Corbis; BOTTOM RIGHT: Getty Images

　　At my firm, Townsend-Greenspan, I focused on heavy industry—textiles, mining, railroads, and especially steel. Studying steel put me in an excellent position to warn of the recession of 1958—my first forecast of the U.S. economy as a whole.

　　Walter Daran/Time Life Pictures/Getty Images

　　When I took my first Washington job in 1974,1 left Townsend-Greenspan in the hands of vice presidents (from left) Kathy Eichoff, Lucille Wu, and Bess Kaplan (seated). Former vice president Judith Mackey (right) came back temporarily to help out. The predominance of women made Townsend-Greenspan unusual in the economics world. The New York Times/Redux

　　My involvement in public life started with Richard Nixon's campaign for the presidency in 1967. I was an unpaid member of the campaign staff. Though I was impressed by Nixon's intelligence, he had a dark side that troubled me, and I decided against joining the administration. Seated to my left at this July 1974 meeting is Hewlett-Packard cofounder David Packard, who served as deputy secretary of defense from 1969 to 1971. Bettmann/Corbis

　　My mother congratulates me after I was sworn in as chairman of the Council of Economic Advisors, while President Ford looks on. With the nation reeling from Watergate, high oil prices, and inflation, it was a challenging moment to take a government job. Bettmann/Corbis

　　At this April 1975 meeting in the Oval Office to discuss economic policy, Secretary of State Henry Kissinger had just interupted with news of the U.S. evacuation of Saigon. Left to right: President Ford, Deputy Chief of Staff Dick Cheney, me, Chief of Staff Donald Rumsfeld, Vice President Nelson Rockefeller, and Kissinger. David Hume Kennerly/The Gerald R. Ford Presidential Library/Getty Images

　　I he White House senior staff often gathered in the chief of staff's office to watch the evening news and chew over the day's events. I would add my two cents from the carpet, where I'd stretch out to ease my aching back. David Hume Kennerly/The Gerald R. Ford Presidential Library/Getty Images

　　Working at Camp David, left to right: Secretary of the Treasury Bill Simon, Press Secretary Ron Nessen, President Ford, Dick Cheney, Donald Rumsfeld, and me. David Hume Kennerly/The Gerald R. Ford Presidential Library/Getty Images

　　With President Ford in Palm Springs, 1980. Contrary to his reputation for being physically clumsy, he was a formidable golfer and a former All-American football player. Photograph by Neil Leifer

　　During the presidential campaign of 1980, my mission on this cross-country flight with Ronald Reagan was to brief him on a long list of domestic issues. Adviser Martin Anderson, in the foreground, put me up to it. "He'll listen to you," he said. But I couldn't get Reagan to stop telling Stories. Michael Evans photograph, courtesy of the Ronald Reagan Presidential Foundation

　　At the Republican convention that July, Henry Kissinger and I tried to persuade former president Ford to become Reagan's running mate. Polls showed that Reagan and Ford would

　　be a "dream ticket," but after a suspenseful twenty-four hours, the negotiations fell apart and the vice presidential nomination went to George H.W. Bush. David Hume Kennedy/'Getty Images

　　Social Security developed financial trouble in the late 1970s and early 1980s, and both Republicans and Democrats knew that it had to be fixed. Reagan's reform commission, which I ran, achieved a compromise. Joining Reagan in the Rose Garden in April 1983 as he signed it into law were leaders from both parties, including Senator Bob Dole (to my left in the photo), Congressman Claude Pepper (partially obscured), and House Speaker Tip O'Neill (joking with the president). The caricature below appeared that year in the financial press.

　　ABOVE: AP Images/Barry Thumma; BELOW: David Leinne

　　History took an astonishing turn when the Berlin Wall fell in November 1989. But even more amazing to me in the following days was the economic ruin exposed by the fall of the wall. By the time Soviet premier Mikhail Gorbachev made his third visit to the United States during the following spring, the Soviet Union itself had begun to disintegrate. He is shown below with President George H. W. Bush and me in a receiving line at a state dinner in Washington on May 31, 1990. LEFT: AP Images/John Gaps HI; BELOW: Courtesy of the George Bush Presidential Library

　　The strain between President George H. W. Bush and the Federal Reserve Board was evident in this July 1991 meeting in the Oval Office. He made no secret of his view that the Fed hadn't eased interest rates sufficiently. He reappointed me as chairman that year but later blamed me for his loss of the presidential election of 1992. Courtesy of the George Bush Presidential Library

　　I he Federal Open Market Committee, the Fed's most powerful and sensitive decision-making group, in session in June 2003. It meets eight times a year. Federal Reserve photo—Britt Leckman

　　I had access to an increasingly broad range of information in my Fed office, as technology revolutionized economic analysis at the Board. Photograph by Diana Walker

　　I made it a point to reserve time each day for quiet study and reflection. Photograph by Linda L. Creighton

　　BLACK MON DAY

　　I still have a letter Nick sent me during that time. He'd taken the extraordinary step of inviting eight prominent economists from industry and academia to the White House for lunch with the president. At the lunch, each economist was asked whether the Fed ought to further cut short-term rates. Put on the spot in front of the president, Nick wrote, "every single one replied that it would do no harm"—and virtually all felt it would help. "Alan, in my travels you stand alone in your view," the letter continued, complaining bluntly of "lack of forceful leadership by the Fed."

　　In the event, the administration's bark was worse than its bite. As my term as Fed chairman ended in the summer of 1991, there was a behind-thescenes meeting in which the treasury secretary was fishing for a commitment to further relax monetary policy in exchange for a second term. Nick later claimed I had made such a deal. In fact there was no way I could commit to that, even if I had wanted to (and even though I privately thought our rate decreases might continue). Nonetheless, President Bush reappointed me. I think he concluded I was his least worst choice: the Fed itself by all accounts was functioning well, there was no other candidate whom Wall Street seemed to prefer, and a change would have roiled the markets.

　　The impasse on monetary policy made it hard for Nick and me to remain friends; though we continued to cooperate professionally, he canceled our weekly breakfasts, and our socializing came to an end. With the election year nearing, the administration decided to change its approach to the Fed and its pigheaded chairman. The "Greenspan account," as they called it in the White House, shifted to CEA chairman Mike Boskin and the president himself.

　　The recovery was in fact finally picking up steam as the campaign season began. By July I felt confident enough to declare that the fifty-mile-per-hour headwinds had partially abated. Later analysis showed that by spring GDP (which in 1990 replaced GNP as the standard measure of aggregate output) was growing at a healthy 4 percent annual rate. But that was hard to discern at the time, and the president, understandably, was concerned that the growth be as robust and obvious as possible.

　　I met with the president only a handful of times that year. He was always extremely cordial. "I don't want to bash the Fed/' he'd say. He'd probe and raise substantive questions based on what he'd been hearing from his business contacts. He'd ask things like, "People are saying restrictions on bank reserves are part of the problem; how should I be looking at this?" These were not questions Reagan would have raised—he had no patience for discussingeconomic policy—and I was delighted that Bush wanted to know. I felt a lot more comfortable dealing with him than I did with Brady because the discussion was never adversarial. But when we talked about interest rates, I was never able to convince him that lowering rates further and faster almost certainly wouldn't have speeded the recovery and would have increased the risk of inflation.

　　The fact was; the economy was recovering, just not in time to save the election. The deficit probably hurt Bush worse than anything else. Although the belated budget cuts and the tax hikes of 1990 had put the country on a somewhat better fiscal footing, the recession cut so deeply into federal revenues that the deficit temporarily mushroomed. It hit $290 billion in the last year of Bush's term. Ross Perot was able to hammer at that in the campaign and succeeded in dividing the Republican vote enough to sink Bush.

　　I was saddened years later when I discovered that President Bush blamed me for his loss. "I reappointed him and he disappointed me," he told a television interviewer in 1998. It's not in my nature to be suspicious. I realized only in retrospect the extent to which Brady and Darman had convinced the president that the Fed was sabotaging him. His bitterness surprised me; I did not feel the same way about him. His loss in the election reminded me of how voters in Britain had ousted Winston Churchill immediately after the Second World War. As best I could judge, Bush had done an exemplary job on the most important issues confronting the United States, our confrontation with the Soviet Union and the crisis in the Middle East. If a president can earn reelection, he did. But then, so did Winston Churchill.

　　S I X THE FALL OF THE WALL

　　It was October 10, 1989. Jack Matlock, the U.S. ambassador to the Soviet Union, was introducing me to an audience of Soviet economists and bankers at Spaso House, the ambassador's official residence in Moscow. My assignment was to explain capitalist finance.

　　Of course, I had no notion that in a month the Berlin Wall would be torn down, or that in a little more than two years the Soviet Union would be no more. Nor did I know that I would, in the years following the Eastern bloc's collapse, become witness to a very rare event: the emergence of competitive market economies from the ashes of centrally planned ones. In the process, the demise of central planning exposed the almost unimaginable extent of the rot that had accumulated over decades.

　　But the biggest surprise that awaited me was an extraordinary tutorial on the roots of market capitalism. This is the system with which, of course, I am most familiar, but my understanding of its foundations was wholly abstract. I was reared in a sophisticated market economy with its many supporting laws, institutions, and conventions long since in place and mature. The evolution I was about to observe in Russia had occurred in Western economies scores of years before I was born. As Russia struggled to recover from the crash of all the institutions related to the old Soviet Union, I felt like a neurologist who learns by observing how a patient functions when a part of the brain has been impaired. Watching markets try to work in the absence of the protection of property rights or a tradition of trust was a wholly new experience for me.

　　But that was all ahead of me as I looked out at the hundred or so people assembled before me at Spaso House and wondered, What are they thinking? How can I reach them? They were all products of Soviet schools, I assumed, and deeply indoctrinated with Marxism. What did they know of capitalist institutions or market competition? Whenever I addressed a Western audience, I could judge its interests and level of knowledge and pitch my remarks accordingly. But at Spaso House, I had to guess.

　　The lecture I had prepared was a dry, diffuse presentation on banks in market economies. It delved into such topics as the value of financial intermediation, various types of risk commercial banks face, the pluses and minuses of regulation, and the duties of central banks. The talk was very slow going, especially as I had to pause paragraph by paragraph for the translator to render my words into Russian.

　　Yet the audience was quite attentive—people stayed alert throughout, and several seemed to be taking detailed notes. Hands went up when I finally reached the end and Ambassador Matlock opened the floor for questions. To my surprise and pleasure, the ensuing half hour of discussion made it obvious that some people got what I was talking about. The questions they asked revealed an understanding of capitalism that startled me in its sophistication.*

　　I'd been invited by Leonid Abalkin, the deputy prime minister in charge of reform. I'd expected our meeting that week to be largely ceremonial, but it turned out to be anything but. An academic economist in his late fifties [*How did these people know so much? In 1991 I finally asked Grigory Yavlinsky, one of Gorbachev's top reformers. He laughed and explained, "We all had access to books on econometrics in the university libraries. The Party ruled that because these were mathematical works, they were purely technical, devoid of ideological content." Of course, the ideology of capitalism was embodied in many of the equations—econometric models revolve around the driving forces of consumer choice and market competition. Thus, Yavlinsky said, Soviet economists had become quite knowledgeable about how markets worked. ]

　　who was one of Gorbachev's kitchen cabinet of reformers, Abalkin had built a reputation for political flexibility and grace. His long face made him look as if he was carrying a lot of stress, and there were plenty of reasons for that to be the case. Winter was setting in, there were reports of looming electricity and food shortages, Gorbachev was talking publicly about the risk of anarchy, and the prime minister had just asked the parliament for emergency powers to ban strikes. Perestroika, Gorbachev's ambitious fouryear-old economic reform initiative, was in danger of collapse. I sensed that Abalkin had his work cut out for him because his boss understood so little of the mechanics of markets.

　　Abalkin asked my opinion of a proposal being touted by the Soviet state planners. It was an inflation-fighting program that revolved around indexation—tying wages to prices—as a way to reassure the population that the purchasing power of their wages wouldn't be destroyed. I told him briefly about the U.S. government's ongoing struggle to foot the bill for having indexed Social Security benefits, and volunteered my strongly held view that indexing is only a palliative that, in the longer run, is likely to cause even more serious problems. Abalkin didn't seem surprised. He said he thought that the transition from bureaucratic central planning to the private market, which he called "the most democratic form of regulating economic activity," would take many years.

　　Fed chairmen had ventured behind the iron curtain before—both Arthur Burns and William Miller had come to Moscow during the period of detente in the 1970s—but I knew they'd never had a conversation like this one. In those years, there had been little to discuss: the ideological and political divide between the centrally planned economies of the Soviet bloc and the market economies of the West was simply too vast. Yet the late 1980s had brought astonishing changes, most obviously in East Germany and other satellites, but also in the Soviet Union itself. Just that spring, Poland had held its first free elections, and the ensuing events had amazed the world. First the Solidarity union won decisively against the Communist Party, and then, instead of sending in the Red Army to reassert control, Gorbachev declared that the USSR accepted the outcome of a free election. More recently East Germany had started to dissolve—tens of thousands of its people took advantage of the state's weakening hold to emigrate illegally to the West. And just days before I arrived in Moscow, Hungary's Communist Party renounced Marxism in favor of democratic socialism.

　　The Soviet Union itself was obviously in crisis. The collapse of oil prices a few years before had eliminated its only real source of growth, and now there was nothing to offset the stagnation and corruption that had become epidemic during the Brezhnev era. Compounding this was the cold war, whose pressure was greatly increased by America's huge arms buildup under President Reagan. Not only was the Soviet Union's grip on its satellites slipping, but also it was having trouble feeding its population: only by importing millions of tons of grain from the West was it able to keep bread on the shelves. Inflation, Abalkin's immediate concern, was indeed out of control—I'd seen with my own eyes long lines outside jewelry stores, where customers desperate to convert rubles into goods with lasting value reportedly were being restricted to one purchase per visit.

　　Gorbachev, of course, was moving as rapidly as he could to liberalize the system and reverse the decay. The general secretary of the Communist Party of the Soviet Union struck me as an extraordinarily intelligent and open man, but he was of two minds. Intelligence and openness were his problems, in a way. They made it impossible for him to ignore the contradictions and lies the system presented him with day in and day out. Though he'd grown up under Stalin and Khrushchev, he could see that his country was stagnating and why, which unraveled his indoctrination.

　　The big mystery to me was why Yuri Andropov, the hard-liner who preceded Gorbachev, had brought him forward. Gorbachev didn't bring down the Soviet Union purposely, yet he did not raise his hand to prevent its dissolution. Unlike his predecessors, he did not send troops into East Germany or Poland when they moved toward democracy. And Gorbachev was calling for his country to become a major player in world trade; without question he understood this was implicitly procapitalist, even if he didn't understand the mechanics of stock markets or other Western economic systems.

　　My visit dovetailed with Washington's growing effort to encourage reform-minded Soviets under Gorbachev's openness policy, glasnost. As soon as the KGB allowed people to attend evening gatherings, for instance, the U.S. embassy instituted a series of seminars at which historians, economists, and scientists could attend lectures by their Western counterparts on previously forbidden subjects such as black markets, ecological problems in the southern republics, and the history of the Stalin era.

　　A large part of my itinerary consisted of meetings with high officials. Each surprised me in some way. While I'd studied free-market economics for much of my life, encountering the alternative and seeing it in crisis forced me to think more deeply than I ever had before about the fundamentals of capitalism and how it differed from a centrally planned system. My first inkling of this difference had come during the drive into Moscow from the airport. In a field beside the roadway, I'd spotted a 1920s steam tractor, a clattering, unwieldy machine with great metal wheels. "Why do you suppose they still use that?" I asked the security man who was with me in the car. "I don't know," he said. "Because it still works?" Like the 1957 Chevrolets on the streets of Havana, it embodied a key difference between a centrally planned society and a capitalist one: here there was no creative destruction, no impetus to build better tools.

　　No wonder centrally planned economic systems have great difficulty in raising standards of living and creating wealth. Production and distribution are determined by specific instructions from the planning agencies to the factories, indicating from whom and in what quantities they should receive raw materials and services, what they should produce, and to whom they should distribute their output. The workforce is assumed to be fully employed, and wages are predetermined. Missing is the ultimate consumer, who in a centrally planned economy is assumed to passively accept the goods planning agencies order produced. Even in the USSR, consumers didn't behave that way. Without an effective market to coordinate supply with consumer demand, the consequences are typically huge surpluses of goods that no one wants, and huge shortages of products that people do want but that are not produced in adequate quantities. The shortages lead to rationing, or to its famous Moscow equivalent—the endless waiting in line at stores. (Soviet reformer Yegor Gaidar, reflecting on the power of being a dispenser of scarce goods, later said, "To be a seller in a department store was the same as being a millionaire in Silicon Valley. It was status, it was influence, it was respect.")

　　The Soviets had staked their entire nation on the premise that central planning, rather than open competition and free markets, is the way to achieve the common good. Contemplating this made me eager to meet Stepan Sitaryan, the right-hand man of the chief of Gosplan, the state planning committee. The Soviet Union had a bureaucracy for everything, and the key ones had names beginning with gos, or state. Gosnab allocated raw materials andsupplies to industry, Gostrud set wages and work rules, Goskomtsen set prices. At the pinnacle sat Gosplan—which, as one analyst memorably put it, dictated "the type, quantity, and price of every commodity produced at every single factory and plant across 11 time zones." Gosplan's vast empire included military factories, which had access to the best labor and the best materials and were universally regarded as the USSR's finest.* In total, Western analysts estimated, the agency controlled between 60 percent and 80 percent of the nation's GDP. And Sitaryan and his boss, Yuri Maslyukov, were the officials at the controls.

　　A diminutive man with a white pompadour and a good command of English, Sitaryan turned me over to a senior Gosplan aide who trotted out elaborate input-output matrices, the mathematics of which would have dazzled even Wassily Leontief, the Russian-born Harvard economist who pioneered them. Leontief's notion was that you could precisely characterize any economy by mapping the flow of materials and labor through it. Done thoroughly, your model would be the ideal instrument panel. Theoretically it would let you anticipate every impact on every segment of the economy from the change of one output, such as the production of tractors—or, more to the point in the Reagan era, a major increase in military production to respond to the U.S. arms buildup for the "Star Wars" missile defense. But Western economists generally considered input-output matrices to be of limited use because they failed to capture the dynamism of an economy—in the real world, the relationships between inputs and outputs almost invariably shift faster than they can be estimated.

　　Gosplan's input-output model had been elaborated to Ptolemaic perfection. But judging by the top aide's remarks, I couldn't see that any of the [*Indeed, the USSR's supposedly passive consumers flocked whenever possible to acquire the superior household goods produced by military factories. These consumers were as sophisticated as any in the West. ]

　　limitations had been solved. So I asked how the model took into account dynamic change. He just shrugged and changed the subject. Our meeting obliged him to keep up the pretext that planners can set production schedules and manage a vast economy more efficiently than free markets can do. I suspected that the aide didn't actually believe that, but I couldn't tell whether what he really felt was cynicism or doubt.

　　One might think that smart planning authorities should have been able to adjust to their models' shortcomings. People like Sitaryan are smart, and they tried. But they took too much on themselves. Without the immediate signals of price changes that make capitalist markets work, how was anyone to know how much of each product to manufacture? Without the help of a market pricing mechanism, Soviet economic planning had no effective feedback to guide it. Just as important, the planners did not have the signals of finance to adjust the allocation of savings to real productive investments that accommodated the population's shifting needs and tastes.

　　Years before becoming Fed chairman, I'd actually tried picturing myself in the central planner's job. From 1983 to 1985,1 served under Reagan on the President's Foreign Intelligence Advisory Board (PFIAB), where I was asked to review U.S. assessments of the Soviet ability to absorb the strain of accelerated armament. The stakes were enormous: The president's Star Wars strategy rested on the assumption that the Soviet economy was no match for ours. Ramp up the arms race, the thinking went, and the Soviets would collapse trying to keep up, or they'd ask to negotiate; in either case, we'd hold out our hands and the cold war would end.

　　The assignment was clearly too important to turn down, but it daunted me. It would be a Herculean task to learn the ins and outs of a production and distribution system so different from ours. Once I dug into the project, though, it took me only a week to conclude that it was impossible: there was no reliable way to assess their economy. Gosplan's data were rotten— Soviet managers up and down the line had every incentive to exaggerate their factories' output and pad their payrolls. Worse, there were large internal inconsistencies in their data that I couldn't reconcile and I suspected neither could Gosplan. I reported to the PFIAB and the president that I couldn't forecast whether the challenge from Star Wars would overload the Soviet economy—and I was fairly certain the Soviets couldn't either. As it turned out, of course, the Soviets didn't try to match Star Wars— Gorbachev came to power and launched his reforms instead.

　　I mentioned none of this to the Gosplan officials. But I was glad I wasn 't in Sitaryan's shoes—the Fed's job was challenging, but Gosplan's was surreal.

　　Meeting with the head of the Soviet central bank, Viktor Gerashchenko, was much less fraught. Officially he was my counterpart, but in a planned economy, in which the state decides who gets funds and who does not, banking plays a much smaller role than in the West: Gosbank was little more than a paymaster and record keeper. If a borrower fell behind in payments on a loan or went into default, so what? Loans were essentially transfers among entities all owned by the state. Bankers did not need to worry about credit standards, or interest rate risks, or market value changes—the financial signals that determine who gets credit, and who does not, and hence who produces what, and sells to whom, in a market economy. All the topics I'd talked about the previous evening were simply not part of Gosbank's world.

　　Gerashchenko was forthcoming and friendly—he insisted we call each other Viktor and Alan. He spoke excellent English, having spent several years running a Soviet-owned bank in London, and he understood what Western banking was about. Like many people, he made believe that the Soviet Union was not that far behind the United States. He sought me out, and sought out other bankers in the West, because he wanted to be part of the prestigious central banking establishment. To me he seemed totally benign, and we had a pleasant talk.

　　Just four weeks later, on November 9, 1989, the Berlin Wall came down. I was in Texas on Fed business, but like everybody else that night I was glued to the TV. The event itself was remarkable, but even more amazing to me in the following days was the economic ruin the fall of the wall exposed. One of the most fateful debates of the twentieth century had been the question of how much government control is best for the common good. After World War II, the European democracies all moved toward socialism, and the balance was tilted toward

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