Let’s put to rest the myth that the Fed is blind to asset bubbles and never intentionally acts to prick them. The truth can be obtained by anyone with an internet browser and a few hours on their hands to read the voluminous Fed Open Market Committee meeting minutes.
In the FOMC meeting minutes from March 22, 1994, Greenspan says (my emphasis in italics):
"When we moved on February 4th, I think our expectation was that we would prick the bubble in the equity markets. What in fact occurred is that, as evidence of the dramatic shift in the economic outlook began to emerge after we moved and long-term rates began to move up, we were also clearly getting a major upward increase in expectations of corporate earnings. While the stock market went down after our actions on February 4th, it has gone down really quite marginally on net over this period. So what has occurred is that while this capital gains bubble in all financial assets had to come down, instead of the decline being concentrated in the stock area, it shifted over into the bond area. But the effects are the same. These are major capital losses, which have required very dramatic changes in the actions and activities on the part of individuals and institutions."
"So the question is, having very consciously and purposely tried to break the bubble and upset the markets in order to sort of break the cocoon of capital gains speculation, we are now in a position—having done that and in a sense succeeded perhaps more than we had intended—to try to restore some degree of confidence in the System."
To try to restore some degree of confidence in "the System," as Greenspan calls it, the Fed injected liquidity in 1994 that restored function to a dysfunctional banking system and rescued the bond market. But what cures one bubble sows the seeds of new ones. As Martin Mayer said in his book The Fed: "The truth is that liquidity, the only significant weapon remaining in the central bank’s arsenal as decision making moves to the markets, will not necessarily go where you want it to go when you need it to go there."
The 1994 liquidity injection kicked off the largest and longest period of real estate appreciation in US history and launched the late 1990s stock market bubble in the bargain. Five years later, in June 1999, the Fed appears to have moved to prick the new stock market bubble in the same purposeful manner as in 1994, except you won’t find the same explicit discussion about pricking bubbles in the minutes of the June 30 FOMC meeting notes. The only reference to asset bubbles comes from the President of the Federal Reserve Banks of Boston, Cathy E. Minehan, during the previous month’s meeting (emphasis added):
"We recently held a meeting of the Bank’s Academic Advisory Council which, as you all know, includes two or three Nobel Prize winners and people from Harvard, MIT, Yale, and so forth. The discussion focused on issues related to productivity growth, labor market tightness, and asset market bubbles. The group was lively, to say the least. But some consensus was reached on the need for action that might take the wind out of asset markets, even in the absence of tighter monetary policy, perhaps through increased margin requirements or increased supervisory oversight on credit extended, particularly in the day trading operations."
