WITH the economy looking extraordinarily weak back in January and Alan Greenspan just about out of room to cut interest rates, the Federal Reserve considered a variety of "unconventional" emergency measures.
Recently-released comments from the policy-making meeting that month show the Fed had what might seem to be a largely academic discussion about the other options available to it. This is an amazing revelation.
I've been giving hints about this sort of thing since September, but I believe the Fed's discussions were much more than just theoretical. I think the Central Bank actually stepped in and saved the stock market.
With the Fed taking an active role in the market, just about anything could happen - both good and bad.
The Fed's intervention in stocks is, to put it mildly, earth shaking in a free-market economy that prides itself for having equities that move up and down on their merits alone.
Let me give credit where it is due. While I was on vacation last week the Financial Times of London quoted a Fed official who didn't want to be named as saying that one of the extraordinary measures considered in January was "buying U.S. equities." The FT quoted the official as saying the Fed could "theoretically buy anything to pump money into the system" including "state and local debt, real estate and gold mines - any asset."
Including stocks.
There are lots of things wrong with the stock market right now.
Despite a wobbly market these past two years, equity prices are still much too high based on current earnings. And the valuation of stocks isn't going to get any more attractive when disappointing first quarter profits are announced by companies in a few weeks.
But all of these things pale in comparison with the impact of the Fed getting involved in the stock market. Forget everything else - this is the most important thing you need to consider right now if you are thinking of getting into the stock market.
I've been writing about the Fed's involvement in the stock market for some time. And I have some first-hand knowledge that I can now add to the FT report.
I had a conversation with a very worried Fed official back on Sept. 17, the day the stock markets reopened in the U.S. following the Trade Center attacks. He was bothered by the market's apparent lack of interest in the Fed's rate cut that morning.
Our discussion moved on to the fact that the Fed could easily intervene in the market by purchasing stock index futures contracts. That's an inexpensive and apparently foolproof way of rigging the market without leaving a trace.
During that telephone conversation I pointed out that just such a plan was proposed during another market disturbance back in 1989 by Robert Heller, who had just left his position as Fed governor.
Heller's suggestion, which was published in The Wall Street Journal, seemed at the time like a trial balloon to see how Wall Street would react to such an extreme solution.
The good news was that nobody appeared to be bothered by Heller's proposal even though it would turn the free-market concept on its ear.
About midday on Sept 17 I faxed the Heller article to my friend at the Fed.
There's no way of proving that the Central Bank took any extraordinary action that day. But a stock market that looked down for the count suddenly perked up.
And since then, equities have staged a good enough rally so that Wall Street is already gloating about the new bull market.
Is this good or bad news?
You'd think that the Fed providing a safety net for the market would be extremely good news for investors. In fact, it would be logical to assume that big losses in stocks would be impossible if the Fed was aggressive in the market.
But there are other things to consider.
The Fed will probably only come to the market's aid if collapsing stock prices are endangering the nation's economy and national security. This would give the federal government an excuse to violate the premises of the market economy. But there are a couple other worries.
One is Japan tried this and it didn't work.
And then there's the big worry: The stock market in the U.S. has worked very well without government interference. In fact, our markets are so much the envy of the world that foreign companies are anxious to list their stocks on our exchanges.
If the FT and my suspicions are correct, Washington is getting into dangerous territory.
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