STOCK INVESTORS EXPECT THE FED TO SAVE THEM. BUT NO 'WARSH PUT' IS COMING.

The following information was released by the Cato Institute:

Jai Kedia

Alan Greenspan ran the U.S. Federal Reserve for 19 years, from August 1987 to January 2006. His tenure as Fed chair coincided almost entirely with the "Great Moderation" a long, sustained period of low and stable U.S. inflation and unemployment. The Greenspan era saw incredible technological progress as the internet permeated ordinary life, much as artificial intelligence is doing now.

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For investors, the Greenspan era marked a debate over the Fed's role in stabilizing financial markets and the belief that the Fed would ease conditions in response to a stock-market crash or to prevent one. This belief was dubbed the "Greenspan put." A put option pays off when asset prices fall, so holding one lets you own risky assets without fear of downside.

Investors came to assume Greenspan's Fed was writing them a put for free. Whenever markets cracked the 1987 crash just weeks into Greenspan's tenure, the hedge-fund blowup and Russian default in 1998, the demise of the dot-com bubble in 2000 the Fed cut rates and injected liquidity into the financial system. To many investors this implied that stocks had a floor propped up by the Fed. But the Greenspan put was a myth.

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Warsh's first meeting suggests he understands the Fed's problems clearly.

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The reason this matters now is artificial intelligence. The run-up in AI stocks has revived the comparison to the late 1990s, when the internet promised to remake the economy and stock valuations climbed to historic levels. In December 1996, with the boom barely underway, Greenspan wondered aloud whether "irrational exuberance" had gripped asset prices. The market kept climbing for more than three years before it broke.

I am neither predicting nor expecting an AI bubble burst. But the hypothetical still begs answering: If AI stocks are an inflated bubble that eventually bursts, should the new Fed chair, Kevin Warsh, backstop the stock market as Greenspan supposedly did?

That is, will there be a "Warsh put"?

The honest answer starts with what made the Greenspan years work, and it wasn't the put. Greenspan was considered a "maestro" who read the economy by feel and distrusted mechanical rules. Yet when economists go back and measure what his Fed actually did, monetary-policy decisions look strikingly mechanical. Researchers at the Federal Reserve Bank of Richmond found that a simple formula akin to what economist John Taylor proposed in 1993, nudging interest rates up when inflation or growth runs hot and down when they cool closely tracked FOMC rate decisions under Greenspan.

Strip away the mystique and the Greenspan put merely resembles a sensible response to prevailing economic conditions, just as a simple rule designed to account for inflation and growth forecasts would predict.

When the Fed eased after a market rout, it was usually reacting to what the decline foretold. A falling market is an early sign that spending and growth are about to soften. The Fed was moving to counter that slowdown, with any lift to stocks a by-product. The clearest evidence is that the cuts often failed to protect the very investors the Greenspan put supposedly insured. The Fed cut rates in January 2001 as the dot-com market came apart, and stocks kept sliding for almost two more years.

This subtle distinction is crucial. The Greenspan-era stability Wall Street remembers likely came from the predictability of rules-based monetary policy meant to facilitate general economic stabilization, not from a desire to bail out investors. And the Greenspan put, if there ever was such a thing, ran counter to that as the Fed's numerous bailout missteps in the years since Greenspan have demonstrated.

So what should Warsh do as AI valuations climb? The temptation will be to play umpire and decide from the chair whether AI stocks are overpriced and then lean against them, or to hint that the Fed will catch the market if they fall. But nobody, Warsh included, can reliably call a bubble in real time. Greenspan couldn't: His exuberance warning came three years too early. A Fed that sets out to manage asset prices is a Fed making forecasts it has no special power to make.

What investors should want from Warsh is the predictability that made Greenspan's tenure a success a Fed that responds to prevailing economic conditions as they show up in the data. Such a Fed will not rescue a portfolio if AI valuations correct. But it will not wreck the wider economy guessing about them. Over a full cycle, that is the better deal, even for the investors hoping for a backstop.

Warsh has said he wants a more disciplined, less improvisational Fed. The lesson of Greenspan's record is for the Fed to do less, not more. It is to tie monetary policy to a rule not to ask the chair to outguess the market.