The market is hot on "Walsh put options," hoping that the Federal Reserve will backstop the AI bubble, but analysts point out that this is merely a repetition of the old myth of "Greenspan put options."

Written by: Bu Shuqing

Source: Wall Street Journal

As AI stock valuations continue to climb, the market is once again igniting expectations of a Federal Reserve "backstop"—this time, investors are focusing on the incoming Fed chair, Kevin Walsh, hoping for the so-called "Walsh put option." However, analysts indicate that this is just the market repeating a fantasy that never truly existed.

The current enthusiasm for AI stocks has led market participants to frequently reference the historical period of the late 1990s Internet bubble, when the myth of the "Greenspan put option" was deeply ingrained, with investors generally believing that the Federal Reserve would intervene to support the market in the event of a collapse. Now, with Walsh nominated to take over the Fed, the concept of the "Walsh put option" is starting to circulate in the market.

However, analysts suggest that the Greenspan put option is itself a myth, and Walsh is even less likely to replicate that model.

This also means that if AI stock valuations experience a significant correction, investors should not expect the Federal Reserve to intervene proactively to stabilize the stock market. Investors betting on the "Walsh put option" may face the same disappointing outcome as those during the Internet bubble's burst.

The Greenspan Put Option: A Misunderstood Myth?

Greenspan presided over the Federal Reserve from August 1987 to January 2006 for a total of 19 years, nearly completely overlapping with the era of "great moderation" in the U.S. economy—during which inflation was low, the unemployment rate was stable, and Internet technology profoundly changed the lives of ordinary people.

During this period, whenever the market faced severe turmoil—such as the 1987 stock market crash, the 1998 hedge fund collapses and Russian debt default, and the 2000 Internet bubble burst—the Federal Reserve would lower interest rates and inject liquidity into the financial system. This led to a deeply rooted belief among investors: that the Federal Reserve provided an implicit price floor for the stock market, and those holding risk assets had no need to worry about downside risks, which is the origin of the concept of the "Greenspan put option."

However, according to analysis, this belief does not hold up under scrutiny.

Researchers at the Richmond Fed found that the monetary policy decisions during the Greenspan era were actually highly mechanized and closely aligned with the interest rate rule proposed by economist John Taylor in 1993—raising rates when inflation or growth overheats and lowering them otherwise. In other words, the Fed's actions to lower interest rates were merely a routine response to economic data, and the stock market benefits were incidental, not policy objectives.

The strongest counter-evidence comes from 2001: The Fed began lowering rates at the time of the Internet bubble's collapse, but the stock market continued to decline for nearly two more years. The so-called "put option" did not protect those investors who relied on it the most.

The AI Boom Rekindles Old Expectations, Historical Comparisons Have Limitations

The strong performance of AI stocks naturally leads market participants to think of the Internet boom of the late 1990s.

In December 1996, Greenspan publicly questioned whether asset prices had entered "irrational exuberance," but the market rose for more than three years before ultimately crashing—this case alone illustrates that even the Federal Reserve chairman cannot accurately judge the existence or timing of a bubble in real-time.

According to MarketWatch analysis, if the Federal Reserve attempts to actively manage asset prices—whether by trying to cool high valuations or signaling it will intervene during market downturns—it essentially engages in a prediction that the Fed does not possess special capability to make. Greenspan's warning of "irrational exuberance" came a full three years too early, highlighting the limitations of such judgments.

Walsh's Policy Orientation: Rule-Based Over Discretionary Decision-Making

Walsh himself has made it clear that he favors establishing a more disciplined Federal Reserve with less improvisation. This stance is in stark contrast to the market’s expectations for the "Walsh put option."

Analysts believe that what investors should truly hope for is that Walsh continues the real reasons for the successes of the Greenspan era—i.e., a predictable response of monetary policy to economic data, rather than active intervention in asset prices. Such a Federal Reserve will not rescue portfolios when AI valuations correct but will also not harm the broader economic foundation due to speculation about asset bubbles.

From the perspective of a complete economic cycle, a rules-based monetary policy framework is the better choice for investors, even though this means giving up the fantasy of a "backstop." The true legacy of the Greenspan era is the predictability of monetary policy, not that which never truly existed: the put option.