October 27, 2008
A note before beginning. This article focuses on today’s financial and economic crisis. Not affairs of state, war and peace or geopolitics. No guessing who’s number one under those headings. That said:
With so many good choices, it’s hard just picking one. But given the gravity of today’s financial crisis, one name stands out above others. The “maestro,” as Bob Woodward called him in his book by that title. The “Temple of Boom” chairman, according to a New York Times book review. Standing “bestride the Fed like a colossus.” Now defrocked as the “maestro” of misery. Alan Greenspan. From August 11, 1987 to January 31, 2006, as head of the private banking cartel euphemistically called the Federal Reserve. That Ron Paul explains isn’t Federal and has no reserves.
It represents bankers who own it. Big and powerful ones. Not the state or public interest. It prints money. Controls its supply and price. Loans it out for profit and charges the government interest it wouldn’t have to pay if Treasury instead of Federal Reserve notes were issued. People, as a result, pay more in taxes for debt service. The nation is more crisis-prone. Over time they increase in severity. The current one the most serious since the Great Depression. Potentially the greatest ever. The result of Greenspan’s 18 year irresponsible legacy.
He championed deregulation and presided over an earlier version of today’s crisis. The Reagan-era savings and loan fraud. It bankrupted 2200 banks. Cost taxpayers around $200 billion and for many people their savings in S & Ls they thought safe.
In the 1990s, he engineered the largest ever stock market bubble and bust in history through incompetence, subservience to Wall Street, and dereliction of duty. In January 2000, weeks short of the market peak, he claimed that “the American economy was experiencing a once-in-a-century acceleration of innovation, which propelled forward productivity, output, corporate profits, and stock prices at a pace not seen in generations, if ever….Lofty stock prices have reduced the cost of capital. The result has been a veritable explosion of spending on high-tech equipment….And I see nothing to suggest that these opportunities will peter out anytime soon….Indeed many argue that the pace of innovation will continue to quicken….to exploit the still largely untapped potential for e-commerce, especially the business-to-business arena.”
A week later, the Nasdaq peaked at 5048. Lost 78% of its value by October 2002. The S&P 500 49% from its March 2000 high to its October 2002 bottom. Individual investors were left high and dry as a result. For Mr. Greenspan, it was back to engineering multiple bubbles with 1% interest rates and a tsunami of easy money.
He advocated less regulation, not more. Voluntary oversight. The idea that markets work best so let them. Government intervention as the problem, not the solution. In the mid-1990s, he told a congressional committee:
“Risks in financial markets, including derivative markets, are being regulated by private parties. There is nothing involved in federal regulation per se which makes it superior to market regulation.”
On October 23 before the House Government Oversight and Reform committee, he refused to accept blame for the current crisis, but softened his tone and admitted a “flaw” in his ideology. Confessed his faith in deregulation was shaken. Said he was in a “state of shocked disbelief.” Unclear on what went wrong. Not sure “how significant or permanent it is,” and added:
— “We are in the midst of a once-in-a century credit tsunami (requiring) unprecedented measures;”
— “This crisis has turned out to be much broader than anything I could have imagined;”
— “fears of insolvency are now paramount;”
— significant layoffs and unemployment are ahead;
— a “marked retrenchment of consumer spending” as well;
— containing the crisis is conditional on stabilizing home prices;
— at best, it’s “still many months in the future;”
What went wrong with policies that “worked so effectively for nearly four decades,” he asked? Securitizing home mortgages. “Excess demand” for them, and failure to properly price them he answered. Unmentioned was unbridled greed. The greatest ever fraud. No oversight, and a predictable crisis only surprising in its magnitude and how it grew to unmanageable severity.
Greenspan is now softening on regulation but barely enough to matter. Too little, too late by any standard, and only to restore stability after which chastened investors “will be exceptionally cautious.” In the end, in his view, “This crisis will pass, and America will reemerge with a far sounder financial system.” Until another Fed chairman repeats his mistakes. Creates a crisis too big to contain. Destroys unfettered capitalism as we know it. Changes the world irrevocably as a consequence. Unless this time is the big one and does it sooner.
In March 1999, Greenspan was optimistic at the end of a robust decade (that James Petras calls “the golden age of pillage”) with no worries about new millennium meltdowns. He addressed the Futures Industry Association and said it would be “a major mistake” to increase rules on how banks assess risks when they use derivatives. He added: “By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives.” By a compounded 20% rate throughout the decade. Around 30% alone by banks in 1998. And, according to Greenspan, “The reason that (derivatives) growth has continued despite adversity, or perhaps because of it, is that these new financial instruments are an increasingly important vehicle for unbundling risk….the value added of derivatives themselves derives from their ability to enhance the process of wealth creation (and) one counterparty’s market loss is the (other’s) gain.”
Overall, they’ve increased the standard of living of people globally, he claimed. In fact, they contributed to global crises in the 1990s. Hot money in, and meltdowns when it exited. The problem is derivatives work well in bull markets, but are disastrous when they’re down. Going up they do nothing for ordinary people, but during downturns receding tides sink all boats and all in them and aren’t the zero sum game Greenspan suggested.
Worst of all are so-called credit default swaps (CDSs). The most widely traded credit derivative. In the tens of trillions of dollars. A $43 trillion market, according to PIMCO’s Bill Gross. The International Swaps and Derivatives Association (ISDA) estimates it at $54.6 trillion. Down from $62 trillion at yearend 2007. Others place it higher, but key is what they are and how they’re used. They resemble insurance (on risky mortgages), but, in fact, are for little more than casino-type gambling. Unregulated with no transparency in the shadow banking system that dwarfs the traditional one in size and risk.
Gross describes it this way. It “craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever.” CDSs are at the center of shadow banking, and Gross and others warn about possible financial Armageddon if things begin collapsing.
A “Cheerleader for Imprudence”
That, according to James Grant, editor of Grant’s Interest Rate Observer. Greenspan’s “biggest mistake was inciting people to do imprudent things.” He called him “marble-mouthed” for his “Greenspeak” and not simply admitting he “was as blind as those (he) pretended to lead. This sense of security that people invested in the idea of perfect control by an all-knowing brain at the top, that idea’s been shattered.”
- A d v e r t i s e m e n t
In July, Grant was outspoken in a Wall Street Journal op-ed titled “Why No Outrage?” He quoted Mary Elizabeth Lease from the Populist era haranguing farmers to “raise less corn and more hell.” He asked why today’s financial victims aren’t protesting Fed policy “of showering dollars on the (monied) people who would seem to (least) need them.” Where are the “uncounted improvident?” Have they “not suffered (enough) at the hands of what used to be called The Interests? Have the stewards of other people’s money not made a hash of high finance? Where is the people’s wrath?” In the wake of the “greatest (ever) failure of ratings and risk management.”
Greenspan’s Fed cut interest rates to 1%. “House prices levitated as mortgage underwriting standards collapsed.” He claimed earlier that property appreciation was a sign of prosperity and a strong economy and “while home prices do on occasion decline, large declines are rare.” Most homeowners experience “a modest but persistent rise in home values that is perceived to be largely permanent.”
Especially, according to Grant, at a time that “credit markets went into speculative orbit, and an idea took hold. Risk….was yesterday’s problem.” It led to “one of the wildest chapters in the history of lending and borrowing.” As a consequence, an $8 trillion home valuation wealth bubble and an unprecedented oversupply of unsold properties. Now in even more oversupply as owners default. Are foreclosed on or simply walk away from unaffordable underwater assets. They sit empty with no one to buy them except for those able in distressed sales.
The whole episode criminal and avoidable had the Fed used its authority under the 1994 Home Ownership and Equity Protection Act. It authorized the central bank to monitor abuses and intervene, if necessary, to prevent abusive lender practices. It failed to do it.
The result was predictable. People and the economy in crisis. Greenspan orchestrated it. His successor Bernanke did nothing to curb it. Wall Street was on a roll until it crashed. Huey Long once compared JD Rockefeller to “the fat guy who ruins a good barbecue by taking too much.” Wall Street thrives on it. Fed largesse enables it. The problem is their indigestion affects everyone. A stomachache spreading round the world. How bad it’ll get and where it stops nobody knows. Blame it on Greenspan. Our “former clairvoyant,” according to Grant.
The New York Times – Uncharacteristically Critical
Usually a “free-market” cheerleader, even The New York Times voiced criticism. In an October 8 Peter Goodman article titled “Taking Hard New Look at a Greenspan Legacy.” It quoted him in 2004 saying: “Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”
As already explained, he abhorred regulation and championed derivatives. The latter what investor George Soros won’t touch “because we don’t really understand how they work.” What long-time investment banker Felix Rohatyn calls potential “hydrogen bombs.” What Warren Buffett describes as financial “weapons of mass destruction.” What Alan Greenspan thought regulating would be a huge mistake and even today his faith in these instruments remains unshaken.
Others see things differently “and the role that Mr. Greenspan played in setting up (the current) unrest.” Law professor Frank Partnoy says “derivatives are a centerpiece of the crisis.” Given their purchased market value in the hundreds of trillions of dollars. Up from a fraction of that years back. The fact that much of it is toxic junk, and the fear that writing enough off will bankrupt their holders and send shock waves through world economies. They’re already being felt. Especially in emerging markets.
None of this should have happened. “If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman, many economists say, the current crisis might have been averted or muted. Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences.”
It was argued throughout the 1990s “that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system.” Even so, “Mr. Greenspan banked on the good will of Wall Street to self-regulate as he fended off (suggestions of) restrictions.”
As the housing bubble burst and prices began collapsing, “Mr. Greenspan’s record has been up for revision. Economists from across the ideological spectrum have criticized his decision to let the nation’s real estate market continue to boom with cheap credit, courtesy of low interest rates, rather than snuffing out price increases with higher rates.”
He championed adjustable rate mortgages and ignored the clear fraud from subprime ones. In a 2004 speech, he said that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.” He, in fact, endorsed the type abuses and the housing bubble they produced that Fed action should have prevented.
It will be a chapter in his legacy. Along with “the spectacular boom and calamitous bust in derivatives trading.” He declined a Times interview request and referred instead to his record in his memoir, “The Age of Turbulence.” In it, he stated that it’s “superfluous to constrain trading in some of the newer derivatives and other innovative financial contracts of the past decade.” Instead he “preached the transcendent, wealth-creating powers of the market.” Not for Main Street. For Wall Street. What a friend of this writer calls “laissez-unfair.”
Despite convincing evidence to the contrary, he claimed markets are best able to handle risks. Former Fed vice-chairman Alan Blinder said “Proposals to bring even minimalist regulation were basically rebuffed by Greenspan and various people in the Treasury. I think of him as consistently cheerleading on derivatives.” In congressional testimony, he claimed the potential for serious crisis “extremely remote” and dismissively suggested that “risk is part of life.” He also warned that too many rules would damage Wall Street and prompt traders to do business overseas.
Until the present, every debacle under him was resolved (enough at least) and markets stabilized and advanced. He got credit for his “steady hand at the Fed,” and former Senator Phil Gramm said “You will go down down as the greatest chairman in the history of the Federal Reserve Bank.” That comment may go down as the greatest misstatement in the history of the Senate.
This is the same Phil Gramm behind the 1999 Gramm-Leach-Bliley Act that repealed (1933 enacted) Glass-Steagall. It let commercial and investment banks and insurance companies combine and opened the door to rampant speculation, fraud and abuse.
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