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I really didnt get it until very late in 2005 and 2006."
Alan Greenspan
"Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth."
Greenspan's position on derivatives
The most interesting issue this year was Greenspan testimony before a House Oversight and Government Reform Committee hearing on the role of federal regulators in the current financial crisis.
Classic "...I am shocked - shocked, there is gambling going on in this establishment...." "...here are your winnings..." exchange between Humphrey Bogart & Claude Rains in Casablanca is fully applicable to Mr. Greenspan, former known as Maestro.
There is one good overview from Robert Borosage (Greenspan Shocked Disbelief, Oct 24, 2008)
Classic "...I am shocked - shocked, there is gambling going on in this establishment...." "...here are your winnings..." exchange between Humphrey Bogart & Claude Rains in Casablanca
October 24, 2008 | truthout.org
by: Robert Borosage, The Campaign for America's Future
On October 23, former Federal Reserve Chairman Alan Greenspan testified before a House Oversight and Government Reform Committee hearing on the role of federal regulators in the current financial crisis.
It marks the end of an era. Alan Greenspan, the maestro, defender of the market fundamentalist faith, champion of deregulation, celebrator of exotic banking inventions, admitted Thursday in a hearing before Rep. Henry Waxman's House Committee and Oversight and Government Reform that he got it wrong."Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief," he said.
As to the fantasy that banks could regulate themselves, that markets self-correct, that modern risk management enforced prudence: "The whole intellectual edifice, however, collapsed in the summer of last year."
Greenspan spurned the Republican acolytes trying desperately to defend the faith and blame the crisis on the Community Reinvestment Act and the powerful lobby of poor people who forced powerless banks to do reckless things. Greenspan dismissed that goofiness in response to a question from one of its right-wing purveyors, Rep. Todd Platts, R-Pa., noting that subprime loans grew to a crisis only as the unregulated shadow financial system securitized mortgages, marketed them across the world, and pressured brokers to lower standards to generate a larger supply to meet the demand. Private greed, not public good, caused this catastrophe:
"The evidence now suggests, but only in retrospect, that this market evolved in a manner which if there were no securitization, it would have been a much smaller problem and, indeed, very unlikely to have taken on the dimensions that it did. It wasn't until the securitization became a significant factor, which doesn't occur until 2005, that you got this huge increase in demand for subprime loans, because remember that without securitization, there would not have been a single subprime mortgage held outside of the United States, that it's the opening up of this market which created a huge demand from abroad for subprime mortgages as embodied in mortgage-backed securities.But having admitted the failure of his faith, Greenspan could not abandon it. Credit default swaps had to be "restrained," he admitted. Those who create mortgages should be mandated to retain a piece of them to insure responsible lending. Otherwise, the old faith still applied. No new regulations were needed, because the markets "for the indefinite future will be far more restrained than would any currently contemplated new regulatory regime."
Now hung over from their bender, the banks could be depended upon to remain sober "for the indefinite future." Or until taxpayers' money relieves their headaches, and they are free to party once more.
IN ACCORDANCE WITH TITLE 17 U.S.C. SECTION 107, THIS MATERIAL IS DISTRIBUTED WITHOUT PROFIT TO THOSE WHO HAVE EXPRESSED A PRIOR INTEREST IN RECEIVING THE INCLUDED INFORMATION FOR RESEARCH AND EDUCATIONAL PURPOSES. TRUTHOUT HAS NO AFFILIATION WHATSOEVER WITH THE ORIGINATOR OF THIS ARTICLE NOR IS TRUTHOUT ENDORSED OR SPONSORED BY THE ORIGINATOR."VIEW SOURCE ARTICLE" LINKS ARE PROVIDED AS A CONVENIENCE TO OUR READERS AND ALLOW FOR VERIFICATION OF AUTHENTICITY. HOWEVER, AS ORIGINATING PAGES ARE OFTEN UPDATED BY THEIR ORIGINATING HOST SITES, THE VERSIONS POSTED ON TO MAY NOT MATCH THE VERSIONS OUR READERS VIEW WHEN CLICKING THE "VIEW SOURCE ARTICLE" LINKS.
CommentsThis is a moderated forum. It may take a little while for comments to go live.
The only Guantanamo that theSun, 10/26/2008 - 23:37 Captain America (not verified)
The only Guantanamo that the United States has any business running is a concentration camp for the hundreds of wall street executives and their cronies in Bushland that conspired to defraud the American people from their hard earned dollar.There are no free markets inWhat they did dwarfs the damage caused to this country by 911, (no disrespect for the many innocents who died). However, here, every single citizen is a victim of fraud and corruption on a scale that was heretofore inconceivable. Greenspan, Bush and now Paulson have done more than Bin Laden and his hordes could do in a 100 years.
By the way, if you protest YOU wind up locked up for being un-American. What happened America ?
Sun, 10/26/2008 - 19:27 pink elephant (not verified)
There are no free markets in America, any more than there is free lunch. The game was always fixed and Greenspan was the ultimate shill for the fixers. The past thirty years have been an orgy of greed with common sense shoved aside for the sake of uncommon expediency. Americans became infatuated by arcane formulas and dense incomprehensible mathematics to the point that they forget simple arithmetic. America wake up it was only a dream, and a bad one at that.Sun, 10/26/2008 - 19:07 Anonymous (not verified)
So it wasn't the military-industrial complex that did us in after all . . .Sun, 10/26/2008 - 15:40 afrothethics (not verified)
It's clear from comments on this contribution that few readers of Truthout believe Alan Greenspan's sorry testimony before Congress. What has faith in something to do with enforcing the policies of fiduciary responsibility already on the books? All these so-called "experts" on capitalism are now coming out to say "I'm sorry." Well, I won't be sorry for them until they are held monetarily and criminally responsible for their actions, inept or not. The truth is as plain as the nose on your face: Greenspan, the Federal Reserve, the investment banks, the Bush administration and several members of Congress unobtrusively acted to consciously and knowingly to rob the national treasury for the sake of capitalism's sacred cow: capital accumulation on behalf of the nation's political and economic elite. If it looks like class warfare, as David Harvey, author of Neoliberalism, has stated, call it class warfare and act accordingly.Sun, 10/26/2008 - 10:11 DJK (not verified)
We have heard statements like "the mathematical models used for knowing the behavior of derivatives based on subprime mortgages were too difficult to understand", etc. But it doesn't take a genius to understand that when financial instruments are created based on crap (subprime mortgages), that eventually problems will occur with those instruments. In fact, Greenspan and his cronies knew that, which is why they resisted these instruments being regulated by the SEC or even the CFTC. And this is why they turned a blind eye to many of the rating agencies giving many of these instruments AAA ratings. I am sure that a real investigation will reveal numerous instances of fraudulent activity in conjunction with this debacle. Those perpetrators must be identified and brought to justice. While this will not fix our current problem, it hopefully should serve as a deterrent to those who would in the future attempt to again engage in such activities.Sun, 10/26/2008 - 08:13 Robert Iserbyt (not verified)
Well here you have it a confessional lie from the biggest fraud perpetrator in the history of American finance Why the markets ever listened to this criminal in the first place is evidence that our entire nation should be required to take a full year of real unfettered economics just in case they don't understand what is going on now. All the pundits on MSNBC and all the talking heads should be removed from the airwaves. The Bailout what will that do? the answer lies before you.Sun, 10/26/2008 - 02:02 Anonymous (not verified)
Sounds like the "maestro" hit a flat note in his orchestra of greed and deregulation. Come on, do you really think we are all so stupid to buy into the story that you couldn't predict a melt down knowing that those writing the subprimes held no responsibility for their actions? That's like giving a "get out of jail card" to someone who just created a felony! Did anybody even bother to consult the Math PhDs who created these instruments to run possible scenarios -- just in case? why bother when you know you can scare congress, the president and the treasury and ultimately the people into bailing your ass out of worldwide collapse?Sun, 10/26/2008 - 00:24 two7five7one (not verified)
I'm a former real estate broker and my son is a mortgage broker. From about 2004 through the beginning of this "greatest financial crisis since '29", we frequently talked on the phone about the disaster which would ensue when the real estate value appreciation stopped, and people were no longer fueling the economy with money borrowed against their equity, and the sub-prime loan fiasco would end. We knew it would be disastrous, and both of us were astonished that neither the FED nor congress was willing to say or do anything about it. Anyone who has witnessed over the years the cycle of boom/bust/boom/bust in the real estate market knew that after eleven years of unprecedented "boom" -- '96 through '2007 -- the "bust" would be like an earthquake. Paulson and Greenspan and their ilk now denying that they suspected this is just is just their lying to protect the GOP which was benefitting from the booming economy. They should both end up in prison, with all of the GOP members of congress who have had their hands in the cash register.Sat, 10/25/2008 - 23:48 mysterioso (not verified)
Dance clown, dance. First you were against the FED until you became head of the FED. Then you were for trickle down economics and letting the "system" regulate itself until you saw the inevitable destruction it caused. Dance clown, dance. You should be the first one sent to prison under the "Un-American activities act". The arrogance of your testimony before the committee was appalling. You honestly couldn't believe you were wrong !!!Sat, 10/25/2008 - 23:35 slw (not verified)
Shocked disbelief, my foot. Many of us predicted EXACTLY this outcome.Sat, 10/25/2008 - 22:43 topview (not verified)
This is like telling the Fox to watch the Hens and then walking away and trusting him to do the right thing. Government has to return to regulation and see that there is no hanky, Banky going on anymore. Monopolies have to be busted up, like the Communication industry's, the Drug industries and any other Corporations that control to much of the way the Country operates. No more Outsourcing any Government duties.Sat, 10/25/2008 - 22:00 radline9 (not verified)
Shocked Disbelief is a ploy. When they were all riding high, they didn't give a crap. They were going to come out richer than hell anyway.Sat, 10/25/2008 - 20:53 anglohistorian (not verified)
Where's Ayn Rand when you need her? Give me a break Mr Greenspan. Never let history and reality get in the way of the big unregulated celebration of greed like we have had since "Saint Ronald Wilson Reagan", and the other "Free Market" "government is the problem" ideologues. We can spend trillions on war and corporate bailouts, but we can't have a single payer health system? We can't rebuild our infrastructure? Say it again- give me a break!Sat, 10/25/2008 - 20:41 Jtmonrow (not verified)
What about the 1994 Act of Congress that required the Fed to monitor and regulate derivatives? The Act Greenspan ignored?Sat, 10/25/2008 - 20:29 Anonymous (not verified)
"...I am shocked - shocked, there is gambling going on in this establishment...." "...here are your winnings..." exchange between Humphrey Bogart & Claude Rains in CasablancaSat, 10/25/2008 - 19:50 dtroutma (not verified)
This would be the same "shocked disbelief" expressed by Willie Sutton's mother?Sat, 10/25/2008 - 18:06 Anonymous (not verified)
shouldn't Greenspan give his salary and bonus back to taxpayers?
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October 24, 2008 | truthout.org
by: Robert Borosage, The Campaign for America's Future
On October 23, former Federal Reserve Chairman Alan Greenspan testified before a House Oversight and Government Reform Committee hearing on the role of federal regulators in the current financial crisis.
It marks the end of an era. Alan Greenspan, the maestro, defender of the market fundamentalist faith, champion of deregulation, celebrator of exotic banking inventions, admitted Thursday in a hearing before Rep. Henry Waxman's House Committee and Oversight and Government Reform that he got it wrong."Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief," he said.
As to the fantasy that banks could regulate themselves, that markets self-correct, that modern risk management enforced prudence: "The whole intellectual edifice, however, collapsed in the summer of last year."
Greenspan spurned the Republican acolytes trying desperately to defend the faith and blame the crisis on the Community Reinvestment Act and the powerful lobby of poor people who forced powerless banks to do reckless things. Greenspan dismissed that goofiness in response to a question from one of its right-wing purveyors, Rep. Todd Platts, R-Pa., noting that subprime loans grew to a crisis only as the unregulated shadow financial system securitized mortgages, marketed them across the world, and pressured brokers to lower standards to generate a larger supply to meet the demand. Private greed, not public good, caused this catastrophe:
"The evidence now suggests, but only in retrospect, that this market evolved in a manner which if there were no securitization, it would have been a much smaller problem and, indeed, very unlikely to have taken on the dimensions that it did. It wasn't until the securitization became a significant factor, which doesn't occur until 2005, that you got this huge increase in demand for subprime loans, because remember that without securitization, there would not have been a single subprime mortgage held outside of the United States, that it's the opening up of this market which created a huge demand from abroad for subprime mortgages as embodied in mortgage-backed securities.But having admitted the failure of his faith, Greenspan could not abandon it. Credit default swaps had to be "restrained," he admitted. Those who create mortgages should be mandated to retain a piece of them to insure responsible lending. Otherwise, the old faith still applied. No new regulations were needed, because the markets "for the indefinite future will be far more restrained than would any currently contemplated new regulatory regime."
Now hung over from their bender, the banks could be depended upon to remain sober "for the indefinite future." Or until taxpayers' money relieves their headaches, and they are free to party once more.
IN ACCORDANCE WITH TITLE 17 U.S.C. SECTION 107, THIS MATERIAL IS DISTRIBUTED WITHOUT PROFIT TO THOSE WHO HAVE EXPRESSED A PRIOR INTEREST IN RECEIVING THE INCLUDED INFORMATION FOR RESEARCH AND EDUCATIONAL PURPOSES. TRUTHOUT HAS NO AFFILIATION WHATSOEVER WITH THE ORIGINATOR OF THIS ARTICLE NOR IS TRUTHOUT ENDORSED OR SPONSORED BY THE ORIGINATOR."VIEW SOURCE ARTICLE" LINKS ARE PROVIDED AS A CONVENIENCE TO OUR READERS AND ALLOW FOR VERIFICATION OF AUTHENTICITY. HOWEVER, AS ORIGINATING PAGES ARE OFTEN UPDATED BY THEIR ORIGINATING HOST SITES, THE VERSIONS POSTED ON TO MAY NOT MATCH THE VERSIONS OUR READERS VIEW WHEN CLICKING THE "VIEW SOURCE ARTICLE" LINKS.
CommentsThis is a moderated forum. It may take a little while for comments to go live.
The only Guantanamo that theSun, 10/26/2008 - 23:37 - Captain America (not verified)
The only Guantanamo that the United States has any business running is a concentration camp for the hundreds of wall street executives and their cronies in Bushland that conspired to defraud the American people from their hard earned dollar.There are no free markets inWhat they did dwarfs the damage caused to this country by 911, (no disrespect for the many innocents who died). However, here, every single citizen is a victim of fraud and corruption on a scale that was heretofore inconceivable. Greenspan, Bush and now Paulson have done more than Bin Laden and his hordes could do in a 100 years.
By the way, if you protest YOU wind up locked up for being un-American. What happened America ?
Sun, 10/26/2008 - 19:27 - pink elephant (not verified)
There are no free markets in America, any more than there is free lunch. The game was always fixed and Greenspan was the ultimate shill for the fixers. The past thirty years have been an orgy of greed with common sense shoved aside for the sake of uncommon expediency. Americans became infatuated by arcane formulas and dense incomprehensible mathematics to the point that they forget simple arithmetic. America wake up it was only a dream, and a bad one at that.Sun, 10/26/2008 - 19:07 - Anonymous (not verified)
So it wasn't the military-industrial complex that did us in after all . . .Sun, 10/26/2008 - 15:40 - afrothethics (not verified)
It's clear from comments on this contribution that few readers of Truthout believe Alan Greenspan's sorry testimony before Congress. What has faith in something to do with enforcing the policies of fiduciary responsibility already on the books? All these so-called "experts" on capitalism are now coming out to say "I'm sorry." Well, I won't be sorry for them until they are held monetarily and criminally responsible for their actions, inept or not. The truth is as plain as the nose on your face: Greenspan, the Federal Reserve, the investment banks, the Bush administration and several members of Congress unobtrusively acted to consciously and knowingly to rob the national treasury for the sake of capitalism's sacred cow: capital accumulation on behalf of the nation's political and economic elite. If it looks like class warfare, as David Harvey, author of Neoliberalism, has stated, call it class warfare and act accordingly.Sun, 10/26/2008 - 10:11 - DJK (not verified)
We have heard statements like "the mathematical models used for knowing the behavior of derivatives based on subprime mortgages were too difficult to understand", etc. But it doesn't take a genius to understand that when financial instruments are created based on crap (subprime mortgages), that eventually problems will occur with those instruments. In fact, Greenspan and his cronies knew that, which is why they resisted these instruments being regulated by the SEC or even the CFTC. And this is why they turned a blind eye to many of the rating agencies giving many of these instruments AAA ratings. I am sure that a real investigation will reveal numerous instances of fraudulent activity in conjunction with this debacle. Those perpetrators must be identified and brought to justice. While this will not fix our current problem, it hopefully should serve as a deterrent to those who would in the future attempt to again engage in such activities.Sun, 10/26/2008 - 08:13 - Robert Iserbyt (not verified)
Well here you have it a confessional lie from the biggest fraud perpetrator in the history of American finance Why the markets ever listened to this criminal in the first place is evidence that our entire nation should be required to take a full year of real unfettered economics just in case they don't understand what is going on now. All the pundits on MSNBC and all the talking heads should be removed from the airwaves. The Bailout what will that do? the answer lies before you.Sun, 10/26/2008 - 02:02 - Anonymous (not verified)
Sounds like the "maestro" hit a flat note in his orchestra of greed and deregulation. Come on, do you really think we are all so stupid to buy into the story that you couldn't predict a melt down knowing that those writing the subprimes held no responsibility for their actions? That's like giving a "get out of jail card" to someone who just created a felony! Did anybody even bother to consult the Math PhDs who created these instruments to run possible scenarios -- just in case? why bother when you know you can scare congress, the president and the treasury and ultimately the people into bailing your ass out of worldwide collapse?Sun, 10/26/2008 - 00:24 - two7five7one (not verified)
I'm a former real estate broker and my son is a mortgage broker. From about 2004 through the beginning of this "greatest financial crisis since '29", we frequently talked on the phone about the disaster which would ensue when the real estate value appreciation stopped, and people were no longer fueling the economy with money borrowed against their equity, and the sub-prime loan fiasco would end. We knew it would be disastrous, and both of us were astonished that neither the FED nor congress was willing to say or do anything about it. Anyone who has witnessed over the years the cycle of boom/bust/boom/bust in the real estate market knew that after eleven years of unprecedented "boom" -- '96 through '2007 -- the "bust" would be like an earthquake. Paulson and Greenspan and their ilk now denying that they suspected this is just is just their lying to protect the GOP which was benefitting from the booming economy. They should both end up in prison, with all of the GOP members of congress who have had their hands in the cash register.Sat, 10/25/2008 - 23:48 - mysterioso (not verified)
Dance clown, dance. First you were against the FED until you became head of the FED. Then you were for trickle down economics and letting the "system" regulate itself until you saw the inevitable destruction it caused. Dance clown, dance. You should be the first one sent to prison under the "Un-American activities act". The arrogance of your testimony before the committee was appalling. You honestly couldn't believe you were wrong !!!Sat, 10/25/2008 - 23:35 - slw (not verified)
Shocked disbelief, my foot. Many of us predicted EXACTLY this outcome.Sat, 10/25/2008 - 22:43 - topview (not verified)
This is like telling the Fox to watch the Hens and then walking away and trusting him to do the right thing. Government has to return to regulation and see that there is no hanky, Banky going on anymore. Monopolies have to be busted up, like the Communication industry's, the Drug industries and any other Corporations that control to much of the way the Country operates. No more Outsourcing any Government duties.Sat, 10/25/2008 - 22:00 - radline9 (not verified)
Shocked Disbelief is a ploy. When they were all riding high, they didn't give a crap. They were going to come out richer than hell anyway.Sat, 10/25/2008 - 20:53 - anglohistorian (not verified)
Where's Ayn Rand when you need her? Give me a break Mr Greenspan. Never let history and reality get in the way of the big unregulated celebration of greed like we have had since "Saint Ronald Wilson Reagan", and the other "Free Market" "government is the problem" ideologues. We can spend trillions on war and corporate bailouts, but we can't have a single payer health system? We can't rebuild our infrastructure? Say it again- give me a break!Sat, 10/25/2008 - 20:41 - Jtmonrow (not verified)
What about the 1994 Act of Congress that required the Fed to monitor and regulate derivatives? The Act Greenspan ignored?Sat, 10/25/2008 - 20:29 - Anonymous (not verified)
"...I am shocked - shocked, there is gambling going on in this establishment...." "...here are your winnings..." exchange between Humphrey Bogart & Claude Rains in CasablancaSat, 10/25/2008 - 19:50 - dtroutma (not verified)
This would be the same "shocked disbelief" expressed by Willie Sutton's mother?Sat, 10/25/2008 - 18:06 - Anonymous (not verified)
shouldn't Greenspan give his salary and bonus back to taxpayers?
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Oct 23, 2008 | calculatedriskblog.com
I've received numerous emails concerning Greenspan's testimony today. Greenspan has been criticized for keeping rates too low (see CNN: Culprits of the Collapse), however his far larger mistake was opposing oversight when many people were pointing out the extremely lax lending standards.
So I was happy today that the Q&A focused on this issue ... from the WSJ: Greenspan Admits Some Mistakes Amid Grilling by House Lawmakers
"Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity (myself especially) are in a state of shocked disbelief," according to Mr. Greenspan.Greenspan's comments on the economy are also interesting:The panel chairman, Henry Waxman (D., Calif.) criticized Mr. Greenspan's approach to mortgage regulation while he was Fed chairman. The Fed "had the authority to stop the irresponsible lending practices that fueled the subprime mortgage market," Waxman said, but Mr. Greenspan "rejected pleas that he intervene."
...
[W]hen Mr. Waxman pressed "were you wrong" about the benefits of deregulation, Mr. Greenspan responded, "partially." The "flaw" in the assumptions he had over four decades, Mr. Greenspan said, was that lending institutions themselves were best able to protect the interest of their shareholders."Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment," Mr. Greenspan said in the text of prepared testimony to the U.S. House Government Oversight and Reform Committee.Greenspan is now saying what many of us were warning about several years ago.That, in turn, "implies a marked retrenchment of consumer spending as households try to divert an increasing part of their incomes to replenish depleted assets, not only in their 401Ks but in the value of their homes as well," Mr. Greenspan said.
While Mr. Greenspan assured lawmakers that "this crisis will pass" and that the U.S. will end up with a "far sounder financial system," he warned that it won't come quickly.
Mr. Greenspan said a "necessary condition for this crisis to end is a stabilization of home prices in the U.S."
"At a minimum, stabilization of home prices is still many months in the future," he said.
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October 23, 2008 | nakedcapitalism.com
Now that Greenspan has thrown in the towel, the free market ideologues have lost one of their most loyal advocates. From Bloomberg:
Former Federal Reserve Chairman Alan Greenspan called for tighter regulation of financial companies, distancing himself from the free-market culture that he helped to create.Shocked, shocked? Greenspan really has no sense of irony.Firms that bundle loans into securities for sale should be required to keep part of those securities, Greenspan said in prepared testimony to the House Committee on Oversight and Government Reform. Other rules should address fraud and settlement of trades, he said. Greenspan's office released the text ahead of the hearing scheduled for 10 a.m. in Washington....
Today, the former chairman asked: ``What went wrong with global economic policies that had worked so effectively for nearly four decades?'' During his term at the Fed's helm, Greenspan repeatedly warned lawmakers against inhibiting markets, such as by tightening oversight of certain types of derivatives.
Greenspan, reiterated his ``shocked disbelief'' that financial companies failed to execute sufficient ``surveillance'' on their trading counterparties to prevent surging losses. The ``breakdown'' was clearest in the market where securities firms packaged home mortgages into debt sold on to other investors, he said.
doc holiday, October 23, 2008 at 1:18 am
As to Greenspan, his job at a hedge fund speaks volumes and sums up his fraudulent career.
> In totally OT, check out this lion; the music is so-so, but the lion speaks volumes about honesty:
http://www.youtube.com/watch?v=1IgqrEqqjq8
Put the crooks in prison and toss the keys!
Anonymous, October 23, 2008 at 1:40 am
"Now that Greenspan has thrown in the towel, the free market ideologues have lost one of their most loyal advocates."
Balderdash. When Ron Paul (who grilled Greenspan day in and day out for years for his lax policies) starts singing hosannas for central banking and Keynesian stimuli, then let me know.
Starting at least since he was named Fed Chairman, Greenspan has never been an ally of the free markets. As Ayn Rand suspected, he was a social climber, through and through.
baychev, October 23, 2008 at 2:07 am
It seems to me he is addressing the agent/principal problem inherent in an originate-to-distribute model. This is not backtracking on free markets idology. Markets can function well on themselves as long as the government tries to minimize moral hazard through regulation: break up banks, make sure that rating agencies do not do other business with the companies they rate, brokers and dealers should be separate, etc.
This is not that difficult but runs contrary to cronyinsm principles and therefore unimplementable.
doc holiday, October 23, 2008 at 3:42 am
FYI: Shortly after "Atlas Shrugged" was published in 1957, Mr. Greenspan wrote a letter to The New York Times to counter a critic's comment that "the book was written out of hate." Mr. Greenspan wrote: " 'Atlas Shrugged' is a celebration of life and happiness. Justice is unrelenting. Creative individuals and undeviating purpose and rationality achieve joy and fulfillment. Parasites who persistently avoid either purpose or reason perish as they should."
Also see parasitic behavior: Alan Greenspan, the former chairman of the US Federal Reserve, is to become an adviser to Paulson & Co, the $28bn New York-based hedge fund company that achieved spectacular investment returns at the height of the credit squeeze last year.
Mr Greenspan already holds separate advisory roles with Deutsche Bank and Pimco, the asset management firm. The financial terms of the arrangement were not disclosed.
John Paulson, president of the hedge fund, said: "Few people, if any in the world, have the experience with, and depth of understanding of, global financial markets [of Mr] Greenspan."
Jojo, October 23, 2008 at 4:33 am
The End of Libertarianism
By jacob.weisberg
Created 10/20/2008 9:48amA source of mild entertainment amid the financial carnage has been watching libertarians scurrying to explain how the global financial crisis is the result of too much government intervention rather than too little. One line of argument [1] casts as villain the Community Reinvestment Act, which prevents banks from "redlining" minority neighborhoods as not creditworthy. Another theory [2] blames Fannie Mae and Freddie Mac for causing the trouble by subsidizing and securitizing mortgages with an implicit government guarantee. An alternative thesis is that past bailouts encouraged investors to behave recklessly in anticipation of a taxpayer rescue.
There are rebuttals to these claims and rejoinders to the rebuttals. But to summarize, the libertarian apologetics fall wildly short of providing any convincing explanation for what went wrong. The argument as a whole is reminiscent of wearying dorm-room debates that took place circa 1989 about whether the fall of the Soviet bloc demonstrated the failure of communism. Academic Marxists were never going to be convinced that anything that happened in the real world could invalidate their belief system. Utopians of the right, libertarians are just as convinced that their ideas have yet to be tried, and that they would work beautifully if we could only just have a do-over of human history. Like all true ideologues, they find a way to interpret mounting evidence of error as proof that they were right all along.
To which the rest of us can only respond, Haven't you people done enough harm already?
Anonymous, October 23, 2008 at 5:28 am
Thanks for the link, JoJo. I *still* hear this from my communist friends all the time. They tell me that I am co-opted by "capitalist ideology" and that their communist principles have never been given a fair shake in the real world. When they are presented with the idea that real world implementation always will lead to totalitarian dictatorships, either by the difficult process of change in a reluctant portion of the populace or the power vacuum created thereafter, they quickly change the subject. Anarcho-capitalist libertarians are just as utopian, counterfactual and delusional as these communists. I can't believe we don't all openly scoff at them every day. Ron Paul is probably a good man, but his ideas are, to put it nicely, fringe (and wholly without much evidential support). It should not surprise me that the anarcho-capitalists have reacted in the same way "our ideas have never been tried." Cognitive dissonance. Powerful delusion. Hayek always made a point, in discussing Germany's dissent into Naziism, that ideas are powerful. Just be vigilant that the ideas of the anarcho-capitalist fringe don't continue to infect the general population.
Anonymous, October 23, 2008 at 6:12 am
I was wondering when someone would get around to posting Weisberg's sophistry and name-calling masquerading as a column. There are plenty of legitimate arguments against deregulation to be made by more serious people than Weisberg, but I guess that's the kind of fare that has the greatest traction in political discussion, these days.
"Ron Paul is probably a good man, but his ideas are, to put it nicely, fringe (and wholly without much evidential support)."
You're obviously in a big hurry to do your "open scoffing" and not paying much attention to what the man has actually said. He's called the credit crisis to a "t".
Here are some things he said when voting *against* Graham-Leach-Bliley. In the year 1999.
__________________________________"today we are considering a bill aimed at modernizing the financial services industry through deregulation. It is a worthy goal which I support. However, this bill falls short of that goal. The negative aspects of this bill outweigh the benefits .
* The growth in money and credit has outpaced both savings and economic growth. These inflationary pressures have been concentrated in asset prices, not consumer price inflationkeeping monetary policy too easy. This increase in asset prices has fueled domestic borrowing and spending.
* Government policy and the increase in securitization are largely responsible for this bubble. In addition to loose monetary policies by the Federal Reserve, government-sponsored enterprises Fannie Mae and Freddie Mac have contributed to the problem. The fourfold increases in their balance sheets from 1997 to 1998 boosted new home borrowings to more than $1.5 trillion in 1998, two-thirds of which were refinances which put an extra $15,000 in the pockets of consumers on averageand reduce risk for individual institutions while increasing risk for the system as a whole.
* The rapidity and severity of changes in economic conditions can affect prospects for individual institutions more greatly than that of the overall economy. The Long Term Capital Management hedge fund is a prime example. New companies start and others fail every day. What is troubling with the hedge fund bailout was the governmental response and the increase in moral hazard.
* This increased indication of the government's eagerness to bail out highly-leveraged, risky and largely unregulated financial institutions bodes ill for the post S. 900 future as far as limiting taxpayer liability is concerned. LTCM isn't even registered in the United States but the Cayman Islands!
* My main reasons for voting against this bill are the expansion of the taxpayer liability and the introduction of even more regulations. The entire multi-hundred page S. 900 that reregulates rather than deregulates the financial sector could be replaced with a simple one-page bill."
________________________________Again, those familiar with Austrian economics were more prescient about the present circumstances than anyone, but modern commentators are either ignorant of it or so desperate to dismiss it as "fringe" that they won't even consider *looking* at its theoretical framework.
So. We'll just go with the Keynesian approach until it finally bankrupts the U.S.
BeerdedOne, October 23, 2008 at 8:13 am
Libertarianism may be flawed, but it is NOT to blame.
Lets be intellectually honest with ourselves and admit that Libertarians are a misunderstood, heterogeneous and largely marginal (in Washington, atleast) political group. The idea that the Bob Barrs' of the world speak for all libertarians is as ridiculous as the idea that the Bush administration has somehow implemented Libertarian policies since 2000! I'm very unclear what motivation people have to obscure the agenda of the neoconservative / neoliberal corporatists behind a smokescreen of libertarian bashing.
The question shouldn't be couched in the regulation/deregulation framework, but in terms of regulation for and by whom?
Corporatism has invaded our government on both sides of the aisle. Lobbyists hired by corporate interests write the laws that then are masqueraded as the 'regulation' or 'deregulation' that is needed, depending on the political climate and which party is in power.
The revolving door of high level industry/government/industry employment assures that the policy implementation is carried out with a high degree of loyalty to big banking. Watch as it happens again in the wake of this crisis.
Anonymous, October 23, 2008 at 10:16 am
No sense of irony? How about no shame! He is probably the single largest culprit in setting the stage for this mess. If the hired hand in charge of the central bank couldn't see this coming, he is incompetent. If he did see it coming, he is evil. You pick
ruetheday, October 23, 2008 at 10:35 am
Libertarianism (at least the natural rights variant) is based on the unjustified assumption that the right to private property and the right of contract somehow are absolute and must trump all other considerations. Furthermore, there is the additional unjustified assumption that externalities either do not exist or are so insignificant as to be safely ignored.
None of these premises are able to withstand a moment's scrutiny, which is why serious political philosophers don't spend much time responding to libertarians.
With regard to private property, if one follows an entitlement theory of justice, ala Nozick, one always ends up with the question of how to justify the initial acquisition of land and other unproduced natural resources. There is no solution to this problem, despite libertarians' attempts to fudge it with counterfactual, post-hoc rationalizations like labor-mixing and homesteading.
With regard to contracts, any attempt at developing a moral system based on voluntary contract has to not only answer the question of why contracts should be ENFORCED (i.e., why individuals shouldn't be permitted to exit agreements as easily as they enter them when either circumstances or their opinions change) but also must consider 1) the bargaining power of each party entering into the contract and 2) the information available to each party upon entry. Libertarians' excepting of "force" and "fraud" from all agreements is just a simple-minded attempt at punting on the issue of bargaining power and information.
With regard to externalities, libertarianism relies on the unjustified assumption that all human activities can be divided into voluntary action and force (false dichotomy fallacy) and thus rules out the fact that the actions of individuals can indirectly but significantly affect other individuals without their consent. Every man is an island in libertopia. Outside of libertopia, the daily actions of individuals living in society do, in many cases, affect others.
Libertarianism debunked in three easy steps.
doc holiday, October 23, 2008 at 10:54 am
Greenspan simply must continue to evolve as a capitalist and show no loyalty or integrity with his withering shell. He must not be bound to his money-based relationships to the current hedge fund he whores for, or bow before the deals with Pimco, et al. As God is my witness, the man must burrow himself into the exchanges and opportunities available in Zimbabwe, before he returns to Mephistopheles for a new assignment:
Inflation is somewhere in the millions or perhaps the billions and the economy is the fastest shrinking on Earth. But Zimbabwe is the "best investment opportunity" in Africa, financiers at a seminar in South Africa have heard.
In the surreal atmosphere of President Robert Mugabe's domain, this proposition may have a certain logic.
Throughout the economic meltdown, Zimbabwe's stock market has soared because hyperinflation means that people must pour their money into shares to preserve its value.
On Monday, the Zimbabwe Stock Exchange (ZSE) industrials index rose by over 241 per cent. During the investment seminar, a live feed of ZSE prices showed many stocks going up by several hundred per cent, with the leader, Zimnat, up 1,150 per cent in a day. There were no fallers.
Meanwhile, the Zimbabwe Dollar plummeted, falling to 306.8 million against its US counterpart in the course of a morning.
Hirsch V Gupta, October 23, 2008 at 11:26 am
Anon of 7:12a.m.
Thanks for posting the text of Ron Paul's comments from the 1999 act.
His ideas in 1999 were undenaibly better and more organized than he was able to present it during the campaign or during his questing of the Ben Bernanke atthe hearing where he went off on a tangent and just stayed there.
Thanks again.
Sincerely
Hirsch V Gupta
Anonymous, October 23, 2008 at 12:34 pm
Greenspan, a man who truly kneeled at the altar of Market Fundamentalism in 3 out of its 4 ugly incarnations.
Greenspan: the man who called himself a Libertarian, worshiped an Objectivist, and ran his central bank like a Neoliberal.
The 4 ugly pillars of Market Fundamentalism (don't forget the ugliest one, Anarcho-Capitalism!) need to have happen to them exactly what happned to Communism: be consigned to the trash heap of history.
HC, October 23, 2008 at 7:27 pm
The man in charge of the largest counterfeiting operation in the world, enforced by gun point, who willingly intervened in the money markets to distort interest rates is some how a free market ideologue? I am glad politics isn't your specialty Yves I mean how is setting price 'targets' on interest rates any different than pegging a currency or price 'targeting' gasoline or food? Isn't that the whole point of a command economy? To command the prices and thereby the flow of goods? Orwell would be 'proud' Yves
Anonymous, October 24, 2008 at 12:01 am
"Now that Greenspan has thrown in the towel, the free market ideologues have lost one of their most loyal advocates."
Yves have you read Bill Fleckensteins book?
It is the best refutation of Greenspan that I've come across.
The title is :
"Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve."
Doug
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Oct 9, 2008 | NYTimes.com
"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." - Alan Greenspan in 2004
George Soros, the prominent financier, avoids using the financial contracts known as derivatives "because we don't really understand how they work." Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential "hydrogen bombs."
And Warren E. Buffett presciently observed five years ago that derivatives were "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."
One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives - exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. "What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so," Mr. Greenspan told the Senate Banking Committee in 2003. "We think it would be a mistake" to more deeply regulate the contracts, he added.
Today, with the world caught in an economic tempest that Mr. Greenspan recently described as "the type of wrenching financial crisis that comes along only once in a century," his faith in derivatives remains unshaken.
The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as "the pharmacist who fills the prescription ordered by our physician."
But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest.
"Clearly, derivatives are a centerpiece of the crisis, and he was the leading proponent of the deregulation of derivatives," said Frank Partnoy, a law professor at the University of San Diego and an expert on financial regulation.
The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.
If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, 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.
Derivatives were created to soften - or in the argot of Wall Street, "hedge" - investment losses. For example, some of the contracts protect debt holders against losses on mortgage securities. (Their name comes from the fact that their value "derives" from underlying assets like stocks, bonds and commodities.) Many individuals own a common derivative: the insurance contract on their homes.
On a grander scale, such contracts allow financial services firms and corporations to take more complex risks that they might otherwise avoid - for example, issuing more mortgages or corporate debt. And the contracts can be traded, further limiting risk but also increasing the number of parties exposed if problems occur.
Throughout the 1990s, some argued that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system. In meetings with federal officials, celebrated appearances on Capitol Hill and heavily attended speeches, Mr. Greenspan banked on the good will of Wall Street to self-regulate as he fended off restrictions.
Ever since housing began to collapse, 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. Others have criticized Mr. Greenspan for not disciplining institutions that lent indiscriminately.
But whatever history ends up saying about those decisions, Mr. Greenspan's legacy may ultimately rest on a more deeply embedded and much less scrutinized phenomenon: the spectacular boom and calamitous bust in derivatives trading.
Faith in the System
Some analysts say it is unfair to blame Mr. Greenspan because the crisis is so sprawling. "The notion that Greenspan could have generated a totally different outcome is naοve," said Robert E. Hall, an economist at the conservative Hoover Institution, a research group at Stanford.
Mr. Greenspan declined requests for an interview. His spokeswoman referred questions about his record to his memoir, "The Age of Turbulence," in which he outlines his beliefs.
"It seems superfluous to constrain trading in some of the newer derivatives and other innovative financial contracts of the past decade," Mr. Greenspan writes. "The worst have failed; investors no longer fund them and are not likely to in the future."
In his Georgetown speech, he entertained no talk of regulation, describing the financial turmoil as the failure of Wall Street to behave honorably.
"In a market system based on trust, reputation has a significant economic value," Mr. Greenspan told the audience. "I am therefore distressed at how far we have let concerns for reputation slip in recent years."
As the long-serving chairman of the Fed, the nation's most powerful economic policy maker, Mr. Greenspan preached the transcendent, wealth-creating powers of the market.
A professed libertarian, he counted among his formative influences the novelist Ayn Rand, who portrayed collective power as an evil force set against the enlightened self-interest of individuals. In turn, he showed a resolute faith that those participating in financial markets would act responsibly.
An examination of more than two decades of Mr. Greenspan's record on financial regulation and derivatives in particular reveals the degree to which he tethered the health of the nation's economy to that faith.
As the nascent derivatives market took hold in the early 1990s, and in subsequent years, critics denounced an absence of rules forcing institutions to disclose their positions and set aside funds as a reserve against bad bets.
Time and again, Mr. Greenspan - a revered figure affectionately nicknamed the Oracle - proclaimed that risks could be handled by the markets themselves.
"Proposals to bring even minimalist regulation were basically rebuffed by Greenspan and various people in the Treasury," recalled Alan S. Blinder, a former Federal Reserve board member and an economist at Princeton University. "I think of him as consistently cheerleading on derivatives."
Arthur Levitt Jr., a former chairman of the Securities and Exchange Commission, says Mr. Greenspan opposes regulating derivatives because of a fundamental disdain for government.
Mr. Levitt said that Mr. Greenspan's authority and grasp of global finance consistently persuaded less financially sophisticated lawmakers to follow his lead.
"I always felt that the titans of our legislature didn't want to reveal their own inability to understand some of the concepts that Mr. Greenspan was setting forth," Mr. Levitt said. "I don't recall anyone ever saying, 'What do you mean by that, Alan?' "
Still, over a long stretch of time, some did pose questions. In 1992, Edward J. Markey, a Democrat from Massachusetts who led the House subcommittee on telecommunications and finance, asked what was then the General Accounting Office to study derivatives risks.
Two years later, the office released its report, identifying "significant gaps and weaknesses" in the regulatory oversight of derivatives.
"The sudden failure or abrupt withdrawal from trading of any of these large U.S. dealers could cause liquidity problems in the markets and could also pose risks to others, including federally insured banks and the financial system as a whole," Charles A. Bowsher, head of the accounting office, said when he testified before Mr. Markey's committee in 1994. "In some cases intervention has and could result in a financial bailout paid for or guaranteed by taxpayers."
In his testimony at the time, Mr. Greenspan was reassuring. "Risks in financial markets, including derivatives markets, are being regulated by private parties," he said.
"There is nothing involved in federal regulation per se which makes it superior to market regulation."
Mr. Greenspan warned that derivatives could amplify crises because they tied together the fortunes of many seemingly independent institutions. "The very efficiency that is involved here means that if a crisis were to occur, that that crisis is transmitted at a far faster pace and with some greater virulence," he said.
But he called that possibility "extremely remote," adding that "risk is part of life."
Later that year, Mr. Markey introduced a bill requiring greater derivatives regulation. It never passed.
Resistance to Warnings
In 1997, the Commodity Futures Trading Commission, a federal agency that regulates options and futures trading, began exploring derivatives regulation. The commission, then led by a lawyer named Brooksley E. Born, invited comments about how best to oversee certain derivatives.
Ms. Born was concerned that unfettered, opaque trading could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it," she said in Congressional testimony. She called for greater disclosure of trades and reserves to cushion against losses.
Ms. Born's views incited fierce opposition from Mr. Greenspan and Robert E. Rubin, the Treasury secretary then. Treasury lawyers concluded that merely discussing new rules threatened the derivatives market. Mr. Greenspan warned that too many rules would damage Wall Street, prompting traders to take their business overseas.
"Greenspan told Brooksley that she essentially didn't know what she was doing and she'd cause a financial crisis," said Michael Greenberger, who was a senior director at the commission. "Brooksley was this woman who was not playing tennis with these guys and not having lunch with these guys. There was a little bit of the feeling that this woman was not of Wall Street."
Ms. Born declined to comment. Mr. Rubin, now a senior executive at the banking giant Citigroup, says that he favored regulating derivatives - particularly increasing potential loss reserves - but that he saw no way of doing so while he was running the Treasury.
"All of the forces in the system were arrayed against it," he said. "The industry certainly didn't want any increase in these requirements. There was no potential for mobilizing public opinion."
Mr. Greenberger asserts that the political climate would have been different had Mr. Rubin called for regulation.
In early 1998, Mr. Rubin's deputy, Lawrence H. Summers, called Ms. Born and chastised her for taking steps he said would lead to a financial crisis, according to Mr. Greenberger. Mr. Summers said he could not recall the conversation but agreed with Mr. Greenspan and Mr. Rubin that Ms. Born's proposal was "highly problematic."
On April 21, 1998, senior federal financial regulators convened in a wood-paneled conference room at the Treasury to discuss Ms. Born's proposal. Mr. Rubin and Mr. Greenspan implored her to reconsider, according to both Mr. Greenberger and Mr. Levitt.
Ms. Born pushed ahead. On June 5, 1998, Mr. Greenspan, Mr. Rubin and Mr. Levitt called on Congress to prevent Ms. Born from acting until more senior regulators developed their own recommendations. Mr. Levitt says he now regrets that decision. Mr. Greenspan and Mr. Rubin were "joined at the hip on this," he said. "They were certainly very fiercely opposed to this and persuaded me that this would cause chaos."
Ms. Born soon gained a potent example. In the fall of 1998, the hedge fund Long Term Capital Management nearly collapsed, dragged down by disastrous bets on, among other things, derivatives. More than a dozen banks pooled $3.6 billion for a private rescue to prevent the fund from slipping into bankruptcy and endangering other firms.
Despite that event, Congress froze the Commodity Futures Trading Commission's regulatory authority for six months. The following year, Ms. Born departed.
In November 1999, senior regulators - including Mr. Greenspan and Mr. Rubin - recommended that Congress permanently strip the C.F.T.C. of regulatory authority over derivatives.
Mr. Greenspan, according to lawmakers, then used his prestige to make sure Congress followed through. "Alan was held in very high regard," said Jim Leach, an Iowa Republican who led the House Banking and Financial Services Committee at the time. "You've got an area of judgment in which members of Congress have nonexistent expertise."
As the stock market roared forward on the heels of a historic bull market, the dominant view was that the good times largely stemmed from Mr. Greenspan's steady hand at the Fed.
"You will go down as the greatest chairman in the history of the Federal Reserve Bank," declared Senator Phil Gramm, the Texas Republican who was chairman of the Senate Banking Committee when Mr. Greenspan appeared there in February 1999.
Mr. Greenspan's credentials and confidence reinforced his reputation - helping him to persuade Congress to repeal Depression-era laws that separated commercial and investment banking in order to reduce overall risk in the financial system.
"He had a way of speaking that made you think he knew exactly what he was talking about at all times," said Senator Tom Harkin, a Democrat from Iowa. "He was able to say things in a way that made people not want to question him on anything, like he knew it all. He was the Oracle, and who were you to question him?"
In 2000, Mr. Harkin asked what might happen if Congress weakened the C.F.T.C.'s authority.
"If you have this exclusion and something unforeseen happens, who does something about it?" he asked Mr. Greenspan in a hearing.
Mr. Greenspan said that Wall Street could be trusted. "There is a very fundamental trade-off of what type of economy you wish to have," he said. "You can have huge amounts of regulation and I will guarantee nothing will go wrong, but nothing will go right either," he said.
Later that year, at a Congressional hearing on the merger boom, he argued that Wall Street had tamed risk.
"Aren't you concerned with such a growing concentration of wealth that if one of these huge institutions fails that it will have a horrendous impact on the national and global economy?" asked Representative Bernard Sanders, an independent from Vermont.
"No, I'm not," Mr. Greenspan replied. "I believe that the general growth in large institutions have occurred in the context of an underlying structure of markets in which many of the larger risks are dramatically - I should say, fully - hedged."
The House overwhelmingly passed the bill that kept derivatives clear of C.F.T.C. oversight. Senator Gramm attached a rider limiting the C.F.T.C.'s authority to an 11,000-page appropriations bill. The Senate passed it. President Clinton signed it into law.
Pressing Forward
Still, savvy investors like Mr. Buffett continued to raise alarms about derivatives, as he did in 2003, in his annual letter to shareholders of his company, Berkshire Hathaway.
"Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers," he wrote. "The troubles of one could quickly infect the others."
But business continued.
And when Mr. Greenspan began to hear of a housing bubble, he dismissed the threat. Wall Street was using derivatives, he said in a 2004 speech, to share risks with other firms.
Shared risk has since evolved from a source of comfort into a virus. As the housing crisis grew and mortgages went bad, derivatives actually magnified the downturn.
The Wall Street debacle that swallowed firms like Bear Stearns and Lehman Brothers, and imperiled the insurance giant American International Group, has been driven by the fact that they and their customers were linked to one another by derivatives.
In recent months, as the financial crisis has gathered momentum, Mr. Greenspan's public appearances have become less frequent.
His memoir was released in the middle of 2007, as the disaster was unfolding, and his book tour suddenly became a referendum on his policies. When the paperback version came out this year, Mr. Greenspan wrote an epilogue that offers a rebuttal of sorts.
"Risk management can never achieve perfection," he wrote. The villains, he wrote, were the bankers whose self-interest he had once bet upon.
"They gambled that they could keep adding to their risky positions and still sell them out before the deluge," he wrote. "Most were wrong."
No federal intervention was marshaled to try to stop them, but Mr. Greenspan has no regrets.
"Governments and central banks," he wrote, "could not have altered the course of the boom."
Chicago School economist Milton Friedman (may he spend eternity having to listen to Karl Marx for his theoretical sins) was the "trickle down" originator that as one wag said on another blog, is better described as the "tinkle down" effect.
The reality is, this is a bait and switch situation, however we all know that! We also know that short of killing someone the right base will spin and defend anything . For god's sake let the media and lawyers deal with her tired antics, because they are adding up making both McCain and Palin continue to look like liars..How many more times do we need to hear about the bridge? And use the sense god gave all of us, as well as great sayings like "If it looks like a duck...' and make the decision to vote these nuts out once and for all....
The second, deeper explanation, is that this is merely the most dramatic symptom yet of the disease that continues to ravage the US financial system.
The balance sheets of too many US banks are awash in toxic assets. Most of them can be traced back to wildly negligent investment decisions made during the boom in house prices and other assets in the last five years. In the last eighteen months US house prices have fallen by more than at any time in the last 70 years and a whole host of assets that were backed by that market have become worthless.
This may be more than just another catastrophic end to another financial cycle, however. It could be the end of a whole financial model - investment banking itself.
"It's probably no exaggeration to say we are witnessing the end of an era' said one seasoned financial executive watching events unfold at the weekend.
Fundmentally, across the western world, greed won out over propriety, short term financial gain won out over decades of established practice, and deregulation became the mantra of government.
Bankers made their millions, and the rest of us paid. The tragedy is, they are still in place.
===
If Gerard Baker is correct in his assessment that this could be the end of the US financial model then what will replace it? Globalisation no longer seems such a great idea for sure and de-regulation is a nonsense. Investment bankers are only interested in quick profits today and to hell with future.
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Sep 20, 2008 | The mess that greenspan made
Across the political spectrum in Europe, the former fed chief's name keeps popping up when the discussion turns to "root cause", and Italy's finance minister sets the bar quite high, putting the world's most famous terrorist in the same company as the world's most famous central banker, as reported in the LA Times.
It's a rare day when finance officials, leftist intellectuals and ordinary salespeople can agree on something. But the economic meltdown that wrought its wrath from Rome to Madrid to Berlin this week brought Europeans together in a harsh chorus of condemnation of the excess and disarray on Wall Street.The finance minister of Italy's conservative and pro-U.S. government warned of nothing less than a systemic breakdown. Giulio Tremonti excoriated the "voracious selfishness" of speculators and "stupid sluggishness" of regulators. And he singled out Alan Greenspan, the former chairman of the U.S. Federal Reserve, with startling scorn.
"Greenspan was considered a master," Tremonti declared. "Now we must ask ourselves whether he is not, after [Osama] bin Laden, the man who hurt America the most. . . . It is clear that what is happening is a disease. It is not the failure of a bank, but the failure of a system. Until a few days ago, very few were willing to realize the intensity and the dramatic nature of the crisis."
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Martin Wolf is gloomy:A year of living dangerously for the world: It is now almost a year since the US subprime crisis went global. Many then hoped that the repricing of risk would be no more than a brief interruption.... Such hopes have been disappointed.... So where is the world economy now? And where might it go? Here are some preliminary answers to these questions.
The answer to the first comes in two main parts: continued financial distress and commodity price rises.... Equity investors are not the only people worried about the health of banks. The banks themselves are also worried. Spreads between rates of interest on inter-bank lending in dollars, euros and sterling and expected official rates... [o]n six-month loans... are now as high as at the two previous peaks, in September and December of last year.... This is no mere liquidity crisis. The banks are expressing concern about the solvency of their peers....
Meanwhile, the price of oil is close to $150 a barrel.... has doubled over the past year. In real terms, the price of oil is now 25 per cent higher than in 1979.... [W]hy are commodity prices soaring when the world economy is slowing?... Producers will leave oil in the ground if the rise in real oil prices is expected to be faster than the return on the alternative assets. What determines the current price then is the expected future price. The most important drivers have been the prospective growth in the demand of emerging countries, particularly China, and gloom about alternative sources of supply....
So what happens to the world economy next?... It is hard to see any outcome other than a sustained slowdown in the world economy.... [R]isks could combine in dangerous ways. An attack on Iran might push the price of oil above $200.... If the ongoing deleveraging of the US economy weakened US consumption, the economy might go into a deep recession. US fiscal deficits would then soar and long-term US interest rates might jump. This could make the debt dynamics of the US government look very unpleasant. A flight from the dollar and dollar bonds might even ensue. Who would then want to be running the Federal Reserve?
The good news is that the world economy has held up surprisingly well. The bad news is that the risks remain squarely on the downside...
My reading is somewhat different. Back in the second half of the 1990s, various people went into Alan Greenspan's office. "Raise interest rates!" they said. "Let unemployment go up! The Phillips curve can't have shifted in this far! The natural rate of unemployment can't have fallen so far so fast! These stock market valuations can't be rational! We are headed for a big crash, or a big inflationary spiral--unless you change course now!"
Alan Greenspan responded that there was no sign of overly-tight labor demand, no sign of accelerating demand-pull or wage-push inflation that would warrant interest rate increases. People were indeed investing enthusiastically in high-tech start-ups and those buying stocks at outsized price-earnings ratios. But the people doing the buying and investing were relatively well-off, and were grownups. If it turned out to be a serious bubble, and if the unwinding of the bubble triggered a financial panic and threatened to produce a high-unemployment recession, then would be the moment for the Federal Reserve to step in and clean up the mess. In the meanwhile, it would be a shame to destroy millions of jobs and wreck a period of 4%+ economic growth just because the Federal Reserve thought that it knew better than grownup investors what prices they should be paying for stocks and shares in high-tech startups, and feared that there might be trouble in the future.
Similarly, in the middle years of the decade of the 2000s, various people went into Alan Greenspan's office. "Raise interest rates!" they said. "Let unemployment go up! Long-term interest rates cannot stay this low for long! The sustainable pace of construction can't have risen so far so fast! These real estate valuations can't be rational! We are headed for a big crash, or a big inflationary spiral--unless you change course now!"
Alan Greenspan responded that there was no sign of overly-tight labor demand, no sign of accelerating demand-pull or wage-push inflation that would warrant interest rate increases. People were indeed building houses and buying mortgages and taking out home-equity loans enthusiastically at outsized price-rental and mortgage-value income ratios. But the people doing the buying and investing were relatively well-off, and were grownups. If it turned out to be a serious bubble, and if the unwinding of the bubble triggered a financial panic and threatened to produce a high-unemployment recession, then would be the moment for the Federal Reserve to step in and clean up the mess. In the meanwhile, it would be a shame to destroy millions of jobs and wreck a period of 3%+ economic growth just because the Federal Reserve thought that it knew better than grownup investors what prices they should be paying for mortgages and houses, and feared that there might be trouble in the future.
The unwinding of the dot-com bubble in 2000-2002 went remarkably well: no significant macroeconomic distress, and less financial panic and distress than I believed possible. The unwinding of the real estate bubble in 2007-2009 is so far not going well. There is, by contrast, more financial distress than I believed possible. Who thought that quantitatively sophisticated hedge funds would have enormous unhedged exposure to subprime risk? Who would have thought that highly-leveraged investment banks with an originat-and-sell business model would keep lots of the securities they had originated in their own portfolios--and kept them because they were high yield for their rating, i.e., because the market did not believe they were as low risk as the investment banks had bamboozled the ratings agencies into claiming? Who would have thought that those buying subprime mortgage securities from the likes of Countrywide had done no investigation into how Countrywide was screening out borrowers?
But so far--look: In the dot-com boom of the 1990s we were the winners. The rich investors of America built out a huge amount of fiber-optic cables and conducted an enormous amount of experimentation in business models from which we all benefit. In the real-estate boom of 2000s the rich investors of America and the world built an extra four million houses and loaned the rest of us money at remarkably low interest rates for five years. Those who moved into newly-built houses with teaser-rate mortgages wish those teaser rates would continue--but they won't, and in the meantime they got to live in a nice house for quite a low rent. Those of us who took out big home equity loans wish the low interest rates would continue--but they won't. And those of us who felt rich because our house values have appreciated wish we still could think of ourselves as sleeping on a pile of gold--but we can't.
The dot-com bubble and the real-estate bubble were bad news for the investors in Webvan, WorldCom, Countrywide, FNMA, and securitized subprime mortgages. But they were, by and large, good news for the rest of us. And investors are supposed to take care of themselves.
Now we are not yet out of the woods. If the tide of financial distress sweeps the Fed and the Treasury away--if we find ourselves in a financial-meltdown world where unemployment or inflation kisses 10%--then I will unhappily concede, and say that Greenspanism was a mistake. But so far the real economy in which people make stuff and other people buy it has been remarkably well insulated from panic at 57th and Park and on Canary Wharf.
July 16, 2008 at 02:54 PM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: International Finance, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the Occasion |
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The Agonist
Greenspanism was, more or less, the ability to find ways of getting the future to pay for profits to be taken today.
In game theory we have what is called "rollback". Rollback is when you start from the end state and work backwards through the steps that got you there, because what you are looking for is the point on the chain where a change could be made to the dead variables that will change the outcome. If you know that rich and powerful people are going to place big bets on the eat babies case being the downside, then you have to do something about that. Otherwise they will keep doing it until it happens. And then they will do it again, because you just bailed them out from eating babies, so they are going to double up the bet that you will do it again.
This happened too. One of the first things that Uncle Alan faced was the stock market meltdown of 1987. 25% in one day. Talk about the indicators saying "Jump!" So he did what any central banker would do: he flooded the world with liquidity. This is the realization of 70 years of studying the Great Depression: that to avoid it, the central banks should have ditched the gold standard completely, and eased dramatically in the late 1920's. The reason they didn't was because of two important traumatic facts. They didn't want to ditch the gold standard, and they had just seen the larges bout of inflation since the Napoleonic Wars, and the most dramatic example of hyper-inflation in memory. Easing wasn't to be done, because the results of inflation were burned into their brains.
So once again, there is Uncle Alan, at the right place at the right time to put his thumb on the scales in favor of people of great wealth and privilege. Or more accurately, people who are in power and can spend OPM - Other People's Money - without consequence. The result was a massive bailout of the S&L system which we are still paying for.
This is the lesson of insured economies: that if there is a social insurance, then sooner or later every crisis will be passed along to some entity which the government has said, or is believed, to be committed to bailing out should shit and fan get together for a tango.
Which, rolling back, means that the government should be interfering in bets on the eat babies case, or charging high enough taxes on the very wealthy to pay for insurance against the eat babies case. This is the logic of the FDIC: charge banks insurance for the case of the bank imploding. It is also the logic of a central bank under the control of political authorities, rather than some foobarbazz theory of central banks should be independent so that arabs will credibility believe that when it comes time to fuck the population or keep Arabs in money, that the population should bend over and lube up, because here it comes.
In otherwords, liberalism people. Liberalism is the idea that collective and social action must be used to correct those points where individual action leads to the failure of emergent systems. Or let me put it another way. If you believe in individual freedom and liberty, you want as much as possible to be done through self-organization. Culture, community and the free market are all self-organizing. However, there are points where self-organization pessimalizes rather than optimizes. The first realization, sort of the 19th century one, was that one function of government must be to prevent things from going to hell in a bucket. Bank collapses and the like, are bad things. Once, however you do this, you have to then prevent anyone from profiting in the short term by bringing the system on a collision course for the iceberg and taking bets on whether we will hit it or not.
The cost of this is not small: the military budget is one giant exercise in preventing things from going to hell in a bucket. So to are social insurance schemes. This means that the government must then interfere in the market enough to stop people from betting on these things being broken. Iraq is an example. Lots of people bet that should oil get scarce, we'd steal it from Iraq. They were betting, in short, on a military bail out of the sprawlconomy. Ok, so Bush managed to fuck up the military bail out of the economy, but the belief in Washington is that sooner or later someone in Iraq is going to have to pump oil. The belief that it will happen in time to bail out their political butts is fading, so they are looking at Iran next, which is the next low hanging fruit that we can generate an excuse for war against.
Looking back on Greenspan's career, we see a consistent pattern - a betrayal of logic and principles in favor of a greedy hope that he could stack the deck in favor of his preferred ideological outcome. And now the result that he looks back over that time, and thinks it was one of turbulence. Ha! This has been one of the most stable times in history. The collapse of Communism was a reduction, not an increase, in the global level of uncertainty. It was the safest time to be a financier in decades, with a big population in its peak earning years, an economic energy culture that worked, a global swing to the right, inflation on the downside. It resembles nothing so much as the 1870-1910 period of the classical international gold standard and imperial globalism.
Turbulence, is what is coming, as people who have had promises made to them find out that there is insufficient oil to make good all those promises with the level of technology that we have.
Good night to Greenspanism, that belief that by back room intransparent manipulation of the system that the great dictatorship of the propertariat can be brought about. Because that is what Libertarianism really is, that there is a revolutionary class, and that in the end the struggles of capitalism must bring about the dictatorship of that revolutionary class, and then government will wither away. They just think it is a different group of people who have the revolutionary consciousness to never betray the interests of the structure. They are wrong, as well.
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Grasping Reality with Both Hands
"Feynman's criticism of NASA -- that they were like the child who because he has run out into the road before and not been run over begins to think it's OK to run out into the road -- applies here, too."
"A more measured approach might be to acknowledge the errors and work to convince the political class to move toward regulating and dealing with our situation based on the understanding of what we have recently done so wrong."
Certainly. But actions that are politically possible now simply would not have been three or four years ago. The question of "What should we do now?" is a different one than, "Did Greenspan screw up?".
Did a lot of people think we were in a real-estate bubble a few years ago? Sure. But quite a few people think we're in an oil bubble now -- are we? Real estate in the UK has had as great a run-up in value as in the U.S. -- will the market crash there too? By how much and when? If you think the U.S. bubble bursting was certain and obvious three years ago, you much be equally certain about the UK now -- are you shorting UK real-estate? The same rapid rise in real-estate values has happened in other European countries also (Spain, Ireland):
http://www.nzherald.co.nz/category/story.cfm?c_id=34&objectid=10520610
Has Greenspan or the Bush tax-cuts been responsible in all these places as well?
Who would have thought people would buy into an investment scheme based on an undertaking of great advantage, but no one to know what it is?Answer: Anybody who has been paying attention for any significant period of time during the last three or four hundred years, except perhaps economists and journalists, depending on how you define "paying attention."
The real estate bubble was quite different from the Clinton tech bubble. The real estate bubble involved no real significant advances in technology, just the very well understood mortgage financing mechanism being re-tooled with the same Ponzi mumbo jumbo that has been behind every massive swindle since money was invented. It had relatively little to do with overnight rates (remember the "conundrum") and everything to do with a bad case of Brownie-ism among regulators. In fact, Brownie could be considered the paragon of mop-up-later agency action.
And have you been to the places where the production houses were built? The deterioration is already easily observable in the remote planned communities of Arizona, Nevada and the Central Valley, with no obvious stopping point between where they are now and Mad Max territory. This was one of the grandest misallocations of resources to ever emerge from a low interest rate environment. It is not good.
Posted by: albrt | July 16, 2008 at 10:59 PM
Yes, very few regular people got hurt ... except for those people who got overextended buying houses in 2007. Sorry suckers!I agree with the other poster who said the real problem with Greenspan was his rigid stance against regulation, not anything he did wrong with monetary policy.
Posted by: Bram Cohen | July 16, 2008 at 11:38 PM
Yeah, bakho is spot on. No pilot in the cockpit.It is not so much a liquidity or even a solvency crisis but a trust crisis.
The solution will not be financial. The Fed can do all it wants through its usual tools and now the TAF, TSLF and PDCF, it matters very little if the transmission is plain broken, aka. the US banking system and, beyond that, the financial system as a whole.
And this is what the TED spread, the repeated seizures of the various debt markets (or OTC parodies of a market) and the flight to cash, foreign currencies and (hhharrrg) gold are saying. It's broken. No one trust anyone. The Fed is pushing on a string.
The Fed, the Treasury, the agency alphabet soup and Congress need get dirty and clean up the place to restore trust. I don't have much idea what it entails but whatever it is, it needs to be done and bring out in the open all the crap which is cluttering the system.
One thing I know though for sure: Glass-Steagall needs to come back and with a vengeance.
It took 70 years to get there but now that the trust in the US financial system is gone and squandered, it's going to take something truly drastic to restore it. Otherwise, even if all the stars align nicely and we avoid a deep recession, we're still going to end up with a zombie financial system and a Japanese-style stagnation squared.
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FT.com
From Mr Jιrτme Guillet.
Sir, It was oddly fitting that Alan Greenspan should argue in favour of continued self-regulation of the financial sector ("We will never have a perfect model of risk", March 17) on the very day that self-regulation demonstrated its absolute failure, as the only solution to avoid complete market panic and collapse was seen to be public intervention in the form of massive Fed guarantees over Bear Stearns liabilities.
After denying for years that there was any asset bubble, Mr Greenspan now describes it in excruciating detail, and concludes that it was inevitable, because it is the very nature of financial markets to be occasionally irrational, and to engage in booms and busts. Such a (correct) assessment would seem to be a call for much stricter regulation of how the financial world can be allowed to play with other people's money to limit such cycles. Instead, his insistence that nothing of the kind should be done is an extraordinarily explicit call to privatise financial profits (during the boom) and socialise losses (in the aftermath). As such, it should be treated with all the respect that political extremism deserves; ie, none.
Jιrτme Guillet,
Editor,
European Tribune
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FT.com
- Paul De Grauwe: So the reason why we have this financial crisis is that we can't forecast the future. What a deep insight. We have never been able to forecast the future, but this did not necessarily lead to a financial crisis.
Greenspan's article is a smokescreen to hide his own responsibility in making the financial crisis possible. There are at least two reasons why Greenspan's Federal Reserve bears a heavy responsibility for the present crisis.
First, as has been argued by John Taylor, the Fed kept the interest rate at very low levels for too long after the recession of 2001. The Fed waited until the middle of 2004 to start raising the interest rate from its historically low level of 1%. The point is not that in 2001 the Fed reduced the interest rate too much when it cut it from more than 6% to less than 2% in less than a year. This was probably the right thing to do in a recession. The problem is that it kept the rate there for too long, when the economy showed signs of recovery. This laid the groundwork for a massive credit and liquidity expansion which in turn created an asset bubble in the housing market.
Second, the Fed failed to take up its mandated responsibility to supervise and to regulate the financial institutions. Why did this happen? The root cause is the religious belief of Greenspan in the benevolence of markets and perniciousness of government interventions. At the moment financiers were increasing their exposure to liquidity risk and made fantastic profits doing so, in the knowledge that the Fed was insuring them freely against such a risk, Greenspan stood by and marveled at the creativity of markets. In his wonderful book "The Age of Turbulence" he discusses the new financial instruments and he concludes with a beautiful metaphor: "Why do we wish to inhibit the pollinating bees of Wall Street" (p 372). The problem is that the financiers of Wall Street were mostly pollinating themselves.
The corollary of this religious optimism in the wondrous workings of the financial markets is the belief that governments and the Fed can do nothing to regulate these new financial instruments. On p 489 of the same book Greenspan writes: "Only belatedly did I, and I suspect many of my colleagues, come to realize that the power to regulate administratively was fading; We increasingly judged that we would have to rely on counterparty surveillance to do the heavy lifting". So he did nothing and decided that self regulation is the answer. It can now be seen by everybody except the blind, that financial self-regulation does not work and has never worked. Yet in his FT column Greenspan continues to hope that financial self-regulation will be the "fundamental balance mechanism for global finance".
Religion quite often stands in the way of rational analysis. Greenspan, who was at the helm of the most important monetary institution in the world, failed to take his responsibility to supervise the financial markets blinded as he, and his colleagues, were by a belief that markets and bankers know better than governments.
- Martin Wolf: I have to say that I find myself in agreement with the critics of Mr Greenspan's article, the ideology he displays and some of the policy decisions made at the Fed in the 2000s.
I have laid out some of my thoughts on the lessons of the crisis in my contribution to a superb conference held at the Banque de France. I recommend a careful reading of the proceedings, particularly papers by Kenneth Rogoff, John Taylor and Bill White. I also strongly recommend a short presentation by Helene Rey. The web site is here.
I would like to add nine points.
First, Mr Greenspan ignores the now overwhelming evidence of malfeasance and gross incompetence in the chain of agents, from mortgage origination to the ultimate holders, including rating agencies, banks, investment banks, and so forth. This is not just about poor risk management. It is far worse than that. This was a huge failure of regulation.
Second, we do have to look very carefully at the incentives at work inside the financial system - a subject Mr Greenspan ignores. It is not just about ignorance. It is about wilful ignorance.
Third, it is now clear that the regulatory net has to be both more effective and broader. If Bear Sterns is to be rescued, then the liquidity position of all investment banks becomes a regulatory concern of the highest order. I wonder now how long it will be possible to ignore hedge funds.
Fourth, the reason the regulatory net has to become broader is that, in the end, it is the state that is expected to save the day. Social insurance has its price. The financial industry cannot be allowed to privatise profits and socialise losses on any scale it wishes.
Fifth, the case for treating huge asset price surges as prima facie indicators of excessively loose monetary policy is also overwhelming. Central banks cannot eliminate the bubbles, but they can surely lean against the wind. Cleaning up, afterwards, is far more difficult than some had previously thought, particularly where lending against real estate is involved.
Sixth, we must also ask whether the "risk-management" approach to monetary policy, followed by the Fed under Mr Greenspan and his successor, is not dangerously asymmetrical, since it seems to mean far more energetic responses to downside risks than to upside ones.
Seventh, far too little attention is still being paid to the role of the global imbalances (excess savings outside the US) in shaping the environment for US monetary policy. I believe this partily explains why US monetary policy had to be so loose. (I have a short book on this coming out in the summer.)
Eighth, maybe there must be a US government rescue of mortgagees, as Brad de Long argues. But I would admamantly oppose such an idea for the UK. It is wrong to bail out people who decided to borrow far more money than they could afford in the belief that the relative price of houses can rise without limit (see Alice Rivlin above, on this). I do understand the need to keep the core financial system in being and sustain demand in the economy (though recessions may be unavoidable, if not necessary, from time to time). But public guarantees of mortgage losses are very dangerous.
Finally, nobody should head a central bank for more than 8 years, or so. Mr Greenspan is a brilliant and fascinating man. But the dominance he achieved at the Fed was unhealthy. Nobody is perfect. What is needed is a debate among divergent viewpoints. The position Mr Greenspan had achieved by the late 1990s made this very difficult, if not impossible, to achieve.
Posted by: Martin Wolf
- We should reject this extremism of Greenspan's
From Jιrτme Guillet, Editor, European Tribune
"It was oddly fitting that Alan Greenspan should argue in favour of continued self-regulation of the financial sector on the very day that self-regulation demonstrated its absolute failure."
Read the full letterThe problem with the models is their opacity
From Paul Munton
"Alan Greenspan surely misses the point when he says that 'both risk models and econometric models, as complex as they have become, are still too simple . . ." The problem is not complexity, it is opacity."
Read the full letterThose elusive 'animal spirits'
From Leander Schneider, Concordia University
"With regard to forecasting, do not blame the model, blame the modeller. More to the point: with regard to system behaviour, blame the regulator."
Read the full letterNo remorse for letting the party get out of hand?
From Edward Gottesman
"The central banker's job description is to "take away the punchbowl" before the party gets out of hand. Is a small sign of remorse too much to ask?"
Read the full letterCrisis in the making was there for anyone to see
From Jean Barnard
"When home prices return to 2000 prices the market will stabilise and the economy will heal itself. No amount of artificial "stimulus packages" or manipulation will override that fact."
Read the full letterNo apology?
From Richard Guthrie.
"I've read Alan Greenspan's article over and over, but still can't find any reference to an apology for the fact that the financial apocalypse he describes is in the most part down to the actions/inactions of the US Federal Reserve under his watch."Models can never replace basic, prudent banking
From Tim Keese
"It would be nice if Mr Greenspan would admit his mistake and stop talking about models that didn't work. It was the regulators who didn't work."
Read the full letterSilence speaks louder than words
Posted by: Damian Carrington | March 20th, 2008 at 2:55 pm | Report this comment
From Marcus Miller, University of Warwick
"On the issue of "moral hazard" in banking, Mr Greenspan is silent. Sometimes, silence speaks louder than words."
Read the full letter- I wish to make another key point: even if the FED is not so much at fault for the US Housing Bubble and problems with Mortgage Backed Securities, the U.S. Government certainly is at fault since its actions and laws created the Mortgage Backed Securities market back in late 1970s / early 1980s.
The private Mortgage Backed Securities market, which changed way mortgages made from local banks to often mortgage finance companies with lower lending standards, was copied from the government agency Fannie Mae, Freddie Mac and Ginnie Mae mortgage backed bonds.
Reason for US Congress changing Tax Laws back in late 1970s to allow private Mortgage Backed Bonds was so the S&L Banks could have a way of getting liquidity for mortgages on their books without then having to book tax losses. Reason the S&Ls got into trouble and so many had to be bailed out by US Govt. in late 1970s, was due to High Inflation policies of US Govt. caused by: Federal Budget Deficits starting in the LBJ Vietnam War and Social Welfare programs of the mid-late 1960s, then made worse by Arab Oil Embargo of early to mid-1970s jacking up price of energy. It was huge budget deficits of the late 1960s and 1970s of US Government, caused big Inflation, which caused huge losses on long-term mortgages the S&Ls had made to the 1930s and 1940s born generation (and gave our parents huge gains as their inflation adjusted cost of mortgages went to almost nothing - near end of mortgage term, my parents home mortgage cost less than monthly utility payment, thanks to inflation Inflation caused by Fed. Govt. Deficits).
These Deficits caused huge gains to existing mortgage borrowers in 1970s and 1960s and bankrupted S&Ls. It was response to S&L troubles that led the US Congress (same group that caused the budget deficits) to pass special laws to set up the Mortgage Backed Securities market in response.
OK, SO NOW EVEN INTERNATIONAL PLAYERS AND YOUNGER GENERATION KNOWS THE U.S. GOVERNMENT's FINGERPRINTS ARE ALL OVER THE MORTGAGE BACKED SECURITIES MESS, SINCE IT WAS CONGRESS THAT CHANGED LAWS TO CREATE THE PRIVATE MBS MARKET IN RESPONSE TO THE S&L MESS CAUSED BY BIG US GOVERNMENT DEFICITS AND HIGH INFLATION POLICIES, which started with government over-spending to pay for LBJ's Vietnam War and so-called "Great Society Welfare Programs".
Posted by: Andrew | April 7th, 2008 at 1:42 am | Report this comment- Every crisis needs a scapegoat and, since he?s no longer in charge, Greenspan make a convenient one.
Sure he made mistakes. Everyone makes mistakes. It?s just somewhat troubling that the same person who was lionized for presiding over 15 years plus of unparalleled peace-time wealth creation is (a mere two years later) pilloried for what is (from all indications) shaping up to be a moderate correction.
But that is not the point.
What?s troubling is that the undertone of all this Greenspan bashing: a call for more government.
I realize that the people living in the US are having a hard time dealing with a world organized (for the first time in history) predominantly around free market principles. But there?s putting the genie back.
And what do people really want?
Do they really want the overregulated sixties and stagflation plagued seventies back?
I guess people really do have short memories. Instead of being afraid of government?s suffocating embrace, they pine for the warm and fluffy security blanket that will protect them not only from international competition, but from their own stupidity (was it really Greenspan who forced idiots to take out mortgages they knew they couldn?t afford and other idiots to write them?).
Hard to fight the zeitgeist, though.
All I can say is that I?m glad to be an expat living in Europe where the trend toward less government, less regulation and more personal responsibility.
I?m also glad to one of the few who have the honor to defend the great man and his legacy.
Eventually, once emotions have died down (and the 8 years of the big government the US hurtling toward have taken their toll), I?m sure people will look back and reassess the Greenspan era.
Until then, Greenspan will still go down as the rarest individual of all: a government employee who does not believe more government the answer to every problem.
Posted by: Mladek | April 8th, 2008 at 10:12 am | Report this comment- Robert McDowell: As a banker who specialises in risk and as an economist, I can say that we don't need, nor should we want, perfect models of risk. But,the lack of models and good analysis has not been a principal cause of the credit crunch; a bigger problem is the deafness with which bankers listen to economists during periods of market euphoria (Greenspan's term). We do need economists to be more involved in building global models that incorporate the role of banking and finance, and more economics awareness among our top bankers. But, banks have genuine problems of considerable complexity to relate their own experience to the underlying economy, so-called.Central banks and economic research groups and departments of universities have not stood idly by, but they do presume that they are read and listened to and understood by bankers, and that bankers have not lost sight of classical banking precepts concerning balancing the funding qualities of assets and liabilities alongside the ever-present concerns that should attend matters of morality, trust, reputation and confidence. There is no doubt that setting risk limits constrains asset growth, and that much of banks' four times higher profitabilty per person employed compared to all other business sectors taken together has been gained by gaming long established risk precepts. In large part this has I suspect been a consequence of too many banking officers being persuaded to take early retirement in the past decade and a half, thereby leaving the field of play to a less corporatively responsible generation of traders and financiers.
Posted by: Robert McDowell, Edinburgh | April 8th, 2008 at 1:42 pm | Report this comment
- Mr. Greenspan's attempt to avoid blame in the current housing/banking crisis reads like a fairy tale.
Mr. Greenspan had a front row seat for the Savings and loan Crisis in the early 1990s. He knews from the S&L Crisis that irrational exuberance in Real Estate leads to a dysfunctional banking system. The remedy Mr. Greenspan offered for every US economic crisis was more and more money. This remedy made him popular with Politicians and a celebrity in the world. He hoped that securitization of mortgages would delay the next Real Estate collapse until after he secured his pension and fame.
Mr. Greenspan spent his life trying to be a celebrity, first as a saxophone player, then as a follower of Ayn Rand, and finally the Federal Reserve offered him the opportunity. One day every American will understand that Alan Greenspan finally became a celebrity by destroying the US Dollar.
Posted by: Mr.Wm. Kelleher | April 8th, 2008 at 4:05 pm | Report this comment- Investments, including home prices, like all other financial prices are cyclical. We all know that. And all cycles have their extremes of mood to make cycles happen over and over and over - it's all about fear and greed. And, we know that as well.
Why the surprise that we have a "financial crises" or "housing crises"?
Actually the markets are not in any crises at all.
Markets, like the pendulum, seek a balance. It's the fund manager, investor, individual homeowner that has the "crises" - simply caught up in the economic play-out of the time.
John McLaughlin, Day Traders - Consultant / Coach
Posted by: John McLaughlin, Day Traders - Consultant / Coach | April 10th, 2008 at 10:01 pm | Report this comment
www.DayTradersWin.com- Martin Wolf: The obvious response to Mr Bayley is that the government has to control the price of money, since it can create it without limit. His answer is: go back to the gold standard. I wish him luck with that argument. We know that faced with the choice between a depression and going off gold, governments will always choose the latter. The argument that we should go back onto gold is as futile, therefore, as the argument that divorce should be abolished. There is little point, other than a purely academic one, in making arguments for something that is never going to happen. The interesting point, after all, is that any country in the world could now go onto gold. Name one that has.
Incidentally, there were plenty of financial crises under gold, too.
Posted by: Martin Wolf | April 11th, 2008 at 10:23 am | Report this comment- Robert McDowell (banking economist): I wish to underscore Martin Wolfe's riposte to Mr Peter Bayley That a return to the Gold Standard is futile. It is, however, normal at times of crisis for people to wish for something solid, some fundament where to conmfidently plant their feet, backs to the wall etc. All commodity or labour theories of value are useless in practise, of interest only for historical philosophical debate.
Governments cannot "print money" unfettered, albeit with exceptions that prove this rule like Weimar Germany or present day Zimbabwe. There is nothing of fundamental value in economies that cannot fall or fail absolutely, except perrhaps life itself, and even that in extremis can become horribly cheapened. Economics has two sides, on the one is cash-flow (income, profit and loss). On the other marketable assets, credit and debt balances. In a liberal capitalist economy every tradable asset has a market price. The relationship between money flows and assets, between flows and stocks, is inevitably highly complex and very sensitive to disruption. Inflation is sometimes simplistically described as too much money chasing too few goods. Far more destructive is too many assets chasing too little money.
In developed economies the flows of transactions can reach over 300 times GDP. It is in these circular flows that financial secondary markets exist turning over annually 30 times world GDP (world wages & salaries plus net profits = $55 trillions). Non-financial sector transactions between all bank accounts are 100-150 times world GDP. Each of all banks' assets or liabilities are one and a half times world GDP and can be recycled many times in a year. Household assets (mainly the value of homes) and business assets are at least seven times world GDP. World GDP is about $10,000 per capita. .
Thus we have an enormous financial churn out of which we measure a relatively very small positive or negative result called GDP growth, the tiny differences of which can be highly disruptive to the living standards of billions of people. Relating the stocks and flows of the world precisely is exceedingly difficult to compute. The small differences we seek to measure fall comfortably within margins of data error. That we can do so at all with some confidence when calculating GDP in double-entry book-keeping is an amazing achievement. But, we have not yet succeeded in establishing robust economic accounting for the stocks as well as the flows and how these influence each other.
Economics, capitalist or otherwise, may be likened to a conjurer keeping many plates spinning in the air and not knowing precisely why it is they do not fall more often.
The present financial crisis, like any recession, exposes the vulnerability of markets and market prices, like the plates balancing impossibly on the end of long sticks just because they are kept spinning.It should be no surprise therefore that Governments intervene with a sense of urgency, to save the plates as soon as they wobble, act first, think about it later, try to do better next time. Banks and other financial institutions are the main conduits between stocks and flows, income and assets, and therefore their regulation is the most important of all in our economic system (other than democratic constraints on the power of governments). These controls have to be conceived and managed by human beings; not blindly delegated to Gold or any other commodity measure of to be hoped unchanging value. No values can be fixed; all are relative.
Insofar as our present financial markets crisis has disrupted the hitherto normal or expected flows of money between banks, even if these same bankers had invented and employed too many credit multipliers such that some circular flows were spinning too fast out of control and too risky, it is because bankers have thought more about how to exploit the financial engineering opportunities on the borderlines between income and assets, and less about their responsibilities to safeguard the system, leaving this job too much solely in the hands of the central banks and regulatory supervisors, and ultimately in the hands of governments.
Basel II regulations when completely embedded will resolve many of these problems, including those we are currently desperately struggling with. A central and most sensible aspect of Basel II is its determination (set out in law backed by clear enforcement powers) to ensure that bankers (and others in financial services) do take full responsibility to care about systemic risk, and do have to understand all the risks that hitherto they left largely in the lap of the gods. Governments and their regulators will retain authority, but bankers will have to accept responsibility and become a lot more expert, and work a lot harder, doing so.
Posted by: Robert McDowell, Edinburgh | April 11th, 2008 at 6:49 pm | Report this commentThe FT Economists' Forum is a discussion among some of the world's top economists. As a general rule we accept comments from invited members only, but submissions from others will also be considered.
No remorse for letting the party get out of hand?
Published: March 18 2008 02:00 | Last updated: March 18 2008 02:00
From Mr A. Edward Gottesman.Sir, Alan Greenspan, a sponsor of two of the most wrenching financial crises since the second world war, continues to talk in Delphic phrases about "negative correlations between tradeable assets" and "an elaborate macroeconomic model" ("We will never have a perfect model of risk", March 17). But he gives the game away when he notes that, after a 60 per cent fall in new housing starts since early 2006, supply has only recently fallen below demand for single-family homes in the US. Surely, any classical economist could have recognised an unsustainable asset boom when supply exceeded demand by 250 per cent and prices continued to rise. Was that not a clear sign that money was far too cheap?
The central banker's job description is to "take away the punchbowl" before the party gets out of hand. Is a small sign of remorse too much to ask?
A. Edward Gottesman,
Gottesman Jones & Partners LLP,
London EC4M 7HW
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NYTimes.com
To be sure, callow and inexperienced youths were far from the only ones who extrapolated from recent data to find theories of a new economy believable. Alan Greenspan was 74 and had been chairman of the Federal Reserve board for 12 years when, on April 5, 2000, he embraced the new economy and pointed to profit forecasts by Wall Street analysts as a reason to expect the tech boom to continue.
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economistsview.typepad.com
Saving Resources to Save Growth, by Jeffrey D. Sachs, Project Syndicate: Reconciling global economic growth, especially in developing countries, with the intensifying constraints on global supplies of energy, food, land, and water is the great question of our time. Commodity prices are soaring worldwide ... because increased demand is pushing up against limited global supplies. Worldwide economic growth is already slowing under the pressures...
A new global growth strategy is needed to maintain global economic progress. The basic issue is that the world economy is now so large that it is hitting against limits never before experienced. There are 6.7 billion people, and the population continues to rise by around 75 million per year, notably in the world's poorest countries. ...
Many free-market ideologues ridicule the idea that natural resource constraints will now cause a significant slowdown in global growth. They say that fears of "running out of resources," notably food and energy, have been with us for 200 years, and we never succumbed. Indeed, output has continued to rise much faster than population.
This view has some truth. Better technologies have allowed the world economy to continue to grow despite tough resource constraints in the past. But simplistic free-market optimism is misplaced for at least four reasons.
First, history has already shown how resource constraints can hinder global economic growth. After the upward jump in energy prices in 1973, annual global growth fell from roughly 5% between 1960 and 1973 to around 3% between 1973 and 1989.
Second, the world economy is vastly larger than in the past, so that demand for key commodities and energy inputs is also vastly larger.
Third, we have already used up many of the low-cost options that were once available. Low-cost oil is rapidly being depleted. The same is true for ground water. Land is also increasingly scarce.
Finally, our past technological triumphs did not actually conserve natural resources, but instead enabled humanity to mine and use these resources at a lower overall cost, thereby hastening their depletion.
Looking ahead, the world economy will need to introduce alternative technologies that conserve energy, water, and land, or that enable us to use new forms of renewable energy (such as solar and wind power) at much lower cost than today. ...
Yet investments in new resource-saving technologies are not being made at a sufficient scale, because market signals don't give the right incentives, and because governments are not yet cooperating adequately to develop and spread their use.
If we continue on our current course leaving fate to the markets, and leaving governments to compete with each other over scarce oil and food global growth will slow under the pressures of resource constraints. But if the world cooperates on the research, development, demonstration, and diffusion of resource-saving technologies and renewable energy sources, we will be able to continue to achieve rapid economic progress.
A good place to start would ... the climate-change negotiations... The rich world should commit to financing a massive program of technology development renewable energy, fuel-efficient cars, and green buildings and to a program of technology transfer to developing countries. Such a commitment would also give crucial confidence to poor countries that climate-change control will not become a barrier to long-term economic development.
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There is no doubt that talk of a bailout of Fannie Mae and Freddie Mac has spurred what could be a short-lived spike. Still, it makes you wonder if the market is starting to price in what many say is inevitable after years of profligacy and failed policies: a credit downgrade for the United States.
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Jul 1, 2008 | The Mess That Greenspan Made
This morning's Ahead of the Tape column($) in the Wall Street Journal trots out the same old tired axiom about recent Federal Reserve policy as it relates to financial instability and rising prices, particularly rising oil prices - the old "fireman" metaphor.Like many others, the "fireman as arsonist" model always seemed to make more sense to me.
Follow the logic, if you will...
With the prospect of a world-wide meltdown in banking and credit during an era of rising prices that show up everywhere but in the government's inflation statistics, faced with the choice of saving the global financial system by creating even more money and credit OR reducing the amount of money and credit pumping through its veins in order to contain rising prices, the Bernanke Fed is said to have chosen the lesser of two evils by selecting the former.
In fact, since the credit crisis began almost one year ago, the idea of central banks "tolerating more inflation", erring on the side of more money and credit creation to ensure stability, has become almost conventional wisdom.
And so it was again this morning:
As seen in the Fed Funds vs. Crude Oil graphic above, clearly that hasn't been water coming out of Ben Bernanke's fireman's hose.In a sense, the Fed's decisions of the past few months were easy ones. Inflation worries never went away, but when the house is on fire, nobody complains to the firemen about water damage.
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Actually, I hope it is, or becomes that. Because IMO it is the only way there is a chance that Americans will be made to see the folly of a FIRE-based economy, with its illusion of prosperity.
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Telegraph
Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. "This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility," said Mr [Tim] Bond.
... ... ...
David Woo, the bank's currency chief, said the Fed's policy of benign neglect towards the dollar had been stymied by oil, which is now eating deep into the country's standard of living. "The world has changed all of a sudden. The market is going to push the Fed into a tightening stance," he said.
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nakedcapitalism.com
Remarkably, a post at VoxEU, "The dangers of increased transparency in monetary policymaking," by Ellen Meade and David Stasavage suggest in that one of the effects of the Fed's change in 1993 to publish the minutes of FOMC meetings was less candid discussion (no surprise) which led to greater Greenspan influence over interest rate policy, which then led to the looser monetary policy that the former Fed chief favored:
Analysis of FOMC transcripts before and after Committee members knew that they would be published shows how transparency deadened the debate and reduced the number of challenges to Greenspan's position...The post notes that Greenspan preferred closed-door discussions:Economists have argued that greater transparency is beneficial....But greater transparency of central bank policymaking in which committee deliberations are made more open to the public may prevent the full and frank discussion needed to make the best decisions. In a recent paper (Meade and Stasavage 2008), we compare discussions of the Fed's Federal Open Market Committee (FOMC) before and after committee members knew that all statements would eventually be made public. Our empirical results indicate that after 1993, when FOMC participants knew that their deliberations would be made public, they were less likely to challenge then Fed chairman Alan Greenspan. This suggests that greater transparency hindered free deliberation and may have permitted Greenspan's views on interest rates to dominate US policymaking....
Over the time period that we examine (1989-1997), Chairman Greenspan presented his proposal for the setting of the policy interest rate first and then solicited other meeting participants for their views. After all the participants had expressed their opinions, an official vote was taken on the policy proposal. We focus our analysis on the willingness of the meeting participants to express verbal disagreement with Greenspan's proposed policy before and after 1993.
The empirical results provide clear evidence of a change in the character of FOMC deliberations policymakers were less likely to express verbal disagreement with Greenspan's proposal after 1993. This remains the case even after other potential influences on officials' views, such as a variety of measures of the current economic environment as well as Fed forecasts for inflation, are taken into account.
In Congressional testimony, Alan Greenspan argued against publication, saying that the FOMC "could not function effectively if participants had to be concerned that their half-thought-through, but nonetheless potentially valuable, notions would soon be made public" even with a publication lag of five years. Greenspan noted further that the character of the meetings would change with transcript publication, from lively, useful sessions to bland, sterile ones.A fair bit of research on decision processes has found that groups of experts generally develop better estimates and solutions than individuals. Yet it appears that the need for more openness in Federal Reserve decision making undermined the ability of a high-level group to work through information and come to better answers.
- Comments:
- Doug said...
- Transparency in process leads to less transparency in problem solving because key players keep their real thoughts to themselves. This pattern repeats itself throughout government. For first-hand experience, simply attend your next local town council meeting.
- June 26, 2008 7:47 AM
- S said...
- two words: animal farm. One more: academia
Peripheral Visionary said...
- Interesting point. It validates what I've already discovered in working for the government: that, contrary to popular sentiment, there are very good reasons to have certain specific decision-making processes be less transparent. Interesting that people can see this with client-attorney privilege, but don't always understand the concept when it's other governmental processes.
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globaleconomicanalysis.blogspot.com
Notice Who Takes The Hit
Notice how the typical culprits Citigroup (C), Merrill Lynch (MER), and UBS (UBS) are poised to take the hit. All it takes is reality to set in and for a termination clause to kick in if the companies are insolvent. Is there any doubt that they are? So what's holding up the New York State Insurance Department from making that determination? Here's the answer: $400 billion of derivative contracts are on the line. The odds of a derivatives cascade event over this is not insignificant.
Just one more thing: Anyone remember Greenspan's comment on derivatives? I discussed the answer in The Fed And The Henhouse.
Greenspan May 5th 2005: "Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth."
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nakedcapitalism.com
This week's Institutional Risk Analytics has an alarming title: "Is Risk Management Even Possible in an OTC Marketplace?" By all indications, the article points to a strong "no".
As much as I am a harsh critic of so-called financial innovation, the headline goes further than the case the article makes. OTC markets covers a large territory. The Treasury, corporate, and agency bond markets are OTC. Because those instruments are offered publicly (ie, the size and terms of each issue are known) and the valuation process for these securities is pretty straightforward, the potential for trading in them to cause a large scale problem is no greater than in other simple products (remember, it's possible to create disasters via simple operator error, such as believing as Walter Wriston did, that countries don't go bankrupt).
Even in derivatives-land, some products are sufficiently straightforward, such as simple ("plain vanilla") interest rate and currency swaps, as to not pose undue risks if properly managed. But the problem is that financial firms have come to have high return requirements, and these simple products aren't very lucrative (indeed, some are marginally profitable but the dealers stay in the market because most large players prefer institutions that make markets in the full range of financial products).
A general pattern in the last 15+ years is that large financial firms have take on more and more risk in order to keep their returns high and their profits growing. Some of that is via leverage, some of that is via launching or expanding the market for new products (think CDS and CDOs), some of it is by taking risks they shunned before (think of leveraged loans).
I've only excerpted some bits of this article, but in case you decide to read it in its entirety (which I do recommend), I wanted to address some quotes that give a misleading impression. One is at the start of the article:
OTC derivatives had been legally permitted for the first time in 1993 by a regulatory exemption that Wendy Gramm had adopted as virtually her last act as CFTC chair.That's not correct. OTC equity options and FX options had been around well before 1990. Swiss Bank formed a joint venture, which was a precursor to a full buyout, of O'Connor & Associates, a Chicago-based derivatives trading firm. The reason for the deal was O'Connor's leadership in OTC equity and FX options. Um, those are derivatives, and regulated by the CBOE, which is a self-regulatory organization under the supervision of the SEC. Bankers Trust was another big player in those markets back then. I hate to sound pedantic, but it makes me crazy when people make definitive statements that are just plain wrong.Putting this quibble aside, the article has a very good section on how the FDIC is gearing up for a big increase in bank failures. The rest of the article focuses on the problems posed by OTC markets. Some excerpts:
One veteran federal regulator, who provided comments on our upcoming article for the Journal of Structured Finance, put to rest some of our fears that Washington is clueless about the nature of the OTC problem....:Regulator: You suggest in your article that the issues raised by OTC markets have not been discussed within the regulatory community, but in fact it has and is being discussed intensively. Whether or not the OTC market needs to be officially "regulated" seems debatable, especially since regulators do not have the legal authority to enforce such a change.The IRA: So the US and other nations must simply accept the fact that OTC markets are here to stay and that these inefficient markets will periodically destroy a large financial institution? That seems like a recipe for disaster, financially and politically.
Regulator: Part of the problem is cultural. Today we think that all markets are at a minimum weak form efficient. The Efficient Market Hypothesis is taught as gospel. The underlying assumptions of modern economic thought -- ready prices, informational symmetry, and rational expectations -- are all suspect and have been for a long time. We tend to view economics and modeling as a science governed by laws similar to the laws of nature. We believe that markets can be confined to probability spaces we understand and can reasonably estimate. This is not true.
The IRA: So you agree with our view that risk management of OTC markets is essentially impossible? Or does your statement apply to all financial markets?
Regulator: The reality is that economics is a social science and the attempts to make it "hard" are always going to run aground on the reality that human actions don't follow the "simple" laws of nature; they learn, adapt, herd, swarm, fall prey to trends, forget, remember, forget again - and in a semi-rational and sometimes irrational manner. The probability spaces are impacted by things traditional theory freely jettisons in order to make the model tractable. Therefore, risk models, upon which so much of the OTC market rests, are simply a way to communicate and express views of value -- usually rather naive and simplistic views -- and miss huge chunks of the real underlying "human action" risks.
The IRA: Ludwig von Mises, the author of Human Action, would be pleased to hear your comments. So, again, you agree with our view that most alleged "risk management" systems deployed on Wall Street are really just tools used to do deals and have no real capacity to measure let alone limit risk?
Regulator: The risk and pricing models are often created in order to convince traders and end-user investors that all these financial transactions -- behind which are human behaviors and cash flows -- are "manageable" and can be properly understood with the right analytics, data and "secret sauce." This witchcraft and sorcery can turn a toad into a prince, a rotten apple into a juicy melon. But it's all spurious precision. It's all vaporware. The models are used to create liquidity, which spurs volume, which garners big commissions and large EPS for dealers. The senior managers know that the models and assumptions upon which the higher spread product is based for things like OTC complex instruments are garbage, but you need a "basis" upon which to talk and compare so you can drive business. This charade works 90% of the time when things are calm, but as Hynman Minsky wrote in 1980 "stability is ultimately destabilizing." When risk regimes change, those who don't "know" these truisms find themselves naked.
We then spoke to Bob Feinberg, our favorite observer of financial services policy on Capitol Hill, about the state of the banking industry and congressional efforts to address the subprime financial meltdown....Feinberg: At the last CMRE event that Elizabeth Currier allowed you and I to attend, which was in 2004, Larry Kudlow called for monetary reflation in order to make the economy look healthy so George W. Bush could be re-elected. It's happening again this year on behalf of all incumbents. The late Bob Weintraub called this the presidential cycle. It doesn't always work. In 1992, Greenspan didn't accommodate "41" (aka George H.W. Bush), and for a time there was doubt as to Greenspan's reappointment because 41 blamed Greenspan for his defeat. Fighting deflation becomes the Fed's excuse for pre-election monetary expansion, even if there is no deflation in sight. The way Greenspan put it in 2004 was that deflation was a low-probability, high-value event that must be staved off, just to be safe.The IRA: But is it even possible to reflate the US economy when the financial industry is in such a terrible state?
Feinberg: I stand by my previous view about the model being broken, but I don't think people realize that this can't be fixed, that industries have life cycles, and the banking industry is about a half century past its best-if-used-by date. Greenspan once said to the Senate Banking Committee that some people would say that the only thing banks do is live off the yield curve. Whenever that model isn't available, they have to resort to extremely risky gambits to try to earn the returns Wall Street demands. It's a 19th century business model that got an extension thanks to the ability to arbitrage securities, but once they actually try to create new products, these instruments must be risky and opaque. So they've ended up as GSEs, CDOs and CDEs (Capital-Destroying Entities). Another acronym is the Disaster-Prone Organization (DPO), an expression coined by Prof. Anthony F.C. Sutton in his book, St. Clair, in which he laid out the reasons for the failure of the coal industry, which was just as powerful in its day as the banks are now.
The IRA: So you see the US banking industry going the way of king coal? Obviously the neither the Fed nor the Congress is willing to admit that a big constituency like the banking industry is moribund.
Feinberg: The bottom line is that the system is broken and can't be fixed. The reason the banks keep coming up with opaque products is that they're trying to de-commoditize a business that is mature and adds little or no value to the economy. In fact, over time and on net, the banking system destroys value. I wonder what song and dance the geniuses at Treasury are going to come up with next to justify buying worthless CDOs in the name of "reliquefying the market." I'm fascinated by the application of Gresham's Law to this situation; that bad collateral is manifestly driving out the good. I even read that banks are making bad loans in order to create some bad collateral, because the Fed will buy it.
The IRA: I take it that you do not expect the Congress to propose significant reforms of market structure?
Feinberg: After LTCM, the President's Working Group did a report and found that the financial system was just fine. After Amaranth, I think, some congressional committee(s), certainly Senate Banking, asked the PWG to go back and take a look at what they said in 1998, and PWG came back and said it had nothing to add. They asserted that the opaque market for derivatives could best be monitored by the banking regulators. I think this assertion needs to be rethought given what's happened with Bear and LEH..
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Today in the Financial Times, John Plender has an apple pie and motherhood column on the importance of central bank independence, It's a tad ironic, since he fails to recognize that it's an illusion in the US. But Plender isn't to be faulted. An entire generation has grown up in the Greenspan/Bernanke era, and thus has no idea of what an independent central bank in the US would look like. As the article demonstrates, Plender's view is widely shared:There are few things on which economists are in total agreement. But practitioners of the dismal science come pretty close on the issue of independent central banking. Most see the move to hand operational control of monetary policy to central banking technocrats as having provided vital underpinning for the recent long period of low inflation and stable growth. Yet the independence of the world's leading central banks is increasingly under threat...Former Federal Reserve economist Richard Alford takes issue with that view. Alford has criticized the Fed's recent policies (see here for an interview that was very popular with readers) and has gone digging deeper to find its roots.As yet, the US Federal Reserve's position looks less vulnerable. But Paul McCulley of Pimco, the bond fund manager, believes that the game has changed since the Bear Stearns rescue. This, he argues, was a fiscal policy action little different from the role of Congress in bailing out Chrysler. Having watched the Fed conduct a multibillion-dollar bail-out of an investment bank that it did not supervise, the politicians may now apply pressure for the central bank to firefight elsewhere.
That is not to say the Fed's operational independence in setting interest rates will be impaired. Mr McCulley's point is rather that the Fed will be less independent in regulatory matters, as well in as the size and composition of its balance sheet.
The biggest threat to independence, though, could simply come from a failure to keep the lid on inflation. There are signs on both sides of the Atlantic that monetary policymakers have been slow to recognise the extent of the current inflationary threat.
Alford was so kind as to share with me an article he is developing. It's a bit too long to post in full, so let me give the broad strokes followed by the concluding section.
Few have any memory of America's central bank having a openly contentious relationship with the Treasury and Congress. Even though Paul Volcker had to withstand considerable pressure, some of his predecessors fought open turf wars. Yet from the end of World War II to the (sadly) supine Arthur Burns era, there were not infrequent pitched battles with the Fed with incidents that would seem unthinkable now. For example, Truman summoned the FOMC to pressure them into a more accommodative policy during the Korean War, then issued a White House press release claiming the Fed had made a commitment that it had not agreed to. The Fed played hardball, leaking its version of the meeting, which contradicted the press release. That led Congress to join the fray, trying to bring the Fed to heel via sharply critical hearings.
While Volker did endure widespread criticism and harangues from Congress, even for those who lived through that era. the memories of the ritual roughings up are dim. In addition, there was at least initial support for his harsh measures. Moreover, (unbeknownst to me) Volcker was masterful at defanging Congress long enough for his remedies to take hold. Had someone less adept been at the helm, a firefight might well have ensued.
I do hope Alford's thesis reaches a broader audience. From Alford:
This most recent period is the trickiest to come to grips with. There has been no sustained acceleration in the rate of inflation. The FOMC wasn't called to the White House. No Chairman was denied reappointment. The semi-annual Congressional kerfuffle over monetary policy became a tea party.However, there are reasons to look beneath the tranquil surface. Inflation in the latter part of the period was by one estimate 50-100 basis points lower than it would have been had it not been for globalization and imported disinflation. Furthermore, while measured inflation remained low and relatively stable, there were two significant asset bubbles, the trade deficit reached 6% of GDP, and the personal saving rate fell to 0.0%. Hence the question remains -- did the Fed promote short-term gains and high employment with low inflation, at the expense of long-term problems engendering unsustainable financial and external imbalances?
With respect to the housing bubble, the Fed asserts its innocence. It says that monetary policy was appropriate. It also takes the position that while, ex post, it is clear that supervision and regulation was too lax, no one saw the housing and credit bubble forming. Consequently, they cannot be blamed. There are problems with these defenses.
The assertion that the stance of monetary policy was appropriate given the measured inflation rate just assumes away the problem. If policy contributed to the bubble, then it was inappropriate regardless of the inflation rate. Contrary to the Fed position, people did see the housing and credit bubbles forming, although they were in the minority. Most importantly, the Fed as the central bank and the principle banking regulator alone had the responsibility of forestalling systemic risks. Even if no one else saw the bubble forming, the Fed should have. Saying no one else saw the crisis brewing is no defense.
Since the first Latin American debt crisis, we have had a Fed that has been eager to lean against financial headwinds, but completely unwilling to take in sail when dealing with strong financial tail winds. The Fed did not the lean against either the NASDAQ or housing bubbles. Greenspan acknowledged that the NASDAQ might be a bubble, but decided it was appropriate to wait until the bubble popped and then mop up. Post 2000, the Fed denied the existence of a housing bubble. It ignored the declining credit standards, increased leverage, declining quality spreads and a Fed funds target below that implied by the Taylor Rule. The Fed then chose to characterize the bubble as localized froth even after it started to deflate. It then asserted that it was a contained sub-prime problem.
We have a Fed that is willing to incur short-term costs if it reduces inflation, but will not incur short-term costs to achieve financial stability or external balance. This would be less of a problem if another agency or agencies had the willingness and ability to insure financial and external balance, but it is clear that we do not. The Fed was granted independence and insulated from political pressure in order to accept short-term costs in order to enhance the prospects for long term growth. However, the current Fed, like the Fed of the 1970s, failed to use the freedom it was granted.
Assuming for the moment that the Fed either made an error of commission (spiking the punch bowl) or omission (failure to exercise its regulatory and supervisory powers), is there any reason to believe it was the result of an erosion of the independence of the Fed? Unfortunately, the public record suggests that Fed independence has been compromised. There is reason to believe that Greenspan entered into deals with two of the three administrations during his tenure as Chairman. Some commentators believe that he entered into deals with all three. However, the number is unimportant. What is important is that the Fed's independence was compromised and a very public precedent was set. Never again will an FOMC Chairman be able to say "The Fed does not make deals" to a President or a Secretary of the Treasury or a member of Congress.
Compare the behavior of the Chairmen of the 1950s and Volcker to that of Greenspan. Chairman Eccles and McCabe both lost their Chairmanships because they wouldn't compromise Fed independence. They stood their ground even after being summoned to the White House. Martin, appointed by Truman, was in later life referred to by Truman as "the traitor" presumably for taking the punch bowl away. The public image of Volcker is that of a man who twice a year endured public Congressional assaults, resisted political pressure, and enabled the Fed to stay the course.
Greenspan, on the other hand, jumped at the chance to meet Clinton, traveling to Little Rock before the inauguration. Bob Woodward in his book "Maestro" quotes Clinton telling Gore after the pre-inauguration meeting: "We can do business." Woodward also quotes Secretary of the Treasury Bentsen telling Clinton that they had effectively reached a "gentleman's agreement" with Greenspan. The agreement evidently involved Greenspan's support for budget deficit reduction financed in part by tax increases. It is not clear what Greenspan received.
Even if the deal with Clinton contributed to a good policy mix, Greenspan should never have entered into that agreement/deal/understanding or another agreement/deal/understanding. The very act of negotiating and injecting the Fed into a discussion of budget decisions compromised Fed independence. Why shouldn't Bush have expected the same? Why shouldn't every succeeding President expect the Fed Chairman to be a "business" partner? Refusal to deal on the part of the Fed can no longer be attributed to principle and precedent. Refusal " to do business" will now be viewed as a rejection, partisan or otherwise. The Fed is no longer able to stand apart from political battles. Greenspan severely compromised the Fed standing as an agency insulated from the short-sighted and partisan politics of Washington DC.
Greenspan risked the NASDAQ bubble during the Clinton years (part of the quo for the quid?) and more recently implicitly accepted the risk of a housing bubble as he touted ARMs as the Bush Administration and Congress promoted the ownership society. Financial innovation was lauded while it produced short-term gains. The Fed failed to adequately pursue its regulatory responsibilities as it kept rates low, despite the relatively high levels of leverage, derivatives markets that dwarfed the underlying cash markets, breakdowns in lending standards and credit spreads that even it didn't think compensated for the risks. Like Greenspan, the current Fed implicitly decided to risk long term stability rather than incur short-term costs. With globalization holding down measured inflation, it seems that no risk was not worth taking.
After failing to use the independence granted to it by statute, the Fed is now pushing the bounds of its legal authority. It is making decisions that might better be reserved for elected officials. It argues that these steps are necessary, but the Fed is being drawn into the micro management of credit allocation and income re-distribution -- a far cry from "inflation targeting". The Fed is willingly injecting itself into areas that are the provenance of the Congress. Congress has not objected yet, but it will when it is to Congress's advantage. Will it have costs? How does monetary policy designed by the people responsible for the tax code, fiscal deficit and Federal debt sound?
Greenspan had very considerable political skills, but he did not use them to maintain Fed independence or insulate the Fed as it took policy steps that imposed short-term costs. He curried political favor and opined on issues other than monetary policy. There is no evidence that Bernanke made a deal. Bernanke also made it clear that unlike Greenspan he would refrain from commenting on issues other than monetary policy, but there is evidence that it was too late and that the Fed is "in play". Recent behavior, first by the Administration and now by the Senate, indicates that positions on the Board of Governors are to be treated as patronage jobs doled out to party loyalists. The qualifications of a recent appointment look to be entirely political. Dodd's refusal to consider confirming any appointments until after the next election is just as egregious, especially when one considers the depleted Board, soon to be down to three (2 if one assumes that Bernanke will retire when he isn't reappointed Chairman.), and the challenges facing the Fed.
I am reminded of a Thomas Nast political cartoon from the 1870s. It features a banner across the Capitol building that reads:
"To the victors belong the spoils. We must spoil everything."
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Economist's View
robertdfeinman says...
Slightly off topic, but this thread doesn't seem to be getting much traffic as yet so...
There has been some criticism of the Fed as an institution. Critics feel that it represents the interests of the banking community over the general public. This is reinforced by the quasi-private nature of its governance structure.
In addition there has been a chronic problem of keeping members on the board of governors for their full terms, leaving the board open to claims of political partisanship. There was question about the frequent trips of Alan Greenspan to the Whitehouse during his tenure and whether he was getting or giving advice from the various presidents.
Finally, there is some issue over whether the enabling legislation created a conflict of interest in that the Fed is supposed to promote employment and business expansion at the same time. Most people think that this implies worrying about inflation excessively and thus making decisions which favor one aim over the other. The critics tend to think the labor goals always get the short end of the stick.
Perhaps after nearly a century it is time to open a discussion on the role of a central monetary authority. There are many more types of money now and many new types of financial organizations which were not in existence when the Fed was established. In addition the world financial community is much bigger and more fluid and there are many more sources of wealth and investment than at the time. Even the dropping of the gold standard was not considered when the Fed was created.
If the US were to redesign a new monetary authority what might it look like? Does the concept of a central "bank" even make sense anymore when most financial flows don't involve banks? Should this authority be totally independent of the industries it regulates and/or should the managers be public officials, appointed by the government or via some other mechanism? What should the mandated goals of this authority be?
Could expanded powers of the Treasury, SEC and existing bank regulators such as the Controller of the Currency make the regulation tasks of the Fed unnecessary? It could then be restricted to controlling the money supply through a more limited range of options. Or perhaps the reverse would be better and its powers should be expanded so that there is less overlapping authority than at present.
Over the past 20 years a lot of ink has been spilled on how the Fed is doing and not on how it should be doing it. To my mind this usually means that the axioms need re-examination.
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Mish's Global Economic Trend Analysis
Myth Of The Savings Glut
The above chat perpetuates the myth proposed by Bernanke that some sort of "savings glut" was responsible for the housing boom. This is of course complete nonsense. It is impossible to have "too much savings". Furthermore, much of that proposed "savings" is in reality Chinese printing presses running like mad, selling Yuan (Renmimbi) to buy dollars. This suppressed the value of the Yuan, kept Chinese exports flowing and allowed China to maintain its currency peg. These policies are also causing the Chinese economy to overheat, and a significant factor behind the rise in commodity prices.
For more on these ideas, please see Bernanke Blames Saving Glut For Housing Bubble.
Article Excerpts Point To Damning Indictment Of The Fed
Attitudes and policies by the Fed and the treasury department are what fueled this boom, no matter what Greenspan and Bernanke say to contrary. There are some damning quotes from the article and those are what I will focus on.
May 19, 2000
Treasury undersecretary Gary Gensler says subprime loans are "a good option when the alternative is no access to credit".This has been proven wrong in spades.
Part 1 Boom Excerpts
Greenspan: "I looked at the [subprime] numbers . . . and said, 'Where did they get these numbers from?' "September 2001
The government's efforts to counter the pain of [terrorist attacks and the dotcom] bust pumped air into the next bubble: housing. The Bush administration pushed two big tax cuts, and the Federal Reserve, led by Alan Greenspan, slashed interest rates to spur lending and spending.
Low rates kicked the housing market into high gear. Construction of new homes jumped 6 percent in 2002, and prices climbed. By that November, Greenspan noted the trend, telling a private meeting of Fed officials that "our extraordinary housing boom . . . financed by very large increases in mortgage debt, cannot continue indefinitely into the future," according to a transcript.
The Fed nonetheless kept to its goal of encouraging lending and in June 2003 slashed its key rate to its lowest level ever -- 1 percent -- and let it sit there for a year. "Lower interest rates will stimulate demand for anything you want to borrow -- housing included," said Fed scholar John Taylor, an economics professor at Stanford University.
The average rate on a 30-year-fixed mortgage fell to 5.8 percent in 2003, the lowest since at least the 1960s. Greenspan boasted to Congress that "the Federal Reserve's commitment to foster sustainable growth" was helping to fuel the economy, and he noted that homeownership was growing.
There was something very new about this particular housing boom. Much of it was driven by loans made to a new category of borrowers -- those with little savings, modest income or checkered credit histories. Such people did not qualify for the best interest rates; the riskiest of these borrowers were known as "subprime." With interest rates falling nationwide, most subprime loans gave borrowers a low "teaser" rate for the first two or three years, with the monthly payments ballooning after that.
Government-chartered mortgage companies Fannie Mae and Freddie Mac, encouraged by the Bush administration to expand homeownership, also bought more pools of subprime loans.
One member of the Fed watched the developments with increasing trepidation: Edward Gramlich, a former University of Michigan economist who had been nominated to the central bank by President Bill Clinton. Gramlich would later call subprime lending "a great national experiment" in expanding homeownership.
In 2003, Gramlich invited a Chicago housing advocate for a private lunch in his Washington office. Bruce Gottschall, a 30-year industry veteran, took the opportunity to pull out a map of Chicago, showing the Fed governor which communities had been exposed to large numbers of subprime loans. Homes were going into foreclosure. Gottschall said the Fed governor already "seemed to know some of the underlying problems."
Jan. 31, 2006.
Greenspan, widely celebrated for steering the economy through multiple shocks for more than 18 years, steps down from his post as Fed chairman.
Greenspan puzzled over one piece of data a Fed employee showed him in his final weeks. A trade publication reported that subprime mortgages had ballooned to 20 percent of all loans, triple the level of a few years earlier.
"I looked at the numbers . . . and said, 'Where did they get these numbers from?' "
Greenspan said he did not recall whether he mentioned the dramatic growth in subprime loans to his successor, Ben S. Bernanke.
Bernanke, a reserved Princeton University economist unaccustomed to the national spotlight, came in to the job wanting to reduce the role of the Fed chairman as an outsized personality the way Greenspan had been. Two weeks into the job, Bernanke testified before Congress that it was a "positive" that the nation's homeownership rate had reached nearly 70 percent, in part because of subprime loans.
Bernanke: Two weeks into the job, Bernanke testified before Congress that it was a "positive" that the nation's homeownership rate had reached nearly 70 percent, in part because of subprime loans.
Since then Bernanke has reversed course and is now blaming the "savings glut" for the housing bubble. Greenspan, in interviews is blaming the fall of the Berlin Wall while backtracking on his endorsement of ARMs and derivatives.
Neither is willing to say what is obvious to the entire rest of the world: The Fed, in a foolish attempt to bail out its banking buddies from bad dotcom and foreign loans, took a mildly bad situation and made an international disaster out of it.
Indeed, Fed actions in 2001-2004 have brought about the very deflationistic conditions they sought to prevent. Now, in accordance with the Fed Uncertainty Principle, the Fed is seeking additional powers instead of being disbanded entirely.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Jun 25, 2008 | The Big Picture
Greenspan's touting of ARMs in 2004, with Fed Funds pegged at 1%, was either evil or stupid. I strongly suspect the latter, as Greenspan was and is a mediocre economist. But that don't mean he shouldn't hang for ruining the lives of millions.
... ... ...
Way to weasel out, for some of those on the political right.Cronyism and incompetence is bipartisan, but the hostility to proper regulation and competent regulators is partisan. In between gutting the regulations and regulators and then "tort reform"... Seriously, which party's administrations and judicial appointees undermine whistle-blower protections?
Why did Greenspan and friends allow this to go on so blatantly? Could it be because they were so set against wage inflation that they had to invent a way for wage earners to afford housing? Until we see the motivation, we won't find the cure.
People want to try to pin blame on one major cause of this fiasco...usually, I would shy away from that. But when someone goes by the name "Maestro" they need to be held to a higher authority. You can absolutely pin most of this on Greenspan...he provided the motive through moral hazard (the Greenspan put)...he provided the gun (money growth since 1990s) and looked the other way by not using his powers to regulate lenders given in 1994. he egged it on by saying more borrowers should take ARMs. And he was the boss. Who else needs to be blamed? Mozilo was a low level hack compared to the Maestro.
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Whammer -People who are furious with Bush see this debacle as, primarily, an abject failure of regulation.
The day to day, nitty gritty work of regulation is conducted by career professionals, many of whom are extremely competent and dedicated to what they do. These professionals work in bureaus that report up to the department and department secretaries who are appointed by the President and often serve on the Cabinet.
For 8 years we've had an administration that has been ideologically hostile to governing, has refused to regulate in favor of the unfettered free market, has appointed department heads based on cronyism rather than ability, has under-funded regulatory agencies and has politicized appointments, promotions and retention to a degree unseen before.
For examples see Brownie of FEMA, layoffs of OTS regulators, the politicization of the Justice Department (see commentary by Jeffrey Toobin), and Paul Krugman: http://krugman.blogs.nytimes.com/2008/07/13/look-whos-talking/
For results of this approach to governing see the financial crisis, the environmental record, increased food poisoning incidents, increased near misses at airports, etc.
My question is: at what point is an ideologically driven, tragically wrong bet on governance so destructive that it goes beyond "OOPS, guess we got it wrong."
To me, the people who deliberately looked the other way while the economy of the richest country in history was being systematically looted have committed treason.
In Russia it was called kleptocracy: rule by thieves.
After 9/11 Bin Laden said that one of his goals was to bring down the U.S. economy. Now that this unholy alliance between Washington and Wall Street has caused so much more economic damage than he was able to, shouldn't the people involved be identified and punished for what they are: enemies of the state?
Seems fair to me.
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There's been so much fraud the past few years that we can spend our way out of recession just by hiring enough prosecutors and building enough prisons to put all these MF-ers away for years.A pleasant fantasy, but few of these folks will ever see the inside of a jail.
If an American is robbed by a man in the street of $100, he will want the thief put away for decades. If he is robbed of $20,000 of his tax dollars by a community of wealthy, respectable men, it is simply not a problem.
Most Americans would never put a real thief in jail because they hope to be thieves themselves someday. Actually, Americans admire the thieves, even when they themselves are the thieves' victims.
So much for "pitchforks" and "torches.
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Asia Times
Amongst the worst tragedies of Soviet collectivization was the Ukraine famine of 1932-33, which took six million lives as Joseph Stalin practiced forced appropriation of crops and imposed very low prices for agricultural products in favor of industrialization. Interference with the pricing mechanism and Stalinism in the form of very low prices for agricultural products also caused famines in India in 1965 and in China in 1969, with a human death toll well into the millions.
Monetary policy as practiced by the US Federal Reserve for the past decade is but a form of financial Stalinism, forcing ridiculously low or negative real interest rates, with catastrophic results that are now plaguing the world. Fed policy has disabled the price mechanism in capital markets and set off uncontrolled credit expansion at the expense of capital productivity and> creditworthiness, pushing housing, food, and energy prices to prohibitive levels, and triggering food and energy riots in vulnerable countries. It has undermined the dollar and made the US highly dependent on foreign financing.
The dramatic consequences of Fed policy are unfolding before our very eyes. The financial crisis that broke out in August 2007 has recently taken a turn for the worse. After claiming international and well-established banks and investment banks, it has now reduced the financial savings of ordinary Americans (in retirement accounts) by over 30%.
The fiscal bill for past, ongoing and future bailouts by Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson will be staggering; the US fiscal deficit will be blown up to unthinkable proportions, public debt will be pushed to unprecedented levels, and most public resources will be destined to absorb financial losses at the expense of social and economic programs.
Last, but not least, the long-term inflationary consequences may turn out to be even more dramatic. All these consequences are real and were in part predictable.
So far Bernanke and Paulson have failed miserably in stemming the financial crisis and have brought the US economy to a standstill, in part because Bernanke does not have a feel for the free-market mechanism and in part because he is not a prudent central banker.
It would appear that Bernanke has read a great deal about the Great Depression of 1929-1933 and perhaps very little, or nothing, about the German hyperinflation of 1920-1923. His view is that the Fed was liquidationist of banking institutions during 1929-33. In his view, if the Fed had injected sufficient liquidity during 1929-1932, it would have precluded thousands of bank failures. Therefore, Bernanke is determined not to let that mistake happen again. Consequently, his response to the financial crisis has been a blind and aggressive monetary policy in form of negative interest rates, massive liquidity injection, and massive bailouts.
Bernanke is like the medical doctor who is familiar with one drug, and who prescribes it to every patient he sees at full dose without diagnosis of what ails the patient or thinking what will happen if he takes the wrong medication.
Thinking that the US economy was in a deep recession in 2007, one similar to the Great Depression, he precipitously unleashed monetary policy. His rushed actions have destabilized the financial system, sent commodity prices skyrocketing, and crippled economic growth. The US economy in 2007 had no resemblance to either the institutional setting of the Great Depression or to the immense role and expansionary stance of fiscal policy. Namely, today, there are institutions that can prevent bank runs, such as the Federal Deposit Insurance Corporation, and the federal and state governments (both relatively far bigger than 1929) are running large deficits that should preclude a deep recession, especially if they adopt appropriate policies.
Hence, his inflationary approach was ill-designed and will be very costly in bank failures, high inflation and rising unemployment.
The Fed chairman is by far the most important personality on the US economic and financial landscape. In fact, both Wall Street and Main Street read his statements more carefully than reading the words of a president or the laws of the land. His words and actions are the most influential in the financial and economic world. Being in large part an independent institution, the Fed, largely under Bernanke's predecessor Alan Greenspan, grasped absolute power over economic policymaking and decided to abandon its regulatory power, enabling the development of financial anarchy under the guise of financial engineering and innovations.
Such myopic faith in the free market has turned the US financial markets into a casino. The US president has negligible influence on economic policymaking and has become merely a symbolic figure. By subscribing fully to Bernanke and Paulson policies, the two presidential contenders have renounced their future economic role. The US Congress has become a rubber stamp of Fed policies. It applauded Greenspan�s policies and it now supports Bernanke-Paulson knee-jerk and costly bailouts. The US public is not so much interested in the presidential debates as in how Bernanke and Paulson policies will affect their jobs, retirement savings, tax liabilities and the very livelihoods of their children.
Wrong course will continue
Once the Fed follows a policy path, it hardly changes course, which means the Fed will perpetuate its cheap monetary policy indefinitely. After institutionalizing negative real interest, the Fed wants to institutionalize high housing prices and rents, and a depreciated dollar. While US banks are in the process of strengthening their balance sheets and opting for safe banking, the Fed is forcing them to extend credit regardless of risk and profitability, and to finance with short time resources long-term loans.Recent desperate actions by the Fed consist of bypassing the banking system and extending directly low-cost loans to borrowers regardless of risk and nationalizing the banking system. The Fed sees no limit for issuing trillions of dollars by electronically crediting borrowers.
The Fed has arguably created the most uncertain and unstable economic environment in US history. No one would have predicted that the value of shares would tumble by nearly 5,000 points, or approaching a decline of 40%, in the past three months. There is no basis for making sound financial or economic forecasts. No rational entrepreneur can undertake investment plans under such uncertainties. Foreign investors are scared of inflation and a depreciating dollar and are rushing to gold and safer currencies. It is at best a wait and see attitude.
Central bankers are this week convening for their semi-annual meeting in Washington DC, only to find that the world is no better than it was six months ago. Certainly, they will not surrender their excessive powers and most likely will not accept blame for their imprudent monetary policies that have led to the worst financial crisis in the post-war period.
Interest rate setting by central banks has long been repudiated by monetary economists; it creates distortion between the market and natural interest rates, and triggers a self-cumulative inflationary process. As a form of price control, it creates considerable inefficiencies and misallocation of resources into non-productive uses. With a view to unlocking credit markets, it is an utmost priority both in the US and Europe to free interest rates. Such a step will enable banks to mitigate credit risk, improve their earnings, and for productive borrowers to have access to borrowing. It will dispel inflation fear and pave the way for financial consolidation and recovery. If they reject this step, central banks will only aggravate the current crisis.
Central banks' misguided role
The role of central banks has never been to regulate the economy or promote full employment. It is a simple truth that an economy needs safe money, which serves as a medium of exchange and store of value. The central banks should be principally in charge of managing liquidity and regulating the banking system.These are the most important functions of a central bank. If properly done, they will contribute to a stable macroeconomic framework conducive to economic growth and employment. Given their total neglect of bank regulation in the past two decades, central banks have a long way to go in updating the regulatory framework, streamline financial products, and mitigating sources of risks and speculation.
Regulating the level of economic activity and counteracting recession should fall under fiscal policies. The government has better means, agencies and fiscal instruments to fight economic recession than central bank monetary policy. The recent world crisis has shown that governments have to address shortages in food, energy, infrastructure, and social programs. Each government can draw a comprehensive stabilization program with properly designed fiscal and sectoral policies without compromising monetary stability.
A 10-year spending program on infrastructure, including education and alternative energy development, would be appropriate today, especially in the United States. At the same time, federal credit should be urgently extended to state and local governments until financial order is restored. However, excessive reliance on credit or ex-nihilo money creation is wrong and hazardous.
Central banks should not interfere with the price mechanism; in this respect, institutionalizing long-term housing price controls would be detrimental to the economy. Central banks have to put in place monetary programming consisting of safe limits on credit and money aggregates. Monetary economists never claim that fixed rules for credit and money supply are free of instability. However, if instability were to occur, it can be addressed by fine-tuning.
The US economic ship could capsize in the coming days and weeks. There is urgency for action before chaos spreads farther a field. The same central banks that have announced a coordinated rate cut should admit that this measure is not the proper solution. It will be damaging to financial institutions and will exacerbate world inflation and economic recession.
Instead, they should announce a coordinated decision for freeing up interest rates. They have to allow banks to undertake orderly and long-term recapitalization, relying in the first instance on shareholders or other private holders of capital and only on a case-by-case basis on federal injections of capital with preferred share ownership for the public. And they must adopt urgent regulatory reform, accompanied by strict supervision and enforcement.
Finally, Bernanke and Paulson must jettison their policy of one bailout at a time. with the intention of addressing other issues later, and adopt a comprehensive plan to address all issues now, including support for state and local governments.
Unfortunately, it would appear that the notion that monetary policy is the panacea for addressing all economic problems has gained total currency among central bankers and politicians.
Hossein Askari is professor of international business and international affairs at George Washington University. Noureddine Krichene is an economist at the International Monetary Fund and a former advisor, Islamic Development Bank, Jeddah.
(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)
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Jun 6, 2008 | nakedcapitalism.com
An article in today's Wall Street Journal, "Insider Joins Critics of the Fed, Faulting Credit-Crisis Programs," discusses at some length a recent speech by Richmond Fed president Jeffrey Lacker in which he took issue with some of the Fed's recent financial services industry rescue efforts. The article itself failed to do justice to his speech, which was more nuanced than the usual "bailing out banks creates moral hazard" argument.
In fact, as we'll discuss,, the expanded charter of the Fed calls into question the appropriateness of its independence. It is increasingly making resource allocation decisions which are political in nature and should arguably be debated and determined in that realm.
In his London speech, Lacker defined two types of bank runs: non-fundamental, when the institution is sound but hit by a liquidity crisis, versus a fundamental run, where depositors and creditors wanted out because they know someone would wind up holding the bag. In the latter case, speed of exit is a virtue, since the laggards are the ones who run the risk of not recovering their assets.
The problem with central bank intervention is two-fold. It may not always be possible to parse out whether a crisis is fundamental or non-fundamental in nature. However, when a crisis is fundamental (or as we like to say here, a solvency rather than a liquidity crisis), Fed assistance distorts relative asset prices and delays the relevant markets finding clearing prices. As Lacker stated:
The ideal central bank lending policy would require making clear distinctions between different possible sources of bank or financial distress. If an episode of financial disruption is a true liquidity crisis, like a non-fundamental run on the banking system, then aggressive central bank lending can, in theory, stem the crisis and prevent unnecessary insolvencies that impose real losses on the economy. Lending when in fact the financial sector is just coping with deteriorating fundamentals, however, distorts economic allocations by artificially supporting the prices of some assets and the liabilities of some market participants. Moreover, it is likely to affect the perceptions of market participants regarding future intervention, and thus alter their incentives and future choices.But Lacker made a second set of observations, which the Journal breezed by: the existence of a central bank safety net leads banks to neglect cheap risk reduction measures they could take on their own.
For instance, the big reason that bank runs happen is that depositors go to yank all their funds out at once, when those institutions are set up to handle only a comparatively small proportion of those holdings being withdrawn on any day. But most customers don't need that much liquidity on a daily basis and can be given incentives to sacrifice such quick trigger access. As Lacker points out:
The intuition behind the classic bank run story is that banks are susceptible to runs because depositors are free, at any time, to claim all of their money on demand. This is a contractual choice, and one that makes some sense given depositors' demand for short duration, liquid savings instruments. But if a bank can restrict its depositors' ability to demand their funds on the spot in certain circumstances in the event of heavy demands for withdrawals, for example then the bank will be less susceptible to a run. And there is ample precedent for deposit contracts with such characteristics. In 19th century U.S. banking panics, banks preserved their liquidity, individually, by suspending the convertibility of their deposits into currency. They also had recourse to collective actions through the issuance of loan certificates by clearinghouses in the major cities, which allowed the clearinghouse members to meet their interbank obligations and customers to make interbank transfers without drawing on banks' scarce supplies of currency.While Lacker's candor is refreshing, he has not teased out the full implications of his observations. Supporting the prices of some assets has the effect of enriching certain interests at the expense of others. Similarly, shifting risk from individual banks onto the central bank is believed to be worthwhile because any collective costs are assumed to be lower than that of a financial crisis. But the degree of risk transfer we've seen in the last year, which seems close to a "heads I win, tails you lose" game for the financiers, again raises question of fairness and resource allocation.Axel Leijonhufvud, in a Centre for Economic Policy Research paper "Keynes and the Crisis," (hat tip Richard Alford) does a first-rate job of analyzing what the credit market upheaval has revealed about the limitations of various economic models and institutional arrangement. In particular, he found that it called into question the central premise of modern central banking, including central bank independence (emphasis his):
There are two aspects of the wreckage from the current crisis that have not attracted much attention so far. One is the wreck of what was until a year ago the widely accepted central banking doctrine. The other is the damage to the macroeconomic theory that underpinned that doctrine.There has been a great deal of hostility towards the Fed, as witness by comments here and on other blogs, and by the existence of sites such as "Bernanke Panky News." A lot of that is Greenspan backlash. Having become too willing to take credit for general economic prosperity (and having taken too much interest in the performance of the stock market, something no previous Fed chair gave a fig about), he became the focus of anger over the credit crisis. While the Fed bears significant responsibility, messes this big have many parents.Critical to the central banking doctrine was the proposition that monetary policy is fundamentally only about controlling the price level.5 Using the bank's power over nominal values to try to manipulate real variables such as output and employment would have only transitory and on balance undesirable effects. The goal of monetary policy, therefore, could only be to stabilise the price level (or its rate of change). This would be most efficaciously accomplished by inflation targeting, an adaptive strategy that requires the bank to respond to any deviation of the price level from target by moving the interest rate in the opposite direction.
This strategy failed in the United States. The Federal Reserve lowered the federal funds rate drastically in an effort to counter the effects of the dot.com crash. In this, the Fed was successful. But it then maintained the rate at an extremely low level because inflation, measure by various variants of the CPI, stayed low and constant. In an inflation targeting regime this is taken to be feedback confirming that the interest rate is 'right'. In the present instance, however, US consumer goods prices were being stabilised by competition from imports and the exchange rate policies of the countries of origin of those imports. American monetary policy was far too easy and led to the build-up of a serious asset price bubble, mainly in real estate, and an associated general deterioration in the quality of credit. The problems we now face are in large part due to this policy failure.
A second tenet of the doctrine was central bank independence. Since using the bank's powers to effect temporary changes in real variables was deemed dysfunctional, the central bank needed to be insulated from political pressures. This tenet was predicated on the twin ideas that a policy of stabilising nominal values would be politically neutral and that this could be achieved by inflation targeting. Monetary policy would then be a purely technical matter and the technicians would best be able to perform their task free from the interference of politicians.
Transparency of central banking was a minor lemma of the doctrine. If monetary policy is a purely technical matter, it does not hurt to have the public listen in on what the technicians are talking about doing. On the contrary, it will be a benefit all around since it allows the private sector to form more accurate expectations and to plan ahead more efficiently. But if the decisions to be taken are inherently political in the sense of having inescapable redistributive consequences, having the public listen in on all deliberations may make it all but impossible to make decisions in a timely manner.
When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians. The independence doctrine becomes impossible to uphold.
Consider as examples two columns that have appeared in the Wall Street Journal in recent weeks. One, by John Makin (April 14), argued that leaving house prices to find their own level in the present situation would lead to a disastrous depression. Policy, therefore, should be to inflate so as to stabilise them somewhere near present levels. If the Fed were to succeed in this, it might not find it easy to regain control of the inflation once it had gotten underway, particularly since some of the support of the dollar by other countries would surely be withdrawn. But in any case, the distributive consequences of Makin's proposal are obvious to all who (like myself) are on more or less fixed pensions. The other column, by Martin Feldstein (April 15), argues that the Fed had already gone too far in lowering interest rates and is courting inflation. He wasin favour of the Fed's attempts to unfreeze the blocked markets and restore liquidity by the unorthodox means that Volcker had mentioned.
The likely prospect for the United States in any case is a period of stagflation. The issue is going to be how much inflation and how much unemployment and stagnation are we going to have. To the extent that this can be determined or at least influenced by policy the choices that will have to be made are obviously not of the sort to be left to unelected technicians.
But there has been another thread mixed in with this: resentment at the Fed salvaging the banking industry, with contingent and real costs, in the form of higher inflation, per Alford's and Leijonhufvud's analysis. Now that many of those actions may indeed have been the best among a set of bad choices (although I suspect economic historians will conclude the Fed cut rates too far too fast). However, the big issue is that they involved consequences of such magnitude that they should not have been left to the Fed. I was amazed, and was not alone, when Congress did not dress down the Fed in its hearings on the Bear rescue for the central bank's unauthorized encroachment into fiscal action (ie., if any of the $29 billion in liabilities assumed by the Fed in that rescue comes a cropper, the cost comes from the public purse). So the frustration isn't merely about outcomes, it's about process, about the sense of disenfranchisement. And that will only get worse as this crisis grinds along.
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globaleconomicanalysis.blogspot.com
Open dissent at the Fed continues. I first talked about this a week ago in Infighting At The Fed. Today Lacker Says Fed Loans to Wall Street Risk More Crises.
Richmond Federal Reserve Bank President Jeffrey Lacker said the lending to securities firms that the central bank introduced in March may lay the seeds of further financial crises.Bernanke Loses Support"The danger is that the effect of the recent credit extension on the incentives of financial-market participants might induce greater risk taking," Lacker said in a speech to the European Economics and Financial Centre in London. That "in turn could give rise to more frequent crises," he said.
Lacker urged that the central bank now "clearly" set boundaries for its help to financial markets. In an interview yesterday on the themes of his speech, Lacker said even those new boundaries may not be believed by investors unless a financial firm fails "in a costly way."
The remarks are the strongest warning by an official about the consequences of the Fed's aid to securities dealers, the first lending to nonbanks since the Great Depression. While other regulators have focused on tightening investment-bank oversight in exchange for the lending, Lacker said there's a case for "scaling back" the new programs.
Philadelphia Fed President Charles Plosser urged in a separate speech today that officials specify the conditions "under which the central bank will lend" to firms. He told reporters in New York afterwards that "we run the risk of sowing the seeds of the next crisis."
Thomas Hoenig of Kansas City said last month the Fed's actions were "likely to weaken market discipline," while Minneapolis's Gary Stern in April worried about "adequate incentives to contain" an expansion in the Fed's safety net.
The central bank has introduced three programs since December to help counter the credit crisis. Along with the Primary Dealer Credit Facility, the Fed lends Treasuries to dealers in exchange for mortgage and asset-backed debt through the Term Securities Lending Facility. The Term Auction Facility offers cash loans to banks.
Lacker indicated skepticism about the value of the programs.
"It isn't clear what kind of market failure is being addressed" with the TAF, he said. Central bankers should be wary "that they can substitute their own judgment about the fundamental value of financial instruments," he said.The seeds of this crisis were sewn by the loosey goosey policies of Greenspan for which there was never a dissent from Bernanke, or that matter anyone else (at least in public). And what started as a minor revolt has now turned into a major question of confidence regarding the anything goes policies of Bernanke. That Congress is holding up votes on Fed nominees is also not helping Bernanke any.
If various Fed governors continue openly questioning Bernanke's decisions, he is not going to last long as Fed chairman.
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The Mess That Greenspan Made
The hits keep-a-comin' for former Fed Chairman Alan Greenspan. In today's installment at Bloomberg (hat tip CB), Jonathan Weil turns back the clock to 1963 when the Ayn Rand devotee was formulating his view of the world.
Ironically, this view of things might have described the current condition much better had he not been head of the world's most important central bank for 18 years.
Greenspan's '63 Essay Foretold Subprime Inaction: Jonathan WeilOnce again, had he not been Fed Chairman for almost two decades, helping to transform the world's greatest economy into a country full of leveraged speculators, willing to take risks with borrowed money that they wouldn't have dreamed of years earlier, his 1963 views might be a lot more relevant today.
Why did Alan Greenspan fail to act while the roots of the subprime-mortgage crisis spread? Here's one possible explanation: The Ayn Rand disciple held fast to his unwavering laissez-faire beliefs.Yesterday's New York Times carried a front-page article chronicling the many warnings the former Federal Reserve chairman received about aggressive subprime lenders luring unsuspecting customers into crazy mortgages they never could afford. "Where was Washington?" the newspaper asked. And where was Alan?
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I believe the best answer can be found in an August 1963 article called "The Assault on Integrity" that Greenspan, then 37, wrote for Rand's monthly journal, "The Objectivist." Judging by how he rebuffed Gramlich and others, it looks like he followed his old instincts as the subprime mess festered.Agent of Consumers
"Protection of the consumer against 'dishonest and unscrupulous business practices' has become a cardinal ingredient of welfare statism," Greenspan began his essay, which Rand included in her 1967 book, "Capitalism: The Unknown Ideal.""Left to their own devices, it is alleged, businessmen would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. Thus, it is argued, the Pure Food and Drug Administration, the Securities and Exchange Commission, and the numerous building regulatory agencies are indispensible if the consumer is to be protected from the 'greed' of the businessman.
"But it is precisely the 'greed' of the businessman or, more appropriately, his profit-seeking, which is the unexcelled protector of the consumer.
"What collectivists refuse to recognize is that it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product."
...
"Protection of the consumer by regulation is thus illusory," he said. "Rather than isolating the consumer from the dishonest businessman, it is gradually destroying the only reliable protection the consumer has: competition for reputation."While the consumer is thus endangered, the major victim of 'protective' regulation is the producer: the businessman."
The largely unregulated subprime-lending industry, of course, didn't turn out this way. Countless mortgage brokers and lenders didn't care about their reputations. Wall Street banks, which packaged and pitched the loans as AAA securities, didn't care about theirs either. There were quick killings to be had.
Four decades later, Greenspan's argument seems almost childlike in its idealism. Yet, judging by his inaction, it looks like he never stopped believing.
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According to this report($) in the Financial Times from earlier in the week, it seems that former Fed chief Alan Greenspan remains, in the words of Bloomberg columnist Jonathan Weil, "almost childlike in his idealism" - at least when it comes to asset bubbles.Some highlights:
Central banks should be wary of trying to deal more aggressively with future asset price bubbles in case they suppress innovation and growth, Alan Greenspan has warned.Haven't we had enough innovation and turmoil in the last ten years?"If we want rapid growth in productivity, innovation, standards of living, we may have to accept that there will be periods of turmoil," the former chairman of the US Federal Reserve told the Financial Times.
Rather than try to suppress bubbles, he said, policymakers should ensure that financial institutions were well enough capitalised to withstand the hit from bursting bubbles as well as other shocks.
After successive bubbles in stocks and then in housing, what we probably need now is a good "innovation holiday".
Bubbles, Mr Greenspan argued, were often the by-products of innovation - such as the commercialisation of the internet in the 1990s, or advances in housing finance in the 2000s.So, in this childlike, idealized parallel world, "innovations" in mortgage finance are still considered a good thing and advances in housing finance that pushed the homeownership rate from 67 percent to over 70 percent was well worth the effort.To ask regulators to suppress bubbles would be to ask them either to prevent innovation or to second-guess the value the market puts on it.
"Micro-meddling undermines the basic function of a financial system - that is to direct the savings of society towards its most productive capital investments," he said.
Does anyone believe that anymore?
As for second guessing the value assigned by markets, maybe more people should have second guessed home values in 2004 and 2005 - maybe we wouldn't have such a mess on our hands in 2008.
Financial crises "of necessity are unanticipated - if they are not, they are arbitraged away", he said. "We have many international financial stability forums and none of them anticipated the problems of August 9 2007."Mr Greenspan said the most sensible thing to do was "to increase the capacity of our financial institutions to absorb shocks in general. That means more capital".He should talk to his new employer at Paulson & Co. who made a fortune betting on a subprime collapse last year. Maybe the real problem is that we need more and smarter arbitragers.And lastly, some good news - the era of bubbles is over...
In any event, Mr Greenspan said, "I think the probability of sparking another bubble in the next 10 years is very low."Well, one thing is sure, the Greenspan period is over.Bubbles, he said, required low long-term interest rates, low inflation and macroeconomic stability. They were "a feature of the disinflationary period that followed the end of the cold war".
Mr Greenspan believes that period is over.
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Financial Armageddon
I've got news for those who think the financial crisis is over: Just wait until the derivatives market starts blowing up in earnest. When firms that believed they were hedged discover -- belatedly -- that they aren't. When myriad counterparties positioned on the wrong side of losing trades -- or even on the right side of those that seemed to be winners -- suddenly see gushers of red ink spurting from those paper promises. And, finally, when major players and innocent bystanders alike are bludgeoned into deer-in-the-headlights submission by chaotic conditions that give new meaning to the word "volatility."
In a compelling article, "Hedge Funds in Swaps Face Peril With Rising Junk Bond Defaults," Bloomberg's David Evans delves into the threat posed by the true "financial weapons of mass destruction": credit default swaps.
It's Friday, March 14, and hedge fund adviser Tim Backshall is trying to stave off panic. Backshall sits in the Walnut Creek, California, office of his firm, Credit Derivatives Research LLC, at a U-shaped desk dominated by five computer monitors.
Bear Stearns Cos. shares have plunged 50 percent since trading began today, and his fund manager clients, some of whom have their cash and other accounts at Bear, worry that the bank is on the verge of bankruptcy. They're unsure whether they should protect their assets by purchasing credit-default swaps, a type of insurance that's supposed to pay them face value if Bear's debt goes under.
Backshall, 37, tells them there are two rubs: The price of the swaps is skyrocketing by the minute, and the banks selling the insurance are also at risk of collapsing. If Bear goes down, he tells them, it may take other banks with it.
"There's always the danger the bank selling you the protection on Bear will fail," Backshall says. If that were to happen, his clients could spend millions of dollars for worthless insurance.
Investors can't tell whether the people selling the swaps - - known as counterparties -- have the money to honor their promises, Backshall says between phone calls.
"It's clearly a combination of absolute fear and investors really not knowing," he says.
On this day, a CDS-market meltdown doesn't happen. In a frenzy of weekend activity, the Federal Reserve and JPMorgan Chase & Co. rescue Bear Stearns from bankruptcy -- removing the need for the sellers of credit-default protection to pay up on their contracts.
Chain Reaction
Backshall and his clients aren't the only ones spooked by the prospect of a CDS catastrophe. Billionaire investor George Soros says a chain reaction of failures in the swaps market could trigger the next global financial crisis.
CDSs, which were devised by J.P. Morgan & Co. bankers in the early 1990s to hedge their loan risks, now constitute a sprawling, rapidly growing market that includes contracts protecting $62 trillion in debt.
The market is unregulated, and there are no public records showing whether sellers have the assets to pay out if a bond defaults. This so-called counterparty risk is a ticking time bomb.
"It is a Damocles sword waiting to fall," says Soros, 77, whose new book is called "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means" (PublicAffairs).
"To allow a market of that size to develop without regulatory supervision is really unacceptable," Soros says.
'Lumpy Exposures'
The Fed bailout of Bear Stearns on March 17 was motivated, in part, by a desire to keep that sword from falling, says Joseph Mason, a former U.S. Treasury Department economist who's now chair of the banking department at Louisiana State University's E.J. Ourso College of Business.
The Fed was concerned that banks might not have the money to pay CDS counterparties if there were large debt defaults, Mason says.
"The Fed's fear was that they didn't adequately monitor counterparty risk in credit-default swaps -- so they had no idea of where to lend nor where significant lumpy exposures may lie," he says.
Those counterparties include none other than JPMorgan itself, the largest seller and buyer of CDSs known to the Office of the Comptroller of the Currency, or OCC.
The Fed negotiated the deal to bail out Bear Stearns by allowing JPMorgan to buy it for $10 a share. The Fed pledged $29 billion to JPMorgan to cover any Bear debts.
'Cast Doubt'
"The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets," Fed Chairman Ben S. Bernanke told Congress on April 2. "It could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties."
The Fed was worried about the biggest players in the CDS market, Mason says. "It was a JPMorgan bailout, not a bailout of Bear," he says.
JPMorgan spokesman Brian Marchiony declined to comment for this article.
Credit-default swaps are derivatives, meaning they're financial contracts that don't contain any actual assets. Their value is based on the worth of underlying loans and bonds. Swaps are similar to insurance policies -- with two key differences.
Unlike with traditional insurance, no agency monitors the seller of a swap contract to be certain it has the money to cover debt defaults. In addition, swap buyers don't need to actually own the asset they want to protect.
It's as if many investors could buy insurance on the same multimillion-dollar home they didn't own and then collect on its full value if the house burned down.
Bigger Than NYSE
When traders buy swap protection, they're speculating a loan or bond will fail; when they sell swaps, they're betting that a borrower's ability to pay will improve.
The market, which has doubled in size every year since 2000 and is larger in dollar value than the New York Stock Exchange, is controlled by banks like JPMorgan, which act as dealers for buyers and sellers. Swap prices and trade volume aren't publicly posted, so investors have to rely on bids and offers by banks.
Most of the traders are banks; hedge funds, which are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall; and insurance companies. Mutual and pension funds also buy and sell the swaps.
Proponents of CDSs say the devices have been successful because they allow banks to spread the risk of default and enable hedge funds to efficiently speculate on the creditworthiness of companies.
'Seeing the Logic'
The market has grown so large so fast because swaps are often based on an index that includes the debt of scores of companies, says Robert Pickel, chief executive officer of the International Swaps and Derivatives Association.
"Whether you're a hedge fund, bank or some other user, you're increasingly seeing the logic of using these instruments," Pickel says, adding he doesn't worry about counterparty risk because banks carefully monitor the strength of investors. "There have been a very limited number of disputes. The parties understand these products and know how to use them."
Banks are the largest buyers and sellers of CDSs. New York- based JPMorgan trades the most, with swaps betting on future credit quality of $7.9 trillion in debt, according to the OCC. Citigroup Inc., also in New York, is second, with $3.2 trillion in CDSs.
Goldman Sachs Group Inc. and Morgan Stanley, two New York- based firms whose swap trading isn't tracked by the OCC because they're not commercial banks, are the largest swap counterparties, according to New York-based Fitch Ratings, which doesn't provide dollar amounts.
Untested Until Now
The credit-default-swap market has been untested until now because there's been a steady decline in global default rates in high-yield debt since 2002. The default rate in January 2002, when the swap market was valued at $1.5 trillion, was 10.7 percent, according to Moody's Investors Service.
Since then, defaults globally have dropped to 1.5 percent, as of March. The rating companies say the tide is turning on defaults.
Fitch Ratings reported in July 2007 that 40 percent of CDS protection sold worldwide is on companies or securities that are rated below investment grade, up from 8 percent in 2002. On May 7, Moody's wrote that as the economy weakened, high-yield-debt defaults by companies worldwide would increase fourfold in one year to 6.1 percent by April 2009.
The pressure is building. On May 5, for example, Tropicana Entertainment LLC filed for bankruptcy after the casino owner defaulted on $1.32 billion in debt.
'Complicate the Crisis'
A surge in corporate defaults may leave swap buyers scrambling, many unsuccessfully, to collect hundreds of billions of dollars from their counterparties, says Satyajit Das, a former Citigroup derivatives trader and author of "Credit Derivatives: CDOs & Structured Credit Products" (Wiley Finance, 2005).
"This is going to complicate the financial crisis," Das says. He expects numerous disputes and lawsuits, as protection buyers battle sellers over the technical definition of default - - this requires proving which bond or loan holders weren't paid -- and the amount of payments due.
"It's going to become extremely messy," he says. "I'm really scared this is going to freeze up the financial system."
Andrea Cicione, a London-based senior credit strategist at BNP Paribas SA, has researched counterparty risk and says it's only a matter of time before the sword begins falling. He says the crisis will likely start with hedge funds that will be unable to pay banks for contracts tied to at least $35 billion in defaults.
$150 Billion Loss Estimate
"That's a very conservative estimate," he says, adding that his study finds that losses resulting from hedge funds that can't pay their counterparties for defaults could exceed $150 billion.
Hedge funds have sold 31 percent of all CDS protection, according to a February 2007 report by Charlotte, North Carolina-based Bank of America Corp.
Cicione says banks will try to pre-empt this default disaster by demanding hedge funds put up more collateral for potential losses. That may not work, he says. Many of the funds won't have the cash to meet the banks' requests, he says.
Sellers of protection aren't required by law to set aside reserves in the CDS market. While banks ask protection sellers to put up some money when making the trade, there are no industry standards, Cicione says.
JPMorgan, in its annual report released in February, said it held $22 billion of credit swap counterparty risk not protected by collateral as of Dec. 31.
'A Major Risk'
"I think there's a major risk of counterparty default from hedge funds," Cicione says. "It's inconceivable that the Fed or any central bank will bail out the hedge funds. If you have a systemic crisis in the hedge fund industry, then of course their banks will take the hit."
The Joint Forum of the Basel Committee on Banking Supervision, an international group of banking, insurance and securities regulators, wrote in April that the trillions of dollars in swaps traded by hedge funds pose a threat to financial markets around the world.
"It is difficult to develop a clear picture of which institutions are the ultimate holders of some of the credit risk transferred," the report said. "It can be difficult even to quantify the amount of risk that has been transferred."
Counterparty risk can become complicated in a hurry, Das says. In a typical CDS deal, a hedge fund will sell protection to a bank, which will then resell the same protection to another bank, and such dealing will continue, sometimes in a circle, Das says.
'Daisy Chain Vortex'
The original purpose of swaps -- to spread a bank's loan risk among a large group of companies -- may be circumvented, he says.
"It creates a huge concentration of risk," Das says. "The risk keeps spinning around and around in this daisy chain like a vortex. There are only six to 10 dealers who sit in the middle of all this. I don't think the regulators have the information that they need to work that out."
And traders, even the banks that serve as dealers, don't always know exactly what is covered by a credit-default-swap contract. There are numerous types of CDSs, some far more complex than others.
More than half of all CDSs cover indexes of companies and debt securities, such as asset-backed securities, the Basel committee says. The rest include coverage of a single company's debt or collateralized debt obligations.
A CDO is an opaque bundle of debt that can be filled with junk bonds, auto loans, credit card liabilities and home mortgages, including subprime debt. Some swaps are made up of even murkier bank inventions -- so-called synthetic CDOs, which are packages of credit-default swaps.
AIG $9.1 Billion Writedown
On May 8, American International Group Inc. wrote down $9.1 billion on the value of its CDS holdings. The world's largest insurer by assets sold credit protection on CDOs that declined in value. In 2007, New York-based AIG reported $11.5 billion in writedowns on CDO credit default swaps.
Michael Greenberger, director of trading and markets at the Commodity Futures Trading Commission from 1997 to 1999, says the Fed is fully aware of the risk banks and the global economy face if CDS holders can't cover their losses.
"Oh, absolutely, there's no doubt about it," says Greenberger, who's now a professor at the University of Maryland School of Law in Baltimore. He says swaps were very much on the Fed's mind when Bear Stearns started sliding toward bankruptcy.
"People who were relying on Bear for their own solvency would've started defaulting," he says. "That would've triggered a series of counterparty failures. It was a house of cards."
Risk Nightmare
It's concerns about that house of cards that have kept Backshall, the California fund adviser, up at night. His worries about a nightmare scenario started in early March. The details of what happened are still fresh in his mind.
It's Monday, March 10, and the market is rife with rumors that Bear Stearns will run out of cash. Some of Backshall's clients have pulled their accounts from Bear; others are considering leaving the bank. Backshall's clients are exposed to Bear in multiple ways: They keep their cash and other accounts at the firm, and they use the bank as their broker for trades. Backshall advises them to spread their assets among various banks.
That same day, Bear CEO Alan Schwartz says publicly, "There is absolutely no truth to the rumors of liquidity problems."
Backshall's clients are suspicious. They see other hedge funds pulling their accounts from Bear. In the afternoon after Schwartz's remarks, the cost of protection soars past 600 basis points from 450 before Schwartz's statement.
CEO Didn't Calm Fears
Swaps are priced in basis points, or hundredths of a percentage point. At 600 basis points, a trader would pay $6,000 a year to insure $100,000 of Bear Stearns bonds.
"I don't think his comments did anything to calm fears," Backshall says.
The next day, March 11, Securities and Exchange Commission Chairman Christopher Cox says his agency is monitoring Bear Stearns and other securities firms.
"We have a good deal of comfort about the capital cushions at these firms at the moment," he says.
Cox's comments are overshadowed by rumors that European financial firms had stopped doing fixed-income trades with Bear, Backshall says.
"Nobody has a clue what's going on," he says. Bear swap costs are gyrating between 540 and 665.
For most investors, just getting default-swap prices is a chore. Unlike stock prices, which are readily available because they trade on a public exchange, swap prices are hard to find. Traders looking up prices on the Internet or on private trading systems see information that is hours or days old.
'Terribly Primitive'
Banks send hedge funds, insurance companies and other institutional investors e-mails throughout the day with bid and offer prices, Backshall says. For many investors, this system is a headache.
To find the price of a swap on Ford Motor Co. debt, for example, even sophisticated investors might have to search through all of their daily e-mails, he says.
"It's terribly primitive," Backshall says. "The only way you and I could get a level of prices is searching for Ford in our inbox. This is no joke."
In the past three years, at least two companies have developed software programs that automatically parse an investor's incoming messages, yank out CDS prices and build them into real-time price displays.
The charts show the highest bids and lowest offering prices for hundreds of swaps. Backshall tracks prices he gets from banks using the new software.
'It's Very Hard'
Backshall has been talking with hedge fund managers in New York all week.
"We'd quite frankly been warning them and giving them advice on how to hedge," he says of the Bear Stearns crisis and banks overall. "It's very hard to hedge the counterparty risk. These institutions are thinly capitalized in the best of times."
The night of Thursday, March 13, Backshall can't sleep. He lies awake worrying about Bear and counterparty risk. The next morning, he arrives at work at 5 a.m., two and a half hours before sunrise.
Through the window of his ninth-floor corner office, he takes a moment to watch the distant flickers of light in the rolling foothills of Mount Diablo. Across the street, he sees the still-dark Walnut Creek train station, about 30 miles (48 kilometers) east of San Francisco.
Backshall, wearing jeans and a blue, button-down shirt, sits at his desk, staring at a pair of the 27-inch (68.6- centimeter) monitors that display swap costs. CDS prices jumped by more than 10-fold in just a year. The numbers show rising fear, he says.
Until early in 2007, the typical price of a credit-default swap tied to the debt of an investment bank like Merrill Lynch & Co., Bear Stearns or Morgan Stanley was 25 basis points.
'Unknowns Are Out There'
If a swap buyer wanted to protect $10 million of assets in the event of a company default, the contract would cost about 0.25 percent of $10 million, or $25,000 a year for a five-year protection contract.
Backshall's screens tell him the cost of buying protection on Bear Stearns debt in the past 24 hours has been moving in a range between 680 and 755 basis points.
"The unknowns are out there," Backshall says.
He advises his clients not to buy CDS protection on Bear because the price is too high and the time is wrong. It's too late to buy swaps now, he says.
At 9:13 Friday morning in New York, JPMorgan announces it will loan money to Bear using funds provided by the Federal Reserve. The JPMorgan statement doesn't say how much it will lend; it says it will "provide secured funding to Bear Stearns, as necessary."
'Significantly Deteriorated'
Bear CEO Schwartz says his firm's liquidity has "significantly deteriorated" during the past 24 hours. Protection quotes drop immediately into the low 500s, as some dealers think a rescue has begun.
That doesn't last long.
"Very quickly, the trading action is swinging violently wider," Backshall says. Bear's swap cost jumps to 850 basis points that afternoon, his screen shows. "When fear gets hold, fundamental analysis goes out the window," he says.
In the calmest of times, making reasoned decisions about swap prices is a challenge. Now, it's impossible. Traders don't have access to any company data more recent than Bear's February annual report. Sharp-eyed investors looking through that filing might have spotted a paragraph that's strangely prescient.
"As a result of the global credit crises and the increasingly large numbers of credit defaults, there is a risk that counterparties could fail, shut down, file for bankruptcy or be unable to pay out contracts," Bear wrote.
'Material Adverse Effect'
"The failure of a significant number of counterparties or a counterparty that holds a significant amount of credit-default swaps could have a material adverse effect on the broader financial markets," the bank wrote.
Even after JPMorgan's Friday morning announcement, the market is alive with rumors. Backshall's clients tell him they've heard some investment banks have stopped accepting trades with Bear Stearns and some money market funds have reduced their short-term holdings of Bear-issued debt.
On Sunday, March 16, the Federal Reserve effectively lifts the sellers of Bear Stearns protection out of their misery. JPMorgan agrees to buy Bear for $2 a share.
While that's devastating news for Bear shareholders -- the stock had traded at $62.30 just a week earlier -- it's the best news imaginable for owners of Bear debt. That's because JPMorgan agreed to cover Bear's liabilities, with the Fed pledging $29 billion to cover Bear's loan obligations.
Turned to Dust
For traders who sold protection on Bear's debt, the bailout is a godsend. Faced with the prospect of having to hand over untold millions to their counterparties just three days earlier, they now have to pay out nothing.
For traders who bought protection swaps just a few days earlier -- when prices were in the 600s to 800s -- the Fed bailout is crushing. Their investments have turned to dust.
On Monday morning, the cost of default protection on Bear plunges to 280. Backshall sits back in his chair and for the first time in two weeks, he can breathe easier.
"No wonder I look so tired all the time," he says, finally showing a bit of a smile.
When it bailed out Bear Stearns, the Federal Reserve effectively deputized JPMorgan to monitor the credit-default- swap market, says Edward Kane, a finance professor at Boston College. Because regulators don't know where the risks lie, they're helpless, Kane says.
Default swaps shift the risk from a company's credit to the possibility that a counterparty might fail, says Kane, who's a senior fellow at the Federal Deposit Insurance Corporation's Center for financial Research.
'Off Balance Sheet'
"You've really disguised traditional credit risk, pushed it off balance sheet to its counterparties," Kane says. "And this is not visible to the regulators."
BNP analyst Cicione says regulators will be hard-pressed to prevent the next potential breakdown in the swaps market.
"Apart from JPMorgan, there aren't many other banks out there capable of doing this," he says. "That's what's worrying us. If there were to be more Bear Stearnses, who would step in and give a helping hand? You can't expect the Fed to run a broker, so someone has to take on assets and obligations."
Banks have a vested interest in keeping the swaps market opaque, says Das, the former Citigroup banker. As dealers, the banks see a high volume of transactions, giving them an edge over other buyers and sellers.
"Dealers get higher profitability through lack of transparency," Das says. "Since customers don't necessarily know where the market is, you can charge them much wider margins."
Banks Try to Hedge
Banks try to balance the protection they've sold with credit-default swaps they purchase from others, either on the same companies or indexes. They can also create synthetic CDOs, which are packages of credit-default swaps the banks sell to investors to get themselves protection.
The idea for the banks is to make a profit on each trade and avoid taking on the swap's risk.
"Dealers are just like bookies," Kane says. "Bookies don't want to bet on games. Bookies just want to balance their books. That's why they're called bookies."
The banks played the role of dealers in the CDO market as well, and the breakdown in that market holds lessons for what could go wrong with CDSs. The CDO market zoomed to $500 billion in sales in 2006, up fivefold from 2001.
Banks found a hungry market for CDOs because they offered returns that were sometimes 2-3 percentage points higher than corporate bonds with the same credit rating.
CDO Market Dried Up
By the middle of 2007, mortgage defaults in the U.S. began reaching record highs each month. Banks and other companies realized they were holding hundreds of billions in toxic debt. By August 2007, no one would buy CDOs. That newly devised debt market dried up in a matter of months.
In the past year, banks have written off $323 billion from debt, mostly from investments they created.
Now, if corporate defaults increase, as Moody's predicts, another market recently invented by banks -- credit-default swaps -- could come unstuck. Arturo Cifuentes, managing director of R.W. Pressprich & Co., a New York firm that trades derivatives, says he expects a rash of counterparty failures resulting in losses and lawsuits.
"There's a high probability that many people who bought swap protection will wind up in court trying to get their payouts," he says. "If things are collapsing left and right, people will use any trick they can."
Frank Partnoy, a former derivatives trader and now a securities law professor at the University of San Diego School of Law, says it's high time for the market to let in some sunshine.
Centralized Pricing
"There should be a centralized pricing service for credit-default swaps," he says. Companies should disclose their swaps holdings, he adds.
"For example, a bank might disclose the nature of its lending exposure based on its use of credit-default swaps as a hedge," he says.
Last year, the Chicago Mercantile Exchange set up a federally regulated, exchange-based market to trade CDSs. So far, it hasn't worked. It's been boycotted by banks, which prefer to continue their trading privately.
Leo Melamed, 76, chairman emeritus of Chicago Mercantile Exchange Holdings Inc., says there aren't any easy solutions.
"Plus we're not sure the banks want us to be in this business because they do make a good deal of money, and we might narrow the spreads considerably," he says.
'Central Clearing House'
For now and for some time in the future, CDSs will remain unregulated and their trades will be done in the secrecy of Wall Street's biggest securities firms. That means counterparty risk will stay out of the sight of the public and regulators.
"In order for us to get away from worries about counterparty risk, in order for us to encourage more trading and more transparency, there's got to be some way to bring all the price data together with exchange trading or a central clearinghouse," Backshall says.
Until that happens, the sword of Damocles will remain poised to fall, as banks, hedge funds and insurance companies can only guess whether their trillions of dollars in swaps are covered by anything other than darkness.
(Hat tip to Naked Capitalism)
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May 13, 2008 | Econbrowser
Fed Chair Ben Bernanke on Tuesday offered his perspective on the appropriate response of the Fed to the ongoing turmoil in financial markets. I still think he's overlooking a key element of what's been happening.
Bernanke observed:Meeting creditors' demands for payment requires holding liquidity-- cash, essentially, or close equivalents. But neither individual institutions, nor the private sector as a whole, can maintain enough cash on hand to meet a demand for liquidation of all, or even a substantial fraction of, short-term liabilities. Doing so would be both unprofitable and socially undesirable. It would be unprofitable because cash pays a lower return than other investments. And it would be socially undesirable, because an excessive preference for liquid assets reduces society's ability to fund longer-term investments that carry a high return but cannot be liquidated quickly.
However, holding liquid assets that are only a fraction of short-term liabilities presents an obvious risk. If most or all creditors, for lack of confidence or some other reason, demand cash at the same time, a borrower that finances longer-term assets with liquid liabilities will not be able to meet the demand. It would be forced either to defer or suspend payments or to sell some of its less-liquid assets (presumably at steep discounts) to make the payments. Either option may lead to the failure of the borrower, so that the loss of confidence, even if not originally justified by fundamentals, will tend to be self-confirming. If the loss of confidence becomes more general, a broader crisis may ensue.
Bernanke concludes that it's the responsibility of the central bank to stop such self-fulfilling instability. But he neglects to discuss the key feature of a healthy financial system that is supposed to prevent such a problem from ever arising. Specifically, any institution that is in this position of borrowing short and lending long needs to ensure that a certain fraction of the funds it is lending came not from borrowers but instead from the owners of the institution itself, in the form of net equity. The goal is for the size of this net equity to be larger than the losses the institution would incur from selling its less-liquid assets at steep discounts. As long as it is, no creditors ever have reason to demand cash, and there would be no need for the central bank to step in to prevent a self-fulfilling breakdown.
And the core reason we are in the mess we are today is that these equity stakes were nowhere near sufficient for this purpose. Instead, financial institutions were allowed to take highly leveraged positions whose details are largely opaque to readers of publicly available financial statements. Exhibit A here might be Bear Stearns, whose 2007 10-K reported that Bear had outstanding derivative contracts whose notional value was $13.4 trillion. Much of these were credit-default swaps, in which the seller receives a fee in exchange for promising to pay any losses incurred by the buyer on some specified asset and time interval. If every such asset lost 100% of its value over the period, then maybe Bear is supposed to pay or receive $13.4 trillion. In practice, the actual price moves and net sum owed would be a small fraction of that notional total.
Now, there is nothing inherently wrong in making financial investments in the form of derivative contracts rather than outright loans. You're doing something similar whenever you buy or sell an option rather than the stock itself. But, if you were to sell an option through an organized exchange, the exchange would require you to satisfy a margin requirement, delivering for safekeeping good funds such that if the price of the underlying asset against which the derivative is written moves against you, you are able to make good on your commitment.
If anything like a reasonable margin requirement had been in effect, Bear Stearns could not possibly have gotten into contracts totaling $13.4 trillion notional. But these weren't traded on a regular exchange, so there was no margin requirement, and apparently no real limit on the size of the exposures that Bear Stearns could take on, or the size of what they could bring down with them if they fell.
And that raises the question, Why were counterparties willing to accept these trades with no margin to guarantee payment? To this I'm afraid the answer is, they figured Bear was too big for the Fed to allow it to fail. And on this, I'm afraid they proved to be exactly correct.
I would feel better if Bernanke were less focused on how to "provide liquidity" and more focused on how to get the system deleveraged and more transparent.
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May 16, 2008 | WSJ
Federal Reserve officials have been chatting more about what to do about bubbles, but some are arguing that the central bank should look more closely at its own role in creating bubbles through both supervisory and monetary policy.
Policymakers have basically reaffirmed the orthodox view that as far as monetary policy goes, they shouldn't use interest rates to restrain asset prices. But they are giving more weight to the view, which they have always given some credence, that prudential supervisory policies could have some role to play.
Governor Frederic Mishkin emphasized that point of view in a speech Thursday night and Minneapolis Fed president Gary Stern has also said the Fed should rethink its approach to bubbles. Federal Reserve Chairman Ben Bernanke isn't likely to change his view that the Fed should try to pop bubbles ahead of time but is updating his thinking and will probably give a speech on the subject later this year. Mr. Bernanke's old colleagues at Princeton are also debating the issue.
But amidst all this debate, the Fed has not dwelled much on the role its own monetary and regulatory policies may have played in fueling the housing bubble. James Bianco of Bianco Research complains that the Fed has looked everywhere for a solution but at itself. "It seems that the Federal Reserve thinks bubbles are caused be everyone and everything except, say, a 1% fed funds rate or special liquidity facilities," he writes in a commentary today. If Mr. Mishkin wants to use the Fed's powers more proactively to arrest bubbles, he "should stop voting for irresponsible expansions of Federal Reserve credit that create and promote bubbles." Earlier in the week, he wrote: "The only way for the Federal Reserve to truly fight asset bubbles is to stop creating them! When a crisis hits and they flood the financial system with cheap money, they create a bubble. By fighting the tech stock bust with a 1% funds rate, they helped create the housing bubble. By fighting the credit crisis with a 2% funds rate, they created the commodities bubble. Is this really that hard for them to understand?"
The Fed would argue that its interest rate policies didn't create the bubbles and even if they did, the alternative policies at the time would have required them to accept the certainty of higher unemployment in exchange for some possible benefit of avoiding a collapsed bubble in the future. Although of course, even here some Fed officials are questioning the wisdom of whether it was right, in hindsight, to keep the Fed funds rate at 1%.
Still, like most human beings Fed officials are reluctant to turn the spotlight on themselves too brightly when looking for blame. Fed Chairman Bernanke and vice-Chairman Donald Kohn have recently given speeches on the mistakes banks have made but devoted scant attention to any role the Fed and other bank regulators may have played in making those mistakes more likely. As former Fed Chairman Paul Volcker pointed out earlier this week, banks were allowed to accumulate significant assets in lightly regulated off-balance sheet vehicles.
Although it has been gotten little attention, this was made possible in part thanks to an explicit decision by federal bank regulators in 2003, then finalized in 2004 to exempt banks from holding full capital against such vehicles, which post-Enron accounting changes could potentially have required. (To be sure, regulators did require additional capital to be held against some entities to which banks had short-term funding commitments. And banks eventually found ways around the accounting standard anyway.) The ruling reflected the prevailing belief that as long as the entities were legally separate, the sponsoring banks had limited exposure. "There's always been this mentality that if it's somehow legally separate they're not liable for it anymore and that ignores the reputational risk and the de facto obligation," says Robert Eisenbeis, a former research director at the Federal Reserve Bank of Atlanta and now chief monetary economist at Cumberland Advisors. Sure enough, when some of the vehicles were locked out of the commercial paper market last year, some banks, fearing the damage to their own reputations had the entities failed, took them back onto their balance sheets, straining their capital
The Fed has also, since the mid-1990s, allowed banks to use "value at risk" modeling for capital to be held against their trading book, the idea being that such models are more sensitive than fiat ratios to the actual economic risks banks undertake. The Basel 2 Capital Accord is based on the same principle. But that means when times are good and volatility is low, capital will fall relative to assets, and the opposite will occur when times are bad and volatility is high - leading to a tendency to lend too much in good times and too little in bad. That said, there's no firm evidence that dynamic aggravated the latest crisis.
An alternative approach was taken by the Bank of Spain, as described in The Economist today, which required banks to hold full capital against such entities, with the result that Spanish banks made little use of them. Spain also took the novel approach of raising bank capital requirements as lending accelerated, the opposite of the procyclical tendencies of the international capital standards most countries used. Time will tell if this approach results in less pain in Spain, whose housing bubble has been even larger than the United States' and appears to be deflating. Greg Ip
Comments
Bernanke: Out of Rabbits?
The Federal Reserve is by no means out of rabbits. The problem though is that it will take an ever larger number of this finite and diminishing supply on each successive occasion to achieve the same effect a far smaller number of rabbits, pulled out of the hat, achieved earlier.
In truth, the achievements, while significant in several particular respects, have been small indeed when considered in the context of the gravity of the problem. Many of the "successful" rabbits have enjoyed only a temporary and evanescent success: such success, we expect, has now begun to dissipate. We do not criticize the FED's attempts to create the illusion of success. Illusions are sometimes effective in procuring, in due course, the concrete result they are designed to attain. Such successes depend, however, upon more than manipulating mass psychology and building upon the foundation of wishful thinking of both elite and herd to create a self-fulfilling "prophecy." For to induce among the audience the desired behavior, it is necessary to sustain the illusion and to bolster wishful thinking FAR BEYOND the initial hypnotic effect. This, in turn, is dependent upon the existence of a reality which is not irretrievably beyond a certain maximum malleability.
Comment by moneysage - May 16, 2008 at 1:51 pm(contd)
In the present case, we believe that none of the rabbits the FED has thus far pulled from its hat, nor the range of rabbits it may yet pull, will prove sufficient to paper over the gap between the maximum possible wishful thinking and attendant bullish behavior of banks, businesses, consumers, homeowners, taxpayers, and markets - and the UNDERLYING REALITY.If any government or institution has ever been able to stop a solidly established, well-grounded bear market from being carried - by the gap between price and value it has finally and conclusively discerned, by the domino effect of declining prices, ramifying pressure on growing numbers of market participants, and the attendant evolution of the normal bear market psychology, and, finally, its own momentum - WE HAVE YET TO SEE IT. We do reiterate our belief that there is an IRON LAW OF MARKETS. No one and no institution can overcome this law. We thus feel constrained to regard the FED's well-meaning - if rather tardy efforts to contain the REAL ESTATE BEAR MARKET - as an admirable, if ineluctably futile endeavor.
The real problem is not that there is an ongoing and very serious bear market in residential real estate. The problem is that the regulatory authorities - and most notably, the FED itself - allowed the banking system to overspeculate, overleverage, and "innovate" via securitization - real estate, with the maxing out of said behaviors at the very top of the bull market. Consequently, as the inevitable bear market has gotten underway, it constitutes not a threat of limited consequence, but rather A GRAVE SYSTEMIC THREAT. The successive destruction of the barriers prudently erected to prevent the type of speculative mania which developed in real estate over a period of years and has now turned into panic has in fact undermined the very market system the untrammelled free marketeers sought to liberate forever from the shackles of government regulation. In plain English, the apostles of the free market - from Reagan and Thatcher and Greenspan and Bernanke to the Republican Congress - WENT TOO FAR. Their hubris was too great. Their intellectual arrogance and provincialism, their wilfullness, and, e now brought the financial system of this country to the abyss, threatening to drag down with it our own economy, if not foreign economies as well.
Comment by moneysage - May 16, 2008 at 1:51 pm(contd)
The ideologues of the untrammelled free market have forgotten the wisdom of Santayana:
"Those who forget history are condemned to repeat it."
The free marketeers forgot that there were PROFOUND REASONS for the REGULATORY INNOVATIONS of the New Deal, for the wall of separation erected between commercial and investment banking, for central bank prudence in managing the economy.
The reason for the New Deal reforms, dismantled or ignored, one by one, by the untrammelled free marketeers was just this: in 1933 this country realized that an unregulated free market must inevitably produce, during the down portion of the business and financial cycles, depressions of horrific proportions and duration. They witnessed with their own eyes the great truth spoken by the fictional head of the fictional British banking family, the Pallisers, who observed:"There will always be crashes."
Indeed. The primary purpose of regulation of banks and markets was to create and maintain a firebreak between these inevitable crashes and bear markets, on the one hand, and the real economy, on the other. To contain, in other words, and to limit, the economic damage which would otherwise be wrought by uncontrolled markets and banks.
The Greenspan FED, in declining to fulfill its regulatory responsibilities, played a central role in the development of the preconditions for today's crisis. Now, we think, the illusory "success" of the Bernanke FED in containing the financial crisis and the unfolding economic downturn is starting to dissipate. The by-products of this momentarily successful illusionism - the rally in stocks, in junk bonds and loans, the partial recapitalization of banks, and the heralds of renewed bank lending and of the passing of the worst part of the credit contraction - are now on the brink of dissolving under the fierce pounding of the INTENSIFICATION of the BEAR MARKET IN REAL ESTATE and all that implies for the banking system and the larger economy. Moreover, investors, businesses, and financial and governmental institutions abroad - not to mention many at home - have resumed voting with their money. And what are they voting for? Gold. Oil. Commodities. Foreign currencies.
The FED, we must sadly conclude, has stoked an intensifying inflationary fear at home and abroad WITHOUT having ended the financial system crisis, which will likely re-emerge in the next round of damage to bank "assets" as real estate price continue to decline and commercial real estate starts sinking. The reflationary actions of the central bank have played a central role in intensifying the flight from the dollar and the flight to safety - now perceived to reside in metals, oil, and agricultural produce. New rounds of rate cuts and liquidity infusions - which we fully expect - will more likely than not have a net negative impact, as the heightened terror of inflation produces yet more inflation with the consequence of undermining the consumer to a greater extent than FED monetary largesse is able to bolster him.
Comment by moneysage - May 16, 2008 at 1:51 pmIf money is the ultimate commodity, making it too cheap, free or even paying people to take it can only breed near-infinite ways to waste it without consequence. We keep telling the young 'uns that raising cows makes no sense when the milk is free, but all these "grown-ups" keep corrupting them with fancy dancy ideas about fast money.
Comment by M Hazard - May 16, 2008 at 1:52 pmDoes it work that way??? Like SarBox, can we simply up and say "Now It Matters Again!" and not merely make it so, but with our usual ghastly hubris SUDDENLY re-become the good little boys and girls we all thought we once were?
I think not.
How did we get into this mess? Why is it every solution is the same, or worse yet like the man stuck in quicksand, every political economic move we make makes things worse?
We got into this mess because we thought we had it all figured out. Think about the little things I was re-watching A Beautiful Mind, and while I admire the artful direction and performances of the movie, there is a key corrupted conceit to the movie. The movie Forrest Gump has the same or similar corrupted conceit, though it is more often discussed. The conceits in both movies are pretty darn obvious, so I'll let you ponder it over the weekend and beyond
Sometimes little things can tell you alot.
We made this bed, and we're going to have to sleep in it.
Comment by s25 - May 16, 2008 at 1:53 pmThe Saudis rejected Bush's proposal to increase oil production. Prepare for a $10 a gallon oil.
Comment by Anonymous - May 16, 2008 at 2:09 pmCertainly the Feds could have been more proactive in stopping the housing/credit bubble. More control is certainly the answer, if I remember my history lessons, The Great Depression was preceded by a huge bubble.
The commodity, banking and ancillary industries have become totally to free to do as they please. These industries lead the masses to their own financial demise.
A free market with constraints/guidelines is where the answer lies.
Oyl Slick
Comment by Oyl Slick - May 16, 2008 at 2:17 pmFed, Greenspan or Ben, are doing the same: blow another bubbles when one bursted. Greenspan blued the real estate bubble when tech was bursted, now Ben is blowing commodity bubble for real estate one. Never ending.
Comment by Bubble Boy - May 16, 2008 at 2:30 pm I
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May 16, 2008 | naked capitalism
The fulminating over what to do about our
miscreantsocializedunrepentant and as yet unreconstituted financial services sector continues. Since massive subsidies have been extended in the form of help to the mortgage business and an alphabet soup of Federal Reserve facilities, with nary a demand made of the beneficiaries of this largess, it seems that the authorities have perilous little leverage over their wayward charges.Of course, in reality that isn't so; a determined regulator can, if nothing else, harass a company into submission (the Japanese are masters of this technique) and they have more powerful tools at their disposal. But that presupposes the will to intervene, which despite the crisis, still appears to be sorely lacking.
The collective response resembles the storied boiled frog effect: the heat goes up, or in this case, the public outlays continue, yet legislators, regulators, and the public remain remarkably passive as the expenses continue to rise. Of course, it doesn't hurt that many of these costs are contingent liabilities, so the true damage will come to light only years later, when the perps have moved on to other roles.
But readers beware: the boiled frog is an urban legend. Real frogs have the good sense to hop out of hot water. But in a pot with high enough sides, even a frog that knows it is in trouble will be unable to escape.
The sightings today confirm the difficult of leashing and collaring a complex, sprawling, fast-moving industry. The Financial Times has a comment by Charles Dallara, the head of the Institute of International Finance, an international organization of financial institutions that verges on the sanctimonious. It confidently recites a list of four areas for action and asserts:
Thus, the debate is not about "self-regulation" versus "more regulation". Instead, there is an emerging consensus on the benefits of reinforcing market-based corrections with improved regulatory incentives and structures.A consensus among those who'd rather not be regulated, for sure.Some regulators are getting mad enough to at least threaten action, but it isn't evident that they will be taken seriously. As the Telegraph reports in "EU to launch assault on bankers' bonuses":
A group of key EU finance ministers will today launch an assault on the rewards earned by bankers and top managers in a move that poses a potential threat to the City of London.A confidential document prepared for the gathering in Brussels finds the "short-term" pay structure of modern capitalism has become deformed, causing firms to take on "excessive risk" without regard to the interests of stakeholders or society.
Note that these discussions do not include the UK.Now one can correctly point out that this is silly; the main finance centers are not in Europe to begin with, and having the EU adopt even tougher rules will assure even less high powered finance take place there. But don't assume the EU is that naive. I suspect the credit crisis has at least another bad episode or two coming. The Fed has had to coordinate closely with the ECB on recent interventions. The EU may be trying to take intellectual leadership to force the US and the UK, which is also showing signs of financial distress, into taking more radical action. The EU may be taking a tough public posture while privately harboring more limited, realistic aims.
Ironically, the most sensible proposal comes from a US hedge fund manager. As reported by Ira Ross Sorkin in the New York Times:
Kenneth C. Griffin, who runs one of the biggest and most successful hedge fund firms, has a blunt assessment: "We, as an industry, dropped the ball."The breakdown happened, Mr. Griffin contends, when big investment banks gambled away money and jobs during the late great credit boom. The bosses let all those young gung-ho traders take far too many risks and now everyone is paying the price.
But the answer is simple, in his view. The entire industry needs to overhaul its thinking and, believe it or not, perhaps even accept greater regulation...
When you read that UBS did not even view parts of its mortgage portfolio as having market risk, it becomes very obvious that a number of firms were not dotting the i's and crossing the t's when it comes to risk management," he said while on the panel [at the Milken Institute Global Conference] to a packed room.
How did it come to this?
A problem, he says, is youth and inexperience - and that's coming from a former child prodigy.
"Walk across any of the trading floors - they are full of 29-year-old kids," he said. "The capital markets of America are controlled by a bunch of right-out-of-business-school young guys who haven't really seen that much. You have a real lack of wisdom."
On top of that, many chief executives of big universal banks, the ones that combine all sorts of financial services under one roof, "only understand a small part of the business," Mr. Griffin said, suggesting too many of them come from sales backgrounds. Put those two things together, the traders and the chiefs, and you have the making of an outright debacle.
The problem is compounded further by weak government oversight, he said. "The unwillingness of the Federal Reserve and the S.E.C. to require working capital" limits, he said, only exacerbates the risk-taking environment because the banks are playing the equivalent of no-limit poker. "The sad truth of the matter is it didn't have to be this way," he said.
But Mr. Griffin isn't just a serial complainer. He has thought about solutions.
First, "the investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve," he says.
But that's not all. He also wants new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion. "Everyone is missing the elephant in the room," he said.
It was the interlocking relationships between thousands of investors and banks over credit default swaps that pushed the Fed to help rescue Bear Stearns. In particular, Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives.
That way, instead of investment banks playing matchmaker between parties, an exchange will do it with strict rules in place, eliminating billions of dollars in exposure and creating more transparency.
"It's not sexy, but it's simple, it's cost forward, its straightforward, and it's what we should have done after 1998," referring to the collapse of Long-Term Capital Management, a big hedge fund. He added that it "is a very sad commentary on where we are from a regulatory perspective" that such a move hasn't happened already.
Of course, most big investment banks would hate such a plan, he acknowledged by telephone last week. "The investment banks and commercial banks benefit from the lack of transparency because they are the intermediary," he said. (It also has the effect of making Mr. Griffin's firm more money by cutting out the middleman.)
But he also wants to warn against going too far. "It may be a moment in time where there is quite a bit of fervor to put in place significant regulatory regimes that in my opinion could set this nation way back on the playing field," he said.
He's particularly nervous that excessive regulation could send more jobs overseas. "I see thousands and thousands of jobs at Canary Wharf and in downtown London, jobs that should have been in America in financial services. Derivatives really were developed in America and because of regulatory uncertainty left America."
Note that, as readers have pointed out, moving CDS to exchanges isn't quite that simple. New contracts with different and more standardized features could be exchange traded; the current types don't lend themselves well to that. So the worrisome and potentially wobbly overhang of outstanding CDS would have to run itself off over time. Still, any progress on that front is welcome.And to Griffin's point about regulatory arbitrage; that's where the EU's foray might prove useful. The idea of an international regulation, or failing that, greater international harmonization, is getting traction. But it will take a push, which may come in the form of another leg down in the credit crisis, for that to happen.
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So Uncle Al is the guy who bought booze for all the kids at the party. Now all the kids are sick, and Greenspan doesn't want to be blamed for it.Al, dg : Greenspan isn't campaignin
g for anything. He spoke with a great deal of ambiguity when he held office yet now suddenly is eloquent as can be. I've commented before about his Woody Allen-esqu e demeanor. Is he a tortured comic genius or simply a dirty old man? A economic wizard or overwhelme
d buffoon?
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April 9, 2008 | forestpolicy.typepad.com
At maverecon Willem Butier counters Alan Greenspan's latest claim the he and the US Fed not be held responsible, in large part, for our current mess. Butier's eight policy "tragedies":
Butier elaborates on each. We will bring forward only one, dealing with possibilities for moral hazard. But before we do, I just found Martin Wolf's counter-balancing position, Ft.com, April 8, still praising Greenspan, while fearing that over-zealous regulatory reform spaned by a Greenspan "blame game" will kill the "good" that free-er (my word, Wolf uses "free) market mechanisms bring. Whereas Butier lists eight "tragedies" of Fed policy/practice, Wolf highlights two: (1) regulators should have been "tougher", in subprime and elsewhere, and (2) monetary policy should have been tigher, not looser - to lean against prevailing winds of excess instead of leaning with them.
- The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
- The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
- The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
- The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
- The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
- The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
- The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
- During his years as Chairman of the Federal Reserve Board, Mr. Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan's theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.
David Beckworth, via Macro and Other Musings, adds insight into why Butier's critique is on target:
[T]he Federal Reserve is a monetary hegemon. It holds the world's main reserve currency and many emerging markets are pegged to dollar. Thus, it's monetary policy is exported across the globe. This means that the ECB, even though the Euro officially floats, has to be mindful of U.S. monetary policy lest its currency becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. The Fed's loosening, therefore, of monetary policy in the early-to-mid 2000s triggered a global liquidity glut that set the stage the subsequent housing boom-bust cycle. This is not to say the 'saving glut' and financial innovation had no role, but rather that loose monetary policy was a key factor behind the boom.Back To Butier:The Greenspan Fed: a tragedy of errors, Willem Butier, maverecon:Financial Times, April 8: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.Continue reading "Butier Responds to Greenspan's Latest Attempt to Rewrite History" "
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Mark Wenzel caught my attention with his recent reflections on the intertwined legacies of Ronald Reagan and Alan Greenspan, including the unleashing of "free market fundamentalism", the repeal of Glass-Steagall, and the emergence of the latest loopholes for the rich and powerful to exploit at the yet-to-be-tallied expense of the so-called middle- and lower classes. It is well worth a look, and Wenzel's blog Capital Market Musings worth a bookmark. A snip from Wenzel:
The Credit Bubble, Deregulation Gone Wild and Saving the Financial Industry from Itself, Mark Wenzel, April 4:Go read the rest!West Berlin, Germany. June 12, 1987;
"...if you seek liberalization: Come here to this gate! Mr.
Gorbachev, open this gate! Mr. Gorbachev, tear down this wall!"For the role that America and Ronald Reagan played in that, it represented to many a moment that came to symbolize the best of what America had to offer. There's another side though, the economic one and specifically deregulation of the financial industry, where the aftermath of the transformational presidency that was Ronald Reagan hasn't exactly gone as planned. In regards to the current financial crisis described by many as the worst in multiple generations, billionaire investor George Soros stated here;
"The cause of the current troubles dates back to 1980, when U.S. President Ronald Reagan and U.K. Prime Minister Margaret Thatcher came to power, Soros said. It was during this time that borrowing ballooned and regulation of banks and financial markets became less stringent. These leaders, Soros said, believed that markets are self-correcting, meaning that if prices get out of whack, they will eventually revert to historical norms. Instead, this laissez-faire attitude created the current housing bubble, which in turn led to the seizing up of credit markets..."
Soros further opines elsewhere;
"...regulations have been progressively relaxed until they have practically disappeared".
One of the first targets of financial system deregulation in the Reagan administration was savings banks and commercial banks.
In less then 7 years after the initiation of this major banking deregulation, in February of 1989, President Bush (the first of course) unveiled the S&L bailout plan.
In 1998, the stakes are raised, as the financial industry goes for the juggular. Again from Frontline;
"After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression-era relic."
Fresh off of this "victory", incredulously, the man who was charged with being the banking systems chief regulator, Fed Chairman Alan Greenspan continued to lead the charge towards a completely unregulated financial system as he turned his sites towards championing the growth of unregulated derivatives.
The ensuing years saw the accelerating phenomenon where, with the last major regulatory impediment removed, and more importantly perhaps, not replaced with any form of updated regulation, the credit bubble accelerated, fueled heavily by the explosive growth in unregulated derivatives. #8230;
The result of this is that today we have what is called the $516 trillion shadow banking system, the "secret banking system built on derivatives and untouched by regulation" according to the worlds largest bond fund manager, Bill Gross.
Further, in getting back to the current credit crisis, here we are today, in somewhat of a repeat of the S&L deregulation followed by bailout scenario, in that we have the Glass-Steagall deregulation followed in a similar amount of time by the bailout brigade. This time though, the stakes are much higher.
Is this what we have reduced our financial system to? Where it is so weak and fragile that the failure of a single investment bank threatens a widespread financial calamity. If so, how did we let it reach this point? In my mind, extremist laissez-faire deregulation surely played a heavy part.
So where do we go from here? By no means am I advocating that we turn back time and reinstall the regulations that previously existed "as is". Further, of course regulation can just as easily go too far (see India here). Free markets are constantly evolving and innovating. Rather then always turning to deregulate though, perhaps its time to work more towards liberalization & modernization but not to the point of removing the systems of checks and balances that helped to make America the great economic power that it is.
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Apr 27, 2008 | Naked Capitalism
Grantham's excellent piece is unfortunately too long to present in full; so we'll give some key sections. He starts by focusing on incompetence (object lessons being Volcker versus Greenspan) but as you will see, the real issue is the question of having standards, both individually and as a society. The issue of competence is a subset of this broader concern.
Grantham does a particularly good job of savaging the idea that we can't afford failure, um, economic dislocation. He argues that tolerating imprudence has costs that are dismissed too casually.
From Grantham (courtesy reader Scott):
It's not that the former Fed boss Greenspan was incompetent that is remarkable. Incompetence is common enough after all, even in important jobs. What's remarkable is that so many people don't seem, even now, to get it. Do people just believe high-quality self-justifying blarney? Or is it just that they apparently want to believe that critical jobs in a great country attract great talent by divine right. Sometimes, of course, they do, but sometimes the most important jobs even that of a presidency or a Fed boss end up with mediocrities....Paul Volcker inherited about as big a mess as we have today. He worked out what he had to do and did it with unusual lack of concern about what Congress thought of the necessary pain involved and the number of enemies he might make. He paid the price for forthright behavior by being replaced, despite a record for correct and tough behavior that makes for the most invidious comparison today. When Volcker was replaced, by the way, he did not moan and groan but like an old soldier quietly disappeared. There were no high-profi le announcements about the economy or any $300,000-an-evening appearances paid for by financial firms.
Greenspan came onto my radar screen in the late sixties as a seller of economic and fi nancial advice to the investment industry. To be brutally honest, he was considered run of the mill by anyone I knew then or have met later who knew his service then. His high point in most memories, certainly mine, was a famous call in January 1973 that, "it can," a few days before a market decline of over 60% in real terms, second only to the Great Crash in a century, accompanied also by a bitter recession. This was one of the first of a long line of terrible prognostications for which he has remarkably not been remembered, except by a handful of us amateur historians. Then in the midseventies he disappeared into some government job, of which I was barely aware, until he re-emerged with a bang in 1987, without as far as I can find having done anything documentably very well. And we can agree that at least occasionally people can indeed prove their effectiveness beyond doubt.....We can all wonder at the incredible vision, drive, organizational skill, and willingness to sacrifice resources that were required by the Manhattan Project and compare it to the rudderless or even deliberate avoidance of leadership of the greatest issues today: climate change and energy security. We can only wonder what a Manhattan Project aimed at alternative energy might have accomplished by now, had it been started 15 years ago.
What we have had in lieu of vision, leadership, and backbone is a series of easy paths taken. At the time that Paul Volcker broke the back of infl ation in the early 1980s, the recognition that risk and leverage had consequences was baked into the pie: if you were to take excessive risk you had better win the bet. If you missed the target, the expected result would be more or less total failure, and that seemed then and for decades earlier a reasonable law of nature. Now in contrast we get ready to celebrate the 20th anniversary of the era of the Great Moral Hazard. Slowly at fi rst, but with steadily growing traction, the idea was planted that asset bubbles would be tolerated, but consequences of their bursting would be moderated or avoided entirely by increasingly vigorous actions sometimes, like now, bordering on the hysterical. This is to say that if all went well, enormous profi ts could be made by speculators largely the great fi nancial fi rms, including some formerly conservative blue chip banks by riding and leveraging the bubbles. If all went badly, then the costs would be passed on to others.
The idea that occasional economic setbacks might benefit the system in the long run was one of the early ideas to
disappear. Yet if you prop up weak sisters who would otherwise fail and in failing present their more efficient competitors with extra growth, you must surely weaken the system. Desperation pricing from weak fi rms who simply should not exist can weaken the profi tability of a whole industry, as it has for the airlines. The average efficiency of most industries is reduced with at least some effects on our global competitiveness. With a slightly lower average return on equity, the ability to reinvest drops so that, in this world of moral hazard where recessions are few and mild, GDP growth is a little less than it might have been....The defense of bailouts is that the alternative is ugly.But surely the penalties for excessive risk taking, issuing flaky paper, passing it on often in its entirety to others, and not even understanding the consequences of the low grade paper that you yourself issue should be ugly. "Yes, of course, we would like to punish the excessive risk takers" goes the line, but we can't do it without hurting the innocent economy. But we will never know what can be absorbed if the penalties are always removed by a bailout. In more traditional times, say, from 1945 to 1985, the economy could absorb substantial punishment from recessions and still grow faster than it has done in the last 10 years.
The real incompetence here goes back over 20 years: the refusal to deal with investment bubbles as they form, combined with willingness, even eagerness, to rush to the rescue as they break. It's almost as if neither Greenspan nor Bernanke allows himself to see the bubbles. Greenspan was always confl icted and contradictory about whether bubbles could even exist or not. Bernanke, in contrast, has more of the typical academic's certainty that the established belief in market effi ciency is correct and therefore investment bubbles must be merely the product of investors' overheated imaginations. It would be convenient to have such an important role as Fed Chairman fi lled by someone who actually deals with the real world, messy or not, that is given to inconvenient bursts of euphoria and riddled by considerations of career and business risk, which modify behavior far away from economic efficiency....
As discussed many times in the investment business, pessimism or realism in the face of probable trouble is just plain bad for business and bad for careers. What I am only slowly realizing, though, is how similar the career risk appears to be for the Fed. It doesn't want to move against bubbles because Congress and business do not like it and show their dislike in unmistakable terms. Even Fed chairmen get bullied and have their faces slapped if they stick to their guns, which will, not surprisingly, be rare since everyone values his career or does not want to be replaced ΰ la Volcker. So, be as optimistic as possible, be nice to everyone, bail everyone out, and hope for the best. If all goes well after all, you will have a lot of grateful bailees who will happily hire you for $300,000 a pop. By the way, that such payments to prior Fed offi cials are in themselves a moral hazard and an obvious confl ict of interest that could moderate their prior behavior, is apparently too crude an accusation even to have surfaced yet. Well it should surface. Selling services to financial interests whose fates have been in your hands should simply not be tolerated as acceptable or ethical behavior by a former Fed Chairman.
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April 8, 2008 | Economic Dreams - Economic Nightmares
At maverecon Willem Butier counters Alan Greenspan's latest claim the he and the US Fed not be held responsible, in large part, for our current mess. Butier's eight policy "tragedies":
Butier elaborates on each. We will bring forward only one, dealing with possibilities for moral hazard. But before we do, I just found Martin Wolf's counter-balancing position, Ft.com, April 8, still praising Greenspan, while fearing that over-zealous regulatory reform spaned by a Greenspan "blame game" will kill the "good" that free-er (my word, Wolf uses "free) market mechanisms bring. Whereas Butier lists eight "tragedies" of Fed policy/practice, Wolf highlights two: (1) regulators should have been "tougher", in subprime and elsewhere, and (2) monetary policy should have been tigher, not looser - to lean against prevailing winds of excess instead of leaning with them.
- The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
- The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
- The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
- The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
- The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
- The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
- The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
- During his years as Chairman of the Federal Reserve Board, Mr. Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan's theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.
David Beckworth, via Macro and Other Musings, adds insight into why Butier's critique is on target:
[T]he Federal Reserve is a monetary hegemon. It holds the world's main reserve currency and many emerging markets are pegged to dollar. Thus, it's monetary policy is exported across the globe. This means that the ECB, even though the Euro officially floats, has to be mindful of U.S. monetary policy lest its currency becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. The Fed's loosening, therefore, of monetary policy in the early-to-mid 2000s triggered a global liquidity glut that set the stage the subsequent housing boom-bust cycle. This is not to say the 'saving glut' and financial innovation had no role, but rather that loose monetary policy was a key factor behind the boom.Back To Butier:The Greenspan Fed: a tragedy of errors, Willem Butier, maverecon:Financial Times, April 8: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.5. The Greenspan Fed as moral hazard incubator
In 1998, the Federal Reserve System played an important role in orchestrating the private sector bail-out of Long Term Capital Management (LTCM), a hedge fund brought down by hubris, incompetence and bad luck. Although no Fed money, and indeed no public money of any kind, was committed in the rescue, the Federal Reserve System, through the Federal Reserve Bank of New York and its President, William J. McDonough, played a key role in brokering the deal, by offering its good offices and using its not inconsiderable powers of persuasion to achieve agreement among its 14 major creditor banks (ironically, Bear Stearns refused to participate in the rescue). The reputation of the Fed therefore was put at risk.The reason given by the Fed for its orchestration of this bailout was the fear that, in a final desperate attempt to forestall insolvency, a fire-sale by LTCM of its assets would cause a chain reaction. This rushed liquidation of LTCM's securities to cover its maturing debt obligations would lead to a precipitous drop in the prices of similar securities, which would expose other companies, unable to meet margin calls, to liquidate their own assets. Such positive feedback could create a vicious cycle and a systemic crisis.
This is the same vicious cycle leading to systemic risk story that was trotted out by Timothy F. Geithner, the current President of the New York Fed, to rationalise the bail out of Bear Stearns.
Notable features of the LTCM bailout were (1) that the existing shareholders retained a 10 percent holding, valued at about $400million, and (2) that the existing management of LTCM would retain their jobs for the time being, and with it the opportunity to earn management fees. A rival (rejected) offer by a group consisting of Berkshire Hathaway, Goldman Sachs and American International Group, would have had the shareholders lose everything except for a $250 mln takeover payment and would have had the existing management fired.
One reason given for allowing the existing shareholders to retain a significant share and for keeping the existing managers on board was that only these existing shareholders-managers could comprehend, work out and unwind the immensely complex structures on LTCM's balance sheet. These were the same people, including two academic finance wizards, Myron Scholes and Robert C. Merton, joint winners in 1997 of the Nobel Memorial Prize in Economics, whose ignorance and hubris got LTCM into trouble in the first place.
Any handful of ABD graduate students from a top business school or financial economics programme could have unravelled the mysteries of the LTCM balance sheet in a couple of afternoons. The bail-out of LTCM smacks of crony capitalism of the worst kind. The involvement of the Fed smacks of regulatory capture.
The nature of the bail-out of LTCM meant that there was never any serious effort subsequently to address the potential conflicts of interest arising from simultaneously financing hedge funds, investing in them, and making money executing trades for them, as many investment banks did with Long-Term Capital. Things were even worse because, apart from the inherent potential conflict of interest that is present whenever a party is both a shareholder in and a creditor to a business, the bailout created a serious corporate governance problem because executives of one of the financial institutions that funded the bailout had themselves invested $22 mln in LTCM on their personal accounts. Using shareholder resources for a bail-out of a company to which you have personal exposure is unethical, even where it is legal.
For the Fed to have been involved in this shoddy bailout was a major mistake that soiled its reputation. If the Fed becomes involved (as an 'enabler' and/or by putting its financial resources at risk) in the rescue of a highly leveraged private financial institution, be it a hedge fund, an investment bank or a commercial bank, that private institution should immediately be subject to a special resolution regime, including the appointment of a special public administrator. That is, what is needed is an arrangement for all highly leveraged private financial institutions deemed too big and too systemically important to fail, akin to the treatment of (insured) commercial bank insolvencies under the Federal Deposit Insurance Act.
Under the rules established by the FDIC Improvement Act of 1991, a legally closed bank's charter is revoked and the bank is turned over to the FDIC which serves as receiver or conservator. Typically, the old top management are fired and shareholder control rights are terminated. The shareholders do, however, keep a claim on any residual value that remains after all creditors and depositors have been paid off. {footnote in original}
From a longer-run perspective, the LTCM bail-out can be seen as a key enabler of the 2008 bailout of the investment bank Bear Stearns, another type of highly leveraged financial institution deemed too big to fail by the Fed. In the case of Bear Stearns too, shareholders were left with something 'up front' (two dollars per share initially, subsequently revised to ten dollars per share) and the old management is still in situ. In addition, in the Bear Stearns case, Fed money is directly at risk - the Fed is funding the senior $29 bn of a $30 bn off-balance sheet facility created to warehouse Bear Stearns' most toxic assets.
If the "too big and too systemically important to fail" argument for bailing out large deposit-taking commercial banks is now also applied to other highly leveraged private financial institutions, including but not limited to, investment banks and hedge funds, then a similar special resolution regime, including prompt corrective action provisions must be in place if rampant moral hazard is not to be encouraged. The Greenspan Fed failed to make the case for or press for such reforms, even after the LTCM debacle. They bear a heavy responsibility for the moral hazard created in 1998 and in 2008, and for the future financial crises that will be encouraged and exacerbated by these failures. {emphasis added}
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By contrast, Greenspan's book ``The Age of Turbulence: Adventures in a New World'' had sold 488,000 copies as of March 30, according to Nielsen BookScan.
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J. D. Seagraves (Michigan) - See all my reviewsTHE AGE OF TURBULENCE is a fine book the same way Hitler's MEIN KAMPF is a fine book: It probes deeply into the history and deranged theories of a power-mad dictator.
The early stages of the book offer a fascinating account of Greenspan's childhood, growing up with a single mother in Depression-era New York City. The details here are interesting from a sociological perspective, even if the boy in question did not grow up to become the most powerful and ruinous money master in the history of civilization. The story of his path to prominence is also quite interesting and very well written.
But the later stages of the book is where it falls off. Here Greenspan offers insights into his thoroughly rebuked pseudo-Keynesian monetary and fiscal theories. Worse yet, this arch-dictator of the world's greatest monetary fascism has the audacity to call himself a "libertarian" and a "capitalist." He's far from it.
I would not discourage anyone from reading this book, however, one should not accept Greenspan's central-planning theorems disguised as "free-market" capitalism at face value. This book will teach the uninformed reader a lot about the subject in college they CALL "economics," but nothing of REAL economics. For that, I recommend the works of Murray Rothbard, most notably, his THE CASE AGAINST THE FED.
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Apr 7, 2008 | FT.com
Alan Greenspan has hit back at critics who blame the Federal Reserve under his leadership for causing the US housing bubble by keeping interest rates too low for too long in the early 2000s, saying the evidence of any link between monetary policy and the bubble was "statistically very fragile".
Writing in the Economists' Forum on FT.com, Mr Greenspan says he is "puzzled" why so many commentators seek to explain the US housing bubble in terms of Fed actions when many other economies with different central banks and different monetary policies also saw rapid house price gains.
The former Fed chairman says the most likely cause of this global house price boom was a "dramatic fall in real long term interest rates" around the world, which he believes was caused by abundant global savings.
In any event, Mr Greenspan says, it is only with hindsight that it looks like the US economic recovery was well enough entrenched before 2004 to allow the Fed to start raising interest rates sooner than it did.
"With inflation falling to quite low levels, that was not the way the pre-2004 period was experienced at the time," he says.
In his article, Mr Greenspan reaffirms his long-held belief that central banks cannot effectively "lean against the wind" by setting monetary policy a little tighter than it would otherwise have been during asset price booms.
However, he writes "if it turns out it is feasible" to conduct monetary policy in this way, "I would become a strong supporter of leaning against the wind."
Mr Greenspan also takes issue with those who blame lax regulation by the Fed for allowing a serious deterioration in underwriting standards in the mortage industry. The problem, Mr Greenspan argues, "is not the lack of regulation, but unrealistic expectations about what regulators are able to prevent".
The former Fed chief says the core of the subprime problem "lies with the misjudgments of the investment community". The scramble to invest in what were initially highly profitable subprime loans would have overwhelmed any regulatory effort to slow the growth of this sector, he claims.
Mr Greenspan says the "fierceness" of the retreat from risk since the crisis began in August "surprised" him and had "shaken" his view of the range of possible economic outcomes.
But he remained firmly of the view "that free competitive markets are the unrivalled way to organise economies".
EDITOR'S CHOICE
- Alan Greenspan: The Fed is blameless on the property bubble - Apr-06
- IMF head calls for global action on turmoil - Apr-06
- Wolfgang Mόnchau: Stop ignoring house prices - Apr-06
- Call for action on US housing market - Apr-04
- IMF urges greater focus on housing - Apr-04
- Clive Crook: We need intelligent regulation - Apr-06
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For the recession that began in July 1990:"In the very near term there's little evidence that I can see to suggest the economy is tilting over [into recession]."
Chairman Greenspan, July 1990"...those who argue that we are already in a recession I think are reasonably certain to be wrong."
Greenspan, August 1990"... the economy has not yet slipped into recession."
Greenspan, October 1990Source: "Booms, Busts, and the Role of the Federal Reserve" by David Altig
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Apr 2, 2008 | The Mess That Greenspan Made
A number of you have sent links to the Barron's story about former Fed Chairman Alan Greenspan's mysterious doctoral thesis - thanks.
We'll get to that in a minute.
As part of an email exchange with CR on this topic, the well-known piece of writing from 1967 came up - Gold and Economic Freedom - and, one thing led to another, ultimately resulting in the title of this post.
Not having read this piece in quite some time, save for the well-worn second to last paragraph that seems to pop up everywhere and begins, In the absence of the gold standard, there is no way to protect savings from confiscation through inflation", another quick read reveals a rather remarkable 40-year old:
Gold and Economic FreedomIn addition to examining the fundamental nature of money, a subject that gets scant attention in economic circles these days, this piece is notable for its look at the pre-stock market crash conditions that led to the crash and then to the Great Depression.
Alan Greenspan, 1967Penned by Greenspan 41 years ago and reprinted from the book of essays Capitalism, the Unknown Ideal by Ayn Rand & others. As you read it, ask yourself what happened to this man?
An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense-perhaps more clearly and subtly than many consistent defenders of laissez-faire-that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.
In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.
Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.
...
When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates.The "Fed" succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's.
Most contemporary economic thought about that period conveniently omits the period prior to 1930, looking instead at how the depression could have been shortened if more easy money had been applied more quickly.
This is pretty amazing stuff coming from one of the most important individuals in recent history. That is, an individual who played a major role in shaping the financial and banking system as they exist today - systems that now seem in danger of imploding on a fairly regular basis.
Anyway, on to the story of the "invisible dissertation" by Jim McTague at Barron's:
Greenspan, who left the Fed in 2006 but is still consulted as a genius, might find a metallic exoskeleton exceptionally comforting come May, when the University of Texas Press publishes an unflattering book by Robert Auerbach entitled Deception and Abuse at the Fed: Henry B. Gonzalez Battles Alan Greenspan's Bank.Auerbach, a veteran Fed basher, portrays Greenspan as a real-life Professor Marvel -- who, through double-talk or "garblement," transformed himself into a mighty economic wizard ΰ la Oz. Auerbach strongly implies that Greenspan's 1977 Ph.D. from New York University was obtained in a few months with little more rigor than a matchbook-cover art degree and that Greepthe benefit of distance and perspective or, in this case, a doctoral thesis.
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Apr 2, 2008 | naked capitalism
One paragraph caught my eye:
Among the ideas floated was getting a large group of the most important banks simultaneously to disclose their financial positions based on a "common template" including information on the prices attributed to different securities and the methodologies used to derive them.This would include standardised disclosure of exposures to collateralised debt obligations, residential and commercial mortgage-backed securities, leveraged finance, exposure to off-balance sheet entities and capital and liquidity resources. One party present said there was widespread interest in this idea.
This is a stunning request. The banking authorities don't already posses this information? What were they doing in their regulatory reviews, drinking sherry while listening to PowerPoint presentations? Regulated entities should be reporting on a periodic basis, in formats dictated by the regulators, and that ought to include their pricing methodologies. Otherwise, any data gathering is a garbage-in, garbage-out exercise.This development confirms my worst suspicions. The regulators weren't merely out-maneuvered by bankers skilled in
deceptionfinancial wizardry; they enabled it by taking a "see no evil, hear no evil, speak no evil" stance.The only thing that might make this need defensible is if various national regulators have widely differing frameworks for data compilation, and a one-shot probe is needed to calibrate them. But the FT article did not give that impression. If anything, it implied that the FSF was having to pressure recalcitrant central bankers and financial regulators.
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Economist.com
Alan Greenspan, formerly chairman of the Federal Reserve, said in 2005 that "increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago." Tell that to Bear Stearns, Wall Street's fifth-largest investment bank, the most spectacular corporate casualty so far of the credit crisis.
For the critics of modern finance, Bear's swift end on March 16th was the inevitable consequence of the laissez-faire philosophy that allowed financial services to innovate and spread almost unchecked. This has created a complex, interdependent system prone to conflicts of interest. Fraud has been rampant in the sale of subprime mortgages. Spurred by pay that was geared to short-term gains, bankers and fund managers stand accused of pocketing bonuses with no thought for the longer-term consequences of what they were doing. Their gambling has been fed by the knowledge that, if disaster struck, someone else-borrowers, investors, taxpayers-would end up bearing at least some of the losses.
Since the era of frock coats and buckled shoes, finance has been knocked back by booms and busts every ten years or so. But the past decade has been plagued by them. It has been pocked by the Asian crisis, the debacle at Long-Term Capital Management, a super-brainy hedge fund, the dotcom crash and now what you might call the first crisis of securitisation. If the critics are right and something in finance is broken, then there will be pressure to reregulate, to return to what Alistair Darling, Britain's chancellor of the exchequer, calls "good old-fashioned banking". But are the critics right? What really went wrong with finance? And how can it be fixed?
At first this growth was built on the solid foundations of rising asset prices. The 18 years to 2000 witnessed an unparalleled bull market for shares and bonds. As the world's central banks tamed inflation, interest rates fell and asset prices rose (see chart 2). Corporate restructuring, wage competition and a revolution in information technology boosted profits. A typical portfolio of shares, bonds and cash gave real annual yields of over 14%, calculates Mr Barnes, almost four times the norm of earlier decades. Financial-service firms made hay. The number of equity mutual funds in America rose more than fourfold.
But something changed in 2001, when the dotcom bubble burst. America's GDP growth since then has been weaker than in any cycle since the 1950s, barring the double-dip recovery in 1980-81. Stephen King and Ian Morris of HSBC point out that growth in consumer spending, total investment and exports in this cycle has been correspondingly feeble.
Yet, like Wile E. Coyote running over the edge of a cliff, financial services kept on going. A service industry that, in effect, exists to help people write, trade and manage financial claims on future cashflows raced ahead of the real economy, even as the ground beneath it fell away.
The industry has defied gravity by using debt, securitisation and proprietary trading to boost fee income and profits. Investors hungry for yield have willingly gone along. Since 2000, according to BCA, the value of assets held in hedge funds, with their high fees and higher leverage, has quintupled. In addition, the industry has combined computing power and leverage to create a burst of innovation. The value of outstanding credit-default swaps, for instance, has climbed to a staggering $45 trillion. In 1980 financial-sector debt was only a tenth of the size of non-financial debt. Now it is half as big.
This process has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out.
The banks' course was made possible by cheap money, facilitated in turn by low consumer-price inflation. In more regulated times, credit controls or the gold standard restricted the creation of credit. But recently central banks have in effect conspired with the banks' urge to earn fees and use leverage. The resulting glut of liquidity and financial firms' thirst for yield led eventually to the ill-starred boom in American subprime mortgages.
The dance of debt
The tendency for financial services to run right over the cliff is accentuated by financial assets' habit of growing during booms. By lodging their extra assets as collateral, the intermediaries can put them to work and borrow more. Tobias Adrian, of the Federal Reserve Bank of New York, and Hyun Song Shin, of Princeton University, have shown that since the 1970s, debts have grown faster than assets during booms. This pro-cyclical leverage can feed on itself. If financial groups use the borrowed money to buy more of the sorts of securities they lodged as collateral, then the prices of those securities will go up. That, in turn, enables them to raise more debt and buy more securities.
Indeed, their shareholders would punish them if they sat out the next round-as Chuck Prince let slip only weeks before the crisis struck, when he said that Citigroup, the bank he then headed, was "still dancing". Mr Prince has been ridiculed for his lack of foresight. In fact, he was guilty of blurting out finance's embarrassing secret: that he was trapped in a dance he could not quit. As, in fact, was everyone else.
Sooner or later, though, the music stops. And when it does, the very mechanisms that create abundant credit will also destroy it. Most things attract buyers when the price falls. But not necessarily securities. Because financial intermediaries need to limit their leverage in a falling market, they sell assets (again, the system is pro-cyclical). That lowers the prices of securities, which puts further strain on balance sheets leading to further sales. And so the screw turns until those without leverage will buy.
You do not need bankers to be poorly monitored or over-incentivised for such cycles to work: finance knew booms and manias long before deposit insurance, bank rescues or bonuses. And, human nature being what it is, Jιrτme Kerviel, who lost Sociιtι Gιnιrale a fortune, and the staff of various loss-making, state-owned, German Landesbanks did not need huge pay to lose huge sums. The desire to show that you are a match for the star trader next door, or the bank in the next town, will do.
Yet pay-or at least bad management-probably made this crisis worse. Trades determine bonuses at the end of the year, even though their real value may not become clear until later. Earlier this month a group of financial supervisors reported how managers at the banks worst hit by the crisis had failed to oversee traders or take a broad view of risk across their firms. Perhaps, with proper incentives, managers would have done better.
Alan Johnson, a consultant who designs pay packages for Wall Street, predicts that in future senior executives will face the prospect of some of their bonuses being contingent on the bank's performance over several years. Yet to the extent that many senior bankers are paid in shares they cannot immediately sell, they already are. And to the extent that Bear Stearns's employees owned one-third of the firm, they already looked to the longer term.
If altering pay cannot stop manias, can regulation? The criticism that this crisis is the product of the deregulation of finance misses an important point. The worst excesses in the securitisation mess are encrusted precisely where regulation sought to protect banks and investors from the dangers of untrammelled credit growth. That is because regulations offer not just protection, but also clever ways to make money by getting around them.
Existing rules on capital adequacy require banks to put some capital aside for each asset. If the market leads to losses, the chances are they will have enough capital to cope. Yet this rule sets up a perverse incentive to create structures free of the capital burden-such as credits that last 364 days, and hence do not count as "permanent". The hundreds of billions of dollars in the shadow banking system-the notorious SIVs and conduits that have caused the banks so much pain-have been warehoused there to get round the rules. Spain's banking regulator prudently said that such vehicles could be created, but only if the banks put capital aside. So far the country has escaped the damage seen elsewhere. When reformed capital-adequacy rules are introduced, this is an area that will need to be monitored rigorously.
It is the same with rating agencies, the whipping boys of the crisis. Most bonds used to be issued by companies, and to judge something AAA was straightforward. Perhaps back then it made sense for some investors, such as pension funds, to be obliged to buy top-rated bonds. But this rule created a boundary between AAA and other bonds that was ripe for gaming. Clever people, abetted by the rating agencies, set out to pass off poor credit as AAA, because they stood to make a lot of money. And they did. For a while.
The financial industry is likely to stagnate or shrink in the next few years. That is partly because the last phase of its growth was founded on unsustainable leverage, and partly because the value of the underlying equities and bonds is unlikely to grow as it did in the 1980s and 1990s. If finance is foolishly reregulated, it will fare even worse.
And what of all the clever and misused wizardry of modern finance? Mr Greenspan was half right. Financial engineering can indeed spread risk and help the system work better. Like junk bonds, reviled at the end of 1980s, securitisation will rebound, tamed and better understood-and smaller. That is financial progress. It is a pity that it comes at such a cost.
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March 27, 2008 | economist.com
A Casino sets the odds so that in the long run the casino wins. Similarly when a brokerage house deals with a margin client, it should set requirements so that it wins over the long term. It really doesn't make much difference whether the securities are equities, nonequity or mortgages.
The requirements for buying equities on margin have been worked out over quite a considerable time. By and large they work reasonably well. Nonequity options, such as Dow Jones futures etc. can also be managed fairly well by weighting the requirements towards the greatest risk. This was clearly not done with mortgages at any level. The practice of packaging mortgages obscured things still further.
In all these cases, the requirements must be weighted towards the greatest risk. Because of the laissez-faire attitude which has existed over many years now, normal common sense procedures were abandoned in the quest for profit. I think that the blame for this can be squarely laid with a central banks and controlling agencies, because they did not force the banks to look at worst-case scenarios.
Now, because of panic they have made the situation even worse by underwriting the bank's excesses. There is even less incentive now for banks to examine worst-case scenarios, because the government has become a lender of last resort. This seems to me to be a gross interference with the proper working of the market. If you make a bad bet in the casino of life you can now go to your Uncle Sam for a covering loan. This is no way to deal with situations driven by greed.
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Polymetus wrote:
Kudos Factor wrote: March 26, 2008 11:27March 26, 2008 | economist.com
I'm sorry to have to say this, however, I believe the Economist, and the entire 'News' community should stand up and apologize for their share of this fiasco. It's easy to blame the financial community for it's recent excesses. Yet the 'people' never would have gone along, had it not been for the constant proclamations of the part of the media, that "this is great, the market's making a fortune, jump in or LOSE!"I know that it's not popular or profitable, stating the truth, the whole truth, and nothing but the truth, yet it's the lack of exactly that, that's resulted in our current crisis. I understand that telling people what they WANT to hear sells a lot more content than telling them what they NEED to hear. And, in that, may lay the true problem. Who subsidizes truth?
I will state, IMO, that the Economist has, indeed, been better than most, at adhering to a more accurate, truthful representation of status than most publications, and that I believe it is the Video based media that has unleashed, and, in fact, supported misconceptions about the bubbles we've been in. If I see one more, clueless person, presented on TV as a financial analyst or economic expert, stating for the umpteenth time, that "we're in a NEW economy, one which MUST continue to go up!", well, I'm wise enough to grant no credibility to such folks or their proclamations. However, the very sad truth is that the majority of the population of this globe, are naive, hopeful that such folks are telling the truth and willing to follow their advice. As long as such is the case, the Media MUST bear the responsibility of misleading them, when, as has been the case for decades now, the Media willfully, and knowingly, misinforms the people.
Those of us who understand such things, represent a very small portion of the population. I warned folks for YEARS about what was happening, how and why. My small voice was consistently overwhelmed by the Media, urging folks into ever greater excesses. As little as a year ago, folks were calling me 'fool'. "If I hadn't gone along with this boom," they'd say, "I wouldn't have made all this money!" Now that they're all losers, they say "Why weren't we told?" (By the media, rather than just me, whom we thought we could safely ignore?)
Why is no one talking about the winners? The banks have lost a lot of money... so who have they lost it to? It seems that few people are even asking the question. Are we going to spend all our time looking for scapegoats and blaming the system? Or have we just witnessed the perfect bank robbery? What do you think?The duke wrote:March 26, 2008 11:03
Buying a home is the beginning.2)maintain home
3) improve home
4)pay taxes
5)pay special assessments
6)pay insurance
7) occasionally pay for uninsured damage or below deductable
8)pay for furniture and/or worn out appliances..................
More to owning a home than the intial purchase.
Aaron Krowne said...
I think the president qualifies for his high blame ranking, but Greenspan deserves to be tied with him, certainly.Readers of this blog know the reasons why for the latter, of course.
For Dubya, however, the logic is a little less direct: it's because dollar recycling is at least as responsible (if not more so) for low mortgage rates and exotic products than the Fed's monetary policy. Brad Setser for instance has estimated that dollar recycling lowered mortgage rates by 1-2%.
And who is more responsible for all the deficit spending (and borrowing beyond this) than the national king of insecurity-ridden denial, Bush Minor? The war alone has arguably doubled annual Federal borrowing, never mind the fiscal deficit.
Anyway, even though the Fed lowered rates more than 1 or 2% back in 01-03, that does not constitute a 1:1 lowering of mortgage rates. For a proof by counter-example on that, note how the Fed has lowered rates 2-3% since last year, and mortgage rates have not gone down. This is because dollar recycling and other aspects of the secondary market for mortgages has evaporated.
Contrarians have been crying for years that we'd be paying the piper for chronic deficits. Well, he's here!
March 24, 2008 3:57 PM
- Tim said...
- I always thought that, when the history books are written for this era, you'll see Bush and Greenspan side-by-side, similar to how they are pictured above, so they would be the top two on my list, but with Greenie first.
To be sure, there is plenty of blame to go around, but I always figured that on Wall Street and on Main Street, they were just doin' what they've always done - pushing the limits as far as they are permitted to push them.
In retrospect, the limits that were in place a few years ago were all wrong.
March 24, 2008 4:26 PM
- dearieme said...
- Wot, no Clinton? ASnyway, doesn't the problem go right back to LBJ and Nixon?
March 24, 2008 4:30 PM
- Chuck Ponzi said...
- Aaron,
While I respect your general opinion, I must quibble with the basic premise of your argument...
How exactly does the president control "dollar recycling"?
If he does control it, why doesn't he turn it back on?
And, as an aside, defecit spending is typically inflationary, or at least dis-deflationary. Why, then are we seeing credit deflation?
I think many like to find a scapegoat when the blame-o-meter gives them the opportunity, when in reality, it is the blatant disregard for savings and basic economic illiteracy of most people between the ages of 20 and 65. I hardly think we can blame the current president for that issue.
Besides, we are facing the undercurrents of substantial illegal immigration that is on the one hand lowering wages, as well as lowering the cost of living.
I still don't see how someone can rightly blame the president for the current economic situation.
The mess in Iraq? Blame away, but I can't for the life of me understand a single argument after several years of hearing about it. It just doesn't fit. Dogpiling on a favorite political opponent doesn't win many people over. And, frankly, you should know better.
March 24, 2008 4:36 PM
- Nick said...
- I agree with Chuck; it's hard to see how the president would directly control any aspect of the controls for the economy, aside from speeches about strong dollar policy and whatnot. You can certainly blame the government in general, and I think that's fair; but to single out one particular person or party is disingenuous (or obviously partisan, in the case of Time magazine).
I still maintain that the root cause was the strong belief in Wall Street that if/when risky investments went south, the banks would get bailed out by the government (and their executives would not be personally liable, and would keep their bonuses). How leveraged would IB's be in MBS's if the executives were personally liable for losses (at least to the extent of income from the IB)? How many mortgages would have been securitized if the rating agencies were held accountable for the aggregate default rate based on their ratings, and thus the MBS's were rated conservatively?
The best solution is to let the institutions collapse, and make sure everyone involved who hid information illegally also go down. Don't just make a few examples, make a clean sweep. Convince Wall Street that there won't be a bailout, now or in the future, and they must price in risk and rate securities realistically, or suffer the consequences. Assigning blame to the political scapegoats of the time, however feel-good, is counter-productive to fixing the underlying problem (IMHO).
March 24, 2008 5:27 PM
- getyourselfconnected said...
- I second that the president has very little t do with the economy. The blame lies entiely with the banks and smarties that thought loans gone wild was a good idea. ultimately, the average US citezen is to blame for buying in to the silly notion that 10,000 in home improvemants could make 100,000 plus on resale. Thanks for the predicament guys!
March 24, 2008 7:00 PM
- little larry sellers said...
- Wow, I'm struggling to find the words to express how disheartening it is to read posts like the ones chuck and nick just wrote. The only way I would edit aaron's post is to add a disclaimer that the "tax and spend" Democrats are as irresponsible as the "spend and print money" Republicans. It shouldn't be necessary to point this out at this juncture, but some among us fret more over partisan attacks than the potential destruction of our economic way of life.
The thesis of this blog, unless I'm mistaken, is that our irresponsibility and fiscal recklessness could potentially lead to economic meltdown, perhaps sooner rather than later. I'd say this is a serious matter and I somehow fail to see how our elected officials would be exempt from any blame in our current situation.
Here's a quote from nick that particularly irks me: "The best solution is to let the institutions collapse, and make sure everyone involved who hid information illegally also go down. Don't just make a few examples, make a clean sweep. Convince Wall Street that there won't be a bailout, now or in the future, and they must price in risk and rate securities realistically, or suffer the consequences."
That's all well and wonderful, but how are we supposed to accomplish this with exactly ZERO political will? Do you see any effort from Congress or the Bush administration to bring this to fruition or even question the validity of the Goldilocks economy? Other than Ron Paul and a tiny minority of malcontents, I don't.
As for Bush himself, I would hasten to add that he did not discover his veto pen until July 2006, and that was over lifting funding restrictions on stem cell research. Do you have any conception of how much insane spending he greenlighted over the previous five years? Bush also nominated Easy Al for his fifth term in 2004 so we could be treated to more wacky Fed misadventures. As for Iraq, the costs are estimated to be in somewhere well into the trillions, depending who you ask. I would also question what we have accomplished with such lavish spending in our Middle East wars, but that would make me a partisan hack (even though the Dems supported the war too) so I'll refrain.
I expect Joe Sixpack to effectively defend the status quo since he's long since been lulled to sleep by an insanely positive financial media. But to see readers of blogs like this one, who are privy to our economic woes, quibble over perceived partisan slights is extremely discouraging. Rome is burning and we can't even be bothered to lift a finger to combat the fire, lest we offend the sensibilities of two parties that are perfectly happy to perpetuate this economic charade until the bitter end.
No, politicians did not bring us to this situation alone. But until someone allows us to nominate Fed members, appoint CEOs, or somehow force the media to recognize economic reality, politicians are the one group we can potentially control. We may as well at least make a rudimentary attempt to do so.
Back to basketball for me. I need to cheer up again.
March 24, 2008 7:38 PM
- little larry sellers said...
- One last thing, regarding the comments about blaming the average comsumer. Yes, people are crazy to spend themselves into debt up to their eyeballs. However, when we live in an economy disproportionally based on speculation and short term profit, can we really act surprised when people take extreme risks? Are these crazed consumers wrong to think that our politicans won't do everything possible to bail them out, no matter what the expense?
I hope I don't seem too angry in these posts. The more I read about our economy, the more I think people like me who save and live within their means are the true suckers. People who spend are just going with the flow, and if the economy crashes as badly as I think it might, we're all pretty much SOL together. Maybe I should invent a time machine so I could move to CA in 2003 to flip houses and live extravagantly.
Someone please pass me the Kool-Aid. Don't bother getting me a cup, I'll just use the ladle.
March 24, 2008 7:51 PM
- Chuck Ponzi said...
- Larry,
Again, I have to state it once more. If the president controlled the former situation, and therefore the collapse, why can't he turn it back on.
I agree, if you're mad about the president for something he has done, flame away, but he does not control monetary policy, and we have an inflationary fiscal policy. I still cannot see how we can have deflation pinned on the current president. It just doesn't fit. Where's the link? What bills were passed? How does overspending accrete to asset deflation? It doesn't, it can't, and it won't. There just is absolutely no logical link that I have heard at anytime in the past 8 years that the president controlled housing prices going up or going down. It's neither his accolades when they went up, nor his discredit when they go down. Net-net, even as a much longer-term bubble blogger than I can see most others around here, I still see that most Americans have a much greater net worth today even after 20% or more declines of housing prices than in 2000. Problem is, I don't think the prices are sustainable, even at 2004, 2003, or 2002 prices. When housing is booming, it's not the president who caused it, nor is it his fault when it crashes.
I have to say it one more time.. there were people who piled on Bush 2 when things were going well for the average homedebtor who are still piling on after prices crash. These people just don't like Bush. yes, we get it, thanks for the political opinion, but don't try to treat the rest of the world like fools and tell us something that is a blatant falsehood.
March 24, 2008 10:20 PM
- Anonymous said...
- To give former President Clinton a free pass on this one is irresponsible at best. With no mention of increased CRA lending due to his administrations edict, it's hard to take this article as anything more than a political blog.
Let's be clear. The Fed screwed up big time, but exactly who was President during a signficant portion of Greenspan's rule of terror? You got it. Wild Bill.
Additionally, the Clinton Admin. pushed too hard for change to allow formerly "redlined" areas to develop through aggressive lending by larger banks in order to maintain, or in some instances, increase, their CRA rating. The banks were in a lose-lose situation. Lend in the areas and suffer financial setbacks through write downs and foreclosures, or lose your CRA rating and become crippled with regard to expanding your geographic region through buyouts, mergers, etc.
I would certainly recommend an additional arrow pointing at "consumers." How else do you explain the blatant naiveity to accept an interest rate of 1.95%???
An additional arrow to mortgage brokers, who enjoyed fat premiums of 200 - 300 basis points while simultaneously charging 100-200 basis points to make these loans?
Let's not forget appraisers, who were more than happy to supply inflated values in order to keep their client (the broker and realtor) happy.
Oh yea, and last, but certainly not least, the realtor. Especially the "buyers" agent, who was supposed to represent the buyer and find the best possible scenario for his/her client.
There are not enough arrows to go around, and the industry is finished. Within 5 years, there will be no mortgage broker; instead, there will be six to ten big banks that control things start to finish, charging the same fees, same rate, same appraisal companies, same title companies. This is called an Oligopoly, and it's a position industry/bank leaders have been trying to get to for years.
After 15 years at various levels in this industry, I am done. I began wiping my hands of the mess three years ago when I began competing with used car salesmen that couldn't spell FHA if you spotted them the F and the H.
Now, I teach finance full-time with the hopes of educating future consumers one at a time.
March 25, 2008 3:10 AM
- little larry sellers said...
- Anon,
You'll get no argument from me that Clinton was part of the problem. Really, every President who nominated Greenspan, beginning with Reagan, helped set unfavorable events in motion. This is especially true since Greenspan became a more active bubble blower in the late 90s, post "irrational exuberance". We should agree that the DNC and RNC are not chomping at the bit to return us to fiscal sanity. Hillary Clinton and Obama do not question the Goldilocks economy myth. I'm not even sure what the Dems stand for anymore. And look at how the RNC torpedoed Ron Paul, the one candidate that represented a challenge to the status quo.
chuck,
We seem to be talking at cross purposes. I question your contention that we are in a period of overall deflation. I could be wrong, but I feel that inflation is a greater problem, in which case excessive spending (and the subsequent printing of money to cover said expenses, along with widening deficits) are most definitely problematic. I pointed out that Bush nominated Greenspan to continue in 2004, which is a particularly difficult move to defend. I guess I'm just "flaming" though, since warrented criticism is apparently out of the question.
I also stated that Bush did not veto a single bill until July 2006, and only because that bill dealt with stem cell research. Look it up if you don't believe me. This information can be easily found.
I'm glad Tim posted this Blame-O-Meter because it highlights a major barrier to progress. Why make an attempt to address real world problems when we can quibble over political semantics and debate the merits of two absolutely horrible parties? Next time you see a partisan hack like Limbaugh, Franken, Hannity, or Garafalo, pat them on the back. They've done their job well.At least we all seem to be able to agree on Greenspan, Mozilo, and Cayne. Now, if we can clear the final hurdle on the graph, we might actually get somewhere. Perhaps a lengthy disclaimer stating that when a politician from one party is named, it does not automatically mean that the other party is blameless is in order. It's silly, but if it brings us closer to the task at hand, I'm all for it.
March 25, 2008 4:28 AM
- little larry sellers said...
- Ugh, I wish I could edit posts to fix my spelling of "warranted". You'll have that at 5:30AM, I suppose.
March 25, 2008 4:31 AM
- Anonymous said...
- Corporated greed and the trillions of dollars spent by our government over the last six years on the oversea wars in two countries, as well as pork programs in our country has sucked the money out of our economy, creating massive debt and a credit crunch. Lets not dismiss the fact that we Americans have also contributed to our own demise. Our instatiable appetite to have it all and pay for it later attitude has brought many in our country to financial ruin. I'm no supporter of the Fed Reserve and their manipulation of credit. The fact remains, we the people, our government leaders and corporate america could have prevented this by acting responsible rather then kids gone wild in a candy store free for all.
We are an excessive nation!March 25, 2008 5:07 AM
- Mathlete said...
- A serious examination of the problem would first have to go back to the creation of the Fed in the early 20th Century. Inflation has been the norm ever since, and we occassionaly have periods when the Fed inflates too much and triggers a crisis.
Second on the list would be the New Deal. Social Security & Medicare changed people from savers to spenders. FDIC and other programs protected banks, financial regulation protected Wall Street.
If it wasn't this crisis, it would have been something else.
Proximate causes are Alan Greenspan (he's definitely the biggest player, by orders of magnitude), huge tax cuts for housing but not for other assets in the mid 1990's, regulation aimed at increasing loans to bad credit risks (redlining) in the 1990s, more government encouragement in the 2000s.
I believe the financial innovation is the least blameworthy. In a normal environment, the problems with the new systems would have been worked out over time. The Fed pumping money and government encouragement of housing triggered the massive problems. It's as if in the 1970s, the government got everyone to use computers, and then there were a lot of power failures and airline crashes.
March 25, 2008 7:37 AM
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Mar 21, 2008 | paul.kedrosky.com
Judging by a just-released Washington Post interview, ex-Fed chair Alan Greenspan has gone mad. There is an upside, of course, in that he has delivered the quote of the year so far.
Here is Alan, talking in an interview about how misguided his critics are for suggesting that the recently-ended real estate bubble had its roots in the post dot-com bubble low rates. Implicit in this, of course, is that he should have increased rates sooner to arrest the real estate bubble's expansion:
Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it some time.
Well, there's no denying you can't get any evidence on the matter from Greenspan's career: He avoided raising rates during both bubbles with which he was faced.
And Greenspan continues, offering the following:
"If it weren't the subprime crisis it would have been something else," he said. That is because an era was ending that had seen "disinflationary forces" from developing countries such as China and a "protracted period" in which there was an "underpricing of risk."
Really? Really? Greenspan's Fed didn't prick the real estate bubble because it was saving us from another bubble, whatever it was, that would have been worse? What was it? A lava dome under Los Angeles? Sewer gas under New York? Something else? Because it's really hard to imagine what would have been worse than the real estate bubble, but maybe I lack imagination.
But the tricksy Mr. Greenspan doesn't stop there. Having first said that raising rates doesn't prick asset bubbles, and then sneaking around the side of the issue by arguing that another bubble would have formed anyway, he then spun about and said the following:
Even after the Fed starting raising short-term rates, long-term rates did not rise. He said that at the time "it became apparent that we lost control" of long-term interest rates "as did the Bank of England and all the central banks. As a consequence, we had very little ability to put a brake on the rise in home prices."
Oooh, awesomely argued Alan. In short, even if you had raised rates -- which you wouldn't have, because the Fed can't prick bubbles, and because another worse (unnamed) bubble would have happened anyway -- nothing would have happened, because the Fed lost control of long-term rates. You were totally boxed, and anyone who criticizes you is a clueless nitwit for not seeing that.
Does anyone buy that? I know I don't. Greenspan ably demonstrated that he would cut rates in the face of falling asset prices, so why so skittish about raising them in the face of rapid asset price increases? Something doesn't work in that illogic.
Then again, what does Greenspan care. He has built a career out of this sort of thing, of dancing around clumsy questioners' questions, and this is easy stuff for a skilled obfuscator. Greenspan's minting money as a hedge fund advisor, speaker, and author, and likely giggling every day at the mess that he left on Ben Bernanke's desk.
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Partying Like It's 1929, by Paul Krugman, CVommentary, NY Times: If Ben Bernanke manages to save the financial system from collapse he will - rightly - be praised for his heroic efforts.
But what we should be asking is: How did we get here? Why does the financial system need salvation? Why do mild-mannered economists have to become superheroes?
The answer, at a fundamental level, is that ... having refused to learn from history, we're repeating it.
Contrary to popular belief, the stock market crash of 1929 wasn't the defining moment of the Great Depression. What turned an ordinary recession into a civilization-threatening slump was the wave of bank runs that swept across America in 1930 and 1931.
This banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure. As the decades passed, however, that lesson was forgotten - and now we're relearning it, the hard way. ...
Banks ... sometimes - often based on nothing more than a rumor -... face runs... And a bank that faces a run by depositors ... may go bust even if the rumor was false.
Worse yet, bank runs can be contagious. If depositors at one bank lose their money, depositors at other banks are likely to get nervous, too, setting off a chain reaction. And there can be wider economic effects...
That, in brief, is what happened in 1930-1931, making the Great Depression the disaster it was. So Congress tried to make sure it would never happen again by creating a system of regulations and guarantees that provided a safety net for the financial system.
And we all lived happily for a while - but not for ever after.
Wall Street chafed at regulations that limited risk, but also limited potential profits. And little by little it wriggled free - partly by persuading politicians to relax the rules, but mainly by creating a "shadow banking system" that ... bypass[ed] regulations designed to ensure that banking was safe.
For example, in the old system, savers had federally insured deposits in tightly regulated savings banks, and banks used that money to make home loans. Over time, however, this was partly replaced by a system in which savers put their money in funds that bought asset-backed commercial paper from special investment vehicles that bought collateralized debt obligations created from securitized mortgages - with nary a regulator in sight.
As the years went by, the shadow banking system took over more and more of the banking business, because the unregulated players ... seemed to offer better deals... Meanwhile, those who worried ... that this brave new world of finance lacked a safety net were dismissed as hopelessly old-fashioned.
In fact, however, we were partying like it was 1929 - and now it's 1930.
The financial crisis currently under way is basically an updated version of the wave of bank runs that swept the nation three generations ago. People aren't pulling cash out of banks to put it in their mattresses - but they're doing the modern equivalent, pulling their money out of the shadow banking system and putting into Treasury bills. And the result, now as then, is a vicious circle of financial contraction.
Mr. Bernanke and his colleagues at the Fed are doing all they can to end that vicious circle. We can only hope that they succeed. Otherwise, the next few years will be very unpleasant - not another Great Depression, hopefully, but surely the worst slump we've seen in decades.
Even if Mr. Bernanke pulls it off, however, this is no way to run an economy. It's time to relearn the lessons of the 1930s, and get the financial system back under control.
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Jeff Sachs says Greenspan and the Fed are to blame for our current troubles. Greenspan disagrees:The roots of crisis, by Jeffrey Sachs, Project Syndicate: The US federal reserve's desperate attempts to keep America's economy from sinking ... do not seem to be effective. Although interest rates have been slashed and the Fed has lavished liquidity on cash-strapped banks, the crisis is deepening.
To a large extent, the US crisis was actually made by the Fed... One main culprit was none other than Alan Greenspan, who left the current Fed chairman, Ben Bernanke, with a terrible situation. But Bernanke was a Fed governor in the Greenspan years, and he, too, failed to diagnose correctly the growing problems with its policies.
Today's financial crisis has its immediate roots in 2001, amid the end of the Internet boom and the shock of the September 11 terrorist attacks. It was at that point that the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate - the Federal Funds rate - from 3.5% in August 2001 to a mere 1% by mid-2003. The Fed held this rate too low for too long.
Monetary expansion generally makes it easier to borrow, and lowers the costs of doing so, throughout the economy. It also tends to weaken the currency and increase inflation. All of this began to happen in the US.
What was distinctive this time was that the new borrowing was concentrated in housing. It is generally true that lower interest rates spur home buying, but this time, as is now well known, commercial and investment banks created new financial mechanisms to expand housing credit to borrowers with little creditworthiness. The Fed declined to regulate these dubious practices. Virtually anyone could borrow to buy a house, with little or even no down payment, and with interest charges pushed years into the future. ...
What was stunning was how the Fed, under Greenspan's leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash. There were a few naysayers, but not many in the financial sector itself. ...
With the housing collapse lowering spending, the Fed, in an effort to ward off recession and help banks with fragile balance sheets, has been cutting interest rates since the fall of 2007. But this time, credit expansion is not flowing into housing construction, but rather into commodity speculation and foreign currency.
The Fed's easy money policy is now stoking US inflation rather than a recovery. ... Yet the Fed, in its desperation to avoid a US recession, keeps pouring more money into the system, intensifying the inflationary pressures.
Having stoked a boom, now the Fed can't prevent at least a short-term decline in the US economy, and maybe worse. If it pushes too hard on continued monetary expansion, it won't prevent a bust but instead could create stagflation... The Fed should take care to prevent any breakdown of liquidity while keeping inflation under control and avoiding an unjustified taxpayer-financed bailout of risky bank loans. ...
Recent data make inflation less of a worry, though not completely absent, and I am not as sure as Sachs is that the Fed's unconventional policies steps, e.g. adjusting balance sheets, expanding lending facilities, etc., have not had any effect. We can't know for sure without rerunning the last several months absent the policy steps that have been taken to see how things would have been different, something we'd need a time machine to do, but I think it's safe to say that the Fed's actions have helped some financial firms avoid experiencing more severe problems, and the psychological effect - the perception that the Fed stands ready take action - is also important but hard to measure.
Going back to the question of who caused the crisis, Greenspan says, as usual, get off of it - it wasn't my, or the Fed's, fault:
Greenspan Stands His Ground, by Steven Mufson, Washington Post: ...The record of longtime Federal Reserve chairman Alan Greenspan -- worshipped by business leaders and dubbed "Maestro" in a 2000 biography by The Post's Bob Woodward -- is getting a critical look as his successor Ben S. Bernanke wrestles with problems that began on the Maestro's watch.
Many economists blame Greenspan for lax bank supervision and for keeping interest rates too low, too long from mid-2003 to mid-2004. ...
In an interview yesterday, Greenspan said the Fed wasn't to blame. He said that global forces beyond the control of the Federal Reserve had kept long-term interest rates low, fueling the housing bubble earlier this decade. "Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it some time," he said. "I don't know of a single example of when interest rate policy has been successful in suppressing gains in asset prices."
Regarding the current turmoil, Greenspan said that a market crisis was inevitable. "If it weren't the subprime crisis it would have been something else," he said. That is because an era was ending that had seen "disinflationary forces" from developing countries such as China and a "protracted period" in which there was an "underpricing of risk."
Not all economists are ready to let the former Fed chairman off so easily.
Lee Hoskins, former president of the Cleveland Fed and Fed chairman from 1987 to 1991, says that to find "partial causes" of the credit turmoil, "you have to go back to the Fed's decision to push the federal funds rate down to 1 percent and leave it there for over a year." ...
Greenspan says that the Fed was worried about "corrosive deflation" at the time and that he saw that as a greater threat to the U.S. economy than a housing bubble. "There was a real serious concern about deflation," he said yesterday. "If you look at the notes of the Open Market Committee, the pressures were to go lower than 1 percent. There were no dissents." Bernanke, a member of the Fed board at the time, was also concerned about deflation.
Greenspan also argues that while the Fed has a lot of power over short-term rates, it has less influence over long-term rates, which he asserted were more important to housing prices. ... He said that at the time "it became apparent that we lost control" of long-term interest rates "as did the Bank of England and all the central banks. As a consequence, we had very little ability to put a brake on the rise in home prices." ...
Others reviewing the Greenspan era at the Fed say there is a difference between the way Greenspan reacted during sharp sell-offs of stocks and the way he reacted to the technology and housing bubbles.
Kenneth Rogoff, a Harvard economics professor and former chief economist at the International Monetary Fund, says that "the important point . . . is the philosophy of monetary policy that says 'you don't pay attention to asset prices when they are rising, only when they are falling.' " In reality, Rogoff adds, "if you cut interest rates when asset prices are in free fall, then when asset prices are rising while indebtedness is rising all over country, you need to raise rates. He actively chose not to do that."
Other economists fault Greenspan for his failure to closely regulate big banks. Alan Blinder ... says that the delay in raising rates in 2003-04 was a "minor blemish" on Greenspan's "stellar" record managing monetary policy. But Blinder says that he would give the former chairman "poor marks" for bank supervision, another key role of the Fed. ...
"Lending standards were being horribly relaxed, and the Fed should have done something about that, not to mention about deceptive and in some cases fraudulent practices," Blinder said. ...
Greenspan said that most of the subprime mortgages were originated by firms regulated by other agencies, but he adds, "In retrospect it was clearly a mistake" not to examine bank lending more closely. ...
I'm with Blinder. It wasn't the low interest rates, those were needed at the time, the lack of regulatory oversight was the much bigger problem.
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March 21, 2008 | washingtonpost.com
Ex-Chairman Says Fed Policies Didn't Cause Current Woes
By Steven Mufson
Washington Post Staff Writer
Friday, March 21, 2008; D01Perhaps the Maestro composed some discordant notes after all.
The record of longtime Federal Reserve chairman Alan Greenspan -- worshipped by business leaders and dubbed "Maestro" in a 2000 biography by The Post's Bob Woodward -- is getting a critical look as his successor Ben S. Bernanke wrestles with problems that began on the Maestro's watch.
Many economists blame Greenspan for lax bank supervision and for keeping interest rates too low, too long from mid-2003 to mid-2004. That, the theory goes, fueled the housing bubble and spawned subprime and adjustable-rate mortgages for low-income people, vast numbers of whom can't make their payments now. Banks bought those mortgages in bundles that are worth far less than they originally were. That has led to big write-offs, shaking the entire financial system.
In an interview yesterday, Greenspan said the Fed wasn't to blame. He said that global forces beyond the control of the Federal Reserve had kept long-term interest rates low, fueling the housing bubble earlier this decade. "Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it some time," he said. "I don't know of a single example of when interest rate policy has been successful in suppressing gains in asset prices."
Regarding the current turmoil, Greenspan said that a market crisis was inevitable. "If it weren't the subprime crisis it would have been something else," he said. That is because an era was ending that had seen "disinflationary forces" from developing countries such as China and a "protracted period" in which there was an "underpricing of risk."
Not all economists are ready to let the former Fed chairman off so easily.
Lee Hoskins, former president of the Cleveland Fed and Fed chairman from 1987 to 1991, says that to find "partial causes" of the credit turmoil, "you have to go back to the Fed's decision to push the federal funds rate down to 1 percent and leave it there for over a year." Hoskins says the Fed "made money very cheap, and we began to see the whole leveraging process we see today. The Fed has to take responsibility for some of that excessive growth."
Greenspan says that the Fed was worried about "corrosive deflation" at the time and that he saw that as a greater threat to the U.S. economy than a housing bubble. "There was a real serious concern about deflation," he said yesterday. "If you look at the notes of the Open Market Committee, the pressures were to go lower than 1 percent. There were no dissents." Bernanke, a member of the Fed board at the time, was also concerned about deflation.
Greenspan also argues that while the Fed has a lot of power over short-term rates, it has less influence over long-term rates, which he asserted were more important to housing prices. Even after the Fed starting raising short-term rates, long-term rates did not rise. He said that at the time "it became apparent that we lost control" of long-term interest rates "as did the Bank of England and all the central banks. As a consequence, we had very little ability to put a brake on the rise in home prices."
But other economists say that the very low short-term rates made adjustable-rate subprime mortgages, those with the worst default rates, more attractive than they otherwise would have been. Hoskins also argues that low short-term rates fed excesses at investment banks, which relied heavily on overnight financing while lending long term. "I don't know what Bear Stearns was banking on. I guess that nothing bad would happen -- ever," Hoskins says.
Others reviewing the Greenspan era at the Fed say there is a difference between the way Greenspan reacted during sharp sell-offs of stocks and the way he reacted to the technology and housing bubbles.
Kenneth Rogoff, a Harvard economics professor and former chief economist at the International Monetary Fund, says that "the important point . . . is the philosophy of monetary policy that says 'you don't pay attention to asset prices when they are rising, only when they are falling.' " In reality, Rogoff adds, "if you cut interest rates when asset prices are in free fall, then when asset prices are rising while indebtedness is rising all over country, you need to raise rates. He actively chose not to do that."
Other economists fault Greenspan for his failure to closely regulate big banks. Alan Blinder, a Princeton University economics professor who was vice chairman of the Fed under Greenspan in the mid-1990s, says that the delay in raising rates in 2003-04 was a "minor blemish" on Greenspan's "stellar" record managing monetary policy. But Blinder says that he would give the former chairman "poor marks" for bank supervision, another key role of the Fed.
Blinder said that Greenspan "brushed off" warnings -- most notably from fellow Fed governor Ned Gramlich -- about mortgage abuses and dangers.
"Lending standards were being horribly relaxed, and the Fed should have done something about that, not to mention about deceptive and in some cases fraudulent practices," Blinder said. "This was a corner of the credit markets that was allowed to go crazy. It was populated by a lot of people with minimal financial literacy who were being sold bills of goods by mortgage salesmen."
Gramlich, who died last fall, proposed that the Fed send examiners into the consumer lending offices of Fed-regulated bank holding companies, which he said originated about 30 percent of subprime loans. In a speech last Aug. 31, Gramlich said "this whole subprime experience has demonstrated that taking rates down could have some real costs, in terms of encouraging excessive subprime borrowing." Moreover, he added, there was "a giant hole in the supervisory safety net. . . . It is like a city with a murder law but no cops on the beat."
Greenspan said that most of the subprime mortgages were originated by firms regulated by other agencies, but he adds, "In retrospect it was clearly a mistake" not to examine bank lending more closely. He said it was "very late in the game [that] we realized the size of the problem." He said that Gramlich had written him a note shortly before he died saying that if he had been more convinced, he would have pressed harder for action after Greenspan expressed doubts.
Greenspan has also been widely criticized for comments he made on Feb. 23, 2004, in which he encouraged homeowners to take out adjustable-rate mortgages, or ARMs. In a speech to the Credit Union National Association, Greenspan said that a Fed study showed that many homeowners would have saved tens of thousands of dollars over the previous decade if they had taken ARMs.
In fact, if homeowners had converted from ARMs to 30-year fixed-rate mortgages at that time, they might have avoided the repayment problems some people are now experiencing.
Greenspan said yesterday that he tried to correct those comments on March 2, 2004, less than a month later, in a New York speech praising 30-year fixed mortgages. "If I am guilty of encouraging people to take out adjustable-rate mortgages, I am guilty for 30 days," he said.
In his memoir, "The Age of Turbulence," published last year, Greenspan made scant mention of the time bombs that were planted when he was still chairman.
"I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership initiatives distort market outcomes," Greenspan wrote.
But the former Fed chairman said that the subprime boom would boost home ownership and was "worth the risk." Greenspan said that "protection of property rights, so critical to a market economy, requires a critical mass of owners to sustain political support."
Although home ownership rose from about 64 percent to 69 percent from the early 1990s through the middle of this decade, many analysts say that they doubt that had much effect on U.S. popular support for a market economy.
Regarding the mounting levels of debt, encouraged in part by the low cost of borrowing, Greenspan said that he was "reluctant to underestimate the ability of most households and companies to manage their financial affairs."
Greenspan compared bankers immediately after the Civil War, who he said sought to back two-fifths of their assets with equity, to today's bankers, who "are comfortable with a tenth." Yet, he said, bankruptcy is less prevalent today than it was 140 years ago.
"Rising leverage appears to be the result of massive improvements in technology and infrastructure, not significantly more risk-inclined humans," he wrote. Quoting two 1956 articles in Fortune magazine, alarmed by rising consumer short-term debt and mortgages, Greenspan noted that the magazine's grim forecasts did not come true. Economists worried that the ratio of household debt to household income was so high that it threatened families with delinquency and default, but, Greenspan said, assets and household net worth were rising faster than they knew.
"I do not recall a decade free of surges in angst about the mounting debt of households and businesses," he wrote. "Such fears ignore a fundamental fact of modern life: in a market economy, rising debt goes hand in hand with progress."
Blinder says: "It was not that Americans have too much credit card debt, which they do, or . . . that corporations are overleveraged, which they're probably not. It's not even that the typical American householder has a mortgage that's too big. But in that corner of the [mortgage] market, which turned out to be not such a small corner, a lot of bad practices were going on."
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minyanville.com
In a speech last week in the Gulf, Alan Greenspan told Arab nations to drop their peg to the U.S. dollar. In so doing Greenspan is arguing that inflation is literally built into the U.S. dollar. Greenspan is saying this is why the Arab nations are having such trouble with inflation.
If the Arab nations drop their peg to the dollar, it will further reduce demand for U.S. currency. Talk about putting a knife in the greenback when it's down!
Of course, maybe the Arab nations will think twice about taking advice from the Maestro who advocated ARMS and new-fangled derivatives as instruments that would benefit financial markets and disperse risk.
To quote Greenspan himself, "I would tell audiences that we're facing not a bubble but a froth lots of small local bubbles, which never grow to a scale that could threaten the health of the overall economy." The fact is that quite possibly we are facing the worst housing recession in U.S. history, which could wipe out $4 trillion to 6 trillion in household worth. According to economist Nouriel Roubini, 10 million households may end up with negative equity, and a huge incentive to simply put the house keys in the post.
Let's call it for what it is Greenie's irrational exuberance gave us the most serious credit crisis since 1907. As former Treasury Secretary Lawrence Sumers states, "Price falls in the housing market of this magnitude are likely to mean more than 10 million Americans would have negative equity in their homes, and more than two million foreclosures would take place over the next two years."
We all hope Alan is getting well paid on his speaking tour. One can only imagine what Ayn Rand would think. I can't help pondering whether John Galt asks, "Who the hell is Alan Greenspan?"
So, we can't entirely blame Bernanke for urging lenders to forgive portions of mortgages held by homeowners at risk of defaulting. Ben's in a box. He simply took the reins of the Fed at a difficult time. It is the previous chairman who left the U.S. in a precarious state.
Once revered and lionized, Greenspan may arguably go down in history as one of the most reviled Fed chiefs ever. Greenspan left his job in disarray with housing and big banks in possibly the worst condition in U.S. history. But, then, turnaround is fair play the U.S. dollar was once revered also.
While at the helm and while on his jaunts has Greenspan forgotten that the Fed is entrusted with two duties guarding the purchasing power of the dollar, and insuring that the nation is prosperous?
Given the sad state in which he left the nation there is something downright disdainful in Greenie's talking down the dollar. For someone who enjoyed being so obtuse while at the Fed, perhaps he should just learn to keep his mouth shut now. There are enough Fed Governors throwing slings and arrows out to the media these days. But then, that's America for you the cult of celebrity often trumps good of country.
Like Nero fiddling, Al blew the clarinet while kindling the fire that threatens what was the American Empire. It's none other than the Maestro who connected the notes and dots between the housing bubble and the fragility of the financial system. Indeed, the Maestro conducted while the ship of state was listing.
It's too late for an apology for the loss of power and esteem it has cost the U.S. And, while money flows where money goes, and some seek shelter in the brave new world of the global growth paradigm, it seems inescapable that the dangers created for the U.S. exist for the rest of the world as well.
Be that as it may, no trend goes in a straight line. It's a clichι to say that markets fluctuate. But cliches are so called because they are typically true. Whether the January lows in fact hold for the remainder of the year or not, remains to be seen. Whether that is the story that the Dow Transportation Average is telling us remains to be seen. Whether this is a long-lasting secular Bear market or not remains to be seen. Whether a multi-week, or even a multi-month, rally phase is ahead of us before another downturn remains to be seen.
The best we can do as traders is take it a day at a time when there is so much confusion, and risk is being so overtly shunned. But, the very anathema of risk and the propensity for speculators to have cinched up on their time horizons suggests that endangered species called 'A Trend' may come out of hibernation sooner than later with all due apologies to the Volatility Vultures.
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naked capitalism
Underlying Greenspan's socialistic concern for the solvency of markets is an absence within economics of a theory of credit collapse and panic. This phenomenon is not what Schumpeter meant by creative destruction. However, it is so consistently a feature of economies, that it is surprising that few remain cool and analytical in the face of credit collapse and panic. Yet, from the standpoint of economic theory, it certainly makes more sense to talk about a revaluation of all values rather than prosaically fret about a collapse of confidence. More productively, Rothbard has described the bust as the reassertion of control of the market by consumers compelling investments not suited to consumers desires to be abandoned.
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Harvard Professor of Political Economy has penned a prototypic New York Review of Books essay on Alan Greenspan's
The Age of Turbulence . That means no snarkiness.
What would likely disappoint readers of this blog is that Friedman thinks that Greenspan acquitted himself well in managing monetary policy; he argues that growth was weak after 2001 and the Fed's super-low interest rates did not produce inflation. He amazingly fails to see that negative real interest rates discourage savings (which were already low in the US) and supercharge speculation.
Nevertheless, Friedman makes an observation I haven't seen elsewhere, that despite Greenspan's claim to be a loyal defender of free markets, he was intervened frequently, at least as far as monetary and fiscal policy were concerned:
Greenspan continually reiterates his belief in the power of private economic activity organized in free, competitive markets. Government interference, therefore, is for him mostly a bad idea. It was, he writes, "the embrace of free-market capitalism," not monetary policy, that "helped bring inflation to quiescence." Further, in his view, free markets are not only efficient but robust. In the face of disturbances-higher oil prices, say, or a decline in either consumer or business confidence-they tend to correct themselves. "If the story of the past quarter of a century has a one-line plot summary," he writes, "it is the rediscovery of the power of market capitalism."This mantra is strikingly at odds with Greenspan's account of what he and his colleagues did during his years at the Federal Reserve. They took corrective action, gave advice and even instructions, and took the initiative in anticipating the difficulties markets might face. They did so not just in the immediate aftermath of the September 11 atrocities, which anyone would recognize as out of the ordinary, but in one episode after another throughout his years at the Federal Reserve. Familiar examples include the 1987 stock market crash; the wave of financial problems in many Asian and Latin American countries beginning in 1997; the near collapse of the LTCM hedge fund in 1998; the passage of the millennium from 1999 to 2000 (which many people feared would trigger widespread "Y2K" computer glitches); and many others.
In dealing with such events Greenspan and his colleagues treated financial markets more as delicate flowers requiring careful attention and nursing. Similarly, although he frequently makes clear in what he writes that he rejects Keynesian economics, both at the Federal Reserve and during his time in the Ford White House he consistently advocated a Keynesian stimulus (through tax rebates or lower tax rates) whenever he thought the economy needed a boost.
Friedman gives a good overview of the regulatory lapses, gaps, and missed opportunities that made the subprime mess possible:
Central banking involves more than just making monetary policy, however, and in these broader respects the Federal Reserve, and Greenspan's leadership of it, do bear part of the blame for the subprime collapse and the wider damage to which it has led. As is becoming ever more apparent, many of the lending practices in the mortgage market during these years, especially in the subprime market, involved carelessness, deception, or both. Many people borrowed who had no prospect of servicing the loans they took out; they were hoping either to resell the house at a higher price, or to refinance it and draw on the appreciated value to make their payments. Some borrowers were apparently induced to buy houses they could not afford, or to take out loans they should not have been granted, by irresponsible brokers and other agents keen to make commissions on transactions despite knowing they were inappropriate.Many of the banks that packaged these loans into securities also put them into complex investment "vehicles" that they did not understand, and sold them to investors who understood even less about them. The credit rating agencies, on which investors normally rely to inform them of such risks, were at best useless. Today the wreckage, consisting of abandoned houses, defaulted loans, displaced homeowners, banks making good on the billions of dollars of losses they had guaranteed, and uninsured investors marking down their portfolios, can be seen everywhere. The damage will surely get worse before it begins to abate.
Regulation of financial markets in the United States is both spotty and fragmented among numerous agencies. One problem, from which many individual homebuyers suffered, is a straightforward gap in existing regulation. For years, a stock broker who recommended that a client buy a security that was grossly unsuited for that person had been subject to regulatory sanction, or even redress by private litigation, under the suitability requirements of the National Association of Securities Dealers as well as the New York Stock Exchange's "know your customer" rule. Both sets of rules operate under the aegis of the Securities and Exchange Commission. While they are far from being rigorously enforced, for real estate agents and independent mortgage brokers there are no such rules at all. In addition, poorly disclosed compensation arrangements for brokers, which would be illegal in the securities markets, have persisted in the mortgage market and give mortgage brokers substantial incentives to steer customers into loans that are excessively expensive or risky or both.
But in the buildup to today's mortgage market mess, numerous potentially helpful government agencies also either dropped the ball or looked the other way. As early as 2001 the Treasury Department tried to get subprime lenders to adopt a code of "best practices" and to submit to monitoring, but the large lenders objected and the Treasury did not press the matter. The Department of Housing and Urban Development likewise proposed a set of rules for real estate transactions but then failed to follow through. As recently as 2006 there was an interagency initiative to regulate nontraditional mortgage products such as packaged subprime mortgages, but again nothing came of it. The Office of the Comptroller of the Currency, a bureau of the Treasury Department that is always solicitous of the desire of banks to escape supervision and regulation if they can, has actively thwarted state-level action.
And the Federal Reserve Board, which under the 1968 Truth in Lending Act and other legislation is also responsible for regulating interest rate disclosures (and especially high-cost mortgages), likewise failed to act. This neglect by the Federal Reserve was hardly the result of lack of awareness. Both at the staff level and higher, numerous eyes were squarely on the problem. Edward Gramlich, a member of the Board of Governors from 1997 to 2005, frequently testified before Congress on problems in home finance and called within the Federal Reserve for action to halt abuses and make lending in this market more rational. But Greenspan was consistently unsympathetic, and the Federal Reserve neither took action on its own nor supported action by other agencies. In his book, Greenspan writes:
I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership initiatives distort market outcomes. But I believed then, as now, that the benefits of broadened home ownership are worth the risk.Gramlich died last September. His final book, Subprime Mortgages: America's Latest Boom and Bust,[*] published shortly before his death, likewise welcomed the increase in home ownership that subprime mortgages have made possible-especially among low-income households, and especially among racial minorities. But Gramlich also called for a number of corrective measures. Most important, he argued, was to bring under federal regulation the state-chartered lending institutions that account for half of the subprime lending (but very little in the prime mortgage market). He also called for expanding existing legislation so that more borrowers could prepay their mortgages without penalties. A frequent problem today is that families who cannot meet their higher payments after the initially low two-year "teaser" rate is reset cannot afford to get out of the mortgage either. A third suggestion was to have the federal government fund many of the foreclosure prevention programs that already operate at the local level.Today both Gramlich's analysis and his proposals look even more incisive. Indeed, some policymakers have taken notice. Last summer the Federal Reserve Board and the Office of Thrift Supervision, a bureau within the Treasury Department, launched a limited program to coordinate state-level and federal regulation of mortgage lending. More recently the Bush administration has proposed a moratorium on foreclosures.
Greenspan's opposition to such proposals was consistent with the admiration that he expresses for unfettered markets and the sanctity with which he regards property rights (which in this context really means private rights of contract) throughout his memoir. Both give rise to a systematic aversion to government regulation of private economic activity. For Greenspan, recognition that the workings of such markets sometimes destroy asset values, jobs, or even entire industries is still not ground for interference in the economy in the aggregate, or with individual transactions to which two or more private parties voluntarily agree.
Greenspan frequently appeals to the views of Joseph Schumpeter, the Austrian-ιmigrι Harvard economist of the 1930s and 1940s, who labeled such economic developments "creative destruction." In contrast to Greenspan's careful nursing of the economy and the financial markets in his conduct of monetary policy, his rejection of regulation of the subprime mortgage market and of intervention in the built-up chain of financing that distributed the ownership of these securities (and the consequent risks) throughout the US economy and abroad was of a piece with the economic philosophy he espouses.
Alas, Schumpeter to the contrary, not all destruction is creative. And although Adam Smith (whom Greenspan also admires) explained that the desire to make money is mostly what leads people to undertake economically useful activity, not everyone who is making money is doing something economically useful. Just how much damage the widening ripples of the subprime collapse will inflict, on either the US financial markets or the American economy, is still unclear. But in hindsight one wishes that Alan Greenspan, as Federal Reserve chairman, had clung to his economic philosophy in regulatory matters no more closely than he did in his hands-on conduct of monetary policy. Or that in fulfilling this particular responsibility of the Federal Reserve he had simply listened to Ned Gramlich.
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Much of the debate around Greenspan's legacy has revolved around the matter of hypocrisy, of a man preaching laissez-faire who repeatedly intervened in the market to save the wealthiest players. The economy that is Greenspan's legacy hardly fits the definition of a libertarian market but looks very much like another phenomenon described in his book: "When a government's leaders routinely seek out private-sector individuals or businesses and, in exchange for political support, bestow favors on them, the society is said to be in the grip of 'crony capitalism.'" He was talking about Indonesia under Suharto, but my mind went straight to Iraq under Halliburton. Greenspan is currently warning the world about a dangerous looming backlash against capitalism. Apparently, this has nothing at all to do with the policies of negligent deregulation that were his trademark. Nothing to do with stagnant wages due to free trade and weakened unions, nor with pensions lost to Enron or the dot-com crash, or homes seized in the subprime mortgage crisis. According to Greenspan, rampant inequality is caused by lousy high schools (which also has nothing to do with his ideology's war on the public sphere). I debated Greenspan on Democracy Now! recently and was stunned that this man who preaches the doctrine of personal responsibility refuses to take any at all.
Yet ideological contradictions are only relevant if Greenspan really is a true believer. I'm not convinced. Greenspan writes that as a student he had no interest in big ideas. Unlike his classmates who were in the thrall of Keynesianism with its promise of building a better world, Greenspan was simply good at math. He started doing research for powerful corporations; it was profitable, but Greenspan made no claims to a higher social contribution.
Then he discovered Ayn Rand. "What she did was to make me think why capitalism is not only efficient and practical, but also moral," he said in 1974.
Rand's ideas about the "utopia of greed" allowed Greenspan to keep doing what he was doing but infused his corporate service with a powerful new sense of mission: Making money wasn't just good for him; it was good for society as a whole. Of course, the flip side of this is the cruel disregard for those left behind. "Undeviating purpose and rationality achieve joy and fulfillment," Greenspan wrote as a zealous new convert. "Parasites who persistently avoid either purpose or reason perish as they should." Was it this mindset that served him well as he supported shock therapy in Russia (72 million impoverished) and in East Asia after the 1997 economic crisis (24 million pushed into unemployment)?
Rand has played this role of greed-enabler for countless disciples. According to the New York Times, Atlas Shrugged, her novel that ends with the hero tracing a dollar sign in the air like a benediction, stands as "one of the most influential business books ever written." Since Rand is simply pulped-up Adam Smith, her influence on men like Greenspan suggests an interesting possibility. Perhaps the true purpose of the entire literature of trickle-down theory is to liberate entrepreneurs to pursue their narrowest advantage while claiming global altruistic motives--not so much an economic philosophy as an elaborate, retroactive rationale.
What Greenspan teaches us is that trickle-down isn't really an ideology after all. It's more like the friend we call after some embarrassing excess so that they will tell us, "Don't beat yourself up: You deserve it."
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Seeking Alpha
@NY EE & Travis: the point is not to find "someone" to put all the blame on. rather, to identify those who acted the least responsible even while holding the most influential positions. There can be zero doubt that the position of the Fed chairman was and is one of the most powerful of the entire planet. Its influence will slowly diminish along with the diminishing role of the US Dollar and of the USA but it will remain very powerful for quite some time to come.
There can be zero doubt as well (since it is all well documented) that Greenspan as no other Fed chairman before him has been providing easy and cheap money whenever any perceived problem occurred. Compare prices back when Greenspan took over in 1987 to those that there are now. Greenspan has "achieved" a 70-80% collapse of the purchasing power of the dollar (and thats the ultra-conservative calculation) within his 20 years at the helm of the fed. his forecasts regarding the economy were wrong 9 out of 10 times.
And btw, while we speak of putting the blame on someone: Greenspan himself has refused any and all responsibility and blamed it on everybody else but him.
@travis: nice job of repeating the official mantras without even bordering to think about their silliness. I suggest you look into some books e.g. peter schiff#s "crash proof" or even read some earlier articles and speeches by greenspan which totally falsify each and every of your points.
regarding lon-term rates: Greenspan made it clear time and again that he wanted long-term rates low and that he would keep short-ter, rates low as long as possible. There was very active encouragement by the fed of getting the long yields very very low via excessively low short term rates. how did it work? well, by virtually guranteeing market players that short term rates won't be raised anytime soon and even if, not very much, greenspan induced a much wanted run by big institutions to buy long bonds and financing that with lower short-term debt.
that m,echanism brought the long bonds slowly but steadily down to absurd levels and that is still the case today! It is a vastly distorted market.
Even offcial inflation runs at more than 4% now and the unmassaged and unmanipulated numbers are way above that (just think of the nonsense of "core-cpi" being cpi less the most needed things (energy and food) with the most inelastic demand).
In a free (i.e. not manipulated) market nobody would buy 10yr/30yr treasuries yielding barely 4% and hence losing money in real terms! so give me a break her.
the notion trhat the fed cannot and is not manipulating long-term rates is pure nonsense disproved by reality
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forestpolicy.typepad.com
As I've watched the Securitization Mess unfold since last August, and opined about its inevitability prior, I have been awestruck by the silence from those who ought to have spoken loudly about the systemic corruption at work. I have been disgusted by the wanton greed from those who were knowingly profiteering from what inevitably would hurt those drawn into the deception. I have been dumbfounded by the blind faith of true believers in so-called "new economy" thinking, whether pundits, politicians, or CEOs. In all it brings to mind a couple of my favorite quotes:
Those who give no thought to that which is distant will find sorrow near at hand. Confucius (paraphrased)As to why we don't learn from mistakes, we need not look further than what cognitive psychologists and decision theorists have been yarding together for years under headers like Self-deception Biases, Heuristic Simplification (information processing errors), Emotion/Affect Disorders, and Social Interaction Disorders.People don't learn from the mistakes of others. They seldom learn from their own mistakes. Never underestimate the power of human stupidity. Robert Heinlein (paraphrased)
As to the systemic nature of this Securitization Mess, I'll leave you with Doug Noland's recent words:
Confirmations, Doug Noland, Credit Bubble bulletin, Feb. 22: [T]he unfolding Credit Crisis has made a major leap toward the heart of the Credit system. I have no way of knowing to what degree widening spreads are being dictated by "technical" hedging-related trading dynamics, as opposed to fundamental issues with respect to the faltering U.S. economy; rapidly deteriorating corporate balance sheets; a highly susceptible leveraged speculating community; the vulnerable GSEs; a distressingly illiquid Credit market; and heightened systemic risk more generally. To be sure, a strong case can be made that the current backdrop is quite detrimental to a highly leveraged and speculative Credit system. The markets rallied late this afternoon - and perhaps they will rally further next week - on talk of a bailout for troubled Ambac. Unfortunately, there has been ample Confirmation that the Evolving Credit Crisis has quickly spiraled way beyond the "monolines."Related: Flock Mentality, from AleaP.S. I'm now pulling together recent "finds" from others on the sidebar of my blog. Or you can find them here, via Google Reader "Shared Items" (along with a feed).
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Amazon.com
Sir, you are no Howard Roark,
November 17, 2007 The book reads well because the content is interesting and the writing straightforward. But Alan Greenspan is no Howard Roark. The references to the process of creative destruction (Schumpeter), which wants to echo Greenspan's own famous references to productivity growth in the US economy, look like they were intended to provide the underlying theme of the book, and ultimately a justification for a global liquidity bubble of epic proportions.
By Charles de Trenck The book is useful for what we learn, as well as for its omissions. But eventually the book delivers a flat message. Even if the defense is that this is simple book to attract more readers (and not confuse them with heavy material), the underlying thinking behind the topics does not show depth or originality I expected from Greenspan.
The book is in two parts. The first part is priceless for contemporary updates on the Fed under Greenspan, its thinking, and its interaction with other government branches as well as G's personal relationships with leading figures. Camelot for G was the Clinton administration, his morning baths and his breakfasts with Rubin.
I still conclude, Greenspan, though not creating the global liquidity bubbles single-handedly, presided over the levers that allowed the waves of excessive pump priming which are coming to roost in 2007-08 (or which will be delayed yet again by too aggressive Fed rate cuts led by another spineless Fed governor?).
The second part of the book is mostly regurgitation of current events, which could be read elsewhere, though there are a few relatively interesting chapters such as chapter 24 on energy.
In looking to gauge G's intellectual prowess, I did not find a spark in his thinking process. And I looked hard. Shocking as well is only a cursory command of international issues, where his thinking on global monetary issues is seen to develop only late in his career.
***
I had to read this book. Greenspan was at the heart of successive liquidity induced bubbles over the last 10-20 years, and I had to be sure my perception of him was not unfair. But Greenspan refuses to acknowledge any part in the great liquidity bubbles of 1999-2000 and 2004-06, especially the most recent one.
There are at least two key sell-outs. First, is his complete lack of discussion of the dollar and its relationship to the global economy in his analysis of his time at the Federal Reserve. This lack of discussion on the dollar, except for somewhat canned discussions on China for instance, speaks volumes. This omission confirms what a low level of importance the dollar has had in the conduct of monetary policy (ie, interest rate policy in relation to 'real' inflation and dollar).
After all, it's maybe a problem for other countries if the dollar falls too much, but it's not really an issue within the US, right? Core inflation remains low, right? Wrong. (I really don't know what hedonic adjustments are made to the CPI to keep it so low and there appears to be a growing chorus that disagree with government numbers.)
'Seigneurage', where the US abused its privilege of being the dominant currency by virtue of being the dominant power, will gradually shrink over time. And people like Greenspan simply helped the process along.
Second, the whole underlying justification for low interest rates was based on productivity growth which justified the leveraging up of the private and public balance sheets in the US. But Greenspan's discussion of productivity really stops with the internet and the deepening of the IT revolution in the 1990's. In more recent years, it would appear he was simply projecting what he'd learned in the mid-90s to his many later speeches up through his departure from the Fed. Maybe it was all his public engagements in more recent years that prevented him from doing any original research. (Consider productivity growth in banking post-Spitzer; property after the sub-prime meltdown; and US transport infrastructure.)
Greenspan did show to some extent, in the parts of the book discussing the 1990s and the Clinton Administration, that productivity growth did experience a key revolutionary period in the 1990s. But this is not the point. His testimonies and arguments continued to the end of his Fed governorship that the productivity engine, the same creative destruction that led to the IBM typewriter getting mothballed, supported interest rate cuts to 40-year lows, and which subsequently led to the property, asset backed commercial paper and SIV bubbles we hear so much of in 2007.
Greenspan is too important a figure to write such a shallow review of his career. The failure to discuss his relation to perhaps the biggest economic bubble of all time is unforgivable.
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February 20 2008 | FT.com
From Dr Desmond Lachman.
Sir, Your editorial "Learning from the Greenspan legacy" (February 16) correctly takes Alan Greenspan, the former chairman of the Federal Reserve Bank, to task for having maintained an overly accommodative interest rate policy for too long in the wake of the 2000 dotcom bust. However, it is surprisingly silent on Mr Greenspan's egregious lapses in the exercise of the Federal Reserve's regulatory responsibilities over the US financial system. Those lapses allowed a major easing in lending standards that both fuelled the housing market bubble and spawned today's subprime mortgage lending crisis.
Among the distinguishing characteristics of the US housing market bubble between 2000 and 2006 was the increased resort to subprime mortgage lending and to the only marginally better Alt-A mortgage lending. By 2006, around 40 per cent of all US mortgage lending took that form and a markedly increased proportion of those loans was of the adjustable rate mortgage variety. Further, with the passage of time, there was a progressive deterioration in mortgage lending standards.
This deterioration was reflected in ever higher loan-to-value ratios, often close to 100 per cent, and in the markedly decreased creditworthiness of the borrowers, who all too often were not required to document either their income or their assets.
While a staggering $1,300bn of subprime and $1,000bn of Alt-A lending was being undertaken, Mr Greenspan failed to voice concern over these dangerous lending practices. More importantly, he chose to forgo the regulatory authority vested in the Fed over the US financial system. In particular, he chose not to exercise his authority under the Home Ownership Equity Protection Act to rein in the non-bank mortgage loan originators, which were mainly responsible for originating and distributing subprime mortgages.
When the dust eventually settles on today's housing bust, Mr Greenspan should be held fully to account not only for his overly easy monetary policy stance but also for his dereliction of duty in properly regulating the US financial system.
Desmond Lachman,
American Enterprise Institute,
Washington, DC 20036, USCopyright The Financial Times Limited 2008
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The Big Picture
Why does it appear that this financial dismantlement of the U.S. was planned?
Did you see Stan Liebowitz's piece in the New York Post, providing evidence that it wasn't banks that had decided to engage loose lending practices but Fed regulators that had forced them to do so--for the purpose of avoiding charges of racial discrimination, brought by the federal government if banks' lending officers didn't comply: that is, this entire sub-prime mess is the result of an affirmative-action/racial-quota policy forced upon banks by federal regulators!
In April 2005, while ddressing the Federal Reserve System's Fourth Annual Community Affairs Research Conference, Greenspan opined:
"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for IMMIGRANTS [my emphasis]. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country. With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently EXTENDING CREDIT TO A BROADER SPECTRUM OF CONSUMERS [my emphasis]. The mortgage-backed security helped create a national and even an international market for mortgages, and market support for a wider variety of home mortgage loan products became commonplace. This led to securitization of a variety of other consumer loan products, such as auto and credit card loans [to include no-credit-record/no-down-payment/no-or-very-little-income consumers given ARMs]."
So, why isn't there a class-action suit developing for all those ARM holders, in light of the fact that Allen Greenspan had CRIMINALLY violated his chairmanship duties at the Federal Reserve when he publicly advised prospective home-buyers TO TAKE OUT ARMs; that is, any information related to the housing market coming out of Greenspan has tremendous weight, regarding whatever INSIDE INFORMATION the chairman may possess, so that any of his comments which might influence how prospective home-buyers purchase their mortgages makes him - and the Federal Reserve - liable if home-buyers are damaged by his advice ((by the way, when Leslie Stahl interviewed Greenspan on 60 minutes recently, she had asked him about whether or not he had had a conflict of interest in routinely visiting the White House during Bill Clinton's second presidency, to which question Greenspan had DECEPTIVELY answered: "We are one government," and about which response Leslie Stahl failed to remark to him that the Federal Reserve is a private, share-holding concern-NOT A U.S. GOVERNMENT AGENCY))?
Planned Destruction of America: Open Letter
http://planneddestructionofamerica.blogspot.com/Corporate America: What Went Wrong?
http://corporateamericawhatwentwrong.blogspot.com/
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As readers know, I have long been frustrated with the Fed's "if the only tool you have is a hammer, every problem looks like a nail" behavior.
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Lessons Learned from the Greenspan Era
The Financial Times has an editorial comment looking at the lessons learned from the Greenspan era. I have posted the piece below with my comments in brackets.Learning from the Greenspan Legacy
The subprime crisis is Alan Greenspan's fault, or so we are increasingly told: he offered bankers too much monetary candy and should have put them on a monetary diet instead. Is this criticism justified? And what does it imply for the future behaviour of central banks?Few now have as much confidence in the self-restraint of the financial children as Mr Greenspan was wont to. No less certainly, Mr Greenspan's reputation is sinking. Once hailed as a maestro, he is condemned by many as profligate. The truth is more complex. He was never the genius he was held to be. Nor is he the dunce some now allege. He was merely fallible. As such, he made good and bad calls.
Four features of the global economy low inflation, the global "savings glut", globalisation and the US productivity upsurge have made managing monetary policy seductively difficult. It was difficult because the combination of low interest rates with fast economic growth proved the breeding ground for a succession of asset bubbles, most recently in housing. It was seductive because the bubbles were so popular, at least at the time.
[I concur--rapid real economic growth fueled by productivity gains and accompanied by historically low real interest rates is a Wicksellian no-no. The Fed cannot push the actual real interest rate below the neutral one and expect all will be well. Below is a graph from an earlier post that illustrates these developments (see here for larger picture).]
Even if one grants the difficulty, the US Federal Reserve might have erred: its monetary policy might have been too loose after 2000, particularly when its target interest rate sank to 1 per cent in 2003; it might also have remained loose for too long; it might have been asymmetric, with more attention being paid to downside than upside risks; and it might have paid too little attention to asset prices. Furthermore, under Mr Greenspan, the Fed might have assumed too readily that the financial system was self-policing.
Of these charges, the first is least plausible. After the stock market bubble burst, the case for insurance against deflation was overwhelming. But the argument that policy was loose for rather too long looks convincing, in hindsight. The asymmetric response to asset price movements is also, alas, compelling: in practice, the Fed has responded to asset price declines with greater urgency than to rises.
[Regarding the first charge, the case against deflation was not overwhelming. As suggested by the above figure and as I have made clear elsewhere, there is enough evidence to doubt the deflationary pressures of 2003 were of a malign nature. Rather, it is more reasonable to conclude they were the product of rapid productivity gains. I will concede the evidence is mixed for 2002, but by 2003 the deflationary pressures appear to have been largely benign. The Fed simply misread the deflationary tea leaves in 2003 and thus set a monetary policy in play that was distortionary. A few observers recognized this possibility of misreading the deflatoinary pressures back then and the potential consequences that could follow. Others are now vindicating this view.]
Yet the last charges seem the most important. The Fed's view is that central bankers should respond to asset price bubbles only after they burst. But the bursting of a bubble associated with a credit surge is almost always highly destabilising. Taking at least some preventive action surely makes sense. Finally, the view that financial markets are self-policing is, alas, rather less credible than it was. A year can be a long time in economic policy.
[George Selgin has suggested a monetary policy rule that would address some of these problems. It is a nominal income targeting rule that would allow productivity movements to be more readily reflected in the price level. Selgin calls this the 'Productivity Norm' rule. See here for more about this rule or check out his book "Less than Zero."]
So central bankers have to learn lessons. Yes, the bankers were responsible for bingeing on the cheap money provided. But central banks bear responsibility for providing the feast and need to be more frugal in future. So Ben Bernanke, the Fed chairman, should take note. Using a new supply of candy to cure indigestion might cause even sharper pains tomorrow.
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February 8, 2008 | FS Editorial
THE FINANCIAL TSUNAMI PART IV:
Asset Securitization -- The Last Tango
by F. William Engdahl
February 8, 2008Endgame: Unregulated Private Money Creation
What had emerged going into the new millennium after the 1999 repeal of Glass-Steagall was an awesome transformation of American credit markets into what was soon to become the world's greatest unregulated private money creation machine.
The New Finance was built on an incestuous, interlocking, if informal, cartel of players, all reading from the script written by Alan Greenspan and his friends at J.P. Morgan, Citigroup, Goldman Sachs, and the other major financial houses of New York. Securitization was going to secure a "new" American Century and its financial domination, as its creators clearly believed on the eve of the millennium.
Key to the revolution in finance in addition to the unabashed backing of the Greenspan Fed, was the complicity of the Executive, Legislative and Judicial branches of the US Government right to the Supreme Court. In addition, to make the game work seamlessly, it required the active complicity of the two leading credit agencies in the world-Moody's and Standard & Poors.
It required a Congress and Executive branch that would repeatedly reject rational appeals to regulate over-the-counter financial derivatives, bank-owned or financed hedge funds or any of the myriad steps to remove supervision, control, transparency that had been painstakingly built up over the previous century or more. It required that the major government-certified rating agencies give their credit AAA imprimatur to a tiny handful of poorly regulated insurance companies called Monolines, all based in New York. The monolines were another essential part of the New Finance.
The interlinks and consensus behind the massive expansion of securitization among all these institutional players was so clear and pervasive it might have been incorporated as America New Finance Inc. and its shares sold over NASDAQ.
Alan Greenspan anticipated and encouraged the process of asset securitization for years before his actual nurturing of the phenomenal real estate bubble in the beginning of the first decade of the new Century. In a pathetic attempt to deny his central role after the fall, Greenspan last year claimed that the problem was not mortgage lending to sub-prime customers but the securitization of the sub-prime credits. In April 2005, he sung a quite different hymn to sub-prime securitization. Addressing the Federal Reserve System's Fourth Annual Community Affairs Research Conference, the Fed chairman declared,
"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country. With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers The mortgage-backed security helped create a national and even an international market for mortgages, and market support for a wider variety of home mortgage loan products became commonplace. This led to securitization of a variety of other consumer loan products, such as auto and credit card loans." [1]
That 2005 speech was about the time he later claimed to have suddenly realized securitization was getting out of hand. In September 2007 once the crisis was full force, CBS' Leslie Stahl asked why he did nothing to stop "illegal or shady practices you knew were taking place in sub-prime lending." Greenspan replied, "Err, I had no notion of how significant these practices had become until very late. I didn't really get it until late 2005 and 2006 " [2] (emphasis added-w.e.)
As far back as November 1998, only weeks after the near-meltdown of the global financial system through the collapse of the LTCM hedge fund, Greenspan had told an annual meeting of the US Securities Industry Association, "Dramatic advances in computer and telecommunications technologies in recent years have enabled a broad unbundling of risks through innovative financial engineering. The financial instruments of a bygone era, common stocks and debt obligations, have been augmented by a vast array of complex hybrid financial products, which allow risks to be isolated, but which, in many cases, seemingly challenge human understanding." [3]
That speech was the clear signal to Wall Street to move into asset-backed securitization in a big way. After all, hadn't Greenspan just demonstrated through the harrowing Asia crises of 1997-98 and the systemic crisis triggered by the August 1998 sovereign debt default that the Federal Reserve and its liquidity spigot stood more than ready to bailout the banks in event of any major mishap? The big banks were, after all, clearly now, Too Big To Fail-TBTF.
The Federal Reserve, the world's largest and most powerful central bank with what was arguably the world's most liberal market-friendly Chairman, Greenspan, would back its major banks in the bold new securitization undertaking. When Greenspan said risks "which seemingly challenge human understanding," he signaled that he understood at least in a crude way that this was a whole new domain of financial obfuscation and complication. Central bankers traditionally were known for their pursuit of transparency among banks and conservative lending and risk management practices by member banks.
Not 'ole Alan Greenspan.
Most significantly, Greenspan reassured his Wall Street securities underwriting friends in the Securities Industry Association audience that November of 1998 that he would do all possible to ensure that in the New Finance, the securitization of assets would remain for the banks alone to self-regulate.
Under the Greenspan Fed, the foxes would be trusted to guard the henhouse. He stated:
"The consequence (of the banks' innovative financial engineering-w.e.) doubtless has been a far more efficient financial system The new international financial system that has evolved as a consequence has been, despite recent setbacks, a major factor in the marked increase in living standards for those economies that have chosen to participate in it.
It is important to remember--when we contemplate the regulatory interface with the new international financial system--the system that is relevant is not solely the one we confront today. There is no evidence of which I am aware that suggests that the transition to the new advanced technology-based international financial system is now complete. Doubtless, tomorrow's complexities will dwarf even today's.
It is, thus, all the more important to recognize that twenty-first century financial regulation is going to increasingly have to rely on private counterparty surveillance to achieve safety and soundness. There is no credible way to envision most government financial regulation being other than oversight of process. As the complexity of financial intermediation on a worldwide scale continues to increase, the conventional regulatory examination process will become progressively obsolescent--at least for the more complex banking systems. [4] (emphasis added-w.e.)
One might naively ask, why then surrender all those powers like Glass-Steagall to the private banks far beyond possible official regulatory purview?
Again in October 1999, amid the frenzy of the dot.com IT stock market bubble mania, a bubble which Greenspan repeatedly and stubbornly insisted he could not confirm as a bubble, he once again praised the role of financial derivatives and "new financial instruments reallocating risk in a manner that makes risk more tolerable. Insurance, of course, is the purest form of this service. All the new financial products that have been created in recent years, financial derivatives being in the forefront, contribute economic value by unbundling risks and reallocating them in a highly calibrated manner. He was speaking of securitization on the eve of the all-but certain repeal of the Glass-Steagall Act.[5]
The Fed's "private counterparty surveillance" brought the entire international inter-bank trading system to a screeching halt in August 2007, as panic spread over the value of the trillions of dollars in securitized Asset Backed Commercial Paper and in fact most securitized bonds. The effects of the shock have only begun, as banks and investors slash values across the US and international financial system. But that's getting ahead of our story.
Deregulation, TBTF and Gigantomania among banks
In the United States, between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance. That was far more than in any other period since the advent of federal deposit insurance in the 1930s. It was part of a process of concentration into giant banking groups that would go into the next century.
In 1984 the largest bank insolvency in US history threatened, the failure of Chicago's Continental Illinois National Bank, the nation's seventh largest, and one of the world's largest banks. To prevent that large failure, the Government through the Federal Deposit Insurance Corporation stepped in to bailout Continental Illinois by announcing 100% deposit guarantee instead of the limited guarantee FDIC insurance provided. This came to be called the doctrine of "Too Big to Fail" (TBTF). The argument was that certain very large banks, because they were so large, must not be allowed to fail for fear of the chain-reaction consequences it would have across the economy. It didn't take long before the large banks realized that the bigger they became through mergers and takeovers, the more sure they were to qualify for TBTF treatment. So-called "Moral Hazard" was becoming a prime feature of US big banks. [6]
That TBTF doctrine was to be extended during Greenspan's Fed tenure to cover very large hedge funds (LTCM), very large stock markets (NYSE) and virtually every large financial entity in which the US had a strategic stake. Its consequences were to be devastating. Few outside the elite insider circles of the very large institutions of the financial community even realized the doctrine had been established.
Once the TBTF principle was made clear, the biggest banks scrambled to get even bigger. The traditional separation of banking into local S&L mortgage lenders, large international money center banks like Citibank or J.P. Morgan or Bank of America, the prohibition on banking in more than one state, one by one were dismantled. It was a sort of "level playing field" but level for the biggest banks to bulldoze over and swallow up the smaller and create cartels of finance of unprecedented scope.
By 1996 the number of independent banks had shrunk by more than one-third from the late 1970s, from more than 12,000 to fewer than 8,000. The percentage of banking assets controlled by banks with more than $100 billion doubled to one-fifth of all US banking assets. The trend was just beginning. The banks' consolidation was a direct outgrowth of the removal of geographic restrictions on bank branching and holding company acquisitions by the individual states, formalized in the 1994 Interstate Banking and Branch Efficiency Act. Under the rubric of "more efficient banking" a Darwinian survival of the biggest ensued. They were by no means the fittest. The consolidation was to have significant consequences a decade or so later as securitization exploded in scale beyond the banks' wildest imagination.
J.P.Morgan blazes the trail
In 1995, well into the Clinton-Rubin era, Alan Greenspan's former bank, J.P. Morgan, introduced an innovation that was to revolutionize banking over the next decade. Blythe Masters, a 34-year old Cambridge University graduate hired by the bank, developed the first Credit Default Swaps, a financial derivative instrument that ostensibly let a bank insure against loan default; and Collateralized Debt Obligations, bonds issued against a mixed pool of assets, a kind of credit derivative giving exposure to a large number of companies in a single instrument.
Their attraction was that it was all off the bank's own books, hence away from the Basle Accord's 8% capital rules. The goal was to increase bank returns while eliminating the risk, a kind of "having your cake and eating it too," something which in the real world can only be very messy.
J.P.Morgan thereby paved the way to transform US banking away from traditional commercial lenders to traders of credit, in effect, into securitizers. The new idea was to enable the banks to shift risks off their balance sheets by pooling their loans and remarketing them as securities, while buying default insurance, Credit Default Swaps, after syndicating the loans for their clients. It was to prove a staggering development, soon to hit volumes measured in the trillions for the banks. By the end of 2007 there were an estimated $45,000 billion worth of Credit Default Swap contracts out there, giving bondholders the illusion of security. That illusion, however, was built on bank risk models of default assumptions which are not public and, if like other such risk models, were wildly optimistic. Yet the mere existence of the illusion was sufficient to lead the major banks of the world, lemming-like, into buying mortgage bonds collateralized or backed by streams of mortgage payments from unknown credit quality, and to accept at face value a Moody's or Standard & Poors AAA rating.
Just as Greenspan as new Fed chairman turned to his old cronies at J.P. Morgan when he wanted to grant a loophole to the strict Glass-Steagall Act in 1987, and as he turned to J.P. Morgan to covertly work with the Fed to buy derivatives on the Chicago MMI stock index to artificially manipulate a recovery from the October 1987 crash, so the Greenspan Fed worked with J.P. Morgan and a handful of other trusted friends on Wall Street to support the launch of securitization in the 1990's, as it became clear what the staggering potentials were for the banks who were first and who could shape the rules of the new game, the New Finance.
It was J.P. Morgan & Co. that led the march of the big money center banks beginning 1995 away from traditional customer bank lending towards the pure trading of credit and of credit risk. The goal was to amass huge fortunes for the bank's balance sheet without having to carry the risk on the bank's books, an open invitation to greed, fraud and ultimate financial disaster. Almost every major bank in the world, from Deutsche Bank to UBS to Barclays to Royal Bank of Scotland to Societe Generale soon followed like eager blind lemmings.
None however came close to the handful of US banks which came to create and dominate the new world of securitization after 1995, as well as of derivatives issuance. The banks, led by J.P. Morgan, first began to shift credit risk off the bank balance sheets by pooling credits and remarketing portfolios, buying default protection after syndicating loans for clients. The era of New Finance had begun. Like every major "innovation" in finance, it began slowly.
Very soon after, the new securitizing banks such as J.P. Morgan began to create portfolios of debt securities, then to package and sell off tranches based on default probabilities. "Slice and dice" was the name of the new game, to generate revenue for the issuing underwriting bank, and to give "customized risk to return" results for investors. Soon Asset Backed Securities, Collateralized Debt Securities, even emerging market debt were being bundled and sold off in tranches.
On November 2, 1999, only ten days before Bill Clinton signed the Act repealing Glass-Steagall, thereby opening the doors for money center banks to acquire brokerage business, investment banks, insurance companies and a variety of other financial institutions without restriction, Alan Greenspan turned his attention to encouraging the process of bank securitization of home mortgages.
In an address to America's Community Bankers, a regional banking organization, at a conference on mortgage markets, the Fed chairman stated:
The recent rise in the homeownership rate to over 67 percent in the third quarter of this year owes, in part, to the healthy economic expansion with its robust job growth. But part of the gains have also come about because innovative lenders, like you, have created a far broader spectrum of mortgage products and have increased the efficiency of loan originations and underwriting. Ongoing progress in streamlining the loan application and origination process and in tailoring mortgages to individual homebuyers is needed to continue these gains in homeownership Community banking epitomizes the flexibility and resourcefulness required to adjust to, and exploit, demographic changes and technological breakthroughs, and to create new forms of mortgage finance that promote homeownership. As for the Federal Reserve, we are striving to assist you by providing a stable platform for business generally and for housing and mortgage activity. (emphasis mine-w.e.) [7]
Already on March 8 of that same year, 1999, Greenspan addressed the Mortgage Bankers' Association where he strongly pushed real estate mortgage backed securitization as the wave of the future. He told the bankers there,
"Greater stability in the supply of mortgage credit has been accompanied by the unbundling of the various aspects of the mortgage process. Some institutions act as mortgage bankers, screening applicants and originating loans. Other parties service mortgage loans, a function for which efficiencies seem to be gained by large-scale operations. Still others, mostly with stable funding bases, provide the permanent financing of mortgages through participation in mortgage pools. Beyond this, some others slice cash flows from mortgage pools into special tranches that appeal to a wider group of investors. In the process, mortgage-backed securities outstanding have grown to a staggering $2.4 trillion , automated underwriting software is being increasingly employed to process a rapidly rising share of mortgage applications. Not only does this technology reduce the time it takes to approve a mortgage application, it also offers a consistent way of evaluating applications across a number of different attributes, and helps to ensure that the down-payment and income requirements and interest rates charged more accurately reflect credit risks. These developments enabled the industry to handle the extraordinary volume of mortgages last year with ease, especially compared to the strains that had been experienced during refinancing waves in the past. One key benefit of the new technology has been an increased ability to manage risk (sic). Looking forward, the increased use of automated underwriting and credit scoring creates the potential for low-cost, customized mortgages with risk-adjusted pricing. By tailoring mortgages to the needs of individual borrowers, the mortgage banking industry of tomorrow will be better positioned to serve all corners of the diverse mortgage market. (emphasis mine-w-e-)." [8]
But only after the Fed punctured the dot.com stock bubble in 2000 and after the Greenspan Fed dropped Fed funds interest rates drastically to lows not seen on such a scale since the 1930's Great Depression, did asset securitization literally explode into a multi-trillion dollar enterprise.
Securitization-the Un-Real Deal
Because the very subject of securitization was embedded with such complexity no one, not even its creators fully understood the diffusion of risk, let alone the simultaneous concentration of systemic risk.
Securitization was a process in which assets were acquired by some entity, sometimes called a Special Purpose Vehicle (SPV) or Special Investment Vehicle (SIV).
At the SIV the diverse home mortgages, let's say, were assembled into pools or bundles as they were termed. A specific pool, say, of home mortgage receivables, now took life in the new form of a bond, an asset backed bond, in this case a mortgage backed security. The securitized bond was backed by the cash flow or value of the underlying assets.
That little step involved a complex leap of faith to grasp. It was based on illusory collateral backing whose real worth, as is now dramatically clear to all banks everywhere, was unknown and unknowable. Already at this stage of the process the legal title to the home mortgage of a specific home in the pool is legally ambiguous, as I pointed out in Part I. Who in the chain actually has in his or her physical possession the real, "wet signature" mortgage deed to the hundreds and thousands of homes in collateral? Now lawyers will have a field day for years to come sorting out Wall Street's brilliant opacities.
Securitization usually applied to assets that were illiquid, that is ones that were not easily sold, hence it became common in real estate. And US real estate today is one of the world's most illiquid markets. Everyone wants out and few want in, at least not at these prices.
Securitization was applied to pools of leased property, to residential mortgages, home equity loans, on student loans, credit card or other debts. In theory all assets could be securitized as long as they were associated with a steady and predictable cash flow. That was the theory. In practice, it allowed US banks to skirt tougher new Basle Capital Adequacy Rules, Basle II, designed explicitly in part to close the loophole in Basle I that let US and other banks shove loans wholesale into off-the-books special entities called Special Investment Vehicles or SIVs.
Financial Alchemy: Where the fly hits the soup
Securitization, thus, converted illiquid assets into liquid assets. It did this, in theory, by pooling, underwriting and selling the ownership claims to the payment flows, as asset-backed securities (ABS). Mortgage-backed securities were one form of ABS, the largest by far since 2001.
Here's where the fly hit the soup.
With the US housing market beginning back in 2006 in sharp downturn and rates on Adjustable Rate Mortgages (ARMs) moving sharply higher across the United States, hundreds of thousands of homeowners were being forced to simply "walk away" from their now un-payable mortgages, or be foreclosed on by one or another party in the complex securitization chain, very often illegally, as an Ohio judge recently ruled. Home foreclosures for 2007 were 75% higher than in 2006 and the process is just beginning, in what will be a real estate disaster to rival or likely exceed that of the Great Depression. In California foreclosures were up an eye-popping 421% over the year before.
That growing process of mortgage defaults in turn left gaping holes in the underlying cash payment stream intended to back up the newly issued Mortgage Backed Securities. Because the entire system was totally opaque, no one, least of all the banks holding this paper, knew what was really the case, what asset backed security was good, or what bad. As nature abhors a vacuum, bankers and investors, especially global investors, abhor uncertainty in financial assets they hold. They treat it like toxic waste.
The architects of this New Finance, based on the securitization of home mortgages, however, found that bundling hundreds of disparate mortgages of varying credit quality from across the USA into a big MBS bond wasn't enough. If the Wall Street MBS underwriters were to be able to sell their new MBS bonds to the well-endowed pension funds of the world, they needed some extra juice. Most pension funds are restricted to buying only bonds rated AAA, highest quality.
But how could a rating agency rate a bond which was composed of a putative spream of mortgage payments from 1,000 different home mortgages across the USA? They couldn't send an examiner into every city to look at the home and interview its occupant. Who could stand behind the bond? Not the mortgage issuing bank. They sold the mortgage immediately, at a discount, to get it off their books. Not the Special Purpose Vehicle, they were just there to keep the transactions separate from the mortgage underwriting bank.No something else was needed. Deux Maxima! in stepped the dauntless Big Three (actually Big Two) Credit Raters, the rating agencies.
The ABS Rating Game
Never ones to despair when confronted by new obstacles, clever minds at J.P. Morgan, Morgan Stanley, Goldman Sachs, Citigroup, Merrill Lynch, Bear Stearns and a myriad of others in the game of securitizing the exploding volumes of home mortgages after 2002, turned to the Big Three rating agencies to get their prized AAA. This was necessary because, unlike issuance of a traditional corporate bond, say by GE or Ford, where a known, physical bricks 'n mortar blue-chip company with a long-term credit history stood behind the bond, with Asset Backed Securities no corporation stood behind an ABS. Just a lot of promises on mortgage contracts across America.
The ABS or bond was, if you will, a "stand alone" artificial creation, whose legality under US law has been called into question. That meant a rating by a credit rating agency was essential to make the bond credible, or at least give it the "appearance of credibility," as we now realize from the unraveling of the present securitization debacle.
At the very heart of the new financial architecture that was facilitated by the Greenspan Fed and successive US Administrations over the past two decades and more, was a semi-monopoly held by three de facto unregulated private companies who operated to provide credit ratings for all securitized assets, of course for very nice fees.
Three rating agencies dominated the global business of credit ratings, the largest in the world being Moody's Investors Service. In the boom years of securitization, Moody's regularly reported well over a 50% profit on gross rating revenues. The other two in the global rating cartel were Standard & Poor's and Fitch Ratings. All three were American companies intimately tied into the financial sinews of Wall Street and US finance. The fact that the world's rating business was a de facto US monopoly was no accident. It was planned that way, as a main pillar of the financial domination of New York. The control of the credit rating world was for the US global power projection almost tantamount to US domination in nuclear weapons as a power factor.
Former Secretary of Labor, economist Robert Reich, identified a core issue of the raters, their built-in conflict of interest. Reich noted, "Credit-rating agencies are paid by the same institutions that package and sell the securities the agencies are rating. If an investment bank doesn't like the rating, it doesn't have to pay for it. And even if it likes the rating, it pays only after the security is sold. Get it? It's as if movie studios hired film critics to review their movies, and paid them only if the reviews were positive enough to get lots of people to see the movie."
Reich went on, "Until the collapse, the result was great for credit-rating agencies. Profits at Moody's more than doubled between 2002 and 2006. And it was a great ride for the issuers of mortgage-backed securities. Demand soared because the high ratings had expanded the market. Traders didn't examine anything except the ratings a multibillion-dollar game of musical chairs. And then the music stopped." [9]
That put three global rating agencies-Moody's, S&P, and Fitch-directly under the investigative spotlight. They were de facto the only ones in the business of rating the collateralized securities-Collateralized Mortgage Obligations, Collateralized Debt Obligations, Student Loan-backed Securities, Lottery Winning-backed Securities and a myriad of others-for Wall Street and other banks.
According to an industry publication, Inside Mortgage Finance, some 25% of the $900 billion in sub-prime mortgages issued over the past two years were given top AAA marks by the rating agencies. That comes to more than $220 billion of sub-prime mortgage securities carrying the highest AAA rating by either Moody's, Fitch or Standard & Poors. That is now coming unwound as home mortgage defaults snowball across the land.
Here the scene got ugly. Their model assumptions on which they gave their desired AAA seal of approval was a proprietary secret. "Trust us "
According to an economist working within the US rating business, who had access to the actual model assumptions used by Moody's, S&P and Fitch to determine whether a mortgage pool with sub-prime mortgages got a AAA or not, they used historical default rates from a period of the lowest interest rates since the Great Depression, in other words a period with abnormally low default rates, to declare by extrapolation that the sub-prime paper was and would be into the distant future of AAA quality.
The risk of default on even a sub-prime mortgage, so went the argument, "was historically almost infinitesimal." That AAA rating from Moody's in turn allowed the Wall Street investment houses to sell the CMOs to pension funds, or just about anybody seeking "yield enhancement" but with no risk. That was the theory.
As Oliver von Schweinitz pointed out in a very timely book, Rating Agencies: Their Business, Regulation and Liability, "Securitizations without ratings are unthinkable." And because of the special nature of asset backed securitizations of mortgage loans, von Schweinitz points out, those ABS, "although being standardized, are one-time events, whereas other issuances (corporate bonds, government bonds) generally affect repeat players. Repeat players have less incentive to cheat than 'one time issuers.'" [10]
Put the other way, there is more incentive to cheat, to commit fraud with asset backed securities than with traditional bond issuance, a lot more.
Moody's, S&P's unique status
The top three rating agencies under US law enjoy an almost unique status. They are recognized by the Government's Securities and Exchange Commission (SEC) as Nationally Recognized Statistical Rating Organizations (NRSROs). There exist only four in the USA today. The fourth, a far smaller Canadian rater, is Dominion Bond Rating Service Ltd. Essentially, the top three hold a quasi monopoly on the credit rating business, and that, worldwide.
The only US law regulating rating agencies, the Credit Agency Reform Act of 2006 is a toothless law, passed in the wake of the Enron collapse. Four days before the collapse of Enron, the rating agencies gave Enron an "investment grade" rating, and a shocked public called for some scrutiny of the raters. The effect of the Credit Agency Reform Act of 2006 was null on the de facto rating monopoly of S&P, Moody's and Fitch.
The European Union, also reacting to Enron and to the similar fraud of the Italian company Parmalat, called for an investigation of whether the US rating agencies rating Parmalat has conflicts of interest, how transparent their methodologies were (not at all) and the lack of competition.
After several years of "study" and presumably a lot of behind-the-scenes from big EU banks involved in the securitization game, the EU Commission announced in 2006 it would only "continue scrutiny" (sic) of the rating agencies. Moody's and S&P and Fitch dominate EU ratings as well. There are no competitors.
It's a free country, ain't it?
The raters under US law were not liable for their ratings despite the fact that investors worldwide depend often exclusively on the AAA or other rating by Moody's or S&P as validation of creditworthiness, most especially in securitized assets. The Credit Agency Reform Act of 2006 in no way dealt with liability of the rating agencies. It was in this regard a worthless paper. It was the only law dealing with the raters at all.
As von Schweinitz pointed out, "Rule 10b-5 of the Securities and Exchange Act of 1934 is probably the most important basis for suing on the grounds of capital market fraud." That rule stated "It shall be unlawful for any person to make any untrue statement of a material fact." That sounded like something concrete. But then the Supreme Court affirmed in a 2005 ruling, Dura Pharmaceuticals, ratings are not "statements of a material fact" as required under Rule 10b-5. The ratings given by Moody's or S&P or Fitch are rather, "merely an opinion." They are thereby protected as "privileged free speech," under the US Constitution's First Amendment.
Moody's or S&P could say any damn thing about Enron or Parmalat or sub-prime securities it wanted to. It's a free country ain't it? Doesn't everyone have a right to their opinion?
US courts have ruled in ruling after ruling that financial markets are "efficient" and hence, markets will detect any fraud in a company or security and price it accordingly eventually. No need to worry about the raters then [11]
That was the "self-regulation" that Alan Greenspan apparently had in mind when he repeatedly intervened to oppose any regulation of the emerging asset securitization revolution.
The securitization revolution was all underwritten by a kind of "hear no evil, see no evil" US government policy that said, what is "good for the Money Trust is good for the nation." It was a perverse twist on the already perverse saying from the 1950's of then General Motors chief, Charles E. Wilson, "what's good for General Motors is good for America."
Monoline insurance: Viagra for securitization?
For those CMO sub-prime securities that fell short of AAA quality,there was also another crucial fix needed. The minds on Wall Street came up with an ingenious solution.
The issuer of the Mortgage Backed Security could take out what was known as Monoline insurance. Monoline insurance for guaranteeing against default in asset backed securities was another spin-off of the Greenspan securitization revolution.
Although monoline insurance had begun back in the early 1970's as a guarantee for municipal bonds, it was the Greenspan securitization revolution which gave it its leap into prominence.
As their industry association stated, "The monoline structure ensures that our full attention is given to adding value to our capital market customers." Add value they definitely did. As of December 2007, it was reliably estimated that the monoline insurers, who call themselves "financial guarantors," eleven poorly capitalized, loosely regulated monoline insurers, all based in New York and regulated by that state's insurance regulator, had given their insurance guarantee to enable the AAA rated securitization of over $2.4 trillion worth of Asset Backed Securities. (emphasis mine-f.w.e.).
Monoline insurance became a very essential element in the fraud-ridden Wall Street scam known as securitization. By paying a certain fee, a specialized (hence the term monoline) insurance company would insure or guarantee a pool of sub-prime mortgages in event of an economic downturn or recession in which the poor sub-prime homeowner could not service his monthly mortgage payments.
To quote from the official website of the monoline trade association, "The Association of Financial Guaranty Insurers, AFGI, is the trade association of the insurers and re-insurers of municipal bonds and asset-backed securities. A bond or other security insured by an AFGI member has the unconditional and irrevocable guarantee that interest and principal will be paid on time and in full in the event of a default." Now they regret ever having promised that as sub-prime mortgage resets, growing recession and mortgage defaults are presenting hyperbolic insurance demands on the tiny, poorly capitalized monolines.
The main monoline insurers were hardly household names: ACA Financial Guaranty Corp., Ambac Assurance, Assured Guaranty Corp. BluePoint Re Limited, CIFG, Financial Guaranty Insurance Company, Financial Security Assurance, MBIA Insurance Corporation, PMI Guaranty Co., Radian Asset Assurance Inc., RAM Reinsurance Company and XL Capital Assurance.
A cautious reader might ask the question, "Who insures these eleven monoline insurers who have guaranteed billions indeed trillions in payment flows over the past five or so years of the ABS financial revolution?"
No one, yet, was the short answer. They state, "Eight AFGI member firms carry a Triple-A claims paying ability rating and two member firms carry a Double-A claims paying ability rating." Moody's, Standard & Poors and Fitch gave the AAA or AA ratings.
By having a guarantee from a bond insurer with an AAA credit rating, the cost of borrowing was less than it would normally be and the number of investors willing to buy such bonds was greater.
For the monolines, guaranteeing such bonds seemed risk-free, with average default rates running at a fraction of 1 per cent in 2003-2006. As a result, monolines leveraged their assets to build their books, and it was not being uncommon for a monoline to have insured risks 100 to 150 times the size of its capital base. Until recently, Ambac had capital of $5.7 billion against guarantees of $550 billion.
In 1998, the NY State Insurance Superintendent's office, the only regulator of monolines, agreed to allow monolines to sell credit-default swaps (CDSs) on asset-backed securities such as mortgage backed securities. Separate shell companies would be established, through which CDSs could be issued to banks for mortgage backed securities.
The move into insuring securitized bonds was spectacularly lucrative for the monolines. MBIA's premiums rose from $235m in 1998 to $998m in 2007. Year on year premiums last year increased 140%. Then along came the US sub-prime mortgage crisis, and the music stopped dead for the monolines, dead.
As the mortgages within bonds from the banks defaulted - sub-prime mortgages written in 2006 were already defaulting at a rate of 20 per cent by January 2008-the monolines were forced to step in and cover the payments.
On February 3, MBIA revealed $3.5 billion in writedowns and other charges in three months alone, leading to a quarterly loss of $2.3 billion. That was likely just the tip of a very cold iceberg. Insurance analyst Donald Light remarked, "The answer is no one knows," when asked what the potential downside loss was. "I don't think we will know to perhaps the third or fourth quarter of 2008."
Credit ratings agencies have begun downgrading the monolines, taking away their prized AAA ratings, which means a monoline could no longer write new business, and the bonds it guarantees no longer would hold a AAA rating.
To date, the only monoline to receive downgrades from two agencies - usually required for such a move to impact on a company - is FGIC, cut by both Fitch and S&P. Ambac, the second largest monoline, has been cut to AA by Fitch, with the other monolines on a variety of different potential warnings.
The rating agencies did "computer simulated stress tests" to decide if the monolines could "pay claims at a default level comparable to that of the Great Depression." How much could the monoline insurers handle in a real crisis? They claimed, "Our claims-paying resources available to back members' guarantees totals more than $34 billion." [12]
That $34 billion was a drop in what will rapidly over the course of 2008 appear to be a bottomless bucket. It was estimated that in the Asset Backed Securities market roughly one-third of all transactions were "wrapped" or insured by AAA monolines. Investors demanded surety wraps for volatile collateral or that without a long performance history. [13]
According to the Securities Industry and Financial Markets Association, a US trade group, at the end of 2006 there was a total of some $3.6 trillion worth of Asset Backed Securities in the United States, including of home mortgages, prime and sub-prime, of home equity loans, credit cards, student loans, car loans, equipment leasing and the like. Fortunately not all $3.6 trillion of securitizations are likely to default, and not all at once. But the AGFI monoline insurers had insured $2.4 trillion of that mountain of asset backed securities over the past several years. Private analysts estimated by early February 2008 that the potential insurer payout risks, under optimistic assumptions, could exceed $200 billions. A taxpayer bailout of that scale in an election year would be an interesting voter sell.
Off the books
The entire securitization revolution allowed banks to move assets off their books into unregulated opaque vehicles. They sold the mortgages at a discount to underwriters such as Merrill Lynch, Bear Stearns, Citigroup, and similar financial securitizers. They then in turn sold the mortgage collateral to their own separate Special Investment Vehicle or SIV as they were known. The attraction of a stand-alone SIV was that they and their potential losses were theoretically at least, isolated from the main underwriting bank. Should things ever, God forbid, run amok with the various Asset Backed Securities held by the SIV, only the SIV would suffer, not Citigroup or Merrill Lynch.
The dubious revenue streams from sub-prime mortgages and similar low quality loans, once bundled into the new Collateralized Mortgage Obligations or similar securities, then often got an injection of Monoline insurance, a kind of financial Viagra for junk quality mortgages such as the NINA (No Income, No Assets) or "Liars' Loans," or so-called stated-income loans, that were commonplace during the colossal Greenspan Real Estate economy up until July 2007.
According to the Mortgage Brokers' Association for Responsible Lending, a consumer protection group, by 2006 Liars' Loans were a staggering 62% of all USA mortgage originations. In one independent sampling audit of stated-income mortgage loans in Virginia in 2006, the auditors found, based on IRS records that almost 60% of the stated-income loans were exaggerated by more than 50%. Those stated-income chickens are now coming home to roost or far worse. The default rates on those Liars' Loans, which is now sweeping across the entire US real estate market, makes the waste problems of Tyson Foods factory chicken farms look like a wonderland. [14]
None of that would have been possible without securitization, without the full backing of the Greenspan Fed, without the repeal of Glass-Steagall, without monoline insurance, without the collusion of the major rating agencies, and the selling on of that risk by the mortgage-originating banks to underwriters who bundled them, rated and insured them as all AAA.
In fact the Greenspan New Finance revolution literally opened the floodgates to fraud on every level from home mortgage brokers to lending agencies to Wall Street and London securitization banks to the credit rating agencies. Leaving oversight of the new securitized assets, hundreds of billions of dollars worth of them, to private "self-regulation" between issuing banks like Bear Stearns, Merrill Lynch or Citigroup and their rating agencies, was tantamount to pouring water on a drowning man. In Part V we discuss the consequences of the grand design in New Finance.
* F. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, www.globalresearch.ca. The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
- [1] Greenspan, Alan, Consumer Finance, Remarks at the Federal Reserve System's Fourth Annual Community Affairs Research Conference, Washington, D.C., April 8, 2005, in www.federalreserve.gov/BoardDocs/speeches/2005/20050408/default.htm
- [2] Greenspan, Greenspan Defends Low Interest Rates Interview CBS 60 Minutes, September 16, 2007, in www.cbsnews.com/stories/2007/09/13/60minutes/main3257567.shtml
- [3] Greenspan, The Markets, Excerpts From Greenspan Speech on Global Turmoil, reprinted in The New York Times, November 6, 1998.
- [4] Greenspan, Alan, Remarks by Chairman Alan Greenspan:The structure of the international financial system,
- at the Annual Meeting of the Securities Industry Association, Boca Raton, Florida, November 5, 1998.
- [5] Greenspan, Alan, Measuring Financial Risk in the Twenty-first Century, Remarks Before a conference sponsored by the Office of the Comptroller of the Currency, Washington, D.C., October 14, 1999, in www.federalreserve.gov/boarddocs/speeches/1999/19991014.htm. Here Greenspan states, "...to date, economists have been unable to anticipate sharp reversals in confidence. Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. To anticipate a bubble about to burst requires the forecast of a plunge in the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific investments that make up our broad price indexes of stocks and other assets.
- [6] Federal Deposit Insurance Corporation, History of the 80s, Volume I: An Examination of the Banking Crises of the 1980s and Early 1990s, in www.fdic.gov/bank/historical/history/vol1.html, p.1.
- [7] Greenspan, Alan, Mortgage markets and economic activity, Remarks before a conference on Mortgage Markets and Economic Activity, sponsored by America's Community Bankers, Washington, D.C., November 2, 1999, in www.federalreserve.gov/boarddocs/speeches/1999/19991102.htm.
- [8] Greenspan, Alan, Remarks to Mortgage Bankers' Association, Washington, D.C., March 8, 1999.
- [9] Reich, Robert, Why Credit-rating Agencies Blew It: Mystery Solved, October 23, 2007, Robert Reich's Blog, in robertreich.blogspot.com/2007/10/they-mystery-of-why-credit-rating.html.
- [10] Von Schweinitz, Oliver, Rating Agencies Their Business, Regulation and Liability, Unlimited Publishing LLC, Bloomington, Ind., 2007, pp. 35-36.
- [11] Ibid. pp. 67-97.
- [12] Association of Financial Guaranty Insurers, Our Claims-Paying Ability, in www.afgi.org/who-fact.htm.
- [13]McNichols, James P., Monoline Insurance & Financial Guaranty Reserving, in www.casact.org/pubs/forum/03fforum/03ff231.pdf.
- [14] Dorfman, Dan, Liars' Loans Could Make Many Moan, The New York Sun, Dec. 20, 2006.
© 2008 F. William Engdahl
Editorial ArchiveF. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, www.globalresearch.ca. The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
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naked capitalism
In keeping with Greenspan's tutelage at the knee of Ayn Rand, he has exercised his right not to be constrained by propriety or other rules that govern little men and has gone and sold himself to what is no doubt the highest bidder, Paulson & Company. Paulson is famous for its spectacular big against subprime this year, and its Paulson Credit Opportunities fund was up 410% through August.
It's one thing for Greenspan to sell books and give speeches to try to salvage his reputation. Nixon did that too, with more success and less profit. It is quite another for him to benefit in a far more direct fashion from the devastation he created, by hooking up with the fund that scored the biggest kill from the worst aspects of the negative real interest rates that Greenspan put into effect.
Overly cheap credit always and inevitably leads to bad investments, And Greenspan of all people should have known that. How he can rationalize his actions then and now is beyond me. But I forgot. Objectivism means never having to say you're sorry.
Actually, it is worse than that. More than 50 years ago, this country could be awakened from its nightmare of Joe McCarthy-led Communist-in-every-closet witch hunting by the exposure of McCarthy's methods in the first nationally televised Congressional hearings. The pivotal moment occurred when a Boston lawyer, Joseph Welch, rebuked McCarthy with the now-famous phrase, "Have you no sense of decency, sir, at long last? Have you left no sense of decency?"
But decency and propriety mean nothing in America these days. What used to be recognized as corruption is now shrugged off as business as usual. When a nation loses its moral compass, it also loses its soul.
From the Financial Times:
Alan Greenspan, the former chairman of the US Federal Reserve, is to become an adviser to Paulson & Co, the $28bn New York-based hedge fund company that achieved spectacular investment returns at the height of the credit squeeze last year.Mr Greenspan will join the advisory board of the credit specialist investment house. Paulson will be the only hedge fund that Mr Greenspan will work with under the terms of the agreement.
Paulson was propelled into the spotlight last year as perhaps the biggest known winner in making aggressive bets against US subprime home loans. Investors estimate that its funds racked up profits of $12bn.
Mr Greenspan already holds separate advisory roles with Deutsche Bank and Pimco, the asset management firm. The financial terms of the arrangement were not disclosed.
John Paulson, president of the hedge fund, said: "Few people, if any in the world, have the experience with, and depth of understanding of, global financial markets [of Mr] Greenspan."
He said Mr Greenspan would share his perspectives with the Paulson investment management team on the direction of the economy, assessing the potential for and severity of a US recession.
Mr Greenspan served as chairman of the Fed for 18 years until 2006. His pronouncements on the economy through regular public appearances still have the power to move markets.
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Real Estate Blog
If you read my previous article, "Pointing the Finger At Who Is To Blame," you know that the Federal Reserve is often criticized for not having stepped in to resolve our credit problem earlier on. To be more specific, the Fed and Alan Greenspan are criticized for having kept interest rates low for far too long a period of time.
In an article by Jeannine Aversa, AP Economics Writer, she writes about prior Fed Chairman Alan Greenspan and his omission to having been aware of our mortgage dilemma. Here's an excerpt from the article:
"'While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late,' he said in a CBS "60 Minutes" interview to be broadcast Sunday. 'I really didn't get it until very late in 2005 and 2006,' Greenspan said."
"The Greenspan Fed from early 2001 to the summer of 2003 had slashed interest rates to their lowest level in decades. It was done to rescue the economy from the blows of the bursting of the stock market bubble, the 2001 recession, the terror attacks and a wave of accounting scandals that shook Wall Street.
Critics say the Fed kept rates too low for too long, encouraging a Wild West mentality in housing."
What are your thoughts? Was the Fed, under the guidance of Alan Greenspan, the sole perpetrator behind the credit problem that we face today?
My Opinion:
I think everyone should be held accountable to a certain extent.
--> A manipulation of the capital markets made the risk/reward incentive enticing enough for investors to back the lenders.
--> The lenders then pushed the envelope by continuing to open up loan programs
--> The brokers on the street level pushed these loan programs with some help from their comrades, the appraisers
--> then borrowers jumped at owning as much property as they could with hopes of "flipping" their investment and in the process took the lowest teaser rate bid being offered by the pool of brokers.
I think the source of the problem in it's simplistic form was: "Easy Money" being issued.
And it was perpetuated by everyone!
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January 23, 2008 | FS Editorial
Greenspan's Grand Design
by F. William Engdahl
January 23, 2008The Long-Term Greenspan Agenda
Seven years of Volcker monetary "shock therapy" had ignited a payments crisis across the Third World. Billions of dollars in recycled petrodollar debts loaned by major New York and London banks to finance oil imports after the oil price rises of the 1970's, suddenly became non-payable.
The stage was now set for the next phase in the Rockefeller financial deregulation agenda. It was to come in the form of a revolution in the very nature of what would be considered money-the Greenspan "New Finance" Revolution.
Many analysts of the Greenspan era focus on the wrong facet of his role, and assume he was primarily a public servant who made mistakes, but in the end always saved the day and the nation's economy and banks, through extraordinary feats of financial crisis management, winning the appellation, Maestro.[1]
Maestro serves the Money Trust
Alan Greenspan, as every Chairman of the Board of Governors of the Federal Reserve System was a carefully-picked institutionally loyal servant of the actual owners of the Federal Reserve: the network of private banks, insurance companies, investment banks which created the Fed and rushed in through an almost empty Congress the day before Christmas recess in December 1913. In Lewis v. United States, the United States Court of Appeals for the Ninth Circuit stated that "the Reserve Banks are not federal instrumentalities but are independent, privately owned and locally controlled corporations." [2]
Greenspan's entire tenure as Fed chairman was dedicated to advancing the interests of American world financial domination in a nation whose national economic base was largely destroyed in the years following 1971.
Greenspan knew who buttered his bread and loyally served what the US Congress in 1913 termed "the Money Trust," a cabal of financial leaders abusing their public trust to consolidate control over many industries.
Interestingly, many of the financial actors behind the 1913 creation of the Federal Reserve are pivotal in today's securitization revolution including Citibank, and J.P. Morgan. Both have share ownership of the key New York Federal Reserve Bank, the heart of the system.
Another little-known shareholder of the New York Fed is the Depository Trust Company (DTC), the largest central securities depository in the world. Based in New York, the DTC custodies more than 2.5 million US and non-US equity, corporate, and municipal debt securities issues from over 100 countries, valued at over $36 trillion. It and its affiliates handle over $1.5 quadrillion of securities transactions a year. That's not bad for a company that most people never heard of. The Depository Trust Company has a sole monopoly on such business in the USA. They simply bought up all other contenders. It suggests part of the reason New York was able for so long to dominate global financial markets, long after the American economy had become largely a hollowed-out "post-industrial" wasteland.
While free market purists and dogmatic followers of Greenspan's late friend, Ayn Rand, accuse the Fed Chairman of hands-on interventionism, in reality there is a common thread running through each major financial crisis of his 18 plus years as Fed chairman. He managed to use each successive financial crisis in his eighteen years as head of the world's most powerful financial institution to advance and consolidate the influence of US-centered finance over the global economy, almost always to the severe detriment of the economy and broad general welfare of the population.
In each case, be it the October 1987 stock crash, the 1997 Asia Crisis, the 1998 Russian state default and ensuing collapse of LTCM, to the refusal to make technical changes in Fed-controlled stock margin requirements to cool the dot.com stock bubble, to his encouragement of ARM variable rate mortgages (when he knew rates were at the bottom), Greenspan used the successive crises, most of which his widely-read commentaries and rate policies had spawned in the first place, to advance an agenda of globalization of risk and liberalization of market regulations to allow unhindered operation of the major financial institutions.
The Rolling Crises Game
This is the true significance of the crisis today unfolding in US and global capital markets. Greenspan's 18 year tenure can be described as rolling the financial markets from successive crises into ever larger ones, to accomplish the over-riding objectives of the Money Trust guiding the Greenspan agenda. Unanswered at this juncture is whether Greenspan's securitization revolution was a "bridge too far," spelling the end of the dollar and of dollar financial institutions' global dominance for decades or more to come.
Greenspan's adamant rejection of every attempt by Congress to impose some minimal regulation on OTC derivatives trading between banks; on margin requirements on buying stock on borrowed money; his repeated support for securitization of sub-prime low quality high-risk mortgage lending; his relentless decade-long push to weaken and finally repeal Glass-Steagall restrictions on banks owning investment banks and insurance companies; his support for the Bush radical tax cuts which exploded federal deficits after 2001; his support for the privatization of the Social Security Trust Fund in order to funnel those trillions of dollars cash flow into his cronies in Wall Street finance-all this was a well-planned execution of what some today call the securitization revolution, the creation of a world of New Finance where risk would be detached from banks and spread across the globe to the point no one could identify where real risk lay.
When he came in 1987 again to Washington, Alan Greenspan, the man hand-picked by Wall Street and the big banks to implement their Grand Strategy was a Wall Street consultant whose clients numbered the influential J.P. Morgan Bank among others. Before taking the post as head of the Fed, Greenspan had also sat on the boards of some of the most powerful corporations in America, including Mobil Oil Corporation, Morgan Guaranty Trust Company and JP Morgan & Co. Inc. His first test would be the manipulation of stock markets using the then-new derivatives markets in October 1987.
The 1987 Greenspan paradigm
In October 1987 when Greenspan led a bailout of the stock market after the October 20 crash, by pumping huge infusions of liquidity to prop up stocks and engaging in behind-the scene manipulations of the market via Chicago stock index derivatives purchases backed quietly by Fed liquidity guarantees. Since that October 1987 event, the Fed has made abundantly clear to major market players that they were, to use Fed jargon, TBTF-Too Big To Fail. No worry if a bank risked tens of billions speculating in Thai baht or dot.com stocks on margin. If push came to liquidity shove, Greenspan made clear he was there to bail out his banking friends.
The October 1987 crash which saw the sharpest one day fall in the Dow Industrials in history-508 points-was exacerbated by new computer trading models based on the so-called Black-Sholes Option Pricing theory, stock share derivatives now being priced and traded just as hog belly futures had been before.
The 1987 crash made clear was that there was no real liquidity in the markets when it was needed. All fund managers tried to do the same thing at the same time: to sell short the stock index futures, in a futile attempt to hedge their stock positions.
According to Stephen Zarlenga, then a trader who was in the New York trading pits during the crisis days in 1987, "They created a huge discount in the futures market The arbitrageurs who bought futures from them at a big discount, turned around and sold the underlying stocks, pushing the cash markets down, feeding the process and eventually driving the market into the ground."
Zarlenga continued, "Some of the biggest firms in Wall Street found they could not stop their pre-programmed computers from automatically engaging in this derivatives trading. According to private reports they had to unplug or cut the wiring to computers, or find other ways to cut off the electricity to them (there were rumors about fireman's axes from hallways being used), for they couldn't be switched off and were issuing orders directly to the exchange floors.
"The New York Stock Exchange at one point on Monday and Tuesday seriously considered closing down entirely for a period of days or weeks and made this public It was at this point that Greenspan made an uncharacteristic announcement. He said in no uncertain terms that the Fed would make credit available to the brokerage community, as needed. This was a turning point, as Greenspan's recent appointment as Chairman of the Fed in mid 1987 had been one of the early reasons for the market's sell off." [3]
What was significant about the October 1987 one-day crash was not the size of the fall. It was the fact that the Fed, unannounced to the public, intervened through Greenspan's trusted New York bank cronies at J.P. Morgan and elsewhere on October 20 to manipulate a stock recovery through use of new financial instruments called derivatives.
The visible cause of the October 1987 market recovery was when the Chicago-based MMI future (Major Market Index) of NYSE blue chip stocks began to trade at a premium, midday Tuesday, at a time when one after another Dow stock had been closed down for trading.
The meltdown began to reverse. Arbitrageurs bought the underlying stocks, re-opening them, and sold the MMI futures at a premium. It was later found that only about 800 contracts bought in the MMI futures was sufficient to create the premium and start the recovery. Greenspan and his New York cronies had engineered a manipulated recovery using the same derivatives trading models in reverse. It was the dawn of the era of financial derivatives.
Historically, at least most were led to believe, the role of the Federal Reserve, the Comptroller of the Currency among others, was to act as independent supervisors of the largest banks to insure stability of the banking system and prevent a repeat of the bank panics of the 1930's, above all in the Fed's role as "lender of last resort."
Under the Greenspan regime, after October 1987 the Fed increasingly became the "lender of first resort," as the Fed widened the circle of financial institutions worthy of the Fed's rescue from banks directly-which was the mandated purview of Fed bank supervision-to the artificial support of stock markets as in 1987, to the bailout of hedge funds as in the case of the Long-Term Capital Management hedge fund solvency crisis in September 1998.
Greenspan's last legacy will be leaving the Fed and with it the American taxpayer with the role as Lender of Last Resort, to bail out the major banks and financial institutions, today's Money Trust, after the meltdown of his multi-trillion dollar mortgage securitization bubble.
By the time of repeal of Glass-Steagall in 1999, an event of historic importance that was buried in the financial back pages, the Greenspan Fed had made clear it would stand ready to rescue the most risky and dubious new ventures of the US financial community. The stage was set to launch the Greenspan securitization revolution.
It was not accidental, or ad hoc in any way. The Fed laissez faire policy towards supervision and bank regulation after 1987 was crucial to implement the broader Greenspan deregulation and financial securitization agenda he hinted at in his first October 1987 Congressional testimony.
On November 18, 1987, only three weeks after the October stock crash, Alan Greenspan told the US House of Representatives Committee on Banking, " repeal of Glass-Steagall would provide significant public benefits consistent with a manageable increase in risk." [4]
Greenspan would repeat this mantra until final repeal in 1999.
The support of the Greenspan Fed for unregulated treatment of financial derivatives after the 1987 crash was instrumental in the global explosion in nominal volumes of derivatives trading. The global derivatives market grew by 23,102% since 1987 to a staggering $370 trillion by end of 2006. The nominal volumes were incomprehensible.
Destroying Glass-Steagall restrictions
One of Greenspan's first acts as Chairman of the Fed was to call for repeal of the Glass-Steagall Act, something which his old friends at J.P.Morgan and Citibank had ardently campaigned for. [5]
Glass-Steagall, officially the Banking Act of 1933, introduced the separation of commercial banking from Wall Street investment banking and insurance. Glass-Steagall originally was intended to curb three major problems that led to the severity of the 1930's wave of bank failures and depression:
Banks were investing their own assets in securities with consequent risk to commercial and savings depositors in event of a stock crash. Unsound loans were made by the banks in order to artificially prop up the price of select securities or the financial position of companies in which a bank had invested its own assets. A bank's financial interest in the ownership, pricing, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell. It was a colossal conflict of interest and invitation to fraud and abuse.
Banks that offered investment banking services and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in harm to their customers, including borrowers, depositors, and correspondent banks. Similarly, today, with no more Glass-Steagall restraints, banks offering securitized mortgage obligations and similar products via wholly owned Special Purpose Vehicles they create to get the risk "off the bank books," are complicit in what likely will go down in history as the greatest financial swindle of all times-the sub-prime securitization fraud.
In his history of the Great Crash, economist John Kenneth Galbraith noted, "Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.
"The legislative history of the Glass-Steagall Act," Galbraith continued, "shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments." Galbraith noted that "During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars' worth of securities in three interconnected investment trusts--Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing."
Operation Rollback
The major New York money-center banks had long had in mind the rollback of that 1933 Congressional restriction. And Alan Greenspan as Fed Chairman was their man. The major money-center US banks, led by Rockefeller's influential Chase Manhattan Bank and Sanford Weill's Citicorp, spent over one hundred hundreds million dollars lobbying and making campaign contributions to influential Congressmen to get deregulation of the Depression-era restrictions on banking and stock underwriting.
That repeal opened the floodgates to the securitization revolution after 2001.
Within two months of taking office, on October 6, 1987, just days before the greatest one-day crash on the New York Stock Exchange, Greenspan told Congress, that US banks, victimized by new technology and ''frozen'' in a regulatory structure developed more than 50 years ago, were losing their competitive battle with other financial institutions and needed to obtain new powers to restore a balance: ''The basic products provided by banks - credit evaluation and diversification of risk - are less competitive than they were 10 years ago.''
At the time the New York Times noted that "Mr. Greenspan has long been far more favorably disposed toward deregulation of the banking system than was Paul A. Volcker, his predecessor at the Fed." [6]
That October 6, 1987 Greenspan testimony to Congress, his first as Chairman of the Fed, was of signal importance to understand the continuity of policy he was to implement right to the securitization revolution of recent years, the New Finance securitization revolution. Again quoting the New York Times account, "Mr. Greenspan, in decrying the loss of the banks' competitive edge, pointed to what he said was a 'too rigid' regulatory structure that limited the availability to consumers of efficient service and hampered competition. But then he pointed to another development of 'particular importance' - the way advances in data processing and telecommunications technology had allowed others to usurp the traditional role of the banks as financial intermediaries. In other words, a bank's main economic contribution - risking its money as loans based on its superior information about the creditworthiness of borrowers - is jeopardized."
The Times quoted Greenspan on the challenge to modern banking posed by this technological change: 'Extensive on-line data bases, powerful computation capacity and telecommunication facilities provide credit and market information almost instantaneously, allowing the lender to make its own analysis of creditworthiness and to develop and execute complex trading strategies to hedge against risk,' Mr. Greenspan said. This, he added, resulted in permanent damage 'to the competitiveness of depository institutions and will expand the competitive advantage of the market for securitized assets,' such as commercial paper, mortgage pass-through securities and even automobile loans."
He concluded, 'Our experience so far suggests that the most effective insulation of a bank from affiliated financial or commercial activities is achieved through a holding-company structure.' [7] In a bank holding company, the Federal Deposit Insurance fund, a pool of contributions to guarantee bank deposits up to $100,000 per account, would only apply to the core bank, not to the various subsidiary companies created to engage in exotic hedge fund or other off-the-balance-sheet activities. The upshot was that in a crisis such as the unraveling securitization meltdown, the ultimate Lender of Last Resort, the insurer of bank risk becomes the American public taxpayer.
It was a hard fight in Congress and lasted until final full legislative repeal under Clinton in 1999. Clinton presented the pen he used in November 1999 to sign the repeal act, the Gramm-Leach-Bliley Act, into law as a gift to Sanford Weill, the powerful chairman of Citicorp, a curious gesture for a Democratic President, to say the least.
The man who played the decisive role in moving Glass-Steagall repeal through Congress was Alan Greenspan. Testifying before the House Committee on Banking and Financial Services, February 11, 1999, Greenspan declared, "we support, as we have for many years, major revisions, such as those included in H.R. 10, to the Glass-Steagall Act and the Bank Holding Company Act to remove the legislative barriers against the integration of banking, insurance, and securities activities. There is virtual unanimity among all concerned--private and public alike--that these barriers should be removed. The technologically driven proliferation of new financial products that enable risk unbundling have been increasingly combining the characteristics of banking, insurance, and securities products into single financial instruments."
In his same 1999 testimony Greenspan made clear repeal meant less, not more regulation of the newly-allowed financial conglomerates, opening the floodgate to the current fiasco: "As we move into the twenty-first century, the remnants of nineteenth-century bank examination philosophies will fall by the wayside. Banks, of course, will still need to be supervised and regulated, in no small part because they are subject to the safety net. My point is, however, that the nature and extent of that effort need to become more consistent with market realities. Moreover, affiliation with banks need not--indeed, should not--create bank-like regulation of affiliates of banks." [8] (Italics mine-f.w.e.)
Breakup of bank holding companies with their inherent conflict of interest, which led tens of millions of Americans into joblessness and home foreclosures in the 1930's depression, was precisely why Congress passed Glass-Steagall in the first place.
' strategies unimaginable a decade ago '
The New York Times described the new financial world created by repeal of Glass-Steagall in a June 2007 profile of Goldman Sachs, just weeks prior to the eruption of the sub-prime crisis: "While Wall Street still mints money advising companies on mergers and taking them public, real money - staggering money - is made trading and investing capital through a global array of mind-bending products and strategies unimaginable a decade ago." They were referring to the securitization revolution.
The Times quoted Goldman Sachs chairman Lloyd Blankfein on the new financial securitization, hedge fund and derivatives world: "We've come full circle, because this is exactly what the Rothschilds or J. P. Morgan, the banker were doing in their heyday. What caused an aberration was the Glass-Steagall Act."[9]
Blankfein as most of Wall Street bankers and financial insiders saw the New Deal as an aberration, openly calling for return to the days J. P. Morgan and other tycoons of the 'Gilded Age' of abuses in the 1920's. Glass-Steagall, Blankfein's "aberration" was finally eliminated because of Bill Clinton. Goldman Sachs was a prime contributor to the Clinton campaign and even sent Clinton its chairman Robert Rubin in 1993, first as "economic czar" then in 1995 as Treasury Secretary. Today, another former Goldman Sachs chairman, Henry Paulson is again US Treasury Secretary under Republican Bush. Money power knows no party.
Robert Kuttner, co-founder of the Economic Policy Institute, testified before US Congressman Barney Frank's Committee on Banking and Financial Services in October 2007, evoking the specter of the Great Depression:
"Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s - lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn't paper at all, and the whole process is supercharged by computers and automated formulas." [10]
Dow Jones Market Watch commentator Thomas Kostigen, writing in the early weeks of the unraveling sub-prime crisis, remarked about the role of Glass-Steagall repeal in opening the floodgates to fraud, manipulation and the excesses of credit leverage in the expanding world of securitization:
"Time was when banks and brokerages were separate entities, banned from uniting for fear of conflicts of interest, a financial meltdown, a monopoly on the markets, all of these things.
"In 1999, the law banning brokerages and banks from marrying one another - the Glass-Steagall Act of 1933 - was lifted, and voila, the financial supermarket has grown to be the places we know as Citigroup, UBS, Deutsche Bank, et al. But now that banks seemingly have stumbled over their bad mortgages, it's worth asking whether the fallout would be wreaking so much havoc on the rest of the financial markets had Glass-Steagall been kept in place.
"Diversity has always been the pathway to lowering risk. And Glass-Steagall kept diversity in place by separating the financial powers that be: banks and brokerages. Glass-Steagall was passed by Congress to prohibit banks from owning full-service brokerage firms and vice versa so investment banking activities, such as underwriting corporate or municipal securities, couldn't be called into question and also to insulate bank depositors from the risks of a stock market collapse such as the one that precipitated the Great Depression.
"But as banks increasingly encroached upon the securities business by offering discount trades and mutual funds, the securities industry cried foul. So in that telling year of 1999, the prohibition ended and financial giants swooped in. Citigroup led the way and others followed. We saw Smith Barney, Salomon Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.
"At brokerage firms there are supposed to be Chinese walls that separate investment banking from trading and research activities. These separations are supposed to prevent dealmakers from pressuring their colleague analysts to give better results to clients, all in the name of increasing their mutual bottom line.
"Well, we saw how well these walls held up during the heyday of the dot-com era when ridiculously high estimates were placed on corporations that happened to be underwritten by the same firm that was also trading its securities. When these walls were placed within their new bank homes, cracks appeared and - it looks ever so apparent - ignored.
"No one really questioned the new fad of collateralizing bank mortgage debt into different types of financial instruments and selling them through a different arm of the same institution. They are now
"When banks are being scrutinized and subject to due diligence by third-party securities analysts more questions are raised than when the scrutiny is by people who share the same cafeteria. Besides, fees, deals and the like would all be subject to salesmanship, which means people would be hammering prices and questioning things much more to increase their own profit - not working together to increase their shared bonus pool.
"Glass-Steagall would have at least provided what the first of its names portends: transparency. And that is best accomplished when outsiders are peering in. When every one is on the inside looking out, they have the same view. That isn't good because then you can't see things coming (or falling) and everyone is subject to the roof caving in.
"Congress is now investigating the subprime mortgage debacle. Lawmakers are looking at tightening lending rules, holding secondary debt buyers responsible for abusive practices and, on a positive note, even bailing out some homeowners. These are Band-Aid measures, however, that won't patch what's broken: the system of conflicts that arise when sellers, salesmen and evaluators are all on the same team. [11] (emphasis mine--f.w.e.)
Greenspan's dot.com bubble and its consequences
Before the ink was dry on Bill Clinton's signature repealing Glass-Steagall, the Greenspan fed was fully engaged in hyping their next crisis-the deliberate creation of a stock bubble to rival that of 1929, a bubble which then, subsequently the Fed would pop just as deliberately.
The 1997 Asia financial crisis and the ensuing Russian state debt default of August 1998 created a sea-change in global capital flows to the advantage of the dollar. With Korea, Thailand, Indonesia and most emerging markets in flames following a coordinated, politically-motivated attack by a trio of US hedge funds, led by Soros' Quantum Fund, James Robertson's Jaguar and Tiger funds and Moore Capital Management, as well as, according to reports, the Connecticut-based LTCM hedge fund of John Merriweather.
The impact of the Asia crisis on the dollar was notable and suspiciously positive. Andrew Crockett, the General Manager of the Bank for International Settlements, the Basle-based organization of the world's leading central banks, noted that while the East Asian countries had run a combined current account deficit of $33 billion in 1996, as speculative hot money flowed in, "1998-1999, the current account swung to a surplus of $87 billion." By 2002 it had reached the impressive sum of $200 billion. Most of that surplus returned to the US in the form of Asian central bank purchases of US Treasury debt, in effect financing Washington policies, pushing US interest rates way down and fuelling an emerging New Economy, the NASDAQ dot.com New Economy IT boom. [12]
During the extremes of the 1997-1998 Asia financial crises, Greenspan refused to act to ease the financial pressures until Asia had collapsed and Russia had defaulted in August 1998 on its sovereign debt and deflation had spread from region to region. Then, as he and the New York Fed stepped in to rescue the huge LTCM hedge fund that had become insolvent as a result of the Russia crisis, Greenspan made an unusually sharp cut in Fed Funds interest rates for the first time, by 0.50%. That was followed a few weeks later by a 0.25% cut. That gave the nascent dot.com NASDAQ IT bubble a nice little "shot of whiskey."
By late 1998, amid successive cuts in Fed interest rates and pumping in of ample liquidity, the US stock markets, led by the NASDAQ and NYSE, went asymptotic. In the single year 1999, as the New Economy bubble got into full-swing, a staggering $2.8 trillion increase in the value of equity shares owned by US households was registered. That was more than 25% of annual GDP, all in paper values.
Glass-Steagall restrictions on banks and investment banks promoting the stocks they had brought to market-the exact conflict of interest which prompted Glass-Steagall in 1933-those restraints were gone. Wall Street stock promoters were earning tens of millions in bonuses for fraudulently hyping Internet and other stocks such as WorldCom and Enron. It was the "Roaring 1920's" all over again, but with an electronic computerized turbo charged kicker.
The incredible March 2000 speech
In March 2000, at the very peak of the dot.com stock mania, Alan Greenspan delivered an address to a Boston College Conference on the New Economy in which he repeated his by-then standard mantra in praise of the IT revolution and the impact on financial markets. In this speech he went even beyond previous praises of the IT stock bubble and its putative "wealth effect" on household spending which he claimed had kept the US economy growing robustly.
"In the last few years it has become increasingly clear that this business cycle differs in a very profound way from the many other cycles that have characterized post-World War II America," Greenspan noted. "Not only has the expansion achieved record length, but it has done so with economic growth far stronger than expected."
He went on, waxing almost poetic:
"My remarks today will focus both on what is evidently the source of this spectacular performance--the revolution in information technology When historians look back at the latter half of the 1990s a decade or two hence, I suspect that they will conclude we are now living through a pivotal period in American economic history Those innovations, exemplified most recently by the multiplying uses of the Internet, have brought on a flood of startup firms, many of which claim to offer the chance to revolutionize and dominate large shares of the nation's production and distribution system. And participants in capital markets, not comfortable dealing with discontinuous shifts in economic structure, are groping for the appropriate valuations of these companies. The exceptional stock price volatility of these newer firms and, in the view of some, their outsized valuations indicate the difficulty of divining the particular technologies and business models that will prevail in the decades ahead."
Then the Maestro got to his real theme, the ability to spread risk by technology and the Internet, a harbinger of his thinking about the then infant securitization phenomenon:
The impact of information technology has been keenly felt in the financial sector of the economy. Perhaps the most significant innovation has been the development of financial instruments that enable risk to be reallocated to the parties most willing and able to bear that risk. Many of the new financial products that have been created, with financial derivatives being the most notable, contribute economic value by unbundling risks and shifting them in a highly calibrated manner. Although these instruments cannot reduce the risk inherent in real assets, they can redistribute it in a way that induces more investment in real assets and, hence, engenders higher productivity and standards of living. Information technology has made possible the creation, valuation, and exchange of these complex financial products on a global basis
Historical evidence suggests that perhaps three to four cents out of every additional dollar of stock market wealth eventually is reflected in increased consumer purchases. The sharp rise in the amount of consumer outlays relative to disposable incomes in recent years, and the corresponding fall in the saving rate, is a reflection of this so-called wealth effect on household purchases. Moreover, higher stock prices, by lowering the cost of equity capital, have helped to support the boom in capital spending.
Outlays prompted by capital gains in equities and homes in excess of increases in income, as best we can judge, have added about 1 percentage point to annual growth of gross domestic purchases, on average, over the past half-decade. The additional growth in spending of recent years that has accompanied these wealth gains, as well as other supporting influences on the economy, appears to have been met in equal measure by increased net imports and by goods and services produced by the net increase in newly hired workers over and above the normal growth of the workforce, including a substantial net inflow of workers from abroad. [13]
What is perhaps most incredible was the timing of Greenspan's euphoric paean to the benefits of the IT stock mania. He well knew that the impact of the six interest rate increases he had instigated in late 1999 were sooner or later going to chill the buying of stocks on borrowed money.
The dot-com bubble burst one week after the Greenspan speech. On March 10, 2000, the NASDAQ Composite index peaked at 5,048, more than double its value just a year before. On Monday, March 13 the NASDAX fell by an eye-catching 4%.
Then, from March 13, 2000 through to the market bottom, the market lost paper values worth nominally more than $5 trillions, as Greenspan's rate hikes brought a brutal end to a bubble he repeatedly claimed he could not confirm until after the fact. In dollar terms, the 1929 stock crash was peanuts by comparison with Greenspan's dot.com crash. Greenspan had raised interest rates six times by March, a fact which had a brutal chilling effect on the leveraged speculation in dot.com company stocks.
Stocks on margin: Regulation T
Again Greenspan had been present every step of the way to nurture the dot.com stock "irrational exuberance." When it was clear even to most ordinary members of Congress that stock prices were soaring out of control, and that banks and investment funds were borrowing tens of billions of credit to buy more stocks "on margin," a call went out for the Fed to exercise its power over stock margin buying requirements.
By February 2000, margin debt had hit $265.2 billion, up 45 percent in just four months. Much of the increase came from increased borrowing through online brokers and was being channeled into the NASDAQ New Economy stocks.
Under Regulation T, the Fed had the sole authority to set initial margin requirements for the purchase of stocks on credit, which had been at 50% since 1974.
If the stock market were to take a serious fall, margin calls would turn a mild downturn into a crash. Congress believed that this was what happened in 1929, when margin debt equaled 30 percent of the stock market's value. That was why it gave the Fed power to control initial margin requirements in the Securities Act of 1934.
The requirement had been as high as 100 percent, meaning that none of the purchase price could be borrowed. Since 1974, it had been unchanged, at 50 percent, allowing investors to borrow no more than half the purchase price of equities directly from their brokers. By 2000 this margin mechanism acted like gasoline poured on a raging bonfire.
Congressional hearings were held on the issue. Investment managers such Paul McCulley of the world's then-largest bond fund, PIMCO, told Congress, "The Fed should raise that minimum, and raise it now. Mr. Greenspan says "no," of course, because (1) he cannot find evidence of a relationship between changes in margin requirements and changes in the level of the stock market, and (2) because an increase in margin requirements would discriminate against small investors, whose only source of stock market credit is their margin account." [14]
On the margin
But in the face of the obvious 1999-2000 US stock bubble, not only did Greenspan repeatedly refuse to change stock margin requirements, but also in the late 1990s, the Fed chairman actually began to talk in glowing terms about the New Economy, conceding that technology had helped increase productivity. He was consciously fuelling the market's "irrational exuberance."
Between June 1996 and June 2000, the Dow rose 93% and the NASDAQ rose 125%. The overall ratio of stock prices to corporate earnings reached record highs not seen since the days before the 1929 crash.
Then, in 1999, Greenspan initiated a series of interest rate hikes, when inflation was even slower than it was in 1996 and productivity was growing even faster. But by refusing to tie rate rises to a rise in margin requirements, which would clearly have signaled that the Fed was serious about cooling the speculative bubble in stocks, Greenspan impacted the economy with higher rates, evidently designed to increase unemployment and press labor costs lower to further raise corporate earnings, not to cool the stock buying frenzy of the New Economy. Accordingly, the stock market ignored it.
Influential observers, including financier George Soros and Stanley Fischer, deputy director at the International Monetary Fund, advocated that the Fed let the air out of the credit boom by raising margin requirements.
Greenspan refused this more sensible strategy. At his re-confirmation hearing before the US Senate Banking Committee in 1996, he said that he did not want to discriminate against individuals who were not wealthy and therefore needed to borrow in order to play the stock market (sic). As he well knew, the traders buying stocks on margin were mainly not poor and needy but professional traders out for a free lunch, which Greenspan well knew. Interesting, however, was that that was precisely the argument Greenspan would repeat for justifying his advocacy of lending to sub-prime poor credit persons, to let the poorer get in on the home ownership bonanza his policies after 2001 had created. [15]
The stock market began to tumble in the first half of 2000, not because labor costs were rising, but because limits of investor credulity were finally reached. The financial press including the Wall Street Journal, which a year before was proclaiming dot.com executives as pioneers of the new economy, were now ridiculing the public for having believed that the stock of companies that would never make a profit could go up forever.
The New Economy, as one Wall Street Journal writer put it, now "looks like an old-fashioned credit bubble." [16] In the second half of that year, American consumers whose debt-to-income ratios were at record highs, began to pull back. Christmas sales flopped, and by early January 2001 Greenspan reversed himself and lowered interest rates. In twelve successive rate cuts, the Greenspan Fed brought US Fed funds rates, rates that determined short-term and other interest rates in the economy, from 6% down to a post-war low of 1% by June 2003.
Greenspan held Fed rates to those historic lows, lows not seen for that length of time since the Great Depression, until June 30, 2004, when he began the first of what were to be fourteen successive rate increases before he left office in 2006. He took Fed funds rates from the low of 1% up to 4.5% in nineteen months. In the process, he killed the bubble that was laying the real estate golden egg.
In speech after speech the Fed chairman made clear that his ultra-easy money regime after January 2001 had as prime focus the encouragement of investing in home mortgage debt. The sub-prime phenomenon-something only possible in the era of asset securitization and Glass-Steagall repeal, combined with unregulated OTC derivatives trades-was the predictable result of deliberate Greenspan policy. The close scrutiny of the historical record makes that abundantly clear.
- [1] Woodward, Bob, Maestro: Alan Greenspan's Fed and the American Economic Boom, Nov 2000. Woodward's book is an example of the charmed treatment Greenspan was accorded by the major media. Woodward's boss at the Washington Post, Catharine Meyer Graham, daughter of the legendary Wall Street investment banker Andre Meyer, was an intimate Greenspan friend. The book can be seen as a calculated part of the Greenspan myth-creation by the influential circles of the financial establishment.
- [2] Lewis vs United States, 680 F.2d 1239 (9th Cir. 1982).
- [3] Zarlenga, Stephen, Observations from the Trading Floor During the 1987 Crash, in http://www.monetary.org/1987%20crash.html.
- [4] Greenspan, Alan, Testimony before the Subcommittee on Financial Institutions Supervision, US House of Representatives, Nov. 18, 1987. http://fraser.stlouisfed.org/historicaldocs/ag/download/27759/Greenspan_19871118.pdf.
- [5] Hershey jr., Robert D., Greenspan Backs New Bank Roles, The New York Times, October 6, 1987.
- [6] Hershey, op.cit.
- [7] Ibid.
- [8] Greenspan, Alan, Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking and Financial Services, U.S. House of Representatives, February 11, 1999, in Federal Reserve bulletin, April 1999.
- [9] Anderson, Jenny, Goldman Runs Risks, Reaps Rewards, The New York Times, June 10, 2007.
- [10] Kuttner, Robert, Testimony of Robert Kuttner Before the Committee on Financial Services, Rep. Barney Frank, Chairman, U.S. House of Representatives, Washington, D.C., October 2, 2007
- [11] Kostigen, Thomas, Regulation game: Would Glass-Steagall save the day from credit woes?, Dow Jones MarketWatch, Sept. 7, 2007, in http://www.marketwatch.com/news/story/would-glass-steagall-save-day-credit.
- [12] Engdahl, F. William, Hunting Asian Tigers: Washington and the 1997-98 Asia Shock, reprinted in http://www.jahrbuch2000.studien-von-zeitfragen.net/Weltfinanz/Hedge_Funds/hedge_funds.html.
- [13] Greenspan, Alan, The revolution in information technologyBefore the Boston College Conference on the New Economy, Boston, Massachusetts, March 6, 2000.
- [14] McCulley, Paul, A Call For Fed Action: Hike Margin Requirements!, testimony before The House Subcommittee on Domestic and International Monetary Policy on March 21, 2000.
- [15] Alan Greenspan as Fed chairman repeatedly asserted it was impossible to judge if a speculative bubble existed during the rise of such a bubble. In August 2002, after his clear strategy of Fed rate rises was obvious to market players, he reiterated this: "We at the Federal Reserve considered a number of issues related to asset bubbles--that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact--that is, when its bursting confirmed its existence.---Alan Greenspan Remarks by Chairman Alan Greenspan Economic volatility At a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming August 30, 2002.
- [16] Faux, Jeff, The Politically Talented Mr. Greenspan, Dissent Magazine, Spring 2001.
© 2008 F. William Engdahl
Editorial ArchiveF. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, www.globalresearch.ca. The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
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The Federal Reserve's recent surprise decision to lower its short-term interest rate target by three-quarters of a point has received much attention. Most commentary has focused on the idea that the Fed is trying to stimulate spending in the hope of preventing a recession. Over-looked, and equally important, is the fact that lower interest rates raise asset prices, which is something Wall Street desperately needs to prevent a systemic meltdown.
The Federal Reserve is right to play the interest rate card aggressively since the economy-wide costs of a financial meltdown are so large. But let's not fool ourselves about Wall Street and free markets. The Fed is using its government granted power of fixing interest rates to bailout Wall Street. That is welfare, Federal Reserve-style.
Normally, economists focus on the effect of interest rates on business investment and consumer spending. The thinking is that lower rates cause increased spending, albeit with long and variable lags and the net impact is also highly uncertain and contingent on the state of confidence.
However, another feature of lower interest rates is that they increase the price of fixed income assets. Thus, when interest rates go down, bond prices go up, and that is critical for understanding recent Federal Reserve policy moves.
The U.S. financial system is currently deeply stressed. Growing perceptions of heightened default risk on mortgages and consumer debts have caused large price declines for securities backed by these assets. That in turn has caused massive losses at banks and insurance companies, eroding their capital. This erosion has placed many firms in danger of regulatory insolvency, unable to meet capital requirements. Some are in deeper danger of bankruptcy with the value of liabilities exceeding assets.
The problem is acutely visible among bond insurers, where rising default rates have reduced asset values while simultaneously increasing potential payouts on insured securities. If the bond insurers are downgraded, this could trigger a cascade of losses that could fracture the system. This is because insured bonds would fall in value, thereby wiping out further capital.
This possibility means maintaining asset prices, and preventing further mark-to-market losses is critical. The Fed's problem is that as quickly as it has been lowering the federal funds rate, default rates on mortgage and consumer debts have been rising. Consequently, rising credit risk has offset the effect of a lower federal funds rate, so that asset prices have remained weak.
Moreover, there are pitfalls in the low interest rate policy. On one hand lower rates increase bond prices and also reduce defaults on adjustable rate mortgages. On the other hand, lower interest rates could trigger a wave of mortgage re-financing by those good risks still capable of re-financing. That would cause pre-payment losses to holders of existing mortgage backed securities, while also concentrating the proportion of remaining bad risks. The net effect is prices of mortgage-backed securities could fall further.
The fact that Wall Street needs this helping hand has important public policy implications. The existing system of regulation by capital requirements helps discipline risk-taking, but it has proven inadequate. The problem is individual firms do not take account of the impact of their risk-taking on others, so that the system takes on too much risk. This problem can only be solved by a system-wide regulator who monitors and limits total risk-taking. Yet, that is exactly what the Federal Reserve has rejected during the last twenty-five years of de-regulation.
Remedying this failing calls for deep regulatory reform that is nothing less than paradigm change. This is something the Fed will resist and Congress will have to push. But until deep regulatory reform is enacted, the "welfare for Wall Street" problem will persist.
Copyright Thomas I. Palley
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groups.msn.com
The ABS Rating Game
Never ones to despair when confronted by new obstacles, clever minds at J.P. Morgan, Morgan Stanley, Goldman Sachs, Citigroup, Merrill Lynch, Bear Stearns and a myriad of others in the game of securitizing the exploding volumes of home mortgages after 2002, turned to the Big Three rating agencies to get their prized AAA. This was necessary because, unlike issuance of a traditional corporate bond, say by GE or Ford, where a known, physical bricks 'n mortar blue-chip company with a long-term credit history stood behind the bond, with Asset Backed Securities no corporation stood behind an ABS. Just a lot of promises on mortgage contracts across America.
The ABS or bond was, if you will, a "stand alone" artificial creation, whose legality under US law has been called into question. That meant a rating by a credit rating agency was essential to make the bond credible, or at least give it the "appearance of credibility," as we now realize from the unraveling of the present securitization debacle.
At the very heart of the new financial architecture that was facilitated by the Greenspan Fed and successive US Administrations over the past two decades and more, was a semi-monopoly held by three de facto unregulated private companies who operated to provide credit ratings for all securitized assets, of course for very nice fees.
Three rating agencies dominated the global business of credit ratings, the largest in the world being Moody's Investors Service. In the boom years of securitization, Moody's regularly reported well over a 50% profit on gross rating revenues. The other two in the global rating cartel were Standard & Poor's and Fitch Ratings. All three were American companies intimately tied into the financial sinews of Wall Street and US finance. The fact that the world's rating business was a de facto US monopoly was no accident. It was planned that way, as a main pillar of the financial domination of New York. The control of the credit rating world was for the US global power projection almost tantamount to US domination in nuclear weapons as a power factor.
Former Secretary of Labor, economist Robert Reich, identified a core issue of the raters, their built-in conflict of interest. Reich noted, "Credit-rating agencies are paid by the same institutions that package and sell the securities the agencies are rating. If an investment bank doesn't like the rating, it doesn't have to pay for it. And even if it likes the rating, it pays only after the security is sold. Get it? It's as if movie studios hired film critics to review their movies, and paid them only if the reviews were positive enough to get lots of people to see the movie."Reich went on, "Until the collapse, the result was great for credit-rating agencies. Profits at Moody's more than doubled between 2002 and 2006. And it was a great ride for the issuers of mortgage-backed securities. Demand soared because the high ratings had expanded the market. Traders didn't examine anything except the ratings a multibillion-dollar game of musical chairs. And then the music stopped."
That put three global rating agencies-Moody's, S&P, and Fitch-directly under the investigative spotlight. They were de facto the only ones in the business of rating the collateralized securities-Collateralized Mortgage Obligations, Collateralized Debt Obligations, Student Loan-backed Securities, Lottery Winning-backed Securities and a myriad of others-for Wall Street and other banks.
According to an industry publication, Inside Mortgage Finance, some 25% of the $900 billion in sub-prime mortgages issued over the past two years were given top AAA marks by the rating agencies. That comes to more than $220 billion of sub-prime mortgage securities carrying the highest AAA rating by either Moody's, Fitch or Standard & Poors. That is now coming unwound as home mortgage defaults snowball across the land.
Here the scene got ugly. Their model assumptions on which they gave their desired AAA seal of approval was a proprietary secret. "Trust us "
According to an economist working within the US rating business, who had access to the actual model assumptions used by Moody's, S&P and Fitch to determine whether a mortgage pool with sub-prime mortgages got a AAA or not, they used historical default rates from a period of the lowest interest rates since the Great Depression, in other words a period with abnormally low default rates, to declare by extrapolation that the sub-prime paper was and would be into the distant future of AAA quality.
The risk of default on even a sub-prime mortgage, so went the argument, "was historically almost infinitesimal." That AAA rating from Moody's in turn allowed the Wall Street investment houses to sell the CMOs to pension funds, or just about anybody seeking "yield enhancement" but with no risk. That was the theory.
As Oliver von Schweinitz pointed out in a very timely book, Rating Agencies: Their Business, Regulation and Liability, "Securitizations without ratings are unthinkable." And because of the special nature of asset backed securitizations of mortgage loans, von Schweinitz points out, those ABS, "although being standardized, are one-time events, whereas other issuances (corporate bonds, government bonds) generally affect repeat players. Repeat players have less incentive to cheat than 'one time issuers.'"
Put the other way, there is more incentive to cheat, to commit fraud with asset backed securities than with traditional bond issuance, a lot more.
Moody's, S&P's unique status
The top three rating agencies under US law enjoy an almost unique status. They are recognized by the Government's Securities and Exchange Commission (SEC) as Nationally Recognized Statistical Rating Organizations (NRSROs). There exist only four in the USA today. The fourth, a far smaller Canadian rater, is Dominion Bond Rating Service Ltd. Essentially, the top three hold a quasi monopoly on the credit rating business, and that, worldwide.
The only US law regulating rating agencies, the Credit Agency Reform Act of 2006 is a toothless law, passed in the wake of the Enron collapse. Four days before the collapse of Enron, the rating agencies gave Enron an "investment grade" rating, and a shocked public called for some scrutiny of the raters. The effect of the Credit Agency Reform Act of 2006 was null on the de facto rating monopoly of S&P, Moody's and Fitch.
The European Union, also reacting to Enron and to the similar fraud of the Italian company Parmalat, called for an investigation of whether the US rating agencies rating Parmalat has conflicts of interest, how transparent their methodologies were (not at all) and the lack of competition.
After several years of "study" and presumably a lot of behind-the-scenes from big EU banks involved in the securitization game, the EU Commission announced in 2006 it would only "continue scrutiny" (sic) of the rating agencies. Moody's and S&P and Fitch dominate EU ratings as well. There are no competitors.
It's a free country, ain't it?
The raters under US law were not liable for their ratings despite the fact that investors worldwide depend often exclusively on the AAA or other rating by Moody's or S&P as validation of creditworthiness, most especially in securitized assets. The Credit Agency Reform Act of 2006 in no way dealt with liability of the rating agencies. It was in this regard a worthless paper. It was the only law dealing with the raters at all.
As von Schweinitz pointed out, "Rule 10b-5 of the Securities and Exchange Act of 1934 is probably the most important basis for suing on the grounds of capital market fraud." That rule stated "It shall be unlawful for any person to make any untrue statement of a material fact." That sounded like something concrete. But then the Supreme Court affirmed in a 2005 ruling, Dura Pharmaceuticals, ratings are not "statements of a material fact" as required under Rule 10b-5. The ratings given by Moody's or S&P or Fitch are rather, "merely an opinion." They are thereby protected as "privileged free speech," under the US Constitution's First Amendment.
Moody's or S&P could say any damn thing about Enron or Parmalat or sub-prime securities it wanted to. It's a free country ain't it? Doesn't everyone have a right to their opinion?
US courts have ruled in ruling after ruling that financial markets are "efficient" and hence, markets will detect any fraud in a company or security and price it accordingly eventually. No need to worry about the raters then
That was the "self-regulation" that Alan Greenspan apparently had in mind when he repeatedly intervened to oppose any regulation of the emerging asset securitization revolution.
The securitization revolution was all underwritten by a kind of "hear no evil, see no evil" US government policy that said, what is "good for the Money Trust is good for the nation." It was a perverse twist on the already perverse saying from the 1950's of then General Motors chief, Charles E. Wilson, "what's good for General Motors is good for America."
Monoline insurance: Viagra for securitization?
For those CMO sub-prime securities that fell short of AAA quality,there was also another crucial fix needed. The minds on Wall Street came up with an ingenious solution.
The issuer of the Mortgage Backed Security could take out what was known as Monoline insurance. Monoline insurance for guaranteeing against default in asset backed securities was another spin-off of the Greenspan securitization revolution.
Although monoline insurance had begun back in the early 1970's as a guarantee for municipal bonds, it was the Greenspan securitization revolution which gave it its leap into prominence.
As their industry association stated, "The monoline structure ensures that our full attention is given to adding value to our capital market customers." Add value they definitely did. As of December 2007, it was reliably estimated that the monoline insurers, who call themselves "financial guarantors," eleven poorly capitalized, loosely regulated monoline insurers, all based in New York and regulated by that state's insurance regulator, had given their insurance guarantee to enable the AAA rated securitization of over $2.4 trillion worth of Asset Backed Securities. (emphasis mine-f.w.e.).
Monoline insurance became a very essential element in the fraud-ridden Wall Street scam known as securitization. By paying a certain fee, a specialized (hence the term monoline) insurance company would insure or guarantee a pool of sub-prime mortgages in event of an economic downturn or recession in which the poor sub-prime homeowner could not service his monthly mortgage payments.
To quote from the official website of the monoline trade association, "The Association of Financial Guaranty Insurers, AFGI, is the trade association of the insurers and re-insurers of municipal bonds and asset-backed securities. A bond or other security insured by an AFGI member has the unconditional and irrevocable guarantee that interest and principal will be paid on time and in full in the event of a default." Now they regret ever having promised that as sub-prime mortgage resets, growing recession and mortgage defaults are presenting hyperbolic insurance demands on the tiny, poorly capitalized monolines.
The main monoline insurers were hardly household names: ACA Financial Guaranty Corp., Ambac Assurance, Assured Guaranty Corp. BluePoint Re Limited, CIFG, Financial Guaranty Insurance Company, Financial Security Assurance, MBIA Insurance Corporation, PMI Guaranty Co., Radian Asset Assurance Inc., RAM Reinsurance Company and XL Capital Assurance.
A cautious reader might ask the question, "Who insures these eleven monoline insurers who have guaranteed billions indeed trillions in payment flows over the past five or so years of the ABS financial revolution?"
No one, yet, was the short answer. They state, "Eight AFGI member firms carry a Triple-A claims paying ability rating and two member firms carry a Double-A claims paying ability rating." Moody's, Standard & Poors and Fitch gave the AAA or AA ratings.
By having a guarantee from a bond insurer with an AAA credit rating, the cost of borrowing was less than it would normally be and the number of investors willing to buy such bonds was greater.
For the monolines, guaranteeing such bonds seemed risk-free, with average default rates running at a fraction of 1 per cent in 2003-2006. As a result, monolines leveraged their assets to build their books, and it was not being uncommon for a monoline to have insured risks 100 to 150 times the size of its capital base. Until recently, Ambac had capital of $5.7 billion against guarantees of $550 billion.
In 1998, the NY State Insurance Superintendent's office, the only regulator of monolines, agreed to allow monolines to sell credit-default swaps (CDSs) on asset-backed securities such as mortgage backed securities. Separate shell companies would be established, through which CDSs could be issued to banks for mortgage backed securities.
The move into insuring securitized bonds was spectacularly lucrative for the monolines. MBIA's premiums rose from $235m in 1998 to $998m in 2007. Year on year premiums last year increased 140%. Then along came the US sub-prime mortgage crisis, and the music stopped dead for the monolines, dead.
As the mortgages within bonds from the banks defaulted - sub-prime mortgages written in 2006 were already defaulting at a rate of 20 per cent by January 2008-the monolines were forced to step in and cover the payments.
On February 3, MBIA revealed $3.5 billion in writedowns and other charges in three months alone, leading to a quarterly loss of $2.3 billion. That was likely just the tip of a very cold iceberg. Insurance analyst Donald Light remarked, "The answer is no one knows," when asked what the potential downside loss was. "I don't think we will know to perhaps the third or fourth quarter of 2008."
Credit ratings agencies have begun downgrading the monolines, taking away their prized AAA ratings, which means a monoline could no longer write new business, and the bonds it guarantees no longer would hold a AAA rating.
To date, the only monoline to receive downgrades from two agencies - usually required for such a move to impact on a company - is FGIC, cut by both Fitch and S&P. Ambac, the second largest monoline, has been cut to AA by Fitch, with the other monolines on a variety of different potential warnings.
The rating agencies did "computer simulated stress tests" to decide if the monolines could "pay claims at a default level comparable to that of the Great Depression." How much could the monoline insurers handle in a real crisis? They claimed, "Our claims-paying resources available to back members' guarantees totals more than $34 billion."
That $34 billion was a drop in what will rapidly over the course of 2008 appear to be a bottomless bucket. It was estimated that in the Asset Backed Securities market roughly one-third of all transactions were "wrapped" or insured by AAA monolines. Investors demanded surety wraps for volatile collateral or that without a long performance history.
According to the Securities Industry and Financial Markets Association, a US trade group, at the end of 2006 there was a total of some $3.6 trillion worth of Asset Backed Securities in the United States, including of home mortgages, prime and sub-prime, of home equity loans, credit cards, student loans, car loans, equipment leasing and the like. Fortunately not all $3.6 trillion of securitizations are likely to default, and not all at once. But the AGFI monoline insurers had insured $2.4 trillion of that mountain of asset backed securities over the past several years. Private analysts estimated by early February 2008 that the potential insurer payout risks, under optimistic assumptions, could exceed $200 billions. A taxpayer bailout of that scale in an election year would be an interesting voter sell.
Off the books
The entire securitization revolution allowed banks to move assets off their books into unregulated opaque vehicles. They sold the mortgages at a discount to underwriters such as Merrill Lynch, Bear Stearns, Citigroup, and similar financial securitizers. They then in turn sold the mortgage collateral to their own separate Special Investment Vehicle or SIV as they were known. The attraction of a stand-alone SIV was that they and their potential losses were theoretically at least, isolated from the main underwriting bank. Should things ever, God forbid, run amok with the various Asset Backed Securities held by the SIV, only the SIV would suffer, not Citigroup or Merrill Lynch.
The dubious revenue streams from sub-prime mortgages and similar low quality loans, once bundled into the new Collateralized Mortgage Obligations or similar securities, then often got an injection of Monoline insurance, a kind of financial Viagra for junk quality mortgages such as the NINA (No Income, No Assets) or "Liars' Loans," or so-called stated-income loans, that were commonplace during the colossal Greenspan Real Estate economy up until July 2007.
According to the Mortgage Brokers' Association for Responsible Lending, a consumer protection group, by 2006 Liars' Loans were a staggering 62% of all USA mortgage originations. In one independent sampling audit of stated-income mortgage loans in Virginia in 2006, the auditors found, based on IRS records that almost 60% of the stated-income loans were exaggerated by more than 50%. Those stated-income chickens are now coming home to roost or far worse. The default rates on those Liars' Loans, which is now sweeping across the entire US real estate market, makes the waste problems of Tyson Foods factory chicken farms look like a wonderland.
None of that would have been possible without securitization, without the full backing of the Greenspan Fed, without the repeal of Glass-Steagall, without monoline insurance, without the collusion of the major rating agencies, and the selling on of that risk by the mortgage-originating banks to underwriters who bundled them, rated and insured them as all AAA.
In fact the Greenspan New Finance revolution literally opened the floodgates to fraud on every level from home mortgage brokers to lending agencies to Wall Street and London securitization banks to the credit rating agencies. Leaving oversight of the new securitized assets, hundreds of billions of dollars worth of them, to private "self-regulation" between issuing banks like Bear Stearns, Merrill Lynch or Citigroup and their rating agencies, was tantamount to pouring water on a drowning man. In Part V we discuss the consequences of the grand design in New Finance.
F. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, www.globalresearch.ca.
The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
F. William Engdahl is a leading analyst of the New World Order, author of the best-selling book on oil and geopolitics, A Century of War: Anglo-American Politics and the New World Order,' His writings have been translated into more than a dozen languages.
Reviews of Engdahl's Seeds of Destruction
What is so frightening about Engdahl's vision of the world is that it is so real. Although our civilization has been built on humanistic ideals, in this new age of "free markets", everything-- science, commerce, agriculture and even seeds-- have become weapons in the hands of a few global corporation barons and their political fellow travelers. To achieve world domination, they no longer rely on bayonet-wielding soldiers. All they need is to control food production. (Dr. Arpad Pusztai, biochemist, formerly of the Rowett Research Institute Institute, Scotland)
If you want to learn about the socio-political agenda --why biotech corporations insist on spreading GMO seeds around the World-- you should read this carefully researched book. You will learn how these corporations want to achieve control over all mankind, and why we must resist... (Marijan Jost, Professor of Genetics, Krizevci, Croatia)
The book reads like a murder mystery of an incredible dimension, in which four giant Anglo-American agribusiness conglomerates have no hesitation to use GMO to gain control over our very means of subsistence... (Anton Moser, Professor of Biotechnology, Graz, Austria).
The CRG grants permission to cross-post original Global Research articles on community internet sites as long as the text & title are not modified. The source and the author's copyright must be displayed. For publication of Global Research articles in print or other forms including commercial internet sites, contact: [email protected]
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Feb 09, 2008 | New York Times Blog
You know, if it wasn't for the bit about lying us into war, lying about just about everything else, fearmongering for political gain, making America synonymous with torture, busting the budget to cut taxes for the rich, and so on, I'd almost feel sorry for George W. Bush.
You see, it's gradually becoming clear that the second half of the 1990s was in many respects just a lucky period for the U.S. economy - and that our luck has now run out.
Import prices were falling in the 90s, partly because of a surplus of oil, partly because third-world exporters were flooding the world with cheap goods, partly because the dollar was strong. Here's the ratio of the BLS measure of import prices to non-energy, non-food consumer prices:
Cheap imports no moreAnd productivity growth was high, probably because of the big early payoff to the internet and other forms of networking:
Productivity boom, goneI remember describing it at the time as "1979 upside down": the bad things that happened in the late 70s, with soaring oil prices and lagging productivity, were running in reverse. Now it seems to be all over.
Bill Clinton got some credit for all this - but the big, undeserved beneficiary was Alan Greenspan, who looked like a genius when he was mostly just in the right place at the right time.
Now Ben Bernanke is having to try and clean up the mess Greenspan made - and do it in a much less favorable environment
Comments
- It's good to see that you are beginning to recognize that the credit formerly given to Greenspan was a result of fallacious post-hoc-ergo-prompter-hoc reasoning.
But apparently you think that the error was related to personality, rather than policy. You should stop and consider whether monetary policy has also been the beneficiary of this type of reasoning.
Greenspan was not solely responsible either for the housing bubble or the credit crisis, although he did nothing to help. Most economists missed the housing bubble, and essentially all missed the makings of the credit crisis. A person who is willing to buck the conventional wisdom to the extent that would have been necessary to foresee and forestall these problems would have been very unlikely to be appointed to the Fed chairmanship, or even to reach the eminence that is required for such an appointment.
- Posted by skeptonomist
- It is nice to finally see more and more people understanding, or at least becoming more aware, that Greenspan put us in this mess. I just saw a book about it while skimming through Borders earlier today. I even sat through several lectures at the NY Fed explaining how Greenspan was reckless with his 1% interest rates for so long. Will Greenspan ever take responsibility? Do you think he even realizes what he did?
http://justenjoytheshow.blogspot.com/
- Posted by Meds
- I'd suggest part of the productivity growth spike was a result of NAFTA, and free trade in general, reducing the number of factory employees. Once domestic industrial employment had reached a new equilibrium, and the remaining workers had been "crammed down" on wages and benefits, productivity growth began to revert to trend. The internet was part of the spike in productivity growth, not so much in terms of American workers being empowered to do more, but in terms of the ability to use VoIP to empty out the back offices and send most of the jobs elsewhere. That's nice for shareholders and consumers but not so good for the employees who have been cast off or gave away benefits and pay to keep their jobs.
To take an example, Apple computer used to have several domestic factories and call centers. Now those spots are gone. The company still has a good sized staff in the US, but compared to what it was before it really it is all head and no body.
Of course the hollowing out of the American economy is catching up with us now. After years of keeping up appearances via debt it appears we might be forced to live within our diminished means. One wonders what will happen to corporate profits when there are no more consumers to consume.
- Posted by Donald H
- Krugman misses a key point about Greenspanthat he realized that productivity was increasing so much in the 90's that he did not have to raise interest rates and choke off the expansion. Greenspan did this by looking at the data (really looking at the data, such things as freight car utilization and such).
It is true he did flood the economy in the early part of this decade and that lead directly to the current bubble. I think he did it for idealogical reasonsW was trying to increase economic stratification in our society through his tax policies and this appealed to the Ayn Rand acolyte, so W needed to be reelected by any means necessary.
- Posted by km
- It is too simple to say that Allan Greenspan has made a mess of it. Deregulation and Privatization have been the bane of ordinary citizens in this country for sometime now. He wasn't alone in his elitist notions that resulted in the American public slowly and steadily losing necessary reliable protections that should be afforded in a civilized society.
These days, a person cannot even use the banking system if he does not first agree to arbitration in lieu of the constitutional right to sue when damaged and, not too long ago, many current interest rates would be called loan sharking.
Greenspan has been part and parcel of the extremist view that we can trust economic entities to regulate themselves. The result of all of this has been all manner of financial meltdowns, scandals, losses of homes and pensions. In the end, it is the taxpayer that must clean up the mess, not a Ben Bernanke.
Deregulation and Privatization are not legitimate economic or philosophical concepts. They are concepts born of greed, and certainly, there is no economic or philosophical justification for all of those foxes that are currently in charge of our regulatory chicken coops.
Allan Greenspan has said, "The rich do not hurt anyone." Of course they do; where in the world does he believe that the money comes for the corruption of almost every segment of American life, particularly our political life?
- Posted by Lewis Walsh
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February 8, 2008 | guardian.co.uk
The US economy relies upon asset price inflation and rising indebtedness to fuel growth - and this contradiction has global implications
A second big American interest-rate cut in a fortnight, alongside an economic stimulus plan that united Republicans and Democrats, demonstrates that US policymakers are keen to head off a recession that looks like the consequence of rising mortgage defaults and falling home prices. But there is a deeper problem that has been overlooked: the US economy relies upon asset price inflation and rising indebtedness to fuel growth.
Therein lies a profound contradiction. On one hand, policy must fuel asset bubbles to keep the economy growing. On the other hand, such bubbles inevitably create financial crises when they eventually implode.
This is a contradiction with global implications. Many countries have relied for growth on US consumer spending and investments in outsourcing to supply those consumers. If America's bubble economy is now tapped out, global growth will slow sharply. It is not clear that other countries have the will or capacity to develop alternative engines of growth.
America's economic contradictions are part of a new business cycle that has emerged since 1980. The business cycles of presidents Ronald Reagan, George Bush Sr, Bill Clinton, and George Bush share strong similarities and are different from pre-1980 cycles. The similarities are large trade deficits, manufacturing job loss, asset price inflation, rising debt-to-income ratios, and detachment of wages from productivity growth.
The new cycle rests on financial booms and cheap imports. Financial booms provide collateral that supports debt-financed spending. Borrowing is also supported by an easing of credit standards and new financial products that increase leverage and widen the range of assets that can be borrowed against. Cheap imports ameliorate the effects of wage stagnation.
This structure contrasts with the pre-1980 business cycle, which rested on wage growth tied to productivity growth and full employment. Wage growth, rather than borrowing and financial booms, fuelled demand growth. That encouraged investment spending, which in turn drove productivity gains and output growth.
The differences between the new and old cycle are starkly revealed in attitudes toward the trade deficit. Previously, trade deficits were viewed as a serious problem, being a leakage of demand that undermined employment and output. Since 1980, trade deficits have been dismissed as the outcome of free-market choices. Moreover, the Federal Reserve has viewed trade deficits as a helpful brake on inflation, while politicians now view them as a way to buy off consumers afflicted by wage stagnation.
The new business cycle also embeds a monetary policy that replaces concern with real wages with a focus on asset prices. Whereas pre-1980 monetary policy tacitly aimed at putting a floor under labour markets to preserve employment and wages, it now tacitly puts a floor under asset prices. This is not a matter of the Fed bailing out investors. Rather, the economy has become so vulnerable to declines in asset prices that the Fed is obliged to intervene to prevent them from inflicting broad damage.
All these features have been present in the current economic expansion. Wages have stagnated despite strong productivity growth, while the trade deficit has set new records. Manufacturing has lost 1.8m jobs. Prior to 1980, manufacturing employment increased during every expansion and always exceeded the previous peak level. Between 1980 and 2000, manufacturing employment continued to grow in expansions, but each time it failed to recover the previous peak. This time, manufacturing employment has actually fallen during the expansion, something unprecedented in American history.
The essential role of asset inflation has been especially visible as a result of the housing bubble, which also highlights the role of monetary policy. Despite the massive tax cuts of 2001 and the increase in military and security spending, the US experienced a prolonged jobless recovery. That compelled the Fed to keep interest rates at historic lows for an extended period, and rates were raised only gradually because of fears about the recovery's fragility.
Low interest rates eventually jump-started the expansion through a house price bubble that supported a debt-financed consumer-spending binge and triggered a construction boom. Meanwhile, prolonged low interest rates contributed to a "chase for yield" in the financial sector that resulted in disregard of credit risk.
In this way, the Fed contributed to creating the sub-prime crisis. However, in the Fed's defence, low interest rates were needed to maintain the expansion. In effect, the new cycle locks the Fed into an unstable stance whereby it must prevent asset price declines to avert recession, yet must also promote asset bubbles to sustain expansions.
So, even if the Fed and US treasury now manage to stave off recession, what will fuel future growth? With debt burdens elevated and housing prices significantly above levels warranted by their historical relation to income, the business cycle of the last two decades appears exhausted.
It is not enough to deal only with the crisis of the day. Policy must also chart a stable long-term course, which implies the need to reconsider the paradigm of the past 25 years. That means ending trade deficits that drain spending and jobs, and restoring the link between wages and productivity. That way, wage income, not debt and asset price inflation, can again provide the engine of demand growth.
In cooperation with Project Syndicate, 2008.
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MSN Money
The truth is that the majority of Greenspan's decisions as Fed chairman from Aug. 11, 1987, to Jan. 31, 2006, were not beneficial to you, nor did they leave the country better off, despite Greenspan's glowing self-critique in his latest book, "The Age of Turbulence."
In reality, the overwhelming majority of people in the United States will be worse off in the years ahead as a result of his stewardship.
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MSN Money
The former Federal Reserve chairman denies he encouraged adjustable-rate mortgages. Here's what he said; you decide.
Having just written a book on Alan Greenspan, I assumed I wouldn't have much more to say on the subject for quite some time. But a week and a half ago, the former Federal Reserve chief made a claim so outrageous I felt it needed to be discussed.
On a recent trip to Canada, I happened to read a story in The Globe and Mail, "Greenspan on the defensive," about a question-and-answer session he'd just done with Sherry Cooper, the chief economist at BMO Nesbitt Burns, before a Vancouver business audience.
Weapons of mass denial
Reporter Wendy Stueck described the chairman's version of a now infamous speech as follows: "Mr. Greenspan also denied being a booster for risky mortgage products, saying that while he noted advantages in some new mortgage products in an oft-referenced 2004 speech, he spoke in favor of conventional mortgages in an address a week later that has been ignored."Being quite familiar with that 2004 speech -- in which the chairman had been rather emphatic -- I was shocked to read this claim. I decided to investigate, first by seeing what exactly Greenspan had said in the Q&A with Cooper.
Here is an excerpt of The Globe and Mail's raw Q&A transcript as captured by a court reporter; no audio recording was allowed. Though a bit rough, I have left the transcript in its original form, except for the removal of some nearly incomprehensible phrases in order to make it more readable.
MR. GREENSPAN: In 2004 I went before a Credit Union . . . and I discussed the pros and cons of various types of consumer finance, and I pointed out that . . . fixed rate 30-year mortgages cost a significant amount over the adjustable rate mortgages to buy the insurance against the rise of interest rates. And I said that there are occasions in which that would be a very good thing, and indeed I made a presentation which said that over the past 10 years it would have been very sensible to have taken them (ARMs) out and then at the end of it said of course if interest rates had gone up, it would have been something else.
MS. COOPER: That part was left out.
MR. GREENSPAN: . . . Seven days later, I appeared before the Economic Club of New York before 1,000 people and I get asked the question: (What) were you really saying. . . . In fact, I am more than willing and have been more than willing to pay the premium for a fixed rate mortgage and indeed the mortgages that I've taken out have always been fixed rate. What I was commenting on and I said wasn't described properly in my earlier remarks was that there are certain occasions when it pays to take the adjustable rate mortgage. If, for example, you are a corporate executive who is going to be in certain cities for two years, it probably makes no sense whatever to take a fixed rate mortgage. Probably be far better to take an adjustable rate mortgage, to take the risk. So I strongly clarified my remarks saying that it's true one of the great inventions was the 30-year fixed rate mortgage in the United States.
That never got picked up.
Indeed the issue stayed that way until very recently when all of a sudden the original one comes up . . . not the one a week later. So I plead not guilty.
Not guilty? Greenspan wants us to believe that he didn't really advocate taking out ARMs and that he was so concerned about being misinterpreted that he clarified the issue when he gave a speech one week later in New York. However, that speech was about the trade deficit, and there is no record of the Q&A he describes.
A lame defense, Mr. Chairman
Greenspan gave 22 speeches in 2004. If he had truly been worried about people misconstruing what he was saying, he could easily have given a speech to clarify the issue. He did not.Here's what he originally said in that Feb. 23, 2004, speech. The emphasis is mine; boldface highlights his endorsement of adjustable-rate mortgages, or ARMs, and the italics illuminate his "defense":
"One way homeowners attempt to manage their payment risk is to use fixed-rate mortgages, which typically allow homeowners to prepay their debt when interest rates fall but do not involve an increase in payments when interest rates rise. Homeowners pay a lot of money for the right to refinance and for the insurance against increasing mortgage payments.
"Calculations by market analysts of the 'option adjusted spread' on mortgages suggest that the cost of these benefits conferred by fixed-rate mortgages can range from 0.5% to 1.2%, raising homeowners' annual after-tax mortgage payments by several thousand dollars. Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.
Bill Fleckenstein's new book is now available. Click here to buy it.
"American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance."American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
Not guilty? You decide.
Published Feb. 4, 2008
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Feb 7, 2008 | forestpolicy.typepad.com
Dean Baker recommends that the media and the American people need to hold the Fed accountable as part of US Government, rather than allowing it to act as a mostly-owned subsidiary of Wall Street banks. Sounds reasonable to me. Here's Baker:
Profit motive, Dean Baker, Feb. 5: Much of the policy elite hold the view that the Federal Reserve's conduct of monetary policy is best carried through in the dark, far way from political debate. This is a profoundly anti-democratic attitude, since the Fed's monetary policy is likely to have far more impact on the economy than anything the politicians spend their time screaming about as the elections roll around.And we all know that the Fed has done an absolutely atrocious job in managing the economy in the last decade. First, Alan Greenspan adopted the view that financial bubbles are cute and decided to let the stock bubble expand until it had created nearly $10 trillion in wealth. Its collapse gave us the 2001 recession. While Greenspan was confident that he could easily deal with the fallout from a stock bubble recession, the fact is that we did not regain the lost jobs until the very end of 2004.
Furthermore, Greenspan relied on the growth of another bubble, in housing, to escape the damage from the stock bubble. This bubble is now bursting, giving us yet another recession, which promises to be much longer and deeper than the last one. This track record suggests that the Fed is in need of some very real oversight.
Unfortunately, the media still treat the Fed as being above the political realm. They never question whether its policies are designed to serve the economy or special interests, such as the major Wall Street banks.
If the media did apply serious scrutiny to the Fed's conduct of monetary policy, they might well be asking about the motives for the most recent round of rate reductions. There can be little doubt that the economy is in serious trouble and badly in need of stimulus, but it is not clear that the recent rate cuts will provide a boost to growth.
There is one route through which lower interest rates will boost the economy. They should help push down the value of the dollar. This will help to boost exports and reduce our trade deficit, although the cost will be somewhat higher inflation, which is undoubtedly one of the factors explaining the jump in long-term interest rates.
It may be that Fed chairman Ben Bernanke is consciously pursuing a lower dollar as the best way to stimulate the economy, but it would be useful if he explained this policy. An explicit commitment to a low-dollar policy is likely to help bring about the goal of a lower dollar, since the statement will affect investors expectations.
It would also be helpful if Bernanke would explain his policy because there is an obvious alternative, less benign, explanation. When banks borrow money they pay the short-term rate. They mostly lend money at the long-term rate. Fed actions that increase the spread between long-term and short-term rates directly increase bank profits. Those with a suspicious mindset might think that the Fed is more interested in beefing up the profits of banks that are rolling in bad debt than in boosting the economy.
Along these lines, the special "term auction facility" that the Fed created to allow banks to borrow money in secret also raises serious questions. The Fed claims to have established this mechanism because it was worried that financial markets attach a stigma to borrowing from the Fed. Whether or not the financial markets are right to attach a stigma, the TAC creates a group of insiders that know about bank borrowing and a group of outsiders who remain clueless.
The country did not get into the current crisis because of too much transparency. There seems little reason to depart from the Fed's longstanding practice of publicly disclosing bank borrowings from the Fed.
It is impossible to know the motivations of Bernanke and the other Fed governors, but there are certainly grounds for suspicion that they may hold the interests of the major Wall Street banks above the interests of the general public. The Fed is an arm of the government, and it is long past time that its conduct of monetary policy received the full scrutiny of the media and Congress.
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Economic Dreams - Economic Nightmares
Dean Baker recommends that the media and the American people need to hold the Fed accountable as part of US Government, rather than allowing it to act as a mostly-owned subsidiary of Wall Street banks. Sounds reasonable to me. Here's Baker:
Profit motive, Dean Baker, Feb. 5: Much of the policy elite hold the view that the Federal Reserve's conduct of monetary policy is best carried through in the dark, far way from political debate. This is a profoundly anti-democratic attitude, since the Fed's monetary policy is likely to have far more impact on the economy than anything the politicians spend their time screaming about as the elections roll around.And we all know that the Fed has done an absolutely atrocious job in managing the economy in the last decade. First, Alan Greenspan adopted the view that financial bubbles are cute and decided to let the stock bubble expand until it had created nearly $10 trillion in wealth. Its collapse gave us the 2001 recession. While Greenspan was confident that he could easily deal with the fallout from a stock bubble recession, the fact is that we did not regain the lost jobs until the very end of 2004.
Furthermore, Greenspan relied on the growth of another bubble, in housing, to escape the damage from the stock bubble. This bubble is now bursting, giving us yet another recession, which promises to be much longer and deeper than the last one. This track record suggests that the Fed is in need of some very real oversight.
Unfortunately, the media still treat the Fed as being above the political realm. They never question whether its policies are designed to serve the economy or special interests, such as the major Wall Street banks.
If the media did apply serious scrutiny to the Fed's conduct of monetary policy, they might well be asking about the motives for the most recent round of rate reductions. There can be little doubt that the economy is in serious trouble and badly in need of stimulus, but it is not clear that the recent rate cuts will provide a boost to growth.
There is one route through which lower interest rates will boost the economy. They should help push down the value of the dollar. This will help to boost exports and reduce our trade deficit, although the cost will be somewhat higher inflation, which is undoubtedly one of the factors explaining the jump in long-term interest rates.
It may be that Fed chairman Ben Bernanke is consciously pursuing a lower dollar as the best way to stimulate the economy, but it would be useful if he explained this policy. An explicit commitment to a low-dollar policy is likely to help bring about the goal of a lower dollar, since the statement will affect investors expectations.
It would also be helpful if Bernanke would explain his policy because there is an obvious alternative, less benign, explanation. When banks borrow money they pay the short-term rate. They mostly lend money at the long-term rate. Fed actions that increase the spread between long-term and short-term rates directly increase bank profits. Those with a suspicious mindset might think that the Fed is more interested in beefing up the profits of banks that are rolling in bad debt than in boosting the economy.
Along these lines, the special "term auction facility" that the Fed created to allow banks to borrow money in secret also raises serious questions. The Fed claims to have established this mechanism because it was worried that financial markets attach a stigma to borrowing from the Fed. Whether or not the financial markets are right to attach a stigma, the TAC creates a group of insiders that know about bank borrowing and a group of outsiders who remain clueless.
The country did not get into the current crisis because of too much transparency. There seems little reason to depart from the Fed's longstanding practice of publicly disclosing bank borrowings from the Fed.
It is impossible to know the motivations of Bernanke and the other Fed governors, but there are certainly grounds for suspicion that they may hold the interests of the major Wall Street banks above the interests of the general public. The Fed is an arm of the government, and it is long past time that its conduct of monetary policy received the full scrutiny of the media and Congress.
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Jan 28, 2008 | businessweek.com
How Real Was the Prosperity?
We're just beginning to figure out how much of the nation's recent growth was the result of a credit-induced frenzy. Here are some guideposts
Mark it down. Clear the slate. Get it all behind us. That's what the big banks are trying to do now. With their massive write-offs, Citigroup (C), Merrill Lynch (MER), and the other big financial institutions hope to take all of their pain at once. In toto, Wall Street firms have taken roughly $100 billion in losses on their investments. Yet investors around the world are still remarkably skittish. On Jan. 21 they sent markets in Asia and Europe plunging. The decline was halted-perhaps temporarily-by the Federal Reserve's 0.75 percentage point surprise cut in rates the next morning, and the promise of more to come. It's possible the combination of Fed rate cuts and quick fiscal stimulus from Washington could keep the U.S. economy out of recession. The Fed originally was created to deal with just this kind of financial crisis, and it's capable of pumping enormous amounts of money into the financial system if needed. "I have a basic faith in the Fed," says Christina D. Romer, an economist at the University of California at Berkeley. "We don't make the kind of mistakes that we used to."
But the underlying problems that ail the markets and the economy cannot be waved away by the Fed's magic wand. In truth, we're at the beginning of a long, arduous process of figuring out how much of the post-tech bubble prosperity was real and how much was the result of a credit-induced frenzy. The answer will determine what we can expect.
Way Beyond Housing
The housing markets, of course, overshot as too many buyers took out subprime mortgages they couldn't afford. The outcome will be a decline in home values, with prices in some areas already down.
But the economic writedown is likely to go far beyond housing. Household spending, consumer debt, financial sector profits: All may need a retrenchment, sudden or gradual, to get back to sustainable levels. That's bad news for investors and the global economy, which still depends heavily on U.S. consumption for growth.
There may even be a reassessment of whether recent productivity gains were fueled by excess credit. If growth in productivity slows, the economy will stagnate, real wages will weaken, corporate earnings targets will be harder to meet, and inflationary risks will increase.
Key Areas
There's no way to tell yet how much of the gains of recent years will have to be written down-how much we will have to reduce our expectations for the future. For now, here are some key areas to watch.
Personal Spending. The rule for a prudent individual is simple: Don't spend more than you make. For a long time, the U.S. economy obeyed that rule. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product. Sometimes consumers would get ahead of the economy for a few years, and sometimes fall behind, but never for very long.
That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GDP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.
Where did we spend the money? On housing and health care, of course. But outsize gains also came in clothing, furniture, recreation equipment, motor vehicles, and consumer electronics-all areas where prices have fallen and imports have surged.
The question now is how much of that extra $3 trillion we will have to give back. Will real consumer spending in the U.S. lag the broader economy for several years? If so, the impact is likely to be felt on imports
Consumer Lending. The past 10 years will go down as one of the greatest consumer-lending sprees ever. Adjusted for inflation, consumer debt-including mortgages-rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. The last time debt rose so fast was the 1960s, as the postwar generation bought homes and autos. If Americans had kept borrowing at their pre-1997 pace, they would have had about $3 trillion less in debt.
The extra debt also represents a formidable obstacle for banks and other financial institutions that might want to lend more to consumers. "Going forward, we're not going to see this credit-driven growth," says Alistair Milne, a professor and banking expert at City University in London. "Banks are saying, 'we have to be more careful here.'"
Corporate Earnings. Yes, there's been a profit boom in recent years. Corporate earnings, as measured by government statisticians, have averaged 8% of GDP over the past decade, up from a low of 6.5% in the early '90s. That has helped propel stocks upward.
But here's an unfortunate truth-the profit surge has been mainly in one area, financial services. Financial institutions have benefited from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates. By contrast, the earnings of nonfinancial companies over the past decade have averaged about 5.3% of GDP, about the same since the mid-1980s. There are few signs of any acceleration, even after years of restructuring.
The question now is how much of the gain in financial profits is sustainable and how much will simply evaporate once the credit binge is over. The problem: No one knows yet how badly the banks will be hit.
Productivity. Now we come to the trickiest area. The clearest sign of U.S. economic health has been growth in productivity, or output per hour worked. The faster productivity rises, the faster the economy grows without inflation, and the higher living standards go. Over the past 10 years, productivity, as measured by the Bureau of Labor Statistics, has grown at a 2.6% annual pace. That's up from a 1.6% annual rate over the previous decade. This extra point of productivity growth means the annual output of the U.S. economy is about $1 trillion higher than it would have been otherwise. Yet despite the higher output, U.S. consumers have taken on an extra $3 trillion in debt. This is a bit like someone who gets a raise, then goes and spends the money-and more-on a new car.
Some of those apparent productivity gains also may be illusory. If the economy was artificially boosted by excess borrowing, that would show up as higher output and, presumably, higher productivity. The implication is that once borrowing recedes to the historical average, actual underlying productivity growth might be lower than we thought.
The outcome won't become clear for a while. But if productivity growth is slower, then the economy's "speed limit"-the maximum growth rate that doesn't push up inflation-would be lower. Presumably, a slower-growing, less productive U.S. would become less attractive to foreign investors
The Stock Market and Global Growth. Investors probably have already taken into account the possibility of a mild U.S. recession. But the reason why the stock market hasn't fallen further-besides the Fed rate cuts-is the belief that the global economy will continue to grow, eventually helping multinational companies such as General Electric (GE).
But no one knows whether a U.S. consumer slowdown will undermine the world economy. It's unclear if Americans are more likely to cut back on imported LCD TVs or Starbucks (SBUX) coffee. The other question is the extent to which a consumer slump in the U.S. will affect business investment overseas. Factories are springing up in China and elsewhere to feed American demand. What if that demand falls?
These are sobering questions to consider. One consolation: The American economy can produce pleasant as well as nasty surprises. Many foresaw the tech bubble of the 1990s bursting; few predicted the housing boom that followed. Maybe a new force will emerge to propel the economy forward and keep spending robust. Right now, that's what everyone wants to know.
Mandel is chief economist for BusinessWeek .
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Jan 28, 2008 | Safe Haven
The Greenspan legacy, however, is for the Federal Reserve Bank to intervene in the markets strategically during times of financial crisis. He first did so early in his career back in 1987 when the Fed added heavy doses of liquidity to arrest the stock market crash. Then there was the expansion of money supply in the weeks leading up to the end of the 20th century when the so-called Y2K computer bug was expected to disrupt financial systems. Lastly, in response to the 2001 recession Greenspan lowered overnight rates to a 1958 low of 1% resulting in record mortgage refinancings that minimized the impact of the 2001-2002 recession. Intervention, rather than being a brief rescue effort, seems to have become a permanent policy.
Another wave of stimulus came from the 2001 and 2003 "Bush tax cuts." There are two ways in which tax cuts can stimulate growth--in the near term by generating extra demand, and in the long run by encouraging increased supply, labor or capital. Add to this the 108th and 109th Congress gone-amuck earmark spending as well as the increased military budget to finance two wars (as of the end of 2007 the Iraq war is estimated to have cost $600bn), and the combination of monetary and fiscal stimulus in the first half of this decade had set the stage for a tidal wave of liquidity.
The overhang of fear resulting from the 2001-2002 bear market also contributed to the current environment as money gravitated from the stock market into "safe assets" such as government and agency bonds. This in turn drove down interest rates on the long end of the yield curve which further lowered borrowing costs. Helpfully, lower rates functioned to help corporations get their balance sheets in order as well as support real estate prices from declining through the 2001-2002 recession.
Ultimately, however, lower interest rates led to a boom in home buying which caused real estate prices to double and triple in some locations. One result was owners taking advantage of their increased home values in the form of mortgage equity loans. The impact was not insignificant on the economy. According to Calculated Risk, GDP as reported for the last six years appreciably improved as a direct result of home equity withdrawals, a trend that first began in 2001 but which came to a halt in 2007.
Not surprisingly a feedback loop developed. Because of the very fact that home valuations were inflated, the use of exotic mortgage products such as ARMs, I/Os, etc. increased from very limited usage in 2001 to approximately 50 percent of the mortgages used to finance homes in California. What should be noted is that the process of incurring debt collateralized by an inflated asset is similar to margining a securities brokerage account as stock prices go up. The benefit is additional liquidity and leverage when asset values increase, but the downside comes when asset prices decrease.
The seriousness of the fallout is now not lost on the public with many of the exotic mortgage products resetting their interest rate after an initial low-rate discount period. Essentially mortgage payment resets are acting like "margin calls" and the "payment shock" is causing a wave of foreclosures. Foreclosures are depressing home prices, which in turn aggravates the problem. Such resets are expected to continue through 2012. The question is whether a moral hazard is created by the government intervening.
Earlier this year, the Center for Responsible Lending published a report which suggested that 2.2 million American households could lose their homes, and as much as $164 billion due to foreclosures. To put this report into historical perspective, at the peak of the credit boom in the 1930s home mortgage loans were offered without the usual documentation, a practice that in the last few years had again become popular through so-called "stated income," "low-doc" or "no-doc" loans. Stated income loans, which were originally conceived to improve access to prime credit for self-employed people with irregular income, had spread like a virus through the lending industry. Unfortunately, it is a virtual invitation to fraud.
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January 22, 2008 | Globe and Mail
As global markets melt like a slab of butter on a hot frying pan, it's about time to figure out who cranked up the stove.
Where's Alan Greenspan, anyway?
Apparently, he anticipated our unwanted scrutiny.
The former U.S. Federal Reserve Board chief has taken great pains to shift blame for the mortgage crisis away from himself and the Fed's low-interest jet fuel of the 2001-04 period.
The maestro's take: A post-Cold War economic boom in the developing world produced a dangerous underpricing of risk on a global scale that no one - not even the Fed - could control.
Don't look at me, Mr. Greenspan argues. Blame China or India.
"The crisis was ... an accident waiting to happen," Mr. Greenspan wrote in a lengthy op-ed piece in the Wall Street Journal in mid-December. "If it had not been triggered by the mispricing of securitized subprime mortgages, it would have been produced by eruptions in some other market."
In other words, the Fed didn't push interest rates lower, the global economy did. China and other countries flooded the West with cheap products, kept wages low in developed countries and pushed down inflation expectations everywhere. Central banks lost control of long-term rates.
And lower interest rates sent asset prices - for stocks and real estate - sharply higher.
"There was clearly little the world's central banks could do to temper this most recent surge in human euphoria," Mr. Greenspan rationalized.
The explanation - like most of what Mr. Greenspan has to say - is thought-provoking. But perhaps just a tad too convenient.
Even if you accept Mr. Greenspan's argument that the Fed wasn't the source of all the easy money, it's tough for him to hide from the reality that he was a cheerleader for a mortgage industry gone wild.
He, along with George W. Bush, was an outspoken advocate for dramatically increased home ownership. And millions of Americans bought homes for the first time during the Greenspan years, fuelling a massive building boom. Many of those homes are now in foreclosure, housing starts have collapsed and prices are falling in most markets.
In a remarkable February, 2004, speech to a gathering of credit union executives, Mr. Greenspan lavished praise on now toxic adjustable-rate mortgage products. The apparent message to home buyers: They'd be crazy not to take the easy money.
Many of those 2004 mortgages, which started with low teaser rates, are now swamping naive homeowners as they reset to unaffordable higher levels.
So who was responsible for the low rates that made these mortgages possible? Even Mr. Greenspan acknowledges that the Fed's record 1-per-cent benchmark interest rate in mid-2003 boosted these exotic mortgages and raised home prices.
Mr. Greenspan conveniently ignores the Fed's other role - as a banking regulator. When the economic history is written, the conclusion may be that the Fed's biggest failing in the Greenspan era is what it didn't do, not what it did.
The Fed, which doesn't directly regulate the mortgage industry, nonetheless turned a blind eye to a host of obvious lending excesses, which caused systemic risk to the banking industry. Fed officials also watched as Wall Street financial alchemists ran amok, inexplicably turning junk mortgages into credit-worthy bonds.
And the Fed stood by as the major banks, brokers and hedge funds embraced this hazardous mortgage market. Indeed, Mr. Greenspan, a libertarian, argued against stricter hedge fund regulation, even after the 1998 collapse of Long Term Capital Management.
There may well have been "mispricing of risk" around the world, as Mr. Greenspan argued. But there was also plenty of evidence of recklessness closer to home, and scant effort to rein it in.
Ben Bernanke, an academic who succeeded Mr. Greenspan in early 2006, is now left to mop up the economic mess. Unlike Mr. Greenspan, the new Fed chief has been reluctant to reward the risk takers with knee-jerk interest rate cuts. He has also urged much stricter lending standards for the mortgage industry.
Mr. Greenspan, meanwhile, earns a tidy living selling his advice to the industry he failed to keep in check while he was a central banker. He makes speeches to financial groups for six-figure fees and sells his consulting services to the likes of bond giant Pimco and Paulson & Co., a New York hedge fund.
The current crisis isn't the making of one man.
But it's fair to say that Mr. Greenspan was a participant in the age of easy money, not just an accidental witness.
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Jan 28, 2008 | The American Prospect
Alan Greenspan is a gold-plated hypocrite. Last week the Federal Reserve Chairman, speaking at a conference in Chicago, warned that the endless federal deficits had become "a significant obstacle to long-term security because the budget deficit is not subject to correction by market forces."
What does Greenspan think caused the deficit - sunspots? He doesn't deign to say. But everyone else knows. While increased military spend ing is part of the story, the huge imbalances that rightly worry the Fed chairman are mainly the predictable result of President Bush's immense tax cuts.
At the time of their enactment, not only did Greenspan fail to warn against the danger; he even gave tax cuts his support. Greenspan's early ideological moorings as a far-right Republican accolyte of Ayn Rand continued to trump his current responsibilities as chief central banker.
It's one thing to deliberately run a deficit during a recession. It's quite another to deliberately blow a huge hole in the government's revenue structure. Greenspan should surely know the difference. But like Bush, Greenspan uses the immense deficits as a rationale to keep cutting social outlays.
The deficits are now projected at $400 billion this year and at comparably destructive levels for the indefinite future. The tax cuts are responsible for more than $3 trillion in long-term revenue losses over 10 years. And Greenspan hasn't even spoken out against the president's campaign to make the cuts permanent.
Just imagine the outcry from Greenspan, Wall Street, and the Republican Party if these deficits had been the result of social spending rather than tax cuts for America's wealthiest. For half of the cost of the projected deficits - $200 billion a year - we could have universal, high-quality child care and health insurance for all Americans. Think of that.
But if some Democratic president had managed to persuade Congress to enact such a program, the right would be going nuts at the fiscal irresponsibility. Clearly the right's fiscal ethics are entirely situational. If deficits are caused by tax cuts for corporations and the rich, well, this is a manageable problem that can be solved by reduced social spending. But if deficits result from spending, Wall Street and the right would have us believe the economy is about to collapse.
Indeed, if the gold medal for hypocrisy goes to Greenspan, Wall Street deficit hawks get the silver medal. Remember the Concord Coalition - that bipartisan group of worthies concerned about federal deficits? It's still there, and a few of its members are actually principled conservatives. You just don't hear as much from it when the deficits are Bush's.
The one recent president, of course, who took deficits seriously was Bill Clinton. Presidents Reagan, Bush I, and Bush II have all been all fiscally reckless. Yet somehow the conservative press would have us believe that it's Democrats who have to live down a reputation of being deficit-happy.
Other notable situational ethicists who get bronze awards for hypocrisy are deficit hawks in the administration. The White House economic policy czar, Steve Friedman, was a prominent investment banker and one of Wall Street's leading critics of fiscal imprudence. Now that he's on the inside, we haven't heard so much as a bleat from him. If he's advising Bush to resist tax cutting for the larger good of the economy, he certainly is having no effect. One wonders how Friedman can look in the mirror.
Likewise Greg Mankiw, the Harvard economist whose best-selling textbook warns that prolonged deficits will raise interest rates and slow economic growth. It is a tradition that eminent economists punch their career tickets by doing a prestigious stint at the Council of Economic Advisers, which Mankiw chairs for Bush. But at what cost?
It would be one thing if Mankiw were a pure technocrat who stayed in the back rooms and crunched numbers. But Mankiw's appointment is a political one, and part of his job is to go out front and vouch for an administration and policies that he knows are deplorable.
What gets lost is the fact that taxing and spending involve political choices. One path involves slightly higher tax rates on America's most privileged in order to pay for decent public services. The other path allows the deserving rich, such as the children of the wealthiest 2 percent of families, to forgo taxation at the expense of needed social outlay. This is the real national choice that is cynically obscured by the running up of endless deficits.
Robert Kuttner is a Prospect co-editor. A version of this article originally appeared in The Boston Globe.
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Bloomberg.com
Hailed as perhaps the greatest central banker who ever lived when he left the Federal Reserve in 2006, Greenspan is under attack from critics ranging from the New York Times to economists at the American Enterprise Institute for his handling of the 2000-2005 housing boom. The former Fed chairman has taken to the media to defend himself, writing in the Wall Street Journal and appearing on network television.
``He's had a bubble reputation that derived from the growth of U.S. household wealth,'' said Edward Chancellor, author of ``Devil Take the Hindmost: A History of Financial Speculation.'' ``As that goes down, his standing as a superstar will suffer.''
At stake is not only Greenspan's legacy but also the future of policies he espoused during 18-1/2 years atop the central bank. Critics blame his aversion to regulation and reluctance to use interest rates to puncture asset bubbles for the boom in mortgage lending and house prices that has since gone bust, threatening to throw the economy into recession.
In an interview, Greenspan said such criticism ignores limits on what regulation and monetary policy can achieve.
Fed Chairman Ben S. Bernanke has already moved away from the laissez-faire approach of his predecessor by proposing new restrictions on subprime mortgages.
High Marks
... ... ...
Some of the earlier enthusiasm for Greenspan's tenure has been tempered by the performance of the economy, particularly the housing market, since he left. Blinder, who wrote in a 2005 paper that Greenspan might be the greatest central banker, now hedges on whether that assessment still stands.
Greenspan still merits a ``summa cum laude'' for his conduct of monetary policy, he said. The 81-year-old former Fed chief falls short of that lofty grade, though, for his oversight of the banking industry, Blinder said.
`Slow on the Draw'
``The Fed and the other regulatory agencies were slow on the draw,'' Blinder said. ``They could have made this debacle substantially smaller, not by better monetary policy, but by better regulatory and supervisory policy.''
Desmond Lachman, a former International Monetary Fund official now at the American Enterprise Institute in Washington, blames Greenspan's libertarian bent for his failure to curb lending abuses: ``That philosophy got us into a lot of trouble.''
Greenspan said in the interview that, while the Fed's bank examiners were hard at work during the mortgage-lending boom, ``we have to be realistic about what regulators can and cannot do.''
``It is extremely rare to uncover fraud other than through whistle-blowers,'' he said. ``You don't get at it through internal audits, you don't get it through outside audits and you certainly don't get it through bank examinations.''
Rates Too Low
Some economists, including Blinder, also fault Greenspan for fostering the housing bubble by keeping interest rates too low for too long. The Fed cut its benchmark rate to a 45-year low of 1 percent in June 2003, held it there for a year, then raised it only gradually, in quarter-percentage-point increments.
``For that episode of monetary policy, I would probably give him a B, where my overall grade is A or A-plus,'' Blinder said.
A simulation by Stanford University professor John Taylor suggested that much of the housing boom could have been avoided if the Fed hadn't cut rates so deeply and had raised them back up more quickly.
Meltzer said that while Greenspan was a ``great Fed chairman,'' he erred in ignoring warnings about the risks of keeping rates low.
``I think he lets himself off much too easy,'' Meltzer said, adding that he told Greenspan at the time that he was exaggerating the danger of deflation and thus making a mistake in cutting interest rates to 1 percent.
Rethinking Approach
Allen Sinai, chief economist at Decision Economics Inc. in New York, said the Fed's experience is leading other central banks to rethink their approach to asset bubbles.
``There is a growing body of thinking in central banking that one should not let these bubbles run and allow them to burst,'' he said. ``They should lean against them.''
Greenspan disagrees with such a strategy. ``There is no evidence that it works other than in computer models,'' the former Fed chief said. He noted that the stock market merely leveled off when the Fed doubled interest rates to 6 percent in 1994-95, then resumed its climb.
Greenspan maintained that the housing bubble was inflated not by the Fed's monetary policy but by a global savings glut that held down long-term interest rates worldwide. As the Fed raised its benchmark rate from 1 percent in 2004 to 4.5 percent in 2006, when Greenspan stepped down, the yield on the Treasury's 10-year note actually fell.
Greenspan also pointed out that the U.S. wasn't alone in experiencing a housing boom in the early 2000s. The IMF said in its World Economic Outlook last October that other nations, including Britain, Spain and Australia, experienced bigger house price run-ups than the U.S.
Cecchetti, professor of international economics at Brandeis' International Business School, said it's natural that Greenspan's legacy is being reassessed.
``With distance, you get perspective,'' he said. ``We'll get a much more balanced view of the Greenspan legacy as the years go by.''
To contact the reporter on this story: Rich Miller in Washington at [email protected]
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nytimes.com
We can debate the impact of low policy interest rates, but a clear failure was the lack of oversight. A number of people saw the problem coming, see Fed Shrugged as Subprime Crisis Spread, but a few people in key positions failed to act, even when it was obvious that there was a systemic problem.
That sounds like Georgetown cocktail party analysis.
the financial system suffered from flawed incentives that encouraged excessive risk-taking.
There have been slips in the public career of Alan Greenspan, but not many. One, however, is immortal. It occurred in late 1974, when he was chairman of the Council of Economic Advisers under US President Gerald Ford, and was bemoaning the ills of inflation. Everyone was hurt by inflation, he told a government meeting, "but if you want to examine percentage-wise who was hurt most. . . it was Wall Street brokers". Well, maybe, in terms of income lost. But you don't win converts to the Republican Party with remarks like that. It was years before Greenspan lived it down.
But the lesson was well taken. Two decades on, Greenspan is at the zenith of his career, reappointed to a third term as chairman of the Federal Reserve, presiding over a robust American economy, the most influential - and among the most admired - of central bankers. He is praised for his judgement and acumen, but not least for the care he takes in what he says. Or rather what he does not say. Obfuscation is a central banker's tool. Greenspan has turned it into an art form.
"If I've made myself too clear, you must have misunderstood me," he once told a business audience. In set-piece appearances on Capitol Hill the man is a sphinx, dispenser of quite indecipherable economic verities. In boom or bust, that lugubrious expression never changes. Sentences about prospects for growth and interest rates ramble on. Clauses slide into clauses, hinting at everything - and their opposite.
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THE FINANCIAL TSUNAMI PART II:
The Financial Foundations of the American Century
by F. William Engdahl
January 16, 2008The ongoing and deepening global financial crisis, nominally triggered in July 2007 by an event involving a small German bank holding securitized assets backed by USA sub-prime real estate mortgages, can best be understood as an essential part of an historical process dating back to the end of the Second World War-the rise and decline of the American Century.
The American Century, proudly proclaimed by Time-Life founder and establishment insider, Henry Luce in a famous 1941 Life magazine editorial, was built on the preeminent role of New York banks and Wall Street investment banks which had by then clearly replaced the City of London as the center of gravity of global finance. Luce's American Century was to be built in a far more calculated manner than the British Empire it replaced.[1]
A then top-secret Council on Foreign Relations postwar planning group, The War & Peace Studies Group, led by Johns Hopkins President and geo-political geographer, Isaiah Bowman, laid out a series of studies designed to lay the foundations of their postwar world, already beginning 1939, well before German tanks had rolled into Poland. The American Empire was to be an empire indeed. But it would not make the fatal mistake of the British or other European empires before, namely to be an empire of open colonial conquest with costly troops in permanent military occupation.
Instead, the American Century would be packaged and sold to the world, above all the emerging countries of Africa, Latin America and Asia, as the guardian of liberty, democracy. It would clothe itself as the foremost advocate of end to colonial rule, a stance which uniquely benefited the only major power without large colonies-namely, the United States.
The new American Century world was to be led by the champion of free trade everywhere, which also uniquely benefited the strongest economy in the early postwar years, the United States. It was a brilliant, if fatally flawed concept. As State Department planning head, George F. Kennan wrote in a confidential internal memo in 1948, "We have about 50% of the world's wealth but only 6.3% of its population Our real task in the coming period is to devise a pattern of relationships which will permit us to maintain this position of disparity without positive detriment to our national security." [2]
The core of the War & Peace Studies, which were designed for and implemented by the US State Department after 1944, was to be the creation of a United Nations organization to replace the British-dominated League of Nations. A central part of that new UN organization, which would serve as the preserver of the US-friendly postwar status quo, was creation of what were originally referred to as the Bretton Woods institutions-the International Monetary Fund and the International Bank for Reconstruction and Development or World Bank.[3] The GATT multinational trade agreements were later added.
The US negotiators in Bretton Woods New Hampshire, led by US Treasury deputy Secretary Harry Dexter White, imposed a design on the IMF and World Bank which insured the two would remain essentially instruments of an "informal" US empire, an empire, initially based on credit, and later, after about 1973, on debt.
New York and the New York Federal Reserve Bank were the heart of the new empire in 1945. The United States held the overwhelming majority of world central bank monetary gold reserves. The postwar Bretton Woods Gold Exchange Standard uniquely benefited the role of the US dollar, then and even now world reserve currency.
All IMF member country currencies were to be fixed in value to the US dollar. In turn, the US dollar, but only the US dollar was fixed to a preset weight of gold at $35 per ounce of gold. At this fixed rate, foreign governments and central banks could exchange dollars for gold.
Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar. It was ingenious and uniquely favorable to the emerging financial power of New York, whose bankers actively shaped the final agreements.
In those days, in stark contrast to the present, the dollar was "as good as gold." The US currency was effectively the world currency, the standard to which every other currency was pegged. As the world's key currency, most international transactions were denominated in dollars.
Maintaining the role of the US dollar as world reserve currency has been the foremost pillar of the American Century since 1945, related to but more strategic even than US military superiority. How that dollar primacy has been maintained to now encompassed the history of countless postwar wars, financial warfare, debt crises, and threats of nuclear war to the present.
Important to place the emergence of the asset securitization revolution in global finance which is now impacting the world financial system in wave after wave of new shocks and dislocations, and to appreciate Alan Greenspan's substantial contribution to preserving the dominance of the dollar as world reserve well beyond the point the US economy ceased being the world's most productive industrial manufacturer, a brief review of the distinct phases in postwar dollar hegemony is useful.
The Golden Years of America's Century
The first phase, which we might call the postwar "golden years," saw the US emerge from the ashes of World War II as the unchallenged global economic Colossus. The US was the dominant world power; no one even came close. Over half of all international money transactions were financed in terms of dollar. The US produced more than half the world output. The US also owned about two thirds of the official gold reserves in the world in 1940.
When various European countries had reserve surpluses, they converted the surpluses into dollar reserves rather than gold because they could earn interest on dollar assets such as US Treasury bonds and dollars could always be converted into gold at $35 per ounce whenever it became necessary. The US dollar was at the center of this system.
American industry, led by General Motors, Ford and Chrysler Motors, the Big Three, were the world class leaders-no one was even close back then. US Steel (before it became USX), machine tool manufacture, aluminum, aircraft and related industries all set the benchmark for global excellence well into the 1950's.
Above all, the American oil giants-Mobil, Standard Oil of New Jersey, Texaco, Gulf Oil-those key companies dominated the unique energy source which was to become essential to unprecedented postwar growth rates in Europe, Japan and the rest of the postwar world-petroleum.[4]
In this early postwar period demand for dollars in the world to finance reconstruction was so great that the primary economic problem faced in the 1950's in Europe, Japan, South Korea and elsewhere was dollar shortages to finance imports of needed US capital equipment, its oil, its consumer products.
The US monetary gold stocks reached a record $24.6 billion in 1949, a huge sum that was comparable today to $211 billion, as gold from abroad poured into the US to pay the deficits in trade run up by foreign nations. New York, backed by gold reserves, was the unchallenged world banker.
This process began to deteriorate after a steep postwar recession in 1957-58. That recession should have been the alarm bell to US economic policy planners and industry that the unique period of profiting from the relative economic dislocation of a war-torn world was at its outer limits. Beginning 1957 the US economy was in need of a substantial regeneration, were it to remain globally competitive. That was not to happen.
By the time of the November 1967 British Sterling crisis, where the British Government was forced to violate IMF rules and devalue Sterling by 14% to maintain their economy amid severe recession, the focus turned on the fact that President Lyndon Johnson's Great Society and disastrous Vietnam War costs were causing the US government to run record budget deficits. The dollar was vulnerable to a run on US gold for the first time since the 1930's.
To hide the extent of those deficits, the Johnson Administration introduced creative accounting. For the first time the Budget director added the funds paid by working Americans into the Federal Social Security Trust Fund, a surplus that was to have been set aside to pay future retirement and related benefits for most Americans, to the Consolidated General Budget-a start to budget fakery which by the early years of the next century were to become huge.
Johnson also began manipulation of key government economic statistics used to compute everything from unemployment to inflation to GDP. The statistical manipulations, for reasons of obvious if fateful political opportunism, were endorsed silently by every succeeding Administration, the most egregious of them being the present Bush-Cheney Administration. [5]
The 1971 dollar coup
Despite all the manipulations, by 1971 US monetary gold reserves had reached a precarious low as foreign trade surplus nations, led by France, had demanded payment in hard gold from the US Federal Reserve for their dollar surpluses. Reality could not so easily be manipulated as government statistics. Europe had emerged, along with Japan, as powerful trade surplus, modern, fast-growing economies.
The United States was becoming a vast rustbelt of decaying, obsolescent manufacture. The spin-doctors of Wall Street and select think-tanks such as the Ford and Rockefeller foundations came up with a linguistic euphemism calling it the "post industrial society," but linguistics did not change the reality. By the late 1960's America's once-booming industrial centers from Detroit to Pittsburgh to Chicago had become sprawling slums of decay, crime and rising unemployment.
Were the United States to lose its last gold reserves, the role of the dollar as unique world reserve currency-the pillar, along with US military superiority, of its postwar American Century imperium-would end abruptly.
To avert such a calamity, in August 1971 President Nixon huddled with his closest advisers, among them a US Treasury official named Paul Volcker, then Under-Secretary of the Treasury for International Monetary Affairs, and a long-time associate of David Rockefeller and the Rockefeller family.
Their task was to come up with a solution. Volcker's "solution" to the massive demand to redeem US dollars for gold was to be as simple as it was to prove destructive to world economic health.
Nixon announced to a startled world on August 15, 1971 that from that day, the United States would not longer honor its international treaty obligations under the Bretton Woods Agreement. Nixon had suspended convertibility of the dollar into gold. The New York Fed's Gold Discount Window was locked shut. World currencies went into a free float against an uncertain dollar, a so-called fiat currency. The dollar now was not backed by gold or even silver but only the "full faith and credit" of the US government, a commodity whose marketable value was beginning to be questioned.
Debt becomes the vehicle
Soon, with the implicit threat of withdrawing its nuclear shield as its prime persuasion, successive US Administrations realized that rather than depending on its role as the world's creditor as it had until 1971, the American Century could theoretically thrive as the world's greatest debtor, so long as American finance and the dollar dominated world finance.
As long as major US postwar satrapies [6] such as Japan, South Korea or Germany, were forced to depend on the US security umbrella, it was relatively simple to pressure their Treasuries into using their US dollar trade surpluses to buy US government debt. In the process, the US bond or debt markets became far and away the world's largest. Wall Street primary bond dealers were replacing Pittsburg steel and Detroit car manufacture as the "business of America."
To paraphrase the famous quip of former GM president Charles Wilson from the 1950's, the new mantra was, "What's good for Wall Street is good for America." It wasn't. The name financial "industry" even became commonplace, as if to designate money as the legitimate successor to production of real physical wealth in the economy.
Debt-dollar debt-was to be the vehicle for a new role of New York banks, led by David Rockefeller's Chase Manhattan and Walter Wriston's Citibank. Their idea was to extend hundreds of billions of dollars in newly acquired OPEC and other petrodollars, which they "persuaded" Saudi and other OPEC governments to bank their new oil surpluses in London or New York banks. Then those dollar deposits from OPEC, called by Henry Kissinger and others at the time, "petrodollars" went in the form of recycled loans to oil importing and dollar-starved Third World economies. [7]
The Carter dollar confidence crisis
This second phase, the post-gold era, fuelled by the manipulated 1973 oil shock and US pressure on Saudi Arabia and OPEC to price oil exclusively in dollars, Kissinger's "petro-dollar recycling,"[8] rolled along without major trouble until early 1979 when the dollar faced a major foreign sell-off during the end of the Jimmy Carter Presidency. The American Century faced one of its greatest challenges at that juncture. German, Japanese even Saudi Arabian central banks began dumping US Treasury holdings in what was called a loss of "confidence" in Carter's world leadership role.
In August 1979, to restore world "confidence" in the dollar, President Jimmy Carter, himself a hand-picked protιgι of David Rockefeller's Trilateral Commission, was forced by the big New York banks, led by David Rockefeller's Chase Manhattan, to accept Paul Volcker, a protιgι of Rockefeller's from Chase Manhattan Bank, as new Chairman of the Federal Reserve with an open mandate to do what was necessary to save the dollar as reserve currency.
On taking office, Volcker bluntly announced, "the standard of living for the average American has to decline." He was Rockefeller's hand-picked choice to save the New York financial markets and the dollar at the expense of the nation's welfare.
The Volcker 'shock therapy'
Volcker's shock therapy, begun in October 1979, lasted until August 1982. Interest rates shot through the roof to double digits. The US and world economies were plunged into a monster recession, the worst since World War II. Within a year, the prime rate had shot up to the unheard-of level of 21.5%, compared to an average of 7.6% for the fourteen previous years, a more than threefold rise in weeks. Official US unemployment peaked at 11%, while unofficially when those who simply had given up seeking work were counted, it was far higher.
Source: AngryBearBlogspot.com
The Shock Therapy of Volcker doubled US official unemployment
The Latin American debt crisis, an ominous foretaste of today's USA sub-prime crisis, erupted as a direct result of the Volcker shock. In August 1982 Mexico announced it could no longer pay in dollars the interest rate service on its staggering debt. It, as most of the Third World from Argentina to Brazil, from Nigeria to Congo, from Poland to Yugoslavia, had fallen for the New York banks' debt trap. The trap was in borrowing what amounted to recycled OPEC petrodollars invested in the major New York and London banks, the Eurodollar banks, which lent the dollars to desperate Third World borrowers initially at "floating rates" tied to London LIBOR rates.
When Libor rose some 300% within months as a result of the Volcker shock therapy, those debtor countries were unable to continue. The IMF was brought in and the greatest looting binge in world history, misnamed the Third World Debt Crisis, was on. Volcker's shock policy, predictably, triggered the crisis.
After seven years of relentlessly high interest rates by the Volcker Fed, sold to the gullible public as "squeezing inflation out of the US economy," by 1986 the internal state of the US economy was horrendous. Much of America came to resemble a Third World country, with its growing slums, double-digit unemployment and growing crime and drug addiction problems. A Federal Reserve study showed that 55% of all American families were net debtors. Federal budget deficits were running at then-unheard-of levels of more than $200 billion annually.
In reality, Volcker, a personal protιgι of David Rockefeller from Rockefeller's Chase Manhattan Bank, had been sent to Washington to do one thing-save the dollar from a free fall collapse that threatened the role of the US dollar as global reserve currency.
That dollar reserve currency role was the hidden key to American financial power.
By letting US interest rates go through the roof, foreign investors flooded in to reap the gains by buying US bonds. Bonds were and are the heart of the financial system. Volcker's shock therapy for the economy meant soaring profits for the New York financial community.
Volcker succeeded only too well in his mission.
The dollar rose to all-time highs against the currencies of Germany, Japan, Canada and other countries from 1979 through the end of 1985. The over-valued US dollar made US manufactured exports prohibitively expensive on world markets and led to a dramatic decline in US industrial exports.
Already high interest rates from the Volcker Fed since October 1979 had led to a major decline in domestic construction, the ultimate ruin of the US automobile industry and with it, steel, as American manufacturers moved to outsource production offshore where the cost advantages were greater. Referring to Paul Volcker and his free-market backers inside the Reagan White House, Republican Robert O. Andersen, then chairman of Atlantic Richfield Oil Co. complained, "they've done more to dismantle American industry than any other group in history. And yet they go around saying everything is great. It's like the Wizard of Oz." [9]
By early 1987 the nation's traditional mortgage banks, the Savings & Loan banks, were in a liquidity crisis that was to ultimately cost US Taxpayers hundreds of billions in government bailouts. The Congress' GAO watchdog agency declared that the Federal Savings & Loan Insurance Corporation, the guarantor against S&L bank panic, was insolvent. Yet under pressure from the S&Ls, huge bank losses were allowed to build as insolvent institutions were allowed to remain open and grow, allowing ever increasing losses to accumulate. The ultimate cost of the 1980's S&L debacle came to more than $160 billion. Some calculated real costs to the economy ran as high as $900 billion. Between 1986 and 1991, the number of new homes constructed dropped from 1.8 to 1 million, the lowest rate since World War II.
America's Second Revolution: the eyes on the Prize
Federal Reserve monetary policy has been typically misrepresented as a series of ad hoc pragmatic responses to recurring crises in post-war banking and finance. The reality is that it has faithfully followed a coherent hidden thread of policy that was first laid out in 1973 by the spokesman then for America's most powerful establishment family.
The policy was outlined in a little-noted book titled, ominously enough, "The Second American Revolution." It was written by John D. Rockefeller III, scion of the powerful Standard Oil and Chase Manhattan Bank empire, and, along with his three brothers-David, Nelson and Laurance-architect of the world arrangement after 1945 known as the American Century.
In his book, Rockefeller declared the establishment's determination to roll back concessions grudgingly granted by the wealthy and powerful during the Great Depression. Rockefeller issued the call in 1973, long before Jimmy Carter or Margaret Thatcher came to office to implement it. He called for a "deliberate, consistent, long-term policy to decentralize and privatize many government functions to diffuse power throughout the society." [10] The latter was a witting deception as his intent was not to diffuse power, but just the opposite-to concentrate that economic and banking power into the hands of a tight-knit elite.
Privatization of essential and socially useful government functions that had been established often with great social agitation and political pressure during the difficult crises of the 1930's, was the Rockefeller agenda. In brief, it was the removal of Depression era government regulations on all aspects of economic and social life in America.
Above all, deregulation of Wall Street and financial markets was the goal, along with a radical reduction in the equalizing of wealth, as seen by Rockefeller and friends, inherent in such programs as Social Security. The George W. Bush "tax cuts for the wealthy" were just a continuation of a three decade agenda of the powerful establishment circles.
Hard as it may be to believe, all major US policy from the 1970's through the misnamed sub-prime crisis today, had a connecting continuous thread. Key Fed and Treasury and other US policymakers always held their "eyes on the Prize."
The "Prize" was untold financial gains to be won through a rollback of major concessions to the working blue collar and middle income Americans, concessions granted during the Great Depression by powerful establishment circles led by the Rockefeller and Morgan banking groups, to forestall a more radical revolt.
Social Security was one target for rollback. Financial deregulation and above all repeal of the 1933 Glass-Steagall Act, was another. Here a well-connected Wall Street banker named Alan Greenspan was to play the decisive role on behalf of the financial deregulation agenda in his tenure as Federal Reserve Chairman lasting from 1987 through 2006. Securitization of sub-prime or junk mortgages was to have been his crowning legacy. As it looks at this writing, it certainly will be, though perhaps not as he and others in Wall Street intended. It will more likely be a crown of disgrace.
(Part III will deal with the Greenspan creation of the securitization revolution and its subsequent demise)
- [1] Luce, Henry, The American Century, reprinted in The Ambiguous Legacy, M. J. Hogan, ed. Cambridge, UK: Cambridge University Press, 1999.
- [2] Kennan, George F., 1948, "PPS/23: Review of Current Trends in U.S. Foreign Policy", Foreign Relations of the United States, Volume I.
- [3] New York Council on Foreign Relations, undated, The War & Peace Studies, http://www.cfr.org.
- [4] Engdahl, F. William, A Century of War: Anglo-American Oil Politics and the New World Order, London, Pluto Press, 2004, pp. 88-9.
- [5] For an excellent historical account of the impact of those systematic government statistical manipulations, see John Williams' http://www.shadowstats.com/. John has been tracking the manipulations for well over two decades, the only systematic attempt I know of.
- [6] The term "satrapy" to describe US relations with Japan, Germany and other postwar allies is used by Zbigniew Brzezinski in his book, The Grand Chessboard: American Primacy and its Geostrategic Imperatives, New York, Basic Books, 1997.
- [7] The best treatment of this new role of endless debt creation backed by US military power as the foundation for the US domination, see the excellent personal account in the remarkable work by Michael Hudson, Super Imperialism: The Economic Strategy of American Empire, London, Pluto Press, 2nd Ed.2003, www.michael-hudson.com. p.289 ff.
- [8] See Engdahl, op.cit., pp.130-141 for an unusual account of the role of then-Secretary of State Kissinger in the events leading to the 400% OPEC oil price rise in 1974.
- [9] Anderson, Robert O., cited in Greider, William, Secrets of the Temple: How the Federal Reserve runs the country, Simon & Schuster, New York, 1987, p. 648.
- [10] Rockefeller, John D. III, The Second American Revolution, Harper & Row, New York, 1973
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Jan 05, 2008 | www.kansascity.com
Critics contend that former Federal Reserve chairman Alan Greenspan pursued interest-rate policies that led to a speculative housing bubble while failing to use the Fed's regulatory powers to crack down on abusive mortgage lending practices.
Here are comments made by Greenspan on housing and mortgages:
- February 2004: "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," Greenspan said in a speech praising the benefits of adjustable-rate mortgages.
- October 2004: "While local economies may experience significant price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversity," Greenspan said, playing down the threat of a national housing bubble.
- May 2005: Greenspan said in a speech that he doubted there was a national housing bubble similar to the one in the stock market. But he said there were a "lot of local bubbles" in housing, and he called the pace of housing price increases unsustainable.
- July 2005: "A decline in the national housing price level would need to be substantial to trigger a significant rise in foreclosures, because the vast majority of homeowners have built up substantial equity in their homes despite large mortgage-market-financed withdrawals of home equity in recent years," Greenspan said in testimony to the House Financial Services Committee.
- September 2007: "I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk. But I believe then, as now, that the benefits of broadened home ownership are worth the risk," Greenspan wrote in his recent memoir, The Age of Turbulence: Adventures in the New World.
- December 2007: "Cash is available, and we should use that in large amounts, as is necessary, to solve the problems of the stress of this," Greenspan said in an interview on ABC's "This Week." He suggested the government should boost support to homeowners facing the prospect of losing their residences because their mortgages were resetting at higher interest rates.
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By Larry Silverstein (New Jersey) - See all my reviews
This review is from: Tough Choices: A Memoir (Paperback)Weighing in at a scant 326 pages including an afterword, this book sucked the life out of me. I couldn't bring myself to read a few pages without the urge to fall asleep. In full disclosure, it was assigned reading and could have contained some thought-provoking concepts to reflect upon since my company is about to get absorbed into a much larger company. Unfortunately, the only thought that this book provoked in me was "when is it going to end?".
After several soporific chapters about her childhood and early work experiences, the next portion of the book focuses on Carly's meteoric rise. Her assessment of peers and superiors were neatly grouped into camps of good versus evil much like Star Wars characters, for easy identification, I suppose. (Guess which ones were the ones that aligned themselves with Carly? Collect two points if you said "the good guys!"). Finally, we come to her undeserved and shocking downfall and dismissal from HP (and please note the dripping sarcasm). While she attempts to pass this book off as a way to provide her adoring public with the truth, to me it came off as vanity with a side order of revenge.
She claims to have done some serious soul searching to understand why so many board members and other high ranking executives suddenly and without cause decided to pull the plug - but instead she chooses to offer up evidence of a conspiracy against her. Maybe she simply wasn't all that and a bag of chips?
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May 4, 2008 | New York Times
PART of the New Deal was a new financial deal. The shameful shenanigans leading up to the 1929 stock market crash and the frightening wave of bank failures during the Depression led directly to the creation of the Securities and Exchange Commission and the Federal Deposit Insurance Corporation.
As we emerge from this, the worst financial crisis since the 1930s, a New Financial Deal may follow. If so, what should some of the reforms be?
A warning to laissez-faire-minded readers: The following is mostly about the dreaded "R" word - regulation. But I'm afraid that we need more of that, starting in the mortgage market.
An inordinate share of the dodgiest mortgages granted in recent years originated outside the banking system. They were marketed aggressively, sometimes unscrupulously, by mortgage brokers who were effectively unregulated; we have now lived to regret that arrangement. The need for a federal mortgage regulator - including a suitability standard for mortgage brokers - is painfully obvious.
Next, we should resist calls to scrap the "originate to distribute" model, wherein banks originate mortgages, which are then packaged into mortgage pools and turned into mortgage-backed securities that are sold to investors around the world. This seemingly convoluted model has given the United States the world's broadest, deepest, most liquid mortgage markets. And that, in turn, has meant lower mortgage interest rates and more homeownership. These are gains worth preserving.
But the model needs some nips and tucks. A far less radical, thouAnd while we're on the subject of M.B.S., we must end the regulatory fiction that off-balance-sheet entities like conduits and S.I.V.'s are unrelated to their parent banks. (S.I.V. stands for structured investment vehicle, if you must know, but please don't ask me the difference between it and a conduit.) Since last summer, we have seen one financial giant after another brought to its knees by losses that originated off balance sheet.
What's the solution? Take Shakespeare's advice and kill all the S.I.V.'s? Probably not, though many will die of natural causes. These financial oddities were invented to exploit the regulatory fiction just mentioned. If you buy the premise that assets held off balance sheet pose no risks to their parent companies, then banks should not be forced to hold capital against them. But if you buy that, you may also be interested in a famous bridge connecting Brooklyn to Manhattan. The remedy here is simple: Apply appropriate capital charges to off-balance-sheet assets.
That brings us to leverage. After all, high leverage means owning a lot of assets with only a little capital. This is where something fundamental changed on March 16. Before that day, only banks had access to the Fed's discount window; broker-dealers took large risks without a safety net. But everything changed when the Federal Reserve became the lender of last resort to selected securities dealers. Because securities firms are now under the Fed's protective umbrella, they must start operating as safely and soundly as banks. That means both closer supervision and less leverage.
How much less? You may recall that Bear Stearns ended its life with leverage of around 33 to 1, meaning that just 3 cents of capital stood behind each dollar of assets. That won't do any longer. Leverage of 10 or 12 to 1 is more typical for a bank. We should all take a deep breath here, because sharply reducing the leverage of securities firms, to bring it close to that of banks, will be a major change in the financial landscape. It will, for example, substantially reduce the profitability of investment houses and, therefore, reduce their scale. But that's the price you pay for access to a publicly financed safety net.
Next come ratings agencies, whose recent performance has drawn criticism. The good news is that they are making good-faith efforts at change. They are improving their analytics, and guarding against conflicts of interest by hiring ombudsmen and submitting to independent third-party reviews. We should applaud and encourage all that. The bad news is that they face an acute incentive problem when they get paid by the issuers of the very securities they rate.
What to do? The third-party reviews should help. My Princeton colleague Dilip Abreu suggests paying ratings agencies with some of the securities they rate, which they would then have to hold for a while. Robert Pozen, head of MFS Investment Management, wants independent investors in the conduits to hire the agencies instead. Another idea would have a public body, like the S.E.C., hire the agencies, paying the bills with fees levied on issuers. If you have a better idea, write your legislators.
LAST, but certainly not least, is something that the United States cannot do on its own. Everyone knows we live in a world of giant multinational financial institutions, huge cross-border flows of capital and increasingly globalized markets. Such an environment demands ever closer international cooperation and coordination among the world's major financial regulators. But today's level of international cooperation is wholly inadequate to the need. Perhaps the current worldwide financial crisis will finally persuade the world's financial regulators that lip service is not enough. At least we can hope.
Finally, let's be clear about the purposes of all these New Financial Deal reforms. They would not banish speculative bubbles from the planet. After all, there have been bubbles for as long as there have been speculative markets. But with each bursting bubble, new flaws in the system are exposed. Like a good roofer after a soaking rainstorm, we should patch the leaks we see now, knowing full well that more leaks will spring up in the future.
Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.
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nakedcapitalism.com
There has been a raft of articles about the Federal Reserve's new found interest in the question of asset bubbles, suggesting that the Fed might be ready to shift policy and exhibit more willingness to rein them in. Yesterday, a page one Wall Street Journal story discussed at length research central bank chairman Bernanke has sponsored at Princeton, and noted:
The Fed is giving the activist approach some thought. In a speech scheduled for delivery Thursday night, Fed Governor Frederic Mishkin suggested that while it was inappropriate to use the blunt instrument of interest-rate increases to prick bubbles, if too-easy credit appeared to be fueling a mania, policy makers might craft a regulatory response that could "help reduce the magnitude of the bubble."Doug Noland at Prudent Bear takes issue with the view that the Fed might be changing its approach and gives a close reading of the Mishkin speech:The conclusions from Professor Mishkin's paper differ only subtly from previous doctrine:First, not all asset price bubbles are alike. Asset price bubbles that are associated with credit booms present particular challenges....Second, monetary policy should not try to prick possible asset price bubbles...Instead, monetary policy should react to asset price bubbles by looking to the effects of asset prices on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability Third, because asset price bubbles can arise from market failures that lead to credit booms, regulation can help prevent feedback loops between asset price bubbles and credit provision. Our regulatory framework should be structured to address failures in information or market incentives that contribute to credit-driven bubbles.
Mishkin suggest regulatory remedies might help prevent unhealthy booms, but even the ideas he presents as possible solutions are minimal. Information failures? The research described in the Journal article essentially said that investors get overly excited about a broad scale innovation and start bidding up prices of related investment opportunities beyond realistic levels. Those with more cautious views step aside, unwilling to get killed, until the bulls exhaust themselves. Pray what information failure can you point to in that? The negative information is out there, just as it was during the housing bubble. But it was ignored. Mishkin is pointing to instrument-specific misunderstandings, as with investors buying MBS and CDOs, they really didn't understand. But what information failure was there in the dot-com era? It was clear to all that the vast majority of companies had no realistic prospect of turning a profit, yet ownership of "eyeballs" became the new version of tulip mania.Back to Noland:
I'll posit this evening that the entire issue of "central bankers vs. asset Bubbles" has become little more than A Red Herring. While it is as of yet too early in the unfolding financial and economic crisis for "consensus opinion" to have reached a similar conclusion, in reality contemporary monetary management can already be proclaimed an unmitigated failure. Cloaked in ideology and a flawed conceptual framework, the Greenspan/Bernanke Fed sat idly by as history's greatest Credit inflation and myriad resulting Bubbles irreparably damaged the underlying structure of the U.S. Credit system and real economy (before going global). And while the Fed executes its latest round of post-asset Bubble "mop up," precarious Credit Bubble dynamics are left to run similar roughshod through global financial and economic systems. Better to downplay the asset Bubble issue for now, as we contemplate the nature of what will be a much altered post-Global Credit approach to central banking.Noland is correct to point to the dangers of continued Fed mission creep. Noland again returns to quoting Miskin:From Mishkin:
The ultimate purpose of a central bank should be to promote the public good through policies that foster economic prosperity. Research in monetary economics describes this objective in terms of stabilizing both inflation and economic activity. Indeed, these objectives are exactly what is embodied in the dual mandate that the Congress has given the Federal Reserve.In no way do I believe "the ultimate purpose of a central bank" is to "foster economic prosperity," and I certainly don't expect any such grandiose mandates to survive in the post-Bubble environment. On many levels the notion that central bank policies are instrumental in creating prosperous economic conditions is problematic. For one, it grossly over promises in regard to the long-term benefits derived from government manipulation of interest-rates. Secondly, it virtually guarantees an accommodative policy regime and, inevitably, a strong inflationist bias. Thirdly, such a nebulous objective invites overly discretionary policymaking, along with an activist and experimental approach to monetary management. Fourthly, such an approach ensures that policymaking errors beget greater and compounding errors.From Mishkin:Volcker could carry this off, as possibly could have earlier former non-academic Fed chairmen (ie, not Arthur Burns). But it seems the Fed has been badly, hopelessly captured by the industry, which is the converse of what is desirable. Unless a new President is able to find and slowly restock the Fed with men and women with some good old fashioned probity, the instability and propensity to financial excess will only get worse.After a bubble bursts and the outlook for economic activity deteriorates, policy should become more accommodative. If monetary policy responds immediately to the decline in asset prices, the negative effects from a bursting asset price bubble to economic activity arising from the decline in wealth and increase in the cost of capital to firms and households are likely to be small. More generally, monetary policy should react to asset price bubbles by looking to the effects of such bubbles on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability.This passage, in particular, goes right to the heart of several key failings of current doctrine...The problem with post-asset Bubble "accommodation" is that it specifically accommodates the very Credit infrastructure and related Monetary Processes that financed the preceding boom. It works to validate the present course of financial innovation (think "Wall Street securitizations," "CDOs" and "carry trades"), while emboldening those at the cutting edge of risk-taking (think "leveraged speculating community").....Moreover, a commitment to aggressively cut rates in response to faltering asset Bubbles openly courts leveraged bond market speculation a market dynamic that engenders artificially low market yields and exacerbates liquidity excess during the late-stage of asset bubbles (think bond market "conundrum"). The last thing a central bank should encourage is an entire industry dedicated to placing leveraged bets on the direction of Federal Reserve policy responses...
The overriding flaw in the Greenspan/Bernanke approach has been to openly disregard Credit Bubble dynamics, in particular the increasingly profound role being played by Wall Street-backed finance in fueling Credit, market liquidity and speculative excesses. I believe The Ultimate Objective of a Central Bank is to Foster Monetary Stability in the broadest sense. In this regard, asset Bubbles should be viewed primarily as important indicators of some type of underlying Monetary Disorder. The key analytical focus must be on the underlying Credit and speculative dynamics fueling the asset price distortions to better understand and rectify the source of "disorder" and the earlier, the better.
The most dangerous policy approach is to further incentivize a system that has already demonstrated a proclivity for Credit and speculative excess employment, output and "deflation" concerns notwithstanding....
Greenspan, Bernanke, Mishkin and others repeatedly stress the inability of policymakers to recognize the existence of a Bubble until after it pops. It is my view that the entire notion of asset prices dictating monetary policy is flawed. The focus should instead be on the underlying sources of monetary fuel the Credit growth and financial flows underpinning asset inflation and economic boom....
Central bankers can and should avoid being in the difficult position of having to respond directly to inflating asset markets. Instead, there must be carefully fashioned, communicated and administered "rules of the game". To begin with, it is incumbent upon the Fed to clearly articulate to the public (and their elected officials) the overwhelming benefits of stable Credit and financial conditions. It must be conveyed that Credit and speculative excesses are destabilizing, fostering boom and bust dynamics and structural impairment. The public must come to appreciate that the effects of destabilizing Credit inflation come in many forms, including asset price inflation and Bubbles, Current Account Deficits, currency debasement, traditional consumer price inflation, and various distortions to underlying Financial and Economic Structures.
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Henry Kaufman, former chief economist of Salomon Brothers in its heydey and a Wall Street eminence grise, joins the chorus of critics who said that the Fed's failure to regulate got us into our economic mess.Note that Kaufman is not new to this theme, just more blunt, as a post from June of last year, "Henry Kaufman Takes the Fed to the Woodshed," attests.
From the Financial Times:
Henry Kaufman, the distinguished Wall Street economist, has added his voice to the debate about the Federal Reserve's role in the credit crisis, saying the central bank failed to give enough importance to its role as a regulator.In a video interview with the Financial Times, Mr Kaufman criticised the Fed's monetary policy. He said it allowed too much credit expansion over the past 15 years and that this contributed to the market turmoil.
"Certainly the Federal Reserve should shoulder a substantial part of this responsibility. . . it allowed the expansion of credit in huge magnitudes," Mr Kaufman said.
"Besides its monetary policy approach, [the Fed] really indicated very clearly that it was performing its role as a supervisor . . . in a minute fashion, not in an encompassing fashion. Monetary policy had a high priority, supervision and regulation within the Fed had a smaller priority."
Mr Kaufman, who is on the board at Lehman Brothers, has long advocated tougher regulation of the biggest financial firms, arguing that they need to be made "too good to fail", rather than remain "too large to fail"....
Mr Kaufman said a distinctive feature of the financial crisis was "much greater lapses in official supervision and regulation than in earlier periods".
He said there should be a new federal regulator appointed who would work with the Federal Reserve but who would have responsibility for "intensively" regulating the 30 or 40 biggest financial firms. Failure to do so could lead to a "crisis that's bigger than the one which we have today".
"The supervision of major financial institutions requires deep skills in credit, deep skills in risk analysis techniques and it requires within that organisation, very skilled, trained professional people," Mr Kaufman said. "That is lacking in the supervisory area in the United States."
He added that recent proposals from Hank Paulson, secretary of the US Treasury, to overhaul US regulation "lack focus". "There is going to be some reform of financial supervision and regulation; hopefully it will be along my lines rather than the big compendium of suggestions that came out of the US Treasury", he said.
5 comments:
- Anonymous said...
- Re: Fed's "role as a regulator", that is a joke! They play politics and Greenspan was like a grandfather with soothing verbage like frothy, but never did you see The Fed regulate! You did however, see Greenspan pump the notion of ARMS and subprimes as he backed the housing bubble, with his fellow crooks!
The Fed Had All It Needed to Avoid Crisis
April 14, 2008; Page A13http://online.wsj.com/article/SB120813709440711857.html?mod=googlenews_wsj
Re: The failure of the Fed to exercise even a minimal standard of prudent regulatory responsibility has been attributed to the opposition of former Chairman Alan Greenspan to interfering with the market process. Yet the chairman was only one of seven members of the Board of Governors and did not have the power to override the wishes of the other six, had they voted to take a strong stance against some of the most egregious practices. The only Fed governor who appears to have comprehended the magnitude of the issue was Edward Gramlich who, unfortunately, was suffering from a terminal illness.
- April 14, 2008 2:43 AM
- Jojo said...
- These guys are all part of the same 'ol boy network. How can anyone expect independent thought/action that would impact their relationships and potential future livelihood?
The only thing that might work is some sort of penalty to be assessed if their decisions prove wrong on review. Maybe public stoning?
- April 14, 2008 4:13 AM
- TallIndian said...
- Surely, LEH is an innoncent victim (collateral damage, if a pun be allowed), of the evil Dr. Greenspan.
Wise old men on, such as those on the board of LEH, were speaking up lo these many years about the dangers of leverage and the corruption of the ratings agencies.
Wise old men, such as thsoe on the board of LEH, strenoulsy criticized the use of FED discount window to prop up over-leveraged investment banks.
Hypocricy thy name name Henry.
- April 14, 2008 4:43 AM
- Anonymous said...
- Well, Henry the director at Lehman, attempts to shift the blame for their own mistakes since Adam and Eve (Adam: the woman made me do it; Eve: it was that snake). Nice try on your part, but I ain't buying. You took the risks and enjoyed the acclaim while it last. Now it's time to suffer the consequences of poor choices.
- April 14, 2008 11:21 AM
- Anonymous said...
- This so called administration is running around blaming everyone and everything else for their failed policies. It has been an unmitigated disaster of policy rather more than a lack of regulatory tools.
It was obvious early in 2002, and not just in monetary policy, that the inmates were running the asylum. Bill Donaldson was one of the first beheadings because he was actually trying to regulate.
There was a conscious policy decision by the Bushco to expand the money supply through credit. Anyone with the timerity to oppose was paid a visit by the administration legbreakers, Dick Cheney and Rumsfeldt, and their idealogue minions.
The current crisis, and policy agenda that has led up to this crisis, is a rerun of the Reagan real estate mess, right down to the same policy team.
More or new regulatory institutions will not address the underlying problem: An idealogue, incompetent administration that has been derelict in its duties to faithfully execute the laws of the United States for the good of our citizens. The administration's actions appear to be criminally negligent in this regard.
- April 15, 2008 7:13 AM
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FT.com
When a wave of destruction hits, everybody looks for somebody to blame. Alan Greenspan, former chairman of the US Federal Reserve, once lauded as the "maestro", has, to his discomfort, become the scapegoat. But even though I dare to disagree with him on some points, much of the criticism is highly unfair. Mr Greenspan remains the most successful central banker of modern times. More important, blame distracts from the challenge, which is to understand what happened, why it happened and what we should do.
Economists' forum - Nov-16
Every week, 50 of the world's most influential economists discuss Martin Wolf's articles on FT.com
As Mr Greenspan pointed out in his response to his critics in the Financial Times on Monday, the housing bubble was not unique to the US. On the contrary, as the background chapter on housing in the International Monetary Fund's latest World Economic Outlook shows, US experience was far from exceptional. On the contrary, the biggest apparent overvaluations occurred in Ireland, the Netherlands and the UK.
The chart shows the proportionate increase in house prices between 1997 and 2007 that cannot be explained by the fundamental drivers: affordability (the lagged ratio of house prices to disposable incomes); growth in disposable incomes per head; interest rates (short- and long-term); credit growth; changes in equity prices; and changes in working-age population. Thus, the rises reveal the extent to which a country has experienced what seems to be a bubble. The US is in the middle ranks.
Similarly, the US is in no way exceptional for the level of residential investment. Somewhat to my surprise, the share of residential investment in UK gross domestic product has been much the same as in the US. The outliers here are Ireland and Spain.
US monetary policy cannot be responsible for all these bubbles. This might not be the case if these other countries had followed US policy slavishly. But they did not (see chart). The Bank of England, for example, followed what seems to be a consistently tighter monetary policy than the Fed. Yet house prices in the UK may be even more overvalued.
The WEO does argue that "the unusually low level of interest rates in the US between 2001 and 2002 contributed somewhat to the elevated rate of expansion in the housing market, in terms of both housing investment and the run-up in house prices up to mid-2005". Moreover, "the impact of easy monetary conditions on the housing cycle presumably was magnified by the loosening of lending standards and excessive risk-taking by lenders". Yet the drawback to these US-specific points, plausible though they may seem, is that they do not explain house-price bubbles elsewhere.
So what might explain these bubbles? I would point to four causes: very low long-term real interest rates, because of the global savings glut; low nominal interest rates, because of both low real rates and the benign inflationary environment; the lengthy experience of economic stability; and, above all, the liberalisation of mortgage finance in many countries. The greater the availability of finance, the easier it was for purchasers to pay higher house prices and the higher those prices, the more willing were people to purchase, in the expectation of still higher prices. The WEO makes clear that house prices tended to rise fastest where finance was most easily available, as one might expect.
If there is little US-specific to explain, a US policymaker cannot be responsible. There are three qualifications to this argument.
First, it is unclear how far house prices are going to fall elsewhere. If the US fall turns out to be exceptionally severe, the bubble there will be relatively bigger than now appears the case. Second, the consequences of the bursting of the bubble may turn out to be worse in the US, because a higher proportion of lenders was persuaded to take on mortgages they could not afford. I will wait for several years of falling house prices in the UK and elsewhere before deciding on that. Finally, the US is the most influential country in the world. It may be held responsible for the movement towards liberalisation. But US influence on other high-income countries can be exaggerated. For better or worse, the latter made up their own minds.
Why, then, are so many Americans determined to blame Mr Greenspan for the mess? I can see three reasons. One is that it is far more painful to admit that the US was, in large measure, the victim of circumstances beyond its control. Another is that it is far easier to complain that the Fed made us do things we now bitterly regret than take responsibility for one's own mistakes. Last, the more one can blame the Fed, the more reasonable become demands for bail- outs now flooding into Washington.
Yet I still disagree with Mr Greenspan on two points.
First, I do believe it should have been possible for regulators to be tougher. In the FT's economists' forum, Mr Greenspan argues that "even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle". Mr Greenspan is saying that there is nothing to be done, even by attacking grotesque abuses, such as undocumented loans and ridiculous "teaser" rates.
Second, I still do not see why, at a time of soaring asset prices, monetary policy should not be tighter than it would otherwise be. This is what I mean by "leaning against the wind". I do not believe that this is likely to stop a bubble forming. A rise in interest rates from, say, 4 per cent to 5 per cent is not going to stop people borrowing to buy an asset they expect to appreciate by 10 per cent this year. But such a policy would push inflation below the normal target. That would give the central bank room for manoeuvre when the bubble burst, since it is far less likely that its credibility would come into question.
Yet the biggest question raised by Mr Greenspan's views lies elsewhere. Essentially, he is arguing that there is no middle way between repressed financial markets, on the one hand, and almost completely free ones, on the other. This is a counsel of despair. I greatly fear that if the people of the world are given this choice, after what I expect to be an expensive crisis, they will choose the former.I also do not find it a logical choice. If we accept that we are going to bail out the financial system when it gets into trouble, regulation is inevitable. The trick is to find simple, robust, rules-governed forms of regulation. The view that this is entirely impossible plays into the hands of those who wish to see the end of free financial markets altogether. Regulation cannot be perfect. But the worse the outcomes now become, the more difficult it will be to defend free financial markets at all. Without a credible design for regulatory improvement, it will prove impossible.
Comments
Edward Hadas: You are surely right to shield Greenspan from the most extreme accusations he was not powerful enough to be guilty of single-handedly creating the current financial stress. Still, you might be a little kind to Greenspan in his persona of "the maestro", the global intellectual leader of central banking. His narrow approach to the regulatory responsibility of central banks allowed him to ignore the massive increase in systemic leverage.
It is hardly as if Greenspan was unaware of the risks that come with building up mountains (or perhaps slag heaps) of debt. Greenspan seems to believe that markets, not the authorities, were best placed to deal with them. I find it hard not to think that financial markets would be healthier today (although many financiers would be less rich) if Greenspan had been less antagonistic to regulatory oversight and less blindly enthusiastic about financial "innovation", techniques which largely translate into new and improved ways to put more debt into the economy.
Edward Hadas is associate editor at Breaking Views.
Posted by: Edward Hadas | April 9th, 2008 at 3:29 pm | Report this comment
- Alan Rohrbach: Greenspan's right; yet Martin Wolf significantly more so on one of his original key points.
There's little doubt Alan Greenspan is a master central banker. He is certainly right on many points that debunk criticism directed at the Fed. There is merit to his analysis on everything from sources of the global housing bubble, to economies remaining questionable out of the 2003 deflation scare into 2004, and tightening of regulations not likely making a difference. Tony Jackson has the right perspective on that in his Monday column: (the) banks " figure out ways around them."
Yet, Mr Wolf is 100 per cent correct on one point Mr Greenspan still refutes: central banks should indeed "lean against the wind". Mr Greenspan is so well-regarded he can develop perspectives on policy and practice with little question. Yet it seems a convenient shift of central bank theory in the wake of the Dot.Com Bubble bursting that Mr Greenspan noted it is not within the remit of central banks to deflate bubbles.
In fact, the practical reason central banks must be the one to lean against generally too fair a wind is included in his analysis. As he aptly noted, "Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality." That is consistent with both he and Ben Bernanke noting previous they were aware of this, yet could do nothing specific. The nature of the beast is that securitizers are trapped in a prison of their own devise once one of their theories (solid or otherwise) is broadly accepted by both investment community and individuals. Demand from investors is driven by animal spirits until there is a shift in general sentiment.
While it is indeed a very blunt instrument, central banks have the primary tool to implement that shift: base rate changes and anticipation of future moves. In his recent extensive exposition on the matter, Mr Bernanke explicitly noted that faulty assumptions about continued asset appreciation played a major part in the housing bubble reaching the extremes which continued into the first half of 2007.* The continued availability of subprime mortgages for securitization was based on belief by home buyers that endless asset appreciation would offset onerous loan covenants. If more economic concern had been fostered in late 2006, it could have deterred some of the irrational exuberance (to borrow a phrase from the Master.) It likely seemed counterintuitive to Mr. Bernanke to raise rates in late 2006. Yet, the DJIA pushing above the January 2000 Dot.Com Bubble high should have been grounds to fear the Credit Bubble would also continue to inflate on the back of asset appreciation expectations.
Even if US stocks were not overvalued on historic price/earnings ratio analysis, central bankers' lack of desire to cool economies to offset a distended cheap credit cycle allowed it to continue. It was their job to deflate expectations even if inflation and equity prices were not obviously overheated at the time. At the very least that might have discouraged the worst late phase excesses Mr Greenspan now cites. Citi's ex-head Chuck Prince was accurate in his assessment that as long as the music is playing everyone will keep dancing. If central banks will not pull the punch bowl (their classic role) when the dance gets too frenetic, it diminishes their influence and leadership.
It also raises a very telling question: If central banks are not responsible for leaning against the wind to deflate bubbles, then (pray tell) to whom does that unsavory task fall? Messrs Greenspan and Bernanke seem content to have the Fed show up with liquidity balm for the third degree financial burns when bubbles flame out like the Hindenburg. Somehow that does not seem a constructive role for central banks.
Mr Greenspan's defense of the Fed was as factually accurate as it was vigorous. However, his review of specific reasons the Fed is blameless for the scale of the housing bubble has provided critics of its failure to 'lean against the wind' the general considerations by which he and his successor may be hoist by their own petards.
Alan Rohrbach is president of Chicago capital markets consultants Rohr International
Posted by: Alan Rohrbach | April 9th, 2008 at 5:54 pm | Report this comment
*Fostering Sustainable Homeownership, March 14, 2008, at the National Community Reinvestment Coalition Annual Meeting, Washington, D.C.
http://www.federalreserve.gov/newsevents/speech/bernanke20080314a.htm- Stephen Roach: The blame game has reached epic proportions in this wrenching financial crisis. Alan Greenspan makes the most inarguable point of all in stating his case for the defense that it is critical to get the lessons right. I couldn't agree more.
Unfortunately, Greenspan has been blinded by a dangerous combination of ideology and politics in his own search for those very lessons. And it was much the same during the 18½ years he spent at the helm of the Federal Reserve. At the core of his principled stand is the belief that the US body politic demands rapid, albeit non-inflationary, economic growth. As a politically-compliant central banker, he has also stated that the independence of the Federal Reserve is not set in stone implying that there is always huge pressure to keep the growth machine humming. And as a market libertarian, he has argued that regulatory intrusion impedes the speed of economic growth. Presto the rest is history and an increasingly painful one at that.
This combination of ideology and politics led to bad economics and to a succession of policy blunders the severity of which are only now becoming evident in this most wrenching of crises. Unlike Martin Wolf, I believe that Greenspan's treatment of The Bubble is the smoking gun. The Greenspan-Bernanke mantra has long been steeped in the belief that markets know best that central bankers should not attempt to override the verdict of millions of market participants in rendering the judgment that an asset bubble has formed. There are the costs to economic growth to consider. And why worry? After all, goes the script, the authorities always have the wherewithal to clean up any post-bubble mess. Maybe not. The mess this time is almost beyond the realm of comprehension.
Yet the problem has never really been the bubble in the narrow sense of the word. Unfortunately, this is one of the weakest links in the Greenspan defense and in Martin's defense of the defense namely, a fixation on whether a serious bubble was forming in America's housing market. Never mind, his earlier arguments that housing markets are local, not national and that it was highly unlikely that nationwide home prices could ever fall. Whoops. Never mind also his equally irrelevant point that there were lots of housing bubbles in the world at the same time and that America's property market excesses didn't look so bad by comparison. Even Martin Wolf buys the peer pressure rationale every one's doing it as exoneration for the Fed.
The problem with America's housing bubble was never its comparison with Ireland. The core of the problem lies in the distortions that asset bubbles created on the real side of the US economy. Courtesy of the most rapid rates of sustained US house price appreciation in the modern post-World War II era, in conjunction with innovative financing techniques that allowed American homeowners to extract equity with ease from their humble abodes, the new age of the asset-dependent consumer was born. Net equity extraction from residential property ironically, based on a statistical framework developed by Alan Greenspan, himself surged from 3 per cent to nearly 9 per cent of disposable personal income in the first half of the current decade.
And so it went in the Age of Excess. Increasingly supported by the confluence of both property and credit bubbles, American consumers spent well beyond their means as those means were delineated by domestic income generation. Personal consumption climbed to an unheard of 72 per cent of real GDP in 2007 a record for America and, for that matter, for any leading economy in the modern history of the world. At the same time, household sector debt soared to a record 134 per cent of disposable personal income. America had the rapid growth that Greenspan felt the body politic wanted. But it was growth based increasingly on fumes.
Unfortunately, the distortions of a bubble-infected US economy didn't stop there. With equity extraction from residential property viewed increasingly as a permanent source of income generation, consumers felt little pressure to save the old-fashioned way out of their paychecks. As a result, the income-based personal saving rate plunged to zero for the first time since the Great Depression. Lacking in domestic saving, an increasingly asset-dependent US economy had to borrow surplus saving from abroad in order to keep growing and run massive current account and trade deficits in order to attract the foreign capital. Greenspan and Bernanke turned this development inside out, as well maintaining that America was simply doing the rest of the world a huge favor by absorbing its surplus saving. Serious dollar risks were always the catch to that favor, but they were typically couched as a problem for a distant day. Suddenly, that day doesn't seem so distant. In retrospect, the dollar bubble was the external face of America's penchant for asset-dependent growth and saving.
The Greenspan defense completely misses the trees from the forest. His place in history will not be defined by a cross-country comparison of housing bubbles. What he missed repeatedly over the years and still misses today are the corrosive impacts this bubble had in fostering the imbalances and excesses of an asset-dependent US economy. Unprecedented consumer leverage is only part of the problem. So, too, is the failure of an aging US population to save at precisely the phase in its life-cycle when it needs to prepare for retirement. Global imbalances are also an outgrowth of this era of excess underscored by America's massive external deficit and, by the way, the protectionist fires it stokes.
Alas, these fault lines were made all the deeper by the Fed's regulatory laxity in an era of unprecedented financial innovation a laxity that, unfortunately, was accompanied by the cheap money that only a narrow CPI inflation targeter could justify. In retrospect, this was the most dangerous tactical blunder of all a combination that created voracious investor demand for opaque and increasingly toxic financial products.
It didn't have to be this way. Saying no to asset bubbles equity, property, or credit was always an option. In contrast to Alan Greenspan, I concur with Martin Wolf and believe that could have been achieved by common sense "leaning against the wind" when faced with the obvious asset bubbles of the past eight years. That would have allowed the Fed to use a variety of anti-bubble tools the bully pulpit of jawboning, more disciplined regulatory oversight, and, ultimately, a tighter monetary policy than a narrow core CPI inflation targeting rule might otherwise suggest.
Yes, economic growth would probably have been slower as a result during the period when the Fed was leaning against asset bubbles. But that shortfall may well pale in comparison to the cost of the post-bubble carnage that is now unfolding. Yet trapped in ideology and politics, Alan Greenspan simply couldn't bring himself to follow the sage advice of one of his predecessors, William McChesney Martin, and "take away the punch bowl just when the party was getting good".
Posted by: Stephen Roach | April 10th, 2008 at 9:05 am | Report this comment- Allan Meltzer: I agree with Martin Wolf. Alan Greenspan erred but he is not responsible for what followed. Martin is right that the critics shift the blame and fail to accept their responsibility. Rates remained too low too long. Deflation was unlikely in an economy with a large budget deficit and a falling exchange rate. But no one insisted that the financial community had to invest in sub-prime loans and other risky assets.
Two other problems contributed to the bad outcome.
First, the Basel Accord required banks to hold more capital if they increased risk. Like most rules written by lawyers, the incentives created by the rule were not considered. Markets respond to costly rules by finding ways to circumvent them. Risky assets moved from banks' balance sheets all over the world. Banks seemed safer but the markets were much riskier, and no one knew where the risks were. We find out when there are failures. Not a good system. Why is there no discussion of changing it?
Second, one has to ask why MBA graduates of the world's best business schools were willing , even eager, to buy and sell loans with no down payment and no credit record. My answer is that their incentives are distorted by the large bonuses they receive. And their supervisors face the same incentives. Sell the junk and earn a big bonus. Refuse and you join the unemployment line.
The compensation system should change. Tax the bonuses heavily to push compensation to more salary. Or, pay the bonuses on 5 year average earnings. I am sure there are other ways of altering incentives.
These are not the only problems, but they are major problems.
The system must be changed. We cannot expect the current system to survive if the bankers get the rewards and the taxpayers share heavily in the losses.
Posted by: Alan Meltzer | April 10th, 2008 at 9:40 am | Report this comment- Andrew Smithers: Errors of judgment are often presented as evidence of moral culpability, causing serious discussion to be buried under piles of recrimination. Martin is thus right to defend Alan Greenspan, particularly as his articles suggest that he is ill-equipped to do so himself. But while personalities should be treated with charity not malice, they should usually be avoided as they distract attention from the issues.
The central issue is neither the housing bubble, nor who or what is to blame for it, but whether central bankers should ignore asset prices and is it wrong to assume that this concern is a hindsight response to recent troubles.
Stephen Wright and I set out in a paper published in World Economics in that Journal's Jan-March 2002 Edition, the case that central bankers should be concerned with asset prices and while we doubted then "whether this view would yet receive support from the majority of economists", it seems likely that views have changed.
A major reason for the change of attitude is the way in which the Greenspan/Bernanke view has shifted its ground. The first defence was that asset prices were irrelevant, but this has become absurd as the Fed has responded to asset price falls. The second was that assets couldn't be valued, but this has been replaced by a conviction, even it seems in the Fed, that many forms of debt today are undervalued. The third, which was that problems could easily be tackled ex-post, has obviously been overtaken by events. The only defence left is the counsel of despair, which is that any attempt to respond to asset price excesses will simply fail.
Only the most pessimistic would hold that this is bound to be true and only the most dedicated exponents of theory over pragmatism would hold that central bankers should not even try to respond to asset prices. This leaves us with the key questions of how to value assets and how central bankers should respond if they become concerned with their level.
One problem is that it has been difficult to get rational attention on the difference between asset values and asset prices. This is partly because we are in the middle of a Kuhnian paradigm shift, in which the Efficient Market Hypothesis ("EMH") is still assumed, though usually implicitly rather than explicitly, in much academic work. I am of course "talking my own book" when I assert that the replacement of the EMH is a key task for the economics profession.
Practice, however, cannot afford to wait for theory to catch up. Even more urgent is agreement about how to respond to concerns about asset prices. At the moment this involves, I think, two questions. The first is whether risky debt instruments have become too cheap and if so whether, as Willem Buiter argues, we need a market maker as well as lender of last resort. The second is whether there are any other short-term steps that still need to be taken to mitigate the immediate risks to the economy.
The second point gives rise to an issue which I have had a part in raising. This is whether bank capital is adequate. Judging by statements from Mervyn King to the House of Commons Treasury Committee and by Lawrence Summers's recent article in the FT, there is a growing consensus that it is not. Banks must therefore be expecting that their capital requirements will be raised in the future. This must inhibit their current lending and thus exacerbate the normal pro-cyclical tightening of bank credit at a time when the impact of this is likely to be made even worse by a change in non-bank credit from creation to destruction.
Governments should perhaps request or require banks to stop paying dividends for the next two years, to give time for new capital regulations to be put in place. As a government request, this should enable bank managements to act sensibly, despite the usual resistance from shareholders and, by increasing their prospective capital, make them less negative to the creation of credit.
Posted by: Andrew Smithers | April 10th, 2008 at 3:22 pm | Report this comment- Robert Brusca: Greenspan protests his guilt arguing that housing pressures existed elsewhere in the world and some bubbles were worse than in the US. First, this is misdirection. Second, it wrongly encourages you to look no more deeply into the US problem.
The US is a huge country with little real land scarcity. I find the comparisons with European countries, relatively less endowed with land and not suffering the decline that US house prices are now, as a spurious comparison. In the US, home ownership has spread to new historic highs. It was enabled by imprudent lending. Imprudent lending was the spur, not scarcity. Oversight of that lending was the Fed's (failed) mission. That's the simple case against Greenspan. It has nothing to do with housing bubbles in Ireland or London. It might have had something to do with people favoring real and hard assets after the stock markets had earlier collapsed destroying confidence in them. Now there is an angle worth pursing
Greenspan's protestations are a case of magician-like misdirection - i.e. classic Greenspan. When it's all said and done Greenspan may be the world's greatest politician- central banker, language- and fact-twister. He is the only CENTRAL BANKER I know who was able to 'propose' and all but pass a FISCAL stimulus passage, single handedly. He is a powerful central banker who used his power and political connections WHILE HE WAS a central banker in office his after-the-fact mumbling, that he wasn't as powerful as he seemed, is just more opacity from the alleged 'Mr Transparency'. While Greenspan pushed for transparency, no one was more opaque as he admits in his book. He admits that he practiced the sort of double-talk he gave us in testimonies before the Congressional financial committees where testimony was duty. Yet he mocked us with gibberish on those occasions. When you consider his arguments you must put this man in context Nothing is what it seems or how he portrays it. He is harder to nail down than Jell-O.
Greenspan is not wholly responsible for the US housing problems but he may have played a greater role in them than any other single person.
Greenspan had bad judgment: he urged fiscal stimulus because budget surpluses were too big - a terrible judgment call. He encouraged people to take the equity from their homes and spend it. He repeated over and over that house prices did not fall nationally. This latter point is an example of a stylized fact that had no merit - but was true - and encouraged poor decisions by others.
In the severe 1980-1982 recession period (s) US nominal house prices did not fall because inflation was so high. Shouldn't a Fed chairman have seen that for what it was, instead of as resiliency? Real house prices had fallen in the past. With lower inflation established, weren't declines in nominal prices possible? Yet, Greenspan admits to urging people to take equity out of their homes jeopardizing their financial standing in order to spend it to spur an economy that hardly need more boost.
Greenspan steered the economy on a wrongful course of action: Consumption in the US also augments trade deficits. But Greenspan urged all this with a low savings rate in place, a looming crises in Medicare-Medicaid costs and with Social Security in need of a fix. He did this ahead of a time that Americans are going to have to support themselves with an untested 401K income program instead of defined pension benefits which they historically relied upon. Having a paid up house with lots of equity in it would have been a boon to such people. But no, that was not the Chairman's advice. This was the guy who was supposed to be Mr Probity. We have yet to see what his advice has wrought. Housing is just the start. Since some have put 401K money (retirement funds) into their house purchase this housing episode has also worsened retirement prospects for many directly.
Greenspan's actions have left the people and government financially much worse off. His biggest failing was as a regulator in not following up advice that things were amiss in the mortgage market when presented with the facts by Fed Governor Ned Gramlich. His after-the-fact 'who could have known' excuse sounds suspiciously like Condoleezza Rice's statement about an FBI that also failed to follow up a hot lead before 9-11 that might have changed history. How long has it been fashionable in the US to lay off the blame on nihilism? Who could know? You WOULD HAVE had you done your job properly that is the correct answer to that seemingly rhetorical question.
Greenspan is culpable in so many ways. He thrusts himself on the scene and imposes his judgment on others; he was not collegial; he was dictatorial. No wonder he was clueless about housing.
While he ignored the Fed's obligation to regulate he testified up and down Washington on the merit of de-regulation everywhere else further spreading the gospel of irresponsibility.
Having no regulation is not as dangerous as making people think they have regulation that isn't there. That was Greenspan's main central banking sin.
Greenspan mostly wasn't there. His ideology was there. He had great timing but poor judgment. He was there for the productivity miracle and gone for the housing collapse. While he was at the Fed the published 'FOMC forecasts' consistently projected growth that was too low and inflation that was too high. A nice - and unusual - matched pair of forecasts errors. When others are wrong things rarely turn out so well. Yes, Greenspan had timing; it was his main asset, not his judgment.
The policies he set in motion as Fed chairman have implications adverse implications - beyond housing. But his fingerprints are all over that problem. I accept none of his excuse, nor find Mr Wolf's acquiescence compelling. I suppose because Japan had earlier gone through a decade of real estate-spurred problems Greenspan can cite them as another example of how it's not his fault.
To the contrary when bubbles appear they appear where people like the prospects. The appearance of past stock and international housing bubbles were warnings that were ignored. Stocks and housing were vulnerable. Oversight was not ramped up, it was set aside. The Greenspan Fed reacted badly to both of those asset bubbles. For one he sat idly by. For the other he wore the short skirt and waved the pompoms. He was Ponzie to that scheme. Blameless? Hardly. And that is only the start of the mischief he has set in motion.
Robert Brusca is a former chief economist at Nikko Securities International and a former chief of the international financial markets division of the Federal Reserve Bank of NY
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April 8th, 2008 | FT.com
13 Responses to "Alan Greenspan: A response to my critics"
Comments
- Christopher Whalen (guest): In my view, the mortal sin of chairman Greenspan was not irresponsible monetary policy, but rather dropping the ball on bank supervision and market structure. I described the ill effects of allowing the liberal academic economists at the Fed's Board of Governors in Washington to set bank supervision policy in a comment in Friday's American Banker.
In particular, in the two decades of Greenspan's tenure, the Fed's Washington staff, other regulators and the Congress allowed and enabled Wall Street to migrate more and more of the investment world off exchange and into the opaque world of over-the-counter instruments. This change is described by people like Treasury Secretary Hank Paulson as "innovation," but my old friend Martin Mayer rightly calls it "retrograde."
In a market comprised primarily of exchange-traded instruments, there is little or no counterparty risk. OTC trades that reference exchange-traded benchmarks are likewise far more stable. By replacing exchange-traded securities with ersatz OTC instruments, Greenspan and the quant economists who dominate the Fed's Washington staff have created vast systemic risk that need not exist at all and that now threatens our entire financial system.
BSC failed not because it had too little capital or too little liquidity, but because the thousands upon thousands of OTC trades which flow through the firm's books are bilateral rather than exchange traded. It was the understandable fear of counterparty risk, not a lack of capital or liquidity, which killed BSC. The irony is that the "financial innovation" of OTC derivatives and structured assets takes us backward in time to the chaotic situation that existed in the US prior to the crash of 1929.
Would that the Congress and the Fed had the courage to confront Paulson and the other banksters who have turned America's financial markets into an increasingly unstable, derivative house of cards. If all federally commercial banks and funds subject to ERISA were required by law to invest only in SEC registered, exchange-traded instruments, the threat of further systemic risk could be eliminated tomorrow. What a shame that neither Chairman Bernanke nor FRBNY President Timothy Geithner said that last week when they appeared before the Senate Banking Committee.
Mr Whalen is a co-founder of Institutional Risk Analytics, a Los Angeles unit of Lord, Whalen LLC that provides customized financial analysis and valuation tools.
Posted by: rc whalen | April 7th, 2008 at 2:36 am | Report this comment- Edward Breen: There is an argument that Mr Greenspan bears responsibility for the US housing bubble and collapse due to his policy of "gradualism" in the increase of the FFR by 1/4 point increments begining in 2004. This argument was not posited by Mr De Grauve and it was not defended by Mr Greenspan. The rational basis of the argument is that the broadcast of the Fed's intention to increase rates in monthly increments until some unstated and unknown condition of interest rate neutrality was eventually reached, encouraged leveraged economic decisons to move forward in order to avoid higher interest rates that were promised to follow. This effect was particularly pronounced in residential housing decsions where borrowers were encouraged to act sooner to buy or refinance, rather then wait until rates certainly would go up. This brought demand for real estate forward and sent false signals to the housing and mortage industries with regard to demand for housing and the value of housing asset collateral. As a consequence the builder community overbuilt and the lending community over leveraged, becoming vulnerable to the inevitable trough in demand that occured as rates continued to rise.
An additional criticism of this "gradualism" policy is that it was begun at an time when there was very low inflation according to the index measures. Mr. Greenspan admits as much in his defense above that he did not leave rates low for too long. He notes that in addtion to low index measures of inflation there was very little growth in the M2. One can fairly ask, whether it was wise to begin raising interest rates gradually at that time, and what was the policy imperative that drove the decision if there was no indication of emerging inflation. Many economists at the time did criticise the decsion as contributing to a "treadmill" effect, where rather than reducing inflation, the gradualism actually created the inflation that is was ostensibly designed to avoid.
In the context of defending policy decisions in the face of uncertainty, Mr. Greenspan should defend his policy of gradualism in FFR increase at a time of no inflation that resulted in a housing bubble and increased inflation before it was ended.
Edward Breen is an attorney and a director of a manufacturing company. He was the president of a real estate development company, Axial Investors Group, during the S&L and real estate collapse of the early 1990s.
Posted by: Edward Breen | April 7th, 2008 at 3:06 pm | Report this comment- Mary S Schranz (guest): Financial markets and institutions serve a useful purpose to channel funds from savers to borrowers. Spending by borrowers increases the current level of economic activity. To the extent that funds are used to increase the public and private capital stock, channeling funds from savers to borrowers increases an economy's productive capacity in the future as well.
Financial markets and institutions also have the potential to destabilize an economy if poor decisions are made when funds are lent or when excessive speculation occurs. Poor decision-making could be the result of poor management or the result of societal incentives that allow financial institutions to take risks with managers and employees bearing little if any of the costs associated with those risks. Because financial institutions use other people's money, there is an inherent potential conflict of interest between the institution's managers and employees and its shareholders, depositors, and others who provide funds to these institutions.
Speculation occurs when monetary policy is too lax. Those with money can either spend it, putting upward pressure on consumer prices, or invest it, be it in stocks, bonds, commodities, derivatives, or real estate. Bubbles can occur in any of these markets when too much money in circulation and interest rates are set too low.
The current crisis in the credit markets is a direct result of misaligned incentives in the financial services industry, government policies that create moral hazard, and loose monetary policy. Addressing each of these issues is necessary to reduce the probability of a similar crisis in the future. To the extent that this requires regulatory reform, the following issues should be considered.
First, long-run economic growth depends on a society's legal, political, and cultural institutions. Faith in the underlying stability of the financial system promotes economic growth. Hence, regulatory reform should be directed toward promoting stability of the financial system without unnecessarily inhibiting the useful function of channeling funds from savers to borrowers. Included in this reform should be the establishment of an institutional framework to manage future financial crises as another crisis will undoubtedly occur at some point.
Second, all financial products of a similar type should be regulated by the same authority. This will create a level playing field and prevent circumvention of regulations within a country. Different products or different lines of business could be regulated by different agencies if a mechanism for interagency cooperation and coordination is also created.
Third, a global financial crisis requires a global regulatory response. The current crisis spread from its source in the US mortgage market to financial institutions throughout the world due to securitization of mortgages and globalized investing. If a country is unwilling to cede direct regulatory oversight to a global regulator, some type of international body to resolve financial crises and disputes should be established to create as level of a global playing field as possible and to prevent circumvention of regulations by crossing country boundaries.
Fourth, internal firm compensation policies and governmental policies that create moral hazard need to be corrected. Minimum capital requirements are a necessary but not a sufficient condition to promote stability in the financial services sector. A minimum level of capital is needed to provide for unanticipated withdrawals from a financial institution. However, if internal company compensation policies and regulatory bailouts reward excessive risk-taking, excessive risk-taking will occur regardless of the capital requirements.
Direct government regulation of compensation within a firm is unwieldy, politically infeasible, and would likely involve greater social losses than those generated by an unregulated system. But moral hazard must be mitigated. A tax on financial institutions that is tied to the riskiness of the institution's investments would reduce the incentive to take excessive risk without destroying the incentive to generate productive innovation in the financial services industry.
Fifth, any institution that expects assistance from the government, either via direct taxpayer dollars or via access to central bank funds, must agree to regulatory supervision. This condition also requires that supervisory authorities supervise. Regulators must be aware of the incentives of financial market participants to take advantage of whatever system is in place and to generate noise that obscures their actions. The tax discussed above would provide the funds necessary for supervision and also provide funds that could be used to address the next crisis.
Sixth, use of off-balance sheet accounting techniques to hide risky investments must be curtailed. Potential liabilities must be clearly disclosed or turned into direct liabilities and moved onto the balance sheet. The accounting regulatory bodies bear some of the responsibility for the current crisis by allowing firms to hide liabilities off the balance sheet. The initial tightening in the credit markets was due to direct losses on mortgage-backed securities. The continuation of the crisis long after the initial losses were reported is due to lack of trust between institutions. Proper accountancy that informs rather than obfuscates will restore trust and prevent a temporary crisis from turning into a long-term loss of faith.
Seventh, central bankers must be vigilant in monitoring asset markets as well as consumer and producer prices when setting monetary policy. A low real interest rate environment creates the incentive for speculation. Excessive leverage in the financial system, enabled by margin requirements on short sales and security purchases that are set too low or by other forms of borrowing by financial market participants, also encourages speculation. As Keynes noted many years ago, "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." It is the responsibility of regulatory authorities to prevent the speculation that threatens the steady stream of enterprise.
Institutions matter. Investors, regulators, and financial institutions should use the current crisis as an opportunity to create an institutional framework that will serve the global economy well in the future, long after the current generation of managers and regulators are gone.Mary S. Schranz is an instructor in economics at Madison Area Technical College
Posted by: Mary S Schranz | April 7th, 2008 at 4:35 pm | Report this comment- Sir I commend you for posting this, however I remain unconvinced. Standing by in 2004 as I watched housing prices in LA appreciate 40% in one year, with a 1% short term Fed Rate fueling $0 down 3% ARMs (some of which were negatively amortized) it escapes me how you don't think this kind of monetary policy fueled this classic bubble of excessive leverage and over speculation.
Posted by: Eddie | April 8th, 2008 at 3:19 am | Report this comment
- Willem Buiter: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.
The Greenspan Fed (August 1987 January 2006) did contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
The Greenspan Fed brought us the Greenspan put (now the Greenspan-Bernanke put). This is the aggressive response of the official monetary policy rate to a sharp decline in asset prices (especially stock prices), even though the asset price declines (a) are unlikely to cause future economic activity to decline by more than was required to meet the Fed's triple mandate and (b) do not convey new information about future economic activity or inflation that would warrant interest rate cuts of this magnitude.
To me, this indicates that the Fed has been co-opted by Wall Street - the Fed has internalised the objectives, concerns, world view and fears of the financial community to an excessive degree. This socialisation into a partial and often highly distorted perception of reality is unhealthy and dangerous.
The Greenspan Fed failed to appreciate the downside of rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for the undoubted virtues of securitisation.
The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
The Greenspan Fed, by enabling the rescue of Long-term capital management in 1998, acted as a moral hazard incubator. Both before and after LTCM, the Greenspan Fed failed to press for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail. This demonstrates either bad judgement or regulatory capture. The moral hazard-fraught rescue of Bear Stearns is the lineal descendant of the LTCM bailout.
During his years as Chairman of the Federal Reserve Board, Alan Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator.
Mr Greenspan consistently saw but half the picture when it came to what makes competitive market capitalism work. He recognised the central roles of greed, self-interest and competition. He failed to appreciate the complementary roles of non-strategic/opportunistic forms of altruism, honesty, trustworthiness, solidarity and cooperation.
He emphasized self-regulation, spontaneous order and the disciplining effect of reputation. He did not understand the weakness of reputational concerns as a (self-)enforcement mechanism ensuring good behaviour, when credible commitment is, at best, limited in a world with short horizons and easy exits.
He failed to appreciate the essential role external/third-party (i.e. state) enforcement of laws, rules and regulations, and the indispensability of collective action when faced with the threat of the breakdown of trust and confidence.
By overselling, at home and all over the world, the virtues of American-style transactions-based financial capitalism and light-touch regulation, Mr. Greenspan has done more to harm the cause of decentralised, competitive market-based financial systems based on private ownership, than even Charles Ponzi.
Alan Greenspan's period as Chairman of the Board of Governors of the Federal Reserve System represents to me the nadir of central banking in advanced economic-financial systems during modern times. While monetary policy was only mildly incompetent, the regulatory failures were horrendous. The US and the world economy will pay the price for Mr Greenspan's misjudgements and errors for years, perhaps decades, to come.
Posted by: Willem Buiter | April 8th, 2008 at 11:45 am | Report this comment- Robert McDowell Guest contributor
I have no criticisms of Greenspan's views. But, I do criticise banks for oignoring economics analysis and for ignoring central banks' and regulators' advice whenever this involves economics. Bank's inhouse economists have been purposefully left out of credit and market risk analysis. Greenspan's advice, like many others, boils down to regretting that short term credit was allowed, even encouraged, and not just by low real bank rates, to speculate in longer term assets and to accept classic liquidity mismatches.
The inter-bank credit market (wholesale finance) has been taken for granted. We can learn from farmers who do not assume there will always be a rainy season. Bankers and non-bank investors in banking assets assumed banks will always be the last to suffer liquidity proiblems.In fact, liquidity risk, which is part of classic banking awareness, has until last year been understood or considered by very few bankers; most, if tested a year ago, would not be able to define it. We may blame New Keynesian thinking for the notion that credit and economic cycles can be banished by stabilisation policy. This dream ignores that long run confidence in stability generates one-way markets i.e. asset bubbles. We need cycles to maintain 2-way markets (uncertainty) and should welcome them.
Too much is being blamed on sub-prime securitised assets. The economic losses (after defaulted debt recoveries) will by themselves not be severe over the medium term - probably less than $200bn in the US including interest and this will roughly vindicate the ratings agencies through-the-cycle risk ratings. The short term knock-on in the financial food chain of leveraged funds and marked-to-market values is much greater. But, the greatest impact will be in the enforced changes in world trade and in general recession events. But, sub-prime is not the main cause of US-led recession, even if property and other asset price bubbles do play a large part - a normal regular cause of cycle downturns.
In part,sub-prime is an outcome too of public policy to extend home ownership to many of the poorest quarter of the population who otherwise would lack financial assets and the related dearth of new social housing.That public finance should bail out those who are over-extended and unbalanced relative to long run trends is proportionate in the circumstances. One important result is to restore belief in the role of government retaning a size commiserate with counter-cyclical responsibilities (about 25% net share of GDP, or 45% budget ratio to GDP).
One glaring omission in the public debate about the Fed's and other regulators' responsibilities is failure to discuss BIS's Basel II new laws and rules relating to a liquidity shock crisis and recession etc.? There should be little doubt that Basel II when fully established is the best that can be currently conceived to clarify and mitigate the current crisis and similar crises.
It is shocking how Basel II has been ignored in the debate.The only explanation must be that Basel II is not yet fully on US banks' agendas (only Europe's) or an erroneous assumption that it concerns credit and solvency risks, but not also systemic and general economy risks?
Basel II contains plenty of sound advice about liquidity risk and credit cycles alongside the advice emanating for years in central banks 'stability reports' about credit bubbles, unfortunately conjoined only rarely with clear instructions to banks to refrain from unbalanced lending, it is valid to suggest that where countries have adopted a multi-strand or tripartite regulatory & supervisory system, banks' sensitivity to whatever central banks tell them has been lost in analysis. Bankers became cynical about macro-economics just as they ignored central banks' stability reports. We may blame Monetarist and New Keynesian precepts alongside short term bonus-driven greed and leveraged credit churning like a Lloyds underwriting snake of old, some fraud and so on.
Six other missing debating points to be noted in passing:
1. banks have not disclosed losses borne directly by their customers in retail investment funds
2. most ABS issues were ultimately sold to Far & Near East investors who have not yet disclosed book losses
3. packaging bank assets for sale was not really complicated (even if too complicated for some)
4. ABS's have been central to the pattern of world trade, which now has to change fast and dramatically. Acquisition of financial assets were not demanded as Greenspan suggests merely because of their apparant profitability, but because they paid for trade deficits
5. securitisations were structured (not just rated) as failsafe and extolled by BIS and other regulators as being the way of the future for how banks would tier globally (financiers - originators - distributors)
6. financial markets are not incorporated within GDP economic models, and therefore no one has published an economic model that accounts for the prese4nt crisis.The public debate is intuitive about the role of regulators, assuming that they actually or potentially police the general quality of the markets. This is a wake-up call to the regulators whose focus has been on individual malfeasance, not the economic conditions.The central banks issue sectoral cross-market data, but rarely back this with instructions to all banks.All commentators under-estimate how much can be known about the markets - a point that Greenspan emphasised. All also under-estimate the future role of Basel II. Basel II goes further than where public debate on the crisis has got to so far, by making it a matter of law that banks should have the equivalent of in-house regulators (independent risk units) caring about a comprehensive range of risks and doing so comprehensively. But Basel II has not yet solidified in the analytical aspects of Pillar II where it concerns economic shocks and liquidity risk.
Pillar I of Basel II concerns solvency of assets in bank & trading books. This is specified in detail and banks have therefore worked on this assiduously. Pillar II is what really counts. the external (economics) context of all risks and especially liquidity risk (liabilities) and systemic risk (banks' actions faced with credit and economic cycles), and generally risk diversification i.e. the balance of risks across all borrowers and depositors and the impact on banks' capital of real world shocks.
The regulators were waiting to do peer reviews to learn from how banks variously solved Pillar II before figuring out how they should then regulate the banks in precisely those matters causing the present global crisis!
Pillar II was not specified in detail by regulators and was left to the banks to work out for themselves. This caused nervousness and anxiety among banks. None of them have the self-confidence to complete Pillar II fully The insurance companies have to do the same work in Solvency II, but are better equipped actuarily to understand the issues, and have more regulatory time to do so. None of the major banks have completed Pillar II in time for the credit crunch or to meet the regulatory deadline in Europe. Almost all are a year or more behind schedule.
It was not until the crisis hit that senior bankers' minds began to be focused adequately on Pillar II - a process of concentration on what even now is only fitfully and chaotically forming. The FSA, among all regulators, has been the benchmark reference par excellence for the banks on Pillar I, while the central banks provided material for Pillar II (now supplanted in my view globally by the FT - an interesting phenomenon created by features writers like Crook, Wolf & Forum, Munchau, Kay and others - the FT has never been so fascinating as over the past year).
But, as some commentators (e.g. papers by Wynne Godley et al) have pointed out, there are no known complete models (GDP economics + finance sector balances + assets values) that can accommodate and forecast the present crisis! The lack of complete models is evidenced here in Wolfe's forum. Some IT and accounting firms offer packages called stress test models, but all are simplistic (viewed by experienced applied economists who know about banking).
The banks have been afraid to allow economists to become involved for fear of economists running the banks. This has been said to me repeatedly by senior bankers and confirmed by regulators. In my view banks have to learn how to econmomically benchmark themselves to their sectors and the sectors to the economy. Any other modeling approaches totally fail. It is not a question of more or less regulation. It is a question of whether banks will seek to comprehensively analyse their business in the wider economic context - something they have been at great pains to avoid.
Basel II insists on comprehensive self-awareness about solvency risks, plus, above all, awareness of the wider economic context. Instead, the banks have devoted over 90% of their risk management work on Pillar I (Solvency) and postponed or avoided Pillar II (Liquidity and Economics modeling). If the credit crunch had arrived 2 years later, or the banks had begun their Pillar II work 2 years earlier, and regulators could have provided detailed advice in the form of complete models (accounting + economic) then there would be much less chaos than we can see now.
Banks have theoretically known that crunches and cycles are inevitable, but hoped and assumed that these would be staved off for some years yet. There were plenty of warnings, including about the inevitable loss of confidence in new derivative instruments that would test credit markets severely, as well as about credit and mortgage bubbles.It is not the job of regulators or governments to inform anyone when a credit cycle is likely to end or a recession will hit. Banks are supposed to do this work themselves.But few did. Even when Merrils and Citi and some others published doom-laden forecasts, these were largely ignored even internally within the forecast issuing banks.
While we can assume that in the medium term future mistakes of recent years such as ignoring systemic risk and economic modeling will not be repeated, how banks (and others) respond and adjust up and down the feeding chain will be so chaotic that it will take the whole of recession plus recovery period (5-6 years) to gain clarity. By that time the realised economic losses directly related to sub-prime delinquency and defaults will be the least of the total losses compared to the losses via all the leverage dependencies, even before losses generated by recessions (first Anglo-Saxon cycle, then 6-8 quarters later Euroland and RoW).
The solution concerns adjustment to shock and recovery financing, which are inevitably Government driven and essentially replacing devallued ABS (mainly MBS) paper with government paper (at a premium). My own preference is to propose adapting non-marketable government bonds for this role ($4trillions in US Federal Debt alone), but this is unlikely to be an opinion attended to.
Robert McDowell
Posted by: Robert McDowell, Edinburgh | April 8th, 2008 at 12:24 pm | Report this comment- Michael Hudson: I would like to make two points that others have not made. One concerns his logic, the other concerns the empirical data the Fed (mis)-used.
First, Mr Greenspan uses a false logic when he argues that private bankers know the financial marketplace better than regulators, because they're there on the spot. No doubt this is true. But Mr. Greenspan argues as if it follows that they should regulate themselves, as if they did NOT know there was a bubble.
Here's the problem. By spring of 2006, bankers knew there was a bubble. The public knew it. In May, I published a cover story in Harpers on the topic. In June, I addressed a bank annual meeting and met with a number of bank presidents. They said that they knew that the loans they were making had no foreseeable way of being repaid. But if they didn't make the loans, they explained, other bankers would do so. And making a bad loan was cost-free. They would turn around and sell it to a packager as quickly as possible, to get it off their own books.
There was no regulator for these packagers. And under Mr. Paulson's recent proposals, the Securities and Exchange Commission will be folded up, its regulatory powers taken away and given to a Fed that does not believe in applying whatever regulatory powers it has (as Mr Crook pointed out so clearly in yesterday's FT).
My second point is more serious. It concerns the Fed's statistics on real estate, specifically on land valuation. If a real estate bubble develops, this is where historical time series get out of whack first. The Fed uses good Census Dept. valuations for overall real estate. But then it uses a methodology that treats land as a "residual," after pretending that buildings increase in value by their "replacement cost," calculated by applying a construction-cost index.
For corporately owned real estate, this showed that all the land in the United States had a NEGATIVE value of $4bn in 1994. In fact, the land statistics were so embarrassing to the Fed under Mr Greenspan's tenure there that they stopped breaking them out separately. (One could calculate them by subtracting the building statistics from the total real estate.)
Six months ago the Fed avoided this embarrassment by incorporating corporate farms and finance into the "corporate" sector, so that the balance is now positive. The statistics show that corporate-held land is about 60 per cent of overall property value. But residential land is only 30 per cent - about $7 trillion instead of $14 trillion.
Bankers and economists take the Fed's data and adjust it for more realistic views. But Mr. Greenspan used this data to encourage homeowners to borrow against their homes to finance their consumption. He called this "equity withdrawal" and even "wealth extraction." But it wasn't the kind of wealth that Adam Smith wrote about in The Wealth of Nations. It was simply asset-price inflation. Everyone knew there was a bubble except, it seems, the maestro. He kept saying the economy was getting richer.
Until his last few speeches at the Fed, that is. The last few sounded pessimistic for the first time, with a flavor of "after me, the deluge."
What makes this discussion so important is that the financial sector paid a reported $400m dollars in 2007-08 to shape Secretary Treasury Hank Paulson's working group on (de)regulatory reform. The financial system is now at a turning point. Bankers have shown that they can't regulate themselves when they're making so much money by feeding the bubble.
Michael Hudson is distinguished professor of economics at University of Missouri (Kansas City),and chief economic adviser to Dennis Kucinich
Posted by: Michael Hudson | April 8th, 2008 at 2:14 pm | Report this comment- [ ] Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to [ ]
Posted by: FT.com | Willem Buiter's Maverecon | The Greenspan Fed: a tragedy of errors | April 8th, 2008 at 3:08 pm | Report this comment
- Xi Fang (Guest contributor): The central questions in this discussion are: first, what should be the objective of financial regulators; and second, what should and could they do to get closer to their objective?
Few would seriously dispute the usefulness of financial innovations, ranging from limited liability corporations to asset backed securities. However, given the very nature of innovation (to borrow from Taleb and Rumsfield) full of unknown unknowns financial failures, and periodically crisis, are inevitable. It's neither feasible nor desirable to prevent financial failures altogether. Ironically, the artificially low volatility enabled by regulators' effort in preventing crisis would sow the seeds of more devastating ones, as the current one could attest.
Therefore the objective of financial regulators should be to strike a sensible (or reasonable, or appropriate, or whatever phrase accepting the role of unknown unknowns and limitations of human rationality) balance between encouraging innovation and maintaining stability. Sensible decisions beg for human judgement and should not be judged ex post based on realised outcome only. Moreover, a wide range of decisions could be regarded as "sensible" at the same time, especially when the uncertainties are huge.
Once we have accepted that preventing financial crisis altogether should not be the objective and that perfectly reasonable and knowledgeable persons could have significantly different views on the best course of actions when facing uncertainties, we could see why many current criticisms on the imprudence of the Fed and Greenspan are unreasonable.
However, that does not mean the Fed and Greenspan, and the current financial regulations at large, are flawless and blameless. Something essential is largely missing in the rationality-paradigm-dominated current financial regulations the recognition of the role of psychology in the financial system.
Every crisis is different, but nearly every crisis is also the same the greed drives prices of assets ranging from tulip and houses to financial securities to unreasonable and unsustainable levels, and the fear drives all to rush for the exit at the same time. Although there have been a large (and some, if not all, reasonable people would treat as large enough) body of evidence ranging from the history of financial crisis to behaviour finance suggesting that the market could be driven by emotions to extreme states for substantial periods and that micro-level deviations from rational economic behaviour could lead to macro-level emerging properties in the complex systems like the financial markets unexplainable by the rationality paradigm which treats irrational (or more accurately, real human) behaviours simply as random (and mostly normal-distributed) and harmless deviations. Although market "failures" like information asymmetry, moral hazard, adverse selection, externalities have been buzz words in the current financial regulations, rarely has any serious thought been given to what if real human beings cannot process the information in the way predicted by the model.
Findings from behaviour finance like the importance of default options have already been used to design better policies to address other economic and financial issues such as organ donation and pension contributions, and it surely could help design a better regulatory system for the financial markets. I appreciate this subject is far less mature than the well-established rationality paradigm, but it's time for us to at least start experimenting. Every crisis brings new opportunities; let's hope this one would be no different.
Xi Fang is a consultant at Europe Economics
Posted by: Xi Fang | April 8th, 2008 at 3:35 pm | Report this comment- Lakshman Achuthan and Anirvan Banerji: A spirited debate is under way about how the US economy got into its current state, marked by a housing downturn, credit crisis and recessionary job losses. Searching for its antecedents, observers have concluded that the housing and credit bubbles guaranteed recession. But because this debate will influence policy for the next economic cycle, the right lessons must be learned from this series of unfortunate events. The debate so far has overlooked an essential point that this recession was actually avoidable as recently as several weeks ago. How could that be?
The Fed has rightly been lauded for its actions this year, but its initial delay is widely downplayed. Yet, because of well-known lags with which monetary policy affects the economy, they needed to be especially quick to act in the face of recession. Instead, as in the lead-up to the 2001 recession, inflation concerns based on backward-looking indicators needlessly inhibited its actions for far too long. This implies a fundamentally flawed approach because on average, inflation has peaked four months after the start of postwar recessions.
Yet, ECRI's forward-looking Future Inflation Gauge, a measure of underlying inflation pressures whose track record has been highlighted by independent analysts , was already in a cyclical downswing last summer. The Fed had a green light to slash rates that it failed to heed.
As the New Year began, The Economist noted, "One of the most reliable gauges is (ECRI's) weekly leading index This index correctly forecast the past two recessions and is now showing its weakest performance since the 2001 recession." But it also cited our view that "prompt policy stimulus could still avert a formal downturn."
Shortly thereafter, Fed chairman Ben Bernanke not only began aggressive monetary stimulus, but also endorsed quick fiscal stimulus, emphasizing that "it would not be window dressing." Apparently realizing that the economy was on the cusp of recession, he may have understood that only timely fiscal stimulus could save the day. Given the history of fiscal stimulus arriving too late to head off recession, how was that even possible? Because, for the first time, premature pessimism had created a unique opportunity for a self-correcting recession prophecy.
Prominent pundits have been predicting a US recession since 2005, when Hurricane Katrina hit an economy under assault from Fed rate hikes and oil price spikes, a combination that had triggered many a past recession. With the advent of the home price downturn, the gloomy chorus grew.
By early 2007, respected Wall Street analysts were predicting up to 100 basis points of rate cuts by year-end. By early June, faced with accelerating economic growth, they abruptly switched their call to zero rate cuts. The economy's unexpected resilience actually triggered the credit crisis by invalidating expectations of modest resets to subprime adjustable rate mortgages.
US growth plunged following the credit crisis, but the economy grew stubbornly through year-end. In fact, in 2007 US real GDP rose by 2.5 per cent, compared with 2.3 per cent in the eurozone. Still, persistent pessimism made the dollar swoon further, cementing an export-driven boost to manufacturing.
The drumbeat of downbeat commentary induced business managers to aggressively reduce inventories, cutting the inventory/sales ratio to a record low. This created a unique opportunity for policy stimulus to avert recession.
Typically, business managers, surprised by recession, face a Wile E. Coyote moment when the floor falls away and demand plummets. Stuck with soaring inventories, they slash production and jobs, thereby reducing income and spending, which in turn feeds back into lower sales, triggering further production cutbacks, perpetuating the vicious cycle that is the hallmark of recession.In every recession, the manufacturing sector accounts for the majority of job losses, largely due to such inventory cycle dynamics. But this time, with inventories cut to the bone, this key recession driver was absent. In fact, a sudden step-up in demand would have set manufacturers scrambling to ramp up production and hiring. A quick burst of stimulus would have been unusually potent even if only a fraction had been spent and quickly reversed the recessionary vicious cycle.
Policymakers seemed to get the urgency. In January, Treasury secretary Hank Paulson declared that "time is of the essence", House Speaker Nancy Pelosi spoke of "timely, targeted and temporary" stimulus, and the Administration and Congress enacted a tax rebate package with exemplary speed but designed it to reach consumers several months later! It was as if the medics had arrived and taken a quick decision to administer CPR in a few months.
It was certainly possible to devise innovative ways to get money to consumers in short order. Perhaps what doomed the effort is the received wisdom that fiscal policy is never timely.
A recession means many months of job losses that boost foreclosures, worsening the credit crisis. But if stimulus had reached consumers in weeks instead of months, it would have forestalled a recession, helping to stabilize the housing market. Such a soft landing would have bought some breathing room in which to resolve the credit crisis until the lagged effect of monetary policy kicked in.
Given the magnitude of the housing and credit bubbles, there was no way to avoid paying the piper once they had popped. But in this instance, resolving those excesses did not require a recession.
Arguably, in a market economy, recessions are cathartic. But this recession is causing unnecessary collateral damage to millions of innocent bystanders while making it politically expedient to throw far more money at the problem than was needed to avert recession in the first place. Therefore, this is a needlessly expensive recession of choice.
Alan Greenspan recently emphasized the non-linear shifts that occur at business cycle turning points, noting that "you don't gradually fall into recession, you jump". That is precisely why the timing of policy is so critical in the vicinity of turning points, and why state-of-the-art leading indicator systems, not standard econometric models, are needed to signal the approach of such tipping points.
In February, ECRI's leading index for the nonfinancial services sector, which accounts for five out of eight U.S. jobs, locked onto a recessionary trajectory. In effect, the 3am call on the economy had gone unanswered.
Lakshman Achuthan and Anirvan Banerji are the co-founders of the Economic Cycle Research Institute in New York, and the co-authors of Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy, published by Currency Doubleday
Posted by: Lakshman Achuthan and Anirvan Banerji | April 10th, 2008 at 2:06 pm | Report this comment- Manish Patel: It's astonishing that someone of Greenspan's experience continues to focus on quasi theoretical issues and quasi market conditions.
Three factors have led to the current situation: a) Securitisations (ABCPs) were supported by financial institutions (liquidity facilties), at extremely low risk charges. This enabled leverage which would not ordinarily have been available through regular lending on the banking book; b) subsequently, the appetite to lend grew; c) monetary expansion - I've included this to ensure that the economists don't miss out.
The consequent liquidity crisis, interbank or otherwise is simply a function of inadequate short term funding for numerous vehicles that have long-term liabilities.
The credit crunch therefore, is inevitable, the collapse even more accute. Price inflation and deflation can be created through such structuring, by mixing great practices with bad ones - that is, we mark to market/model exposures, revalue our collateral and keep on leveraging based upon incorrect risk factors (/pricing). Someone woke up, pulled the pin out of the sytem, the banks looked at the real risk (of the liquidity facilities), and guess what, they didn't like what they saw.
Manish Patel is managing director of MPCapital, a quantitative hedge fund, based in Mayfair, London
Posted by: Manish Patel - MPCapital | April 10th, 2008 at 5:54 pm | Report this comment- Mr. Greenspan is correct in stating that the role of regulators primarily involves "shutting the barn door after the horse has bolted". Almost certainly any regulator who correctly anticipated a bubble (or other issue) and successfully took corrective measures to deflate it, would be criticised for unnecessarily interfering with the free market, as there would be no tangible evidence of there have having been a problem in the first place.
There are appear to be at least four defining lessons from the current financial crisis, only one of which indirectly implicates Mr. Greenspan as bearing partial responsibility:
First, that diversification only works if one is truly diversified, i.e. a portfolio of AAA subprime CDOs provides a diversification score of 1.0, as all of the subprime CDOs are exposed to the same systemic risk, namely, price declines in the U.S. housing market;
Second, that the Tier 1 capital (or functional equivalent) held by certain investment banks and other financial institutions (e.g. Bear Stearns and Carlyle Capital Corp.) has proven to be inadequate to provide liquidity during periods of extreme market volatility AND that the types of securities held as Tier 1 capital has been defined too broadly (e.g. bonds issued by Fannie Mae and Freddie Mac that do not have an explicit U.S. Government guarantee.);
Third, that most financial institutions, including investment banks, SIVs and hedge funds have relied too heavily on short-term debt to finance long-term assets, to take advantage of the arbitrage on the yield curve (while it existed) and on short-term vs. long-term credit spreads, thereby further compounding their financial risk;
Fourth, that the rating agency default models will only provide accurate ratings if the model assumptions are consistent with the characteristics of the underlying securities, i.e. the underwriting standards for sub-prime mortgages were much lower than for conforming mortgages and therefore the default assumptions for sub-prime mortgages should have been significantly higher.
I believe that Mr. Greenspan is fundamentally correct that monetary policy (i.e. the level of the Federal Funds Rate) had a relatively limited impact in creating the sub-prime bubble, although it is undeniable that it had some accelerating effect, as Mr. Greenspan himself accepts. The larger issue, and this is where Mr. Greenspan indirectly bears partial responsibility for the current situation, is that largely unregulated financial institutions have taken critical roles in the working of the financial economy of the United States. The proliferation of securitization vehicles whose fundamental economic and financial assumptions went untested by regulators and who had no formal equity capitalization requirements, is analogous to that of a power grid supplied by nuclear power stations - when they run smoothly, one barely notices their presence, except to enjoy the cheap power, however, when they melt down, everyone within range is showered with highly toxic radioactive waste. As I understand the argument put forward by Mr. Greenspan against regulating such entities, because they exclusively sell their packaged securities to sophisticated market participants, caveat emptor should prevail, as the market has a superior ability to assess risk and price risk than a regulator. From my perspective, there are two flaws in this argument, first, the lack of transparency inherent in an unregulated private securitization vehicle actively disadvantages investors in enabling an accurate assessment of the risks, as has clearly happened in the current situation, and second, those sophisticated market participants are themselves critical components of the U.S. financial economy and therefore their insolvency or failure comes at a cost to the economy and/or the taxpayer at large.
This is perhaps best illustrated by comparison with another sector of the energy industry, namely utility and non-utility power generators. Although non-utility power generators are not regulated by state electric regulators, ALL power generators within a state are subject to the same federal and state environmental regulations. It is inconceivable that a non-utility generator should be exempt from air emissions regulations, even if it only sells power to sophisticated market participants. Why? Due to the significant societal impacts of allowing a power plant to emit any amount of SOx, NOx, Mercury, Arsenic, etc. The issue of whether a power plant is owned by a regulated utility or an unregulated non-utility generator is irrelevant for environmental regulation, as they both perform the same task and produce similar pollutants. In my opinion, this applies equally to the situation with Fannie Mae and Freddie Mac versus mortgage securitization vehicles. One group is regulated, the other is not, but they both perform the same task and produce similar securities.
If applied correctly, regulation can enhance the transparency and efficiency of markets. It can also act as a buffer, to prevent the worst excesses of markets from damaging the economy at large. Mr. Greenspan's words as Chairman of the Federal Reserve carried a significant weight against regulation of the hedge fund and securitization universe and I believe that this is the area where we need to examine his legacy, not his monetary policy decisions, which I suspect no mere mortal could have done better.
Posted by: Mark Miles, New York | April 10th, 2008 at 11:36 pm | Report this comment- Richard Werner: Alan Greenspan argues that "the evidence that monetary policy added to the [US] bubble is statistically very fragile". To the extent that he refers to evidence provided by counter-factual simulation models, I would agree. But the evidence of factual work is clear: Regulatory and monetary policy are practically the only two factors responsible for the creation as well as the nature of the aftermath of financial bubbles, and among these two, monetary policy is the more important.
Yet Dr Greenspan rightly criticizes counter-factual analysis. Indeed, too much of economics is based on counter-factual assumptions that bear no relationship to the realities of this world. Such as the assumptions of perfect information, instantly adjustable prices, no transaction costs, complete markets and so on. That is why it is necessary to build models and theories on firm empirical and factual foundations. But if we leave the economists' neverland of perfect information and step into the real world, we find that markets do not clear. This is worse than the widely acknowledged existence of 'market failures' it means that markets in reality operate by quantity rationing, whereby the short side dictates the quantity transacted. In the case of money due to its usefulness there is always excess demand for it so that the suppliers control its allocation. Money is supplied by commercial banks through the process of credit creation. They effectively make allocation decisions akin to Soviet central planners with the difference that they are not concerned with the overall benefit to the country or national policy, but only their narrow short-term self-interest. Recent banking problems remind us of the reality that banks' un-coordinated, short-sighted and self-interested credit allocation plans do not deliver the most beneficial possible outcome to society.
Dr Greenspan further maintains that regulators cannot feasibly act preemptively to prevent bubbles and that no such attempt has ever been successful. This is also not true. For instance, there has never been a housing bubble and bust or systemic banking crisis in Germany under the Bundesbank's watch. There are examples from other countries of decades of prudent and preemptive regulatory and monetary policy. Such policy includes restricting loan-valuation ratios and monitoring bank lending for non-GDP transactions, especially in the real estate market, and giving banks incentives to limit or reduce such lending when it threatens to rise disproportionately.
This is neither difficult to grasp nor to implement. So isn't the truth of the matter that Dr Greenspan like the central bankers in the UK and many other countries purposely chose not to take such prudent policies, because he was happy with the asset bubbles and their consequences, which seemed to suit his particular priorities? The conclusion, then, is that we need to make sure that central bankers are kept on a tighter leash and given the right goals and incentive structures such as in the case of the Bundesbank to look after the interests of the majority, not just a minority of bankers and speculators.
Professor Richard
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naked capitalism
Henry Kaufman, former chief economist of Salomon Brothers in its heydey and a Wall Street eminence grise, joins the chorus of critics who said that the Fed's failure to regulate got us into our economic mess.
Note that Kaufman is not new to this theme, just more blunt, as a post from June of last year, "Henry Kaufman Takes the Fed to the Woodshed," attests.
From the Financial Times:
Henry Kaufman, the distinguished Wall Street economist, has added his voice to the debate about the Federal Reserve's role in the credit crisis, saying the central bank failed to give enough importance to its role as a regulator.In a video interview with the Financial Times, Mr Kaufman criticised the Fed's monetary policy. He said it allowed too much credit expansion over the past 15 years and that this contributed to the market turmoil.
"Certainly the Federal Reserve should shoulder a substantial part of this responsibility. . . it allowed the expansion of credit in huge magnitudes," Mr Kaufman said.
"Besides its monetary policy approach, [the Fed] really indicated very clearly that it was performing its role as a supervisor . . . in a minute fashion, not in an encompassing fashion. Monetary policy had a high priority, supervision and regulation within the Fed had a smaller priority."
Mr Kaufman, who is on the board at Lehman Brothers, has long advocated tougher regulation of the biggest financial firms, arguing that they need to be made "too good to fail", rather than remain "too large to fail"....
Mr Kaufman said a distinctive feature of the financial crisis was "much greater lapses in official supervision and regulation than in earlier periods".
He said there should be a new federal regulator appointed who would work with the Federal Reserve but who would have responsibility for "intensively" regulating the 30 or 40 biggest financial firms. Failure to do so could lead to a "crisis that's bigger than the one which we have today".
"The supervision of major financial institutions requires deep skills in credit, deep skills in risk analysis techniques and it requires within that organisation, very skilled, trained professional people," Mr Kaufman said. "That is lacking in the supervisory area in the United States."
He added that recent proposals from Hank Paulson, secretary of the US Treasury, to overhaul US regulation "lack focus". "There is going to be some reform of financial supervision and regulation; hopefully it will be along my lines rather than the big compendium of suggestions that came out of the US Treasury", he said.
- Comments
- Anonymous said...
- Re: Fed's "role as a regulator", that is a joke! They play politics and Greenspan was like a grandfather with soothing verbage like frothy, but never did you see The Fed regulate! You did however, see Greenspan pump the notion of ARMS and subprimes as he backed the housing bubble, with his fellow crooks!
The Fed Had All It Needed to Avoid Crisis
April 14, 2008; Page A13http://online.wsj.com/article/SB120813709440711857.html?mod=googlenews_wsj
Re: The failure of the Fed to exercise even a minimal standard of prudent regulatory responsibility has been attributed to the opposition of former Chairman Alan Greenspan to interfering with the market process. Yet the chairman was only one of seven members of the Board of Governors and did not have the power to override the wishes of the other six, had they voted to take a strong stance against some of the most egregious practices. The only Fed governor who appears to have comprehended the magnitude of the issue was Edward Gramlich who, unfortunately, was suffering from a terminal illness.
- April 14, 2008 2:43 AM
- Jojo said...
- These guys are all part of the same 'ol boy network. How can anyone expect independent thought/action that would impact their relationships and potential future livelihood?
The only thing that might work is some sort of penalty to be assessed if their decisions prove wrong on review. Maybe public stoning?
- April 14, 2008 4:13 AM
- TallIndian said...
- Surely, LEH is an innoncent victim (collateral damage, if a pun be allowed), of the evil Dr. Greenspan.
Wise old men on, such as those on the board of LEH, were speaking up lo these many years about the dangers of leverage and the corruption of the ratings agencies.
Wise old men, such as thsoe on the board of LEH, strenoulsy criticized the use of FED discount window to prop up over-leveraged investment banks.
Hypocricy thy name name Henry.
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HaloScan.com
Related, from the Financial Times
http://blogs.ft.com/wolfforum/20...itics/#more- 124
Alan Greenspan: A response to my critics
from the comments:
"Willem Buiter: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.The Greenspan Fed (August 1987 January 2006) did contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
The Greenspan Fed brought us the Greenspan put (now the Greenspan-Bernanke put). This is the aggressive response of the official monetary policy rate to a sharp decline in asset prices (especially stock prices), even though the asset price declines (a) are unlikely to cause future economic activity to decline by more than was required to meet the Fed's triple mandate and (b) do not convey new information about future economic activity or inflation that would warrant interest rate cuts of this magnitude.
To me, this indicates that the Fed has been co-opted by Wall Street - the Fed has internalised the objectives, concerns, world view and fears of the financial community to an excessive degree. This socialisation into a partial and often highly distorted perception of reality is unhealthy and dangerous.
The Greenspan Fed failed to appreciate the downside of rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for the undoubted virtues of securitisation.
The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
The Greenspan Fed, by enabling the rescue of Long-term capital management in 1998, acted as a moral hazard incubator. Both before and after LTCM, the Greenspan Fed failed to press for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail. This demonstrates either bad judgement or regulatory capture. The moral hazard-fraught rescue of Bear Stearns is the lineal descendant of the LTCM bailout.
During his years as Chairman of the Federal Reserve Board, Alan Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator.
Mr Greenspan consistently saw but half the picture when it came to what makes competitive market capitalism work. He recognised the central roles of greed, self-interest and competition. He failed to appreciate the complementary roles of non-strategic/opportunistic forms of altruism, honesty, trustworthiness, solidarity and cooperation.
He emphasized self-regulation, spontaneous order and the disciplining effect of reputation. He did not understand the weakness of reputational concerns as a (self-)enforcement mechanism ensuring good behaviour, when credible commitment is, at best, limited in a world with short horizons and easy exits.
He failed to appreciate the essential role external/third-party (i.e. state) enforcement of laws, rules and regulations, and the indispensability of collective action when faced with the threat of the breakdown of trust and confidence.
By overselling, at home and all over the world, the virtues of American-style transactions-based financial capitalism and light-touch regulation, Mr. Greenspan has done more to harm the cause of decentralised, competitive market-based financial systems based on private ownership, than even Charles Ponzi.
Alan Greenspan's period as Chairman of the Board of Governors of the Federal Reserve System represents to me the nadir of central banking in advanced economic-financial systems during modern times. While monetary policy was only mildly incompetent, the regulatory failures were horrendous. The US and the world economy will pay the price for Mr Greenspan's misjudgements and errors for years, perhaps decades, to come."
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Anonymous writes:
Greenspan is such a slut whoring himself out to a hedge fund that deals with economic distortions and witchcraft. It should be policy to not allow a Fed or member of the government to work in a corporation that can use retired employees like Greenspan. In this era of national security why is he allowed to whore himself out with the inside info he has been exposed to? It's absurd for him to be a slut and dance naked before wall street....pathetic and unethical!
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Bloomberg.com
More about Greenspan here in Bloomberg and here in the FT (the FT oped is referenced in the Bloomberg piece). He really comes off as a smug, self-serving jerk.
April 8 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the drop in U.S. home prices will probably end ``well before'' early next year as the number of houses on the market diminishes, aiding an economic rebound.
``It will not be until early 2009 that we will get close to having eliminated most of this'' home inventory, Greenspan told a conference in Tokyo today sponsored by Deutsche Bank AG and co-hosted by Bloomberg LP. ``But it is very likely that home prices will stabilize well before that.''
Greenspan added that the extent of damage stemming from the collapse of the subprime-mortgage market won't be known for months. He described the credit crisis as the worst in 50 years, echoing the assessment of International Monetary Fund economists.
``You won't see asset markets recover until housing prices stabilize,'' said Glenn Maguire, chief Asia-Pacific economist for Societe Generale SA in Hong Kong. ``If Greenspan is correct, you'll see weakness in the economy through 2008.''
The yield on the 10-year Treasury note fell 1 basis point to 3.53 percent as of 10:19 a.m. in New York, according to bond broker Cantor Fitzgerald LP.
Greenspan's successor, Ben S. Bernanke, and other Fed officials have highlighted declining home prices as a major economic risk that may further hurt household wealth and consumer spending.
`Slow, Hesitant Recovery'
``Once the markets start to stabilize, especially if the real economies don't go into a severe recession,'' then ``we can expect a recovery to begin to take place,'' Greenspan, 82, said via satellite from Washington. ``It will be slow, it will be hesitant.''
The health of the U.S. housing market is tied to broader financial markets that rely on bundling mortgages to sell as securities, Greenspan said. The median price of an existing single-family home dropped 8.7 percent in February from a year earlier, the most in four decades of record keeping, according to the Chicago-based National Association of Realtors.
``Have we reached a point where prices are stable? We cannot know that for a couple of months,'' Greenspan said. ``It looks as though we're going to get a very large rate of liquidation, but not until the second half of this year.''
The number of Americans signing contracts to buy previously owned homes declined more than forecast in February. An index of signed purchase agreements decreased 1.9 percent to 84.6, the lowest reading since records began in 2001, the NAR said today. The drop follows a revised 0.3 percent increase in January.
Inflation Pressure
Greenspan said inflation will be contained during the current slowdown before picking up as the world economy recovers.
``It's difficult to imagine any major breakout of inflation as economic slack continues to increase,'' he said. ``What we will see is gradually rising inflationary pressures that will probably be subdued during the current period of slack, but that will surely reemerge when economies pick up.''
Greenspan spoke via satellite from Bloomberg Television's studio in Washington, answering questions from Peter Hooper, chief economist at the securities unit of Deutsche Bank, which hired Greenspan as a consultant in August.
Policies Criticized
Greenspan, who retired in 2006 after 18 years as the U.S. central-bank chief, has come under increasing criticism for his policies as last year's subprime-loan meltdown spread into a broader financial crisis. One recent book, ``Greenspan's Bubbles'' by money manager William Fleckenstein, argues the former Fed chief helped inflate stock and home prices.
In response to the bursting of the Internet and technology bubble and the Sept. 11 terrorist attacks, Greenspan lowered the Fed's key rate in 2001 from 6.5 percent to 1.75 percent, then reduced it further in 2003 to 1 percent, a 45-year low.
He left the rate there for a year before starting to raise borrowing costs in quarter-point increments, leaving it Bernanke to decide when to stop. Some Fed critics, such as Bear Stearns Cos. economist John Ryding, say rates were too low for too long, encouraging the easy credit that helped inflate a housing bubble and has now returned to burn investors.
Greenspan, who published his memoir ``The Age of Turbulence'' in September, has taken to defending his legacy in newspaper articles.
`Very Fragile'
Yesterday, in a Financial Times piece headlined ``The Fed is blameless on the property bubble,'' Greenspan wrote that the evidence is ``very fragile'' that Fed interest-rate policy added to the U.S. bubble and that ``it is not credible that regulators would have been able to prevent the subprime debacle.''
``I was praised for things I didn't do,'' Greenspan said in a Wall Street Journal interview published today. ``I am now being blamed for things that I didn't do.''
Greenspan said today that ``the current credit crisis is the most wrenching in the last half century and possibly more.''
Bernanke, 54, told Congress last week that the U.S. economy may contract in the first half of 2008 and for the first time acknowledged the chance of a recession.
Later today, the Fed releases minutes of its March 18 interest-rate decision and any other conference calls in February and the first half of March. The Federal Open Market Committee that day lowered its benchmark rate by 0.75 percentage point to 2.25 percent, capping 3 points of cuts since September.
To contact the reporters on this story: Scott Lanman in Washington at [email protected]; Lily Nonomiya in Tokyo at [email protected]
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Sep 26, 2007 | uk.reuters.com
(Bernd Debusmann is a Reuters columnist. The opinions expressed are his own)WASHINGTON, Sept 26 (Reuters) - Alan Greenspan, the anti-war U.S. left, virtually the entire Arab world, and Osama bin Laden have something in common: they think the war in Iraq is mainly about oil.
The former Federal Reserve chairman's view is expressed with such crystalline clarity, on page 463 of his just-published memoir, that it's hard to believe it comes from the same man whose convoluted utterances on the U.S. economy drove to the edge of despair market professionals paid to decipher them.
But there's nothing ambiguous about this: "I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil."
This is remarkable language from a life-long Republican deeply embedded in a Washington establishment whose members, from either party, do not find it convenient to ascribe selfish motives to the U.S. use of force.
Military intervention is acceptable, of course, to remove tyrants, spread democracy, bring freedom to the oppressed, or save the world as we know it from annihilation by weapons of mass destruction.
Among the Washington power elite, publicly using the word "oil" in connection with the war in Iraq is a bit like talking about bodily functions at a formal dinner party.
It is best avoided, which made Greenspan's statement all the more startling.
Subsequent "clarifications" brought back some of his customary convolution - oil wasn't the only motive but, yes, oil security is critically important - but no change in the substance. Administration spokesmen shrugged off the remark.
PERCEPTION IS REALITY
Much of the Arab world saw oil as the driving factor of the Bush administration's Iraq policies even before the 2003 attack.
Those who had doubts lost them in the chaotic first post-invasion days when U.S. troops guarded the Ministry of Oil and the Ministry of Interior and stood by as looters picked bare and torched official buildings all over the city and ransacked Iraq's national museum.
Perception is reality, as they say on Wall Street, where Greenspan honed his economic expertise. The American tanks that blocked every entrance to the sprawling oil ministry provided an image that stuck.
The millions around the world who had demonstrated against the war, many hoisting placards that said "No Blood For Oil", felt vindicated.
For al Qaeda and the mass murderer who masterminded the attacks on New York and Washington, it was a propaganda windfall.
Osama bin Laden repeatedly asserted, the last time in a video made to mark the sixth anniversary of September 11, that the American design all along had been to replace Saddam Hussein "with a new puppet to assist in the pilfering of Iraq's oil."
Osama's campaign to portray America as an oil-hungry aggressor predated the Bush administration: in 1997 he said that "The U.S. is increasing its presence in Arab countries to capture their oil reserves."
Future generations of historians might discover what really prompted George W. Bush to attack Iraq rather than focus the vast resources of the U.S. intelligence and military machines on hunting down bin Laden "dead or alive," as the president promised after the September 11 attacks.
Meanwhile, the "war over oil" perception is one of the reasons why the United States has made no progress in polishing its tarnished image around the world.
"Anti-Americanism is extensive," notes the latest global attitude survey from the Pew Research Center, and the U.S. image "remains abysmal in most Muslim countries."
EMPIRE IN DENIAL
In a string of interviews following the publication of his memoir, The Age of Turbulence, Greenspan didn't elaborate why he thought it was "politically inconvenient" to talk about oil. My theory: it conflicts with America's image of itself.
Most Americans tend to see their country as a force for good in the world, holding a special place and offering a shining example of freedom and opportunity. Large parts of the world, in contrast, see the U.S. as an empire driven, like others before it, by self-interest and economic imperatives.
The Scottish historian Niall Ferguson calls the United States an "empire in denial" and says it should act like one, with the patience and perseverance necessary to end what it starts, for example staying in Iraq for 40 years or more.
No such ideas from Greenspan, but a chapter in his book lays out in stark detail just how beholden the United States is to oil, how far it is from the energy independence declared as a goal by a long string of presidents, and how profligate Americans are in burning up oil.
One out of every seven barrels consumed worldwide is burned up on American highways, according to Greenspan, and heavy trucks alone account for as much petroleum as all of Germany.
One fact worth noting: if the war is about oil supplies, success so far is scant. Before the invasion, Iraq pumped 2.5 million barrels a day. Now, it produces 1.9 million bpd. (You can contact the author at [email protected])
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Feb 28, 2008 | foreignpolicy.com
Think Again: Alan Greenspan
January/February 2005U.S. Federal Reserve Board Chairman Alan Greenspan is credited with simultaneously achieving record-low inflation, spawning the largest economic boom in U.S. history, and saving the world from financial collapse. But, when Greenspan steps down next year, he will leave behind a record foreign deficit and a generation of Americans with little savings and mountains of debt. Has the world's most revered central banker unwittingly set up the global economy for disaster?
"Greenspan Is Responsible for the U.S. Economic Boom of the 1990s"
Only in part. The United States experienced an extraordinary period of prosperity in the 1990s. Between 1993 and 2000, 21 million new jobs were created in the United States, and in 2000 the country's unemployment rate briefly dipped below 4 percent for the first time in 30 years. During this boom, the U.S. economy grew at nearly 4 percent a year, adding more than $2 trillion to real U.S. gross domestic product (GDP)-more than the annual output of France.But many stars aligned to produce that outcome, not just good monetary policy on the part of Greenspan's Fed. For starters, a judicious focus on fiscal discipline by former President Bill Clinton's administration brought the budget deficit under control. The Clinton administration managed to lower the deficit every year between 1993 and 1997. By 1998, there was a surplus that lasted until 2001. The 1990s also saw a powerful wave of corporate restructuring and technological change. Together, these two forces set the stage for sustained low inflation and a powerful acceleration of productivity and employment growth.
Greenspan's leadership in monetary policy undoubtedly played an important role in fostering the conditions that allowed the U.S. economy to surge in the 1990s. The chairman helped achieve the economy's high-performance potential during that time period. But no one should believe that the economic boom of the 1990s was the work of just one man or just one monetary policy.
"Greenspan Defeated Inflation in the United States"
No. Credit for breaking the back of double-digit inflation goes to Paul Volcker, Greenspan's tough and courageous predecessor. In the summer of 1979, when Volcker assumed the reins at the Federal Reserve, inflation was raging at 12 percent a year. Eight years later, when Alan Greenspan took over, the inflation rate stood at around 4 percent. During Greenspan's 17-year era, inflation slowed further to 2.5 percent per year. But 80 percent of the drop in inflation occurred under Volcker's stewardship at the Fed.
True, Volcker put the United States through its worst recession in modern times. It was the only way to unwind the destructive interplay between wages and prices that drove U.S. inflation. Greenspan's major challenge was to finish the job Volcker started. That was no easy task, and Greenspan's successes should not be minimized. In only one of Greenspan's 17 years at the Fed (1990) did inflation move above 5 percent; in 11 of those years, inflation was 3 percent or lower.
But there were serious complications along the way, not least of all a dangerous flirtation with outright deflation, or an overall decline in the price level, in early 2003. This problem resulted from Greenspan's biggest gamble-a willingness to push U.S. interest rates to extremely low levels during a period of rapid economic growth. The move gave rise to the destabilizing stock market bubble of the late 1990s, a speculative excess unseen in the United States since the roaring 1920s. The bursting of that bubble in early 2000 transformed an orderly disinflation (i.e., when inflation merely decelerates) into a close call with actual deflation.
"Greenspan Rescued the United States from a Stock Market Meltdown"
Maybe, but at what cost? In early 2004, Greenspan gave a speech to the American Economic Association, arguing that the Fed should feel vindicated in its efforts to contain the 2000 stock market shakeout. By slashing the federal funds rate-the interest rate at which the Fed lends money to other banks-by 5.5 percentage points between January 2001 and June 2003, the Fed limited the severity of the recession that followed the burst of the bubble.
That cure may cause bigger problems down the road. Bubbles have developed in other asset markets (especially corporate bonds, mortgage-backed securities, and emerging-market debt). And Greenspan's rock-bottom interest rates have led to the biggest bubble of all: residential property. Annual inflation in U.S. home prices is now running at a 25-year high of 8.8 percent, with 15 states experiencing double-digit increases in residential property values between mid-2003 and mid-2004.
At the same time, the home-buying and consumption binge has put individual Americans deeply in debt. Greenspan takes comfort that rising home values compensate for increased borrowing, but that rationalization assumes a permanence to rising property prices that belies the long history of volatile asset markets. So far, the Fed and debt-addicted U.S. homebuyers have bucked the odds. Over the last four years, debt accumulated by U.S. families was 60 percent larger than overall U.S. economic growth. Many households in the United States now spend near record-high portions of their monthly incomes on interest expenses, leaving consumers in a precarious position should either interest rates increase or the growth in incomes slow.
History shows that central banks aren't always able to cope when bubbles burst. That was the case with the Bank of Japan in the 1990s, after the Japanese stock and property markets collapsed, and it could still be the case in the United States today. The United States dodged a bullet when the stock market tanked in early 2000. There are no guarantees that highly indebted Americans will be as lucky the second time around.
"Greenspan Saved the World from the 199798 Asian Financial Crisis"
False. Time magazine devoted its February 1999 cover to the "Committee to Save the World." Featured were then U.S. Treasury Secretary Robert Rubin, then Deputy Secretary Lawrence Summers, and Greenspan, all celebrating the end of the worst global financial crisis in more than 60 years. In truth, the world weathered the Asian financial storm only to chart increasingly dangerous waters in the years that followed.
Global economic imbalances have intensified dramatically since 1999.
The United States' gaping current account deficit says it all-$665 billion in mid-2004, equal to a record 5.7 percent of U.S. GDP. Never in history has the world financed such a massive deficit. The United States is sucking up more than 80 percent of the world's surplus savings, requiring capital inflows that average $2.6 billion per business day. And the U.S. deficit is bound to get worse before it gets better.
This huge balance-of-payments gap reflects major disparities between global savings and consumption. A savings-starved U.S. economy is living beyond its means, while Asia and, to a lesser extent, Europe, are plagued by low consumption and high savings. Consequently, the United States is now the world's consumer of last resort. Asian economies, by contrast, are more prone to save and rely on export-led growth strategies, and they are unwilling or unable to stimulate domestic private consumption.
The result is an enormous buildup of U.S. dollars held by Asian nations (more than $2.2 trillion in mid-2004, or twice Asia's holdings in early 2000). These countries then recycle this cash back into the United States by buying U.S. Treasuries. This process effectively subsidizes U.S. interest rates, thus propping up U.S. asset markets and enticing American consumers into even more debt. Awash in newfound purchasing power, Americans then turn around and buy everything from Chinese-made DVD players to Japanese cars.
This is no way to run the global economy. Asia and Europe are increasingly dependent on overly indebted U.S. consumers, while those consumers are increasingly dependent on Asia's interest-rate subsidy. The longer these imbalances persist, the greater the likelihood of a sharp adjustment. A safer world? Not on your life.
"Greenspan Was Alone in Foreseeing the Productivity Revolution"
Yes. In the early 1990s, when the United States was mired in a productivity slump, Greenspan was largely alone in believing that an important shift was at hand. He was right. Worker productivity in the United States grew 3 percent a year between 1996 and 2003, double the anemic 1.5 percent annual increase of the preceding 20 years.
The productivity breakthrough had a profound impact on the performance of the U.S. economy, as well as on Greenspan's command of monetary policy. High-productivity economies can withstand rapid growth without an increase in inflation. So, as U.S. productivity climbed in the late 1990s, Greenspan boldly let the economy fly without raising interest rates. Investors, of course, were thrilled with Greenspan for not standing in the way of rapid economic growth. The stock market bubble of the late 1990s (which he initially warned of, but later ignored) reflected this exuberance. As Greenspan said in early 2000, "When we look back at the 1990s. [w]e may conceivably conclude [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."
Within two months of that statement, the stock market collapsed, but the productivity miracle did not. Whether it will endure, though, remains an open question. Most U.S. businesses have an advanced it infrastructure. The lack of new corporate hiring and the sharp falloff in business expansion point to ever more hollow American corporations. Moreover, the pendulum is now swinging back toward greater government regulation, further constraining corporate risk-taking. The drivers of the productivity miracle of the past eight years may not be sustainable, after all.
"Greenspan Spells a Strong Dollar"
Not necessarily. Until recently, the dollar has generally been stable during Greenspan's 17-year tenure, a noteworthy accomplishment for any central banker. An exception came in 1994 and early 1995, when the dollar weakened sharply, only to regain its strength in the latter half of the 1990s.
But the dollar's past may not be prologue. Global imbalances-underscored by America's record balance-of-payments gap-are best corrected through a cheaper dollar. A cheaper dollar means higher U.S. interest rates, which in turn will suppress U.S. spending and enable a long overdue rebuilding of national savings. Conversely, other currencies will strengthen, forcing the export-led economies of Asia and Europe to embrace long-overdue reforms, including lowering tariffs and making labor markets more flexible.
Today, even Greenspan acknowledges that the world needs a weaker dollar. That's the verdict from America's record (and rising) current account deficit and from Asia and Europe's excess dependence on exports. The hope, of course, is that the dollar experiences a "soft landing," a gentle descent over several years. But in light of the massive U.S. current account deficit, the risk of a hard landing is all too real. The more the current account deficit grows, the greater the odds of an abrupt adjustment. The dollar may be an accident waiting to happen, with a sharp decline in the greenback raising the possibility of collateral damage to stocks, bonds, and price stability. Given the central role the United States plays in driving the world economy, any shock "made in the U.S.A." could reverberate around the world.
"Greenspan Leaves the U.S. Economy in Good Shape for the Future"
The jury is still out. By congressional mandate, the Fed's goals include price stability, full employment, and economic growth. Greenspan's Fed has made progress on all three.
However, some unintended consequences of Greenspan's efforts may jeopardize the United States' long-term economic future. Consider the profound shortfall in U.S. savings. The United States' net national saving rate-the combined saving of households, businesses, and government-fell to 0.4 percent of national income in early 2003, and it has since risen to just 2 percent. Lacking in domestic savings, the United States must import savings from abroad and run massive current account deficits to attract that capital.
Greenspan shares some blame for this problem. It all goes back to the asset economy, his often-expressed belief that financial assets can play an important role in sustaining the U.S. economy. He made that argument in the late 1990s when stock prices went to new highs, and he reiterated it recently with regard to surging home prices.
The catch is, people interpret Greenspan's analysis as advice. So individuals view the appreciation of their home as a proxy for long-term saving and are therefore less inclined to save the old-fashioned way-by putting away cash from their paychecks. This scenario sets U.S. citizens apart from those in most other Western economies. Only in the United States are people aggressively tapping the savings in their homes (through mortgage refinancing) to finance current consumption.
Moreover, the rapid buildup of debt, both domestic and foreign, leaves a savings-short U.S. economy in precarious shape. The problem is compounded by the 77 million aging baby boomers, now approaching their retirement years, when they need savings more than ever. To the extent that Greenspan has condoned asset-based savings (homes) in lieu of income-based savings (cash in the bank), he has unwittingly compounded the United States' most serious long-term problem.
"Greenspan Is Politically Independent"
Yes, but Unfortunately, the Federal Reserve is located in Washington, D.C. That thrusts its chairman into the political arena and has led to some indelicate episodes for Greenspan over the years, including his endorsement of the Bush administration's 2001 tax cuts as the wisest way to spend the government's budget surplus-a surplus that has now disappeared into thin air.
Despite such momentary lapses, there is no evidence that Greenspan has politicized U.S. monetary policy. Although Greenspan is a Republican (he first entered public service as an advisor to President Gerald Ford in 1974), he had no compunction in raising interest rates on GOP administrations, including the current one, at inopportune times. Over the years, Greenspan has been critical of fiscal policies pursued by Democrats and Republicans alike.
But with Greenspan, the line between politicization and policy activism is blurred. There is no mistaking Greenspan's aggressive stance on several key issues driving financial debates and policy. In early 2000, Greenspan made a strong (and ultimately wrong) case for why there wasn't a stock market bubble. More recently, he minimized the immediacy of the United States' current account deficit problems and played down the risks of an oil shock. And, in October 2004, he dismissed concerns over the United States' excess household debt.
The sheer weight of Greenspan's point of view can bear critically on financial markets and the real economy. To the extent that his intellectual activism aligns with Fed policies, investors tend to take Greenspan's messages too far. This tendency compromises his position as an independent central banker. Moreover, his recent role as a cheerleader for policies such as tax cuts compounds already serious imbalances and imparts a pro-growth bias to his central banking philosophy that could make the endgame all the more treacherous. That was the case with stock buying in the late 1990s and could well be the case today in condoning the household debt binge, overvalued property markets, and Asian demand for U.S. Treasuries. Greenspan's stances may not be political-nor may they be prudent.
"It Will Be Difficult to Replace Greenspan"
Hardly. Alan Greenspan's term as a member of the Federal Reserve Board of Governors expires on the last day of January in 2006, at which time he is required to step down. When he does, Greenspan will have served as chairman for more than 18 years under four different presidents, making him the second longest-serving chairman since the founding of the Fed in 1914.
There is understandable apprehension over the transition to new leadership at the Federal Reserve. Business leaders, politicians, and investors expressed similar concerns when the Volcker era came to an end in the summer of 1987. "There is concern in Washington," Paul Glastris reported in the Washington Monthly in 1988, "that Alan Greenspan sees himself as the new Paul Volcker and that he may seriously damage the economy." Yet, aside from a small flutter in the financial markets, the U.S. economy barely skipped a beat when Greenspan replaced Volcker. Shepherding the world's most dynamic economy is not a personal accomplishment. It has more to do with the interplay between markets, consumers, businesses, politicians, and policymakers than any cult of personality a Fed chairman may or may not have.
A key challenge for Greenspan's successor will be rebuilding private-sector savings. It's a critical step if the United States is to close its balance-of-payments deficit and an essential insurance policy for an aging population of baby boomers nearing retirement. Although prudent fiscal policy and budget deficit reduction by the U.S. Congress will be part of any fix, the Fed's monetary policy can also play an important role in fostering a long overdue improvement in national savings.
At the same time, the next Fed chair must be a true internationalist-facing the increasingly daunting challenges of globalization. The United States has enjoyed an unprecedented dominance of the global economy since the mid-1990s. But, like U.S. geopolitical hegemony, its economic dominance is unlikely to last. The next Fed chairman will have to walk a delicate line between domestic imperatives and the challenges posed by other players in the global economy.
History cautions against rendering a premature verdict on the accomplishments of any one economy, or any one central banker. When Alan Greenspan arrived at the Fed in the late 1980s, Japan and Germany dominated the world economy, and the United States was down and out. Over the last 20 years, the fickle pendulum of economic prosperity swung the other way, as the United States redefined the very concept of global economic leadership. Greenspan will be a tough act to follow. But his success was as much an outgrowth of history as it was a reflection of any one person.
Stephen S. Roach is chief economist at Morgan Stanley.
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Sep 17, 2008 | The Guardian
If the mistakes that have collapsed the world's financial markets had been made by statesmen and had led to war, there would be corpses swinging from lampposts. If they had been made by generals, they would be falling on their swords. If they had been made by judges or surgeons or scholars, some framework of professional retribution would be rolling into action. But those responsible for our finances can apparently vanish into the forest like Cheshire cats, leaving only gold-plated grins. Not for them a Hague tribunal or a Hutton inquiry. They are not just good at shedding risk - they shed blame.
We are seeing what historians of ideas call a paradigm shift. In the last century, the necessities of war and the rise of socialism thrust government intervention to the fore. When that failed in the 60s and 70s, the "Reagan-Thatcher revolution" turned the emphasis back to private enterprise and deregulation. That era has ended with astonishing abruptness. Governments in Britain and the US have been nationalising and spending public money with a will that would have made Attlee or Roosevelt blush.
Those of us who learned economics in the old days were taught that banks had to be regulated oligopolies because their role in a capitalist economy was crucial. It relied on the sustenance of public trust which only government, backed by the citizen as taxpayer, could dispense. In Britain, retail banks, merchant banks and building societies were legally distinct, separated by barriers to prevent cross-pollution of the sort that caused the 1929 crash.
JK Galbraith's book on that crash is the Dr Strangelove of financial holocaust. If it offers one lesson, it is that crashes are not acts of God; they are caused by the interaction of corporate behaviour and state regulation. Nor does the market supply its own discipline. Understanding that, wrote Galbraith, "remains our best safeguard against recurrence".
Such lessons learned in youth tend to stick. Hence I remember feeling queasy when Thatcher's "big bang" of 1986 demolished the firewalls and permitted the trading of risk and reward across the entire financial sector. It was a reform repeated in the US with the repeal of the post-depression Glass-Steagall law. The same nervousness greeted each subsequent shock to the system - the 1991 housing crash, Lloyd's of London, Barings, Enron, Northern Rock. Each time we were assured that new lessons had been learned. Light-touch regulation was working fine, even if sometimes boys will be boys.
The naivety of all this is now exposed. Politicians encouraged the public to treat home ownership as a "right"; property became the citizen's gilt-edged stock. Bankers encouraged staff to speculate with depositors' money by awarding them huge bonuses to maintain turnover. Those charged with the guardianship of other people's savings behaved, in effect, like thieves. Sheer greed drove young men and women mad. Nobody in authority batted an eyelid.
At the same time Gordon Brown "set free" the Bank of England to fix interest rates. I recall one commentator telling me that I should be "overjoyed your children and grandchildren will now never have to experience inflation". No, they are just unemployed. It was a charade. On the back of low inflation, the Bank fuelled a credit boom that was clearly vulnerable if prices rose and/or credit collapsed. Both have occurred.
There is no such thing as a "non-political" official rate of interest. The Bank is now under pressure both to cut rates to beat recession, and yet raise them to beat inflation. It cannot do both. Since it would be 1929-style lunacy to increase rates just now, Brown must in effect tell the Bank to reduce them by shifting his inflation target. It is a blatant and properly political decision.
There is no perfect market. Markets need regulation, just as communities need law. Yet as Galbraith again wrote, regulators may start life "vigorous, aggressive, evangelical, even intolerant", but mellow with age and become "an arm of the industry they are regulating - or senile".
To ignore the danger in 125% mortgages or the City bonus culture showed both industry capture and senility. The first was loan-sharkery, and the second was obscene. So distorting to sound finance are year-end bonuses that they should simply be banned. Those with the responsibility of gambling with other people's savings should do so on salary.
While naive Thatcherism may have taken a pasting, there is no reason why capitalism should protest the presence of big government in what is its proper realm. We do not curb state power when the security of the state is at risk. Nor should we do so when the security of the economy is equally jeopardised.
The strangest phenomenon these past few days has been the eagerness to enforce "moral hazard", a concept regarded by the governor of the Bank of England as a deterrent to risk-taking. This is absurd. The collapse of Enron was no deterrent to Lehman derivative traders. The psychology of money does not work that way. The victims of the credit crunch are not just a few wild traders. They are all participants in the UK economy. I cannot see the sense in letting Northern Rock or Lehman or any other deposit-holding institution go bust just so regulators who have failed in their jobs can seem macho after the event.
This is not a question of blowing taxpayers' money on fat cat financiers. I would happily arrest and try all those whose stupidity and greed are about to cause untold hardship to millions - if I could find a law they had broken. Dr Johnson was quite wrong to say a man is "never more innocently employed than in getting money". But when a building collapses, you do not kill the architect. You try to get him to build it again.
Underpinning financial credit is an absolute function of government and one that has not changed since the birth of capital. It clearly needs constant redefinition. When this saga is through there should be a tribunal of inquiry. Then we can be told what needs mending, and whom to take out and shoot
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FromMe2U Sep 17 08The current credit bubble had its roots in the appointment of Alan Greenspan as Chairman of the Federal Reserve Board and FOMC following Volcker who'd done a good job of squeezing inflation out of the US economy albeit at odds with Regean's policies..Greenspan immediately set about earning his moniker "Easy-Al"...===The October 1987 crash was no accident or act of God, it was the direct result of the rampant availability of credit after Greenspan's appointment as well as Portfolio Insurance which like today's toxic deruivatives failed.
Greenspan's cure was to flood Wall Street with dollars, a gambit he repeated time after time.
The Japanese Treasury should also be mentioned as in the 1990s they tried to stabilise their economy with ultra cheap credit which eventually also found its way into the US & UK economies.
The internatiobnal accumulation of US dollars has also been the driver of the rapid rise in the oil price from around USD10 b only 10 years ago: at its peak USD140 b it reflected a price growth of 30% pa probably not to far from the dollar expansion.
We need some retrospective legislation to prosecute those that sought to reduce the value of the ir currencies, like adulterating gold with lead, and we should request Greenspan's extradition (Sir Alan after all) and prosecute him along ith Brown etc.
Hearing Greenspan, Brown etc advise on managing the current economic crisis reminds me o the fireman who having started the blaze runs around to take charge of extinguishing it; in the UK Brown toted as the best to deal with the problem seems just like that,giving the arsonist charge of dousing the flames.
I'd bring back the death penalty to ensure they don't do it again.
Great article, Simon. Except it isn't all about Reagan & Thatcher, as you well know. The man who opened up Pandora's box by repealing Glass-Steagall and replacing it with the Financial Services Modernization Act is none other that William Jefferson Clinton. Slick Willie, along with his pal Greenspan, inaugurated the decade of bubbles by blowing the tech bubble, while Lewinski did the same to him.
And now, as you correctly point out, it's paradigm-change time. The neocon-neoliberal crusade to roll back the state has taken a mortal hit beneath the waterline.
More hits are coming as the fundamental depravity of capitalism is exposed. Not only do the CEO's of Frannie and Freddy walk away as if nothing happened although it's public knowledge that they cooked the books but the SEC doesn't even feign the slightest interest. Lehman's CEO floats serenely away on his golden parachute while the cops eat doughnuts, and isn't even kicked out of his seat at the NY Federal Reserve Board!
The treasury pays lip service to moral hazard hoping to get the banks to blink but finally chickens out and admits it will have to nationalize AIG as well.
The nature of private capital is accumulation and concentration. Capital concentration means mega-corporations like AIG, that not only wield tremendous, self-serving political power but are also "too big to fail." So by definition, capitalism is a system that enriches the few and plunders the public treasury whenever it runs into trouble. You can talk about moral hazard till you're blue in the face but if the government doesn't pay AIG's gambling debts (aka margin calls) today, it'll be the end of the world tomorrow.
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Janissary , Sep 17 08, 1:31am (about 13 hours ago)Does Simon Jenkins or someone else want to explain exactly how "our" deposits were used to gamble? Anyone? No? Maybe because they weren't? Noone has bank accounts with Bear Stearns or Lehman Brothers.Verbum ,Sep 17 08, 3:01am (about 11 hours ago)And again, someone please set out the direct link between the repeal of Glass-Steagall law and the current crisis which has caught on in the Guardian in the last two days? Neither Bear nor Lehman had a commercial/retail banking arm. Merril Lynch is also an investment bank - they're not in the business of opening branches on local high streets. If any high street bank is affected in the next few days (i.e. HBOS) by Lehman and AIG it'll be because of its inability to borrow on the money markets to fund itself - it would face that problem regardless of whether it had an investment banking business or not and HBOS, whose shares have fallen due to that very fear, has virtually no investment banking business anyway. So how would a return of Glass-Steagall in the states or an equivalent law in the UK help? Mr. Jenkins - care to answer? Answer - it wouldn't. What we are witnessing is the failure and death of independent investment banks and the survival of large full-service banks that do everything from the high street up to the City.
Perhaps we will have some comments about how it was bonuses! The bankers were thinking about their own pocket and not the bank/the bank's shareholders as all they cared about was that year's bonus, right? Except that Goldman Sachs was well-known for being one of the highest payers of cash bonuses whilst Lehman more than any other bank paid a large percentage of its bonuses in Lehman shares - so if the "big bonus puts your interests in conflict with the shareholders" theory hold mean Lehman bankers, being shareholders themselves, WOULD have their interests aligned with shareholders and wouldn't take too many risks whilst the ones at Goldman wouldn't have the same interests as shareholders and would take too many risks and thus Lehman stays afloat and Goldman suffers. Except the opposite happened. Hmmm. Things in the real world don't seem to be as simple as they seem on a CiF thread....
This article is, like all the others we are seeing in the Guardian, failing to actually diagnose what has gone wrong and so fails to say anything useful or suggest anything helpful.
Here's something for you all to think about - the key bits of the finance system the public should be very concerned about and so the government should pay particular attention to in protecting are deposit-taking instiutions (where we have our bank accounts) and pension funds (where we invest our retirement money). The key to regulatory reform is to restrict the interaction of THESE instiutions with other riskier institutions like Lehman so as to ensure their stability, without starving high street banks and pension funds of business opportunities and funding. If the impact of Lehman on the bank where we have our accounts can be limited, then the public shouldn't care if an investment bank goes bust affecting other investment banks or hedge fund - the only people who would care would be shareholders and employees of such high-risk institutions, and they know what they are getting themselves into.
Things like Glass-Steagall are a red herring.
Verbum , Sep 17 08, 6:44am (about 7 hours ago)If the mistakes that have collapsed the world's financial markets had been made by statesmen and had led to war, there would be corpses swinging from lampposts. If they had been made by generals, they would be falling on their swords.Simon, mistakes were made by statesmen and they led to wars (Iraq, Afghanistan) and the only corpses are the victims, not prepetrators. And generals made mistakes (i.e. the Fallujah) without having to fall on their swords.
So I don't worry much about the fate of the Captains of The Industry, be it bankers or share traders.
In conclusion - this world is run by fatcats for fatcats and they always land softly and safely on all four.
It seems that since the implosion of the so called SOCIALISM/COMMUNISM the capitalism went ballistic on the, quite false, assumption that since the former were wrong by default the capitalism must be right. Alas, this is like saying that since your neighbour died of pneumonia your tuberculosis is much better.Janissarystevehill , Sep 17 08, 8:12am (about 6 hours ago)This article is, like all the others we are seeing in the Guardian, failing to actually diagnose what has gone wrong and so fails to say anything useful or suggest anything helpful.But the article is calling for an enquiry - to find out what actually happened. Do you agree or disagree?
You spend over 500 words pontificating about side-points the OP made but failed to address the main point. Right at the end you tell us that you have the magical solution.
vadid , Sep 17 08, 9:29am (about 5 hours ago)But when a building collapses, you do not kill the architect. You try to get him to build it again.No. You get a new architect.
Labour's understanding of the City is close to zero, so they just fawn over it instead, and never do anything which might stop house price inflation, believing that any real prudence will just alienate middle England.
This is problem rooted in house prices, and is most keenly felt in the two countries most obsessed by them: the USA and the UK.
Time for a change of government.
What I retain from Galbraith is that the Fed had set interest rates too low (partly because of Churchill fixing $/Sterling interest rates at the wrong level) which led to a credit expansion which first found its outlet in Florida property and property futures then, from 1927-1929, the US stock market.teganjovanka , Sep 17 08, 9:51am (about 4 hours ago)At last! A commentator has used the correct word to describe these people - thieves. This is not a tale of bad regulation, incompetence or greed. it's a tale of criminality, fraud, lies and theft.Tox66 , Sep 17 08, 10:02am (about 4 hours ago)Agreed: Investigation and punishment. Of course, this should not be confined to the idiot bankers but also to the members of the "tripartite regulation system" which the monumental idiot Brown instituted at the start of his reign. Disaster was predicted again and again when this model was mooted but, of course, ignored in this paper 100% because the criticisms came from, amongst other, Christopher Fildes in The Spectator and he's a "Tory" who can't be expected to "understand" the genius and subtlety of Gordon Brown's statist economics. Not that this lessens the huge culpability of the bankers of course, it just means being simple-minded and blaming "capitalism" or whatever will not catch all culprits.KingofFun Sep 17 08, 10:22am (about 4 hours ago)Verbum , Sep 17 08, 10:29am (about 4 hours ago)But when a building collapses, you do not kill the architect. You try to get him to build it again.Splendidly poor analogy...if a building collapses the last thing to do is re-hire the fool who designed it. No, you sue the architect. Corporate negligence. The same applies here.
Since we are all about to suffer from these mistakes of judgement or negligence (which?) the point is surely to get recompense.
if I could find a law they had broken.Any lawyers to oblige us here?
The crazy thing is that weve made such a holy cow out of making money or 'creating wealth as it is optimistically called. The premise is that the relatively few bold 'entrepreneurs will make fortunes allowing bits to drip down the food chain to the lesser beings generally called 'the workers. And thus we allow obscene remuneration packages for the executives because they 'create wealth and thus they deserve appropriate reward. The astronomical pay packets are there to guarantee that only the best will apply. When one questions those pay packets the usual rebuttal is that these are between the Company (its shareholders) and the talented CEO, and essentially this is nobodys business that a CEO of, say, Corporation Y makes X millions a year. This however is a fallacy because the salaries and wages paid by the company are operational expenses and are tax deductible, thus in effect the high pay packets are deducted against the tax paid by the company and therefore minimise the taxable profit, thus reducing the income of the Treasury. Thus the taxpayers are indirectly sponsoring those high pay packets. The boards, which are supposed to control the executive excess and supervise the management of the company (including risk management) are essentially incestuous bodies populated with individuals from top echelons of other companies and assorted former politicians. To put it bluntly theres no real control. The society is sponsoring the capital through education system, yet even best teachers are paid but a fraction of what an accountant makes in a year. Sometimes I wonder how much we would need to pay to people who really contribute to humankind and make a real and lasting difference people like Marie Curie, Louis Pasteur, Alexander Fleming and legion of others? I am sure that names of those people will be still remembered and revered in 300 years, while nobody will know the names of the creative accountants running our banks and corporations (maybe except for their victims). In essence we need to ask ourselves a question what is more important the welfare of the broadly understood community or society, or the welfare of relatively few entrepreneurs. Before anybody accuses me of being a nasty communist, I must point to the undeniable fact that wealth is a social concept and cannot exist outside the society. Just imagine that you are the richest person in the world. Your wealth becomes your well being only when you can buy goods or services. Imagine then that you are a castaway on a remote uninhabited island; you have all the money in the world and nothing or nobody to spend it on. Tough luck, you cant really eat money... But obviously theres more to good old capitalism since its major spiritus movens is greed rather than need, it has to be carefully monitored, just like a nuclear reactor, to prevent uncontrolled chain reaction and a meltdown. We may be witnessing something quite akin to a financial Chernobyl right now. The fall out may be quite deadly.Sluijser ,Sep 17 08, 10:43am (about 3 hours ago)Simon Jenkins, interesting article with some historical meat to it. Some way should be found to retroactively strip those involved of their insane salaries and bonuses for the last few years.Marat ,Sep 17 08, 10:46am (about 3 hours ago)However, don't agree at all with your moral hazard paragraph. I think that what we are seeing is shareholders everywhere withdrawing from enterprises that have indulged in too much risk. Saving Lehmans brothers wouldn't reduce the credit crunch. It would spare the shareholders at the expense of everybody else. Everytime government saves an institution, its own credit (that is, all our credit) suffers. That means, for example, even less room to spend to counter a recession. Therefore, the US and UK are right to judge each case on its own merits and consequences.
Janissary
Does Simon Jenkins or someone else want to explain exactly how "our" deposits were used to gamble? Anyone? No? Maybe because they weren't? Noone has bank accounts with Bear Stearns or Lehman Brothers.E.g. banks like HBOS are vulnerable because they invested in securitised US sub-prime mortgages. So yes, depositor's monies were used to gamble.
And NR's high risk strategy of borrowing money on the markets rather than relying on depositors meant that ultimately their depositor's money was risked.
Both strayed outside the normal activities for high street banks. Not sure what the UK equivalent to Glass-Steagall was but I'm sure there was one and it was relaxed at some stage.
Lehman bankers, being shareholders themselves, WOULD have their interests aligned with shareholders and wouldn't take too many risks whilst the ones at Goldman wouldn't have the same interests as shareholders and would take too many risks and thus Lehman stays afloat and Goldman suffers. Except the opposite happened.Apres eux la deluge. Since the trick had worked for quite a few years, they very likely thought they would have time to cash in those shares before the whole thing would come crashing down. Pride made them think that they would be too smart to be caught out. Pride and greed may even have made them blind to see the real risk. It is like living on a volcano you know will explode again. As the years go by you think it will last your while.
"A tribunal must tell us what to fix. And whom to punish"RayaDunayevskaya , Sep 17 08, 10:51am (about 3 hours ago)Yes a Tribuneral of armed workers.
1. Why is Parliament not being recalled immediately to set up a Parliamentary inquiry into this looting?
2. Why is it that the Govt doesnot impel total transparent disclosure of all assetts, deals and policies by all institutions?
3. Why are we allowing Hedge Funds to gang up and destroy the likes of HBOS?
4. When will we properly Nationalise the Banks, Building Societies and Insurance thiefs?
5. When will we Nationalise the Energy and Water Utilities?
Look what the Labour Party has wrought, telling us that light regulation,Murdoch, Privatisation and Casualisation was the future.
Market Good Public Bad was the Labour Parties Mantra
Labour grovelling to Murdoch and his Corporate friends
Vote Labour short the people
"Any lawyers to oblige us here?"usignuolo , Sep 17 08, 11:02am (about 3 hours ago)Not here, but if there are no real regulatory laws, then no one's going to Ford Mondeo Open Prison, are they?
I think Jenkin's basic premise is correct: the red tape was there to stop overt greed getting out of hand. Reap and sow come to mind.
Although, as was said earlier, it's hard to attain a proper objective assessment on what's going on at the macro level, the follies are standard ones that occur with free-market captialism. Of course, there is much pidgeonholing (re: dumbing down) of the vagaries of the issue (I agree that this is, essentially, an internal banking cock-up regarding the quaint old notion of credit notes above anything else) , but that doesn't mean that this could have been avoided. As ever, it's easy to point out the problems; solutions are as scarce as a Lehman Brothers' Chrimbo Party invite. How to control free-markets without compromising their 'freeness'? Personally, the merits of a Command Economy have long been lost to modern economists with their constant jacking-off over Friedman's pages, but I feel the solution lies, not on trust (for God's sake!), but on treating City Institutions like errant schoolboys until they learn enough common sense (i.e. tighter regulation). Oh, and much more progressive taxation for both business and personal income to ensure that we all have an increased vested interest in the 'money game'. Perhaps then, we won't be so desperate to chase rainbows which do not necessarily exist.
One final point which I think is most important: could we please have an advert by the Halifax where that Howard slits his wrists/puts noose over his neck etc. It would cheer a great deal of this nation.
Cheers!
'Twas ever thus, no?
Janissary - am I missing something here? I thought the root of all this was the US sub prime mortgage market and that what happened is that loans were advanced which people could not repay while the loans themselves were sliced and diced as packages of derivatives which were then bought by banks as assets, because they thought, the risk had been so diluted that it was no longer a risk. Only of course the mortgagees could not repay them and the instruments into which the loans were sliced and diced were so complex the actual level of the risk was not so much spread but incomprehensible. When the inevitable crash came banks and building societies who borrow on the money markets to finance loans, including mortages, could no longer do so and banks also started to hoard their own deposits. So what with sub prime loans crashing and burning and in the firestorm which followed, no loans for legitimate buyers available, everyone suffers. You do not need to be a customer of Bear Stearns or Lehmans to feel the pain. The second argument being advanced is that the banks were justified in buying up and trading derivatives, and the ratings agencies were justified in advancing them high credit ratings, because of the strength of the US housing market historically underpinned them. No one seems to have stopped to ask where the sub prime customes were going to find the money to repay their loans and whether "incentivising" mortgage brokers and bankers to build empires on top of such a pyramid of hot air, was ever sensible.mataharifilms ,Sep 17 08, 11:06am (about 3 hours ago)Despite all the infinitely documented disasters and melt-downs of economic and military history, we haven't addressed the question of how to create leaders with the values of integrity and accountability and the right kind of regulatory authorities to keep those leaders on-mission.Everything that is written about here by S. Jenkins & others is merely unregulated human activity in a leaderless vacuum, at a interestingly difficult time in our history.
The Africans say: 'Uninitiated, the youth will burn down the village just to feel the warmth.' For 'youth' read: greedy, un-eldered people with no authentic community allegiance. Things are starting to up burn quite nicely.
The people we elect and appoint as leaders have to a man or woman almost or no self-awareness or psychology whatsoever, beyond the instincts of animal survival and the burning desire to have control over others for their personal security. Nothing long term will change until this situation is addressed.
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September 9 2008 | FT.com
Published: September 9 2008 19:25 | Last updated: September 9 2008 19:25
In the aftermath of the US Treasury's decision to seize control of Fannie Mae and Freddie Mac, critics have hit at lax oversight of the mortgage companies.
The dominant theme has been that Congress let the two government-sponsored enterprises morph into a creature that eventually threatened the US financial system. Mike Oxley will have none of it.
Instead, the Ohio Republican who headed the House financial services committee until his retirement after mid-term elections last year, blames the mess on ideologues within the White House as well as Alan Greenspan, former chairman of the Federal Reserve.
The critics have forgotten that the House passed a GSE reform bill in 2005 that could well have prevented the current crisis, says Mr Oxley, now vice-chairman of Nasdaq.
He fumes about the criticism of his House colleagues. "All the handwringing and bedwetting is going on without remembering how the House stepped up on this," he says. "What did we get from the White House? We got a one-finger salute."
The House bill, the 2005 Federal Housing Finance Reform Act, would have created a stronger regulator with new powers to increase capital at Fannie and Freddie, to limit their portfolios and to deal with the possibility of receivership.
Mr Oxley reached out to Barney Frank, then the ranking Democrat on the committee and now its chairman, to secure support on the other side of the aisle. But after winning bipartisan support in the House, where the bill passed by 331 to 90 votes, the legislation lacked a champion in the Senate and faced hostility from the Bush administration.
Adamant that the only solution to the problems posed by Fannie and Freddie was their privatisation, the White House attacked the bill. Mr Greenspan also weighed in, saying that the House legislation was worse than no bill at all.
"We missed a golden opportunity that would have avoided a lot of the problems we're facing now, if we hadn't had such a firm ideological position at the White House and the Treasury and the Fed," Mr Oxley says.
When Hank Paulson joined the administration as Treasury secretary in 2006 he sent emissaries to Capitol Hill to explore the possibility of reaching a compromise, but to no avail.
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Aug. 18, 2008 | Bloomberg
As chairman of the Federal Reserve from August 1987 through January 2006, the Maestro was ahead of the pack when he sniffed out a secular increase in productivity growth, the result of a ``once-in-a-lifetime'' technological boom.
Of course, if he was right about productivity, he was wrong about the policy prescription.
``Prices should have fallen'' as companies are able to produce more with less, said Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. ``He fought it tooth and nail. The money had to go somewhere. It went into Nasdaq stocks.''
The burst tech-stock bubble exposed a rash of corporate malfeasance and accounting scandals. An ``infectious greed seemed to grip much of our business community,'' producing a ``once-in- a-generation frenzy of speculation that is now over,'' Greenspan told Congress on July 16, 2002.
Even as he was declaring an end to that generational frenzy, another one was already unfolding. Millions of condo flippers were riding ultra-low interest rates to ultra-high profits, extracting equity from their homes in the process. Now many homeowners find themselves owing more than their house is worth.
Of course, Greenspan argued against the idea of a ``bubble in home prices for the nation as a whole,'' conceding only ``signs of froth in some local markets.'' At the time, home prices were rising at a 15 percent annual rate.
Bubble Radar
Interspersed with the big bubbles in stocks and residential real estate were some singular events for which the cure was always lower interest rates.
Following the near-collapse of hedge fund Long-Term Capital Management in the fall of 1998, Greenspan cut the funds rate by 75 basis points to address the ``seizing up of financial markets.''
Once again, he misjudged the seizure's effect on the economy, which didn't miss a beat. The Nasdaq was the beneficiary of the Fed's largesse, rising 86 percent the following year.
Greenspan's ability to identify asset bubbles -- by his own admission, impossible when he was at the Fed -- improved markedly in the last two years. Everywhere you turned he was identifying a housing bubble, handicapping recession odds, spouting the wisdom gleaned from half a century of following the U.S. economy.
``He's like the forensic pathologist brought in as an expert on how to fix things when in fact he played a large role in causing the problems,'' said Bill Fleckenstein, president of Fleckenstein Capital in Seattle, and author of ``Greenspan's Bubbles.''
Conflict of Interest
Last month, Greenspan showed up on CNBC with Maria Bartiromo and Paul McCulley, managing director at Pacific Investment Management Co. in Newport Beach, California. Pimco happens to be one of Greenspan's three main consulting clients, a relationship that was never disclosed to the audience.
It was positively quaint to see Greenspan and McCulley talking shop -- discussing the likelihood of U.S. recession, slowing global growth and concerns about solvency -- for the benefit of bond investors, er, the viewing audience. All that was missing was a phone number on the bottom of the screen: Call 1- 800-4PIMCO.
And yes, the solvency crisis is a ``once-in-a-century phenomenon,'' according to Greenspan.
Last week, Greenspan showed up on the front page of the Wall Street Journal -- just like old times -- with a forecast for a bottom in housing.
``Home prices in the U.S. are likely to start to stabilize or touch bottom sometime in the first half of 2009,'' Greenspan told the Journal.
Qualified Forecast
Lest he be too clear, the master of garblements qualified his forecast, saying ``prices could continue to drift lower through 2009 and beyond.''
``It's a flexible bottom,'' said Tim Iacono, who devotes a blog to ``The Mess That Greenspan Made.''
What doesn't seem to have dawned on Greenspan or those who interview him is the thread that connects all these disparate events: Greenspan himself.
He presided over two bubbles, one bust and lots of little easy-money rescues. In a stroke of impeccable timing, Greenspan left the Fed in January 2006, a month that holds the once-in-a- century record for single-family housing starts.
Greenspan was widely criticized, inside and outside the Fed, for his tasteless appearance at a private Wall Street function for big investors one week after leaving the central bank.
A year later, I defended his right to earn a living after 18 years as a public servant. My point was that Greenspan can talk all he wants. You can choose not to listen.
Word of Advice
It's a woman's prerogative to change her mind. So here goes.
There is something unseemly about Greenspan's conduct. Former presidents don't criticize U.S. foreign policy during times of war, Jimmy Carter notwithstanding. The same unspoken rule should apply to economic policy.
Unlike his predecessor, Paul Volcker, Greenspan cannot leave the global stage or the media spotlight. Ben Bernanke may be the new Fed quarterback, but Greenspan is still calling in plays (or commenting on them) from the sidelines.
The juxtaposition of Greenspan's frequent TV and print appearances with the economic and financial fallout from his policies isn't helping his reputation. There's enough blame to go around for what started as the subprime crisis, but surely Greenspan, the country's chief economic policy maker for 18 years, must shoulder the lion's share.
So here's my advice, Mr. Greenspan. Give speeches for $150,000 a pop and share your wisdom with your key clients, who must pay you handsomely.
When the press calls, just say ``no comment.'' This is an acquired skill, but I'm sure you'll catch on.
As an economist, surely you appreciate scarcity value.
``I'm reminded of the song by Dan Hicks & the Hot Licks,'' Kasriel said. ``How Can I Miss You If You Won't Go Away?''
(Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)
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August 13, 2008 | themessthatgreenspanmade.blogspot.com
Today's front page story in the Wall Street Journal which carries excerpts from an interview with Former Fed chairman Alan Greenspan is bad on so many levels that it's almost sad to have to write this up, but, here goes.
Former WSJ chief Fed watcher Greg Ip is now gone from the Journal, apparently happily writing away anonymously at The Economist, and David Wessel has occasionally filled the rather large empty shoes left behind.
The results this time are decidedly mixed.
As perhaps part of the general "Murdoch makeover" of the paper where a fluff piece of one sort or another now always appears at the bottom-middle of the front page, the Greenspan interview, also on page one, is an added bonus in the today's edition.
Having lost much of his credibility in recent years, but continuing to mount a strong defense that continues to be effective on a disturbingly large percentage of the population, the amount of caveats and qualifications that David Wessel saw fit to include in today's story was astounding.
Of course the news here was about a possible bottom in home prices in 2009, the remarkably lucid assessment of the government rescue plans for Bear Stearns, Fannie Mae, and Freddie Mac, along with the loopy idea of encouraging immigration to boost demand for housing.
But, look at all the less-than-complimentary commentary that Wessel provided:
But his star no longer shines as brightly as it did when he retired from the Fed in January 2006.The commentary became even more harsh when the general public was included after additional excerpts appeared at this post at the WSJ Real Time Economics blog.Mr. Greenspan has been criticized for contributing to today's woes by keeping interest rates too low too long and by regulating too lightly.
...
In the past, to be sure, Mr. Greenspan's crystal ball has been cloudy. He didn't foresee the sharp national decline in home prices. Recently released transcripts of Fed meetings do record him warning in November 2002: "It's hard to escape the conclusion that at some point our extraordinary housing boom...cannot continue indefinitely into the future."Publicly, he was more reassuring. "While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversity," he said in October 2004. Eight months later, he said if home prices did decline, that "likely would not have substantial macroeconomic implications." And in a speech in October 2006, nine months after leaving the Fed, he told an audience that, though housing prices were likely to be lower than the year before, "I think the worst of this may well be over." Housing prices, by his preferred gauge, have fallen nearly 19% since then. He says he was referring not to prices but to the downward drag on economic growth from weakening housing construction.
A few choice selections are provided below (note that the two apparent "Greenspan Mess" sightings, unfortunately, do not qualify as such as they are in the comments section and not in the main story):
Why didn't he mentioned that it was .HIM THAT CREATED THIS NIGHTMARE .IN THE FIRST PLACE ..While readership may get a boost from a story like this, it does little to add to the Journal's prestige which is increasingly questioned since parent company Dow Jones was purchased by Newscorp.
Comment by ANONYMOUS. - August 13, 2008 at 5:57 pmMr. Greenspan, Thank you for your service to the nation. Now I want to ask you where you were while the problems you speak of were festering. Wasn't it under your watch that the seeds of today's problems were sewn? Many of the points you make are valid; the current system is broken, but again, I ask you why you didn't raise these questions while you were in charge. Today, after the legislation has been signed, it's a bit late to make these criticisms.
While Im at it, let me also suggest that an action on the Fed's part could have cooled the tech bubble before it got out of hand; you could have headed off the tech bubble by raising the Margin Requirements. Thanks.
Comment by Jim Ogburn - August 13, 2008 at 6:07 pm
The irresponsibility of the government to overspend that Mr. Greenspan sponsored for years was transferred to the people. Living beyong the means is the recipe for financial disasters.
Comment by Gabriel - August 13, 2008 at 6:29 pm
This clown is responsible for the housing bubble, yet he still has the nerve to show his ugly face.
Comment by Freddie Big Mac - August 13, 2008 at 6:41 pm
Hey Dont blame ME. Mr.Bubble {ALAN} Started this Night-mare with his policy of..CHEAP,CHEAP MONEY I Inherited this "DEBACLE" I know that the ship is sinking fast .But remember I ONLY WORK HERE .What do you WANT an MIRACLE??????
Comment by BEN BERNANKE. - August 13, 2008 at 8:18 pm
Amazing that I actually agree with this guy on one point: If the government has to give one cent to the GSEs they need to be nationalized and liquidated.This does not absolve him of responsiblity for creating this mess in the first place. Where were the regulators when Wall Street perpetuated this scam? Why did he keep rates irresponsibly low for way too long?
Even now he is dissembling by saying that prices will bottom next year .though they may continue to drift lower past 2009. So what's it going to be? Will they bottom or drift lower? You can never get a straight answer from liars and politicians. IMO, he is both.
Comment by Kodiak - August 13, 2008 at 8:22 pm
In his desperate efforts of late to defend himself, Greenspan blames the housing bubble on a global savings glut that pushed down interest rates. But the Fed policy of easy money helped create that overseas savings glut in the first place by triggering a massive US buying spree from abroad. So he can hardly claim that the Fed under his leadership had no role in creating the conditions for the housing bubble. True, once the world was awash in money, the Fed's efforts to raise rates had much less leverage than usual at home. But the Fed had essentially shot itself in the foot by creating those conditions of excess global liquidity in the first place.
Comment by John - August 13, 2008 at 8:30 pm
Someone should tell this bum to shut up.
Comment by Good Luck - August 13, 2008 at 9:12 pm
I "TOLD" Helicopter BERNANKE .To ALSO KEEP THE RATES "LOW" Until the "BANKS" Get out of this "MESS" .The only problem is .We are "Destroying" the Entire U.S.A. Economy ..So What.
Comment by ALAN GREENSPAN, Mr.BUBBLE. - August 13, 2008 at 9:35 pm
Alan G, regardless of his arguments to the contrary, facilitated the current housing crisis by:1) Keeping rates low during a time that global risk spreads (credit and other (e.g., vol)) were at historic lows. We all knew risk wasn't being priced rationally given the massive glut of liquidity available in the market (at the time).
2) Not caring one iota about bank supervision.
3) Believing arm-chair economists and econometricians (i.e., models) can provide the right answers and
4) Failing to understand the "incentives" created in most organizations to produce accrual earnings, not value.
Comment by Tootrue - August 14, 2008 at 2:51 am
The inescapable conclusion from reading the article is that Mr. Greenspan should have left the chairmanship of the Fed years before he did. His solution to the glut of unsold homes is the latest reason. The man is absolutely off his rocker The best we can do at this point is to stop giving him a platform for his idiotic views on the economy.
Comment by Joe N - August 14, 2008 at 10:26 am
Greenspan, GO PLAY SOME GOLF!!!!!! You are completely overrated, just be glad that you managed to get away with it and leave the mess for someone else to clean up. You didn't know what you were doing then, now is the time to keep your mouth shut.
Comment by T. Time - August 14, 2008 at 11:17 am
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robertreich.blogspot.com
Chinese authoritarian capitalism, on display this week in Beijing, has me thinking about America's democratic capitalism and how we practice it.
Start with the U.S. economy's most powerful government agency: The Fed, of course. Its decision this week to hold short-term interest rates steady was wrong, in my view; it should have lowered them because recessionary forces continue to increase while wage-price inflation doesn't exist. Wages are dropping in real terms. But my opinion and your opinion count for nothing. The Fed is not directly accountable to American voters, or even to Congress or the President.
Months ago the Fed decided to bail out major investment banks. That put billions of taxpayer dollars at risk without so much as a single act of Congress. Lately the Fed has been looking into the capital assets of these banks and telling them how to bolster their liquidity. Probably a good idea, but here again, nobody authorized the Fed to do this.
Now the Fed is issuing proposed regulations governing the credit-card industry specifying when credit card issuers can increase interest rates on existing balances, and barring late fees on customers who weren't given a reasonable amount of time to pay. Personally, I'd also want to stop them from marketing credit cards to people under age 21, and imposing extra charges for paying online.
But what I or you may want is irrelevant. The Fed's proposal has draawn nearly 56,000 comments, yet the Fed isn't compelled to read a single one of them. You see, the Fed is acting without congressional authority. Two weeks ago a congressional committee reported out a Credit Cardholder's Bill of Rights with many of the features of the Fed's regulation, but the banking industry mounted such a lobbying effort against it there's no way it will get enacted this year, or maybe ever.
In other words, Congress is so immobilized we have to rely on the Fed -- which operates mostly in secret, whose chair is appointed every four years but whose other governors have fourteen-year terms, and which doesn't even depend on a congressional appropriation for its own funding but draws interest on the portfolio of Treasury securities it controls.
This isn't Chinese-type authoritarian capitalism, of course, but nor is it, strictly speaking, what we've come to expect from a democracy.
15 Comments:
- Athena Smith said...
- At the same time, its independence
is not absolute.
It must report to Congress, which
ultimately has the power to change the Federal Reserve Act.- Tuesday, 12 August, 2008
- B. Dewhirst said...
- Why do you persist on calling this Democratic Capitalism, Dr. Reich?
When was the last time an American voted for the President of the World Bank? The Chairman of the Fed?
- If given a choice between Greenspan and Bernanke, what sort of a choice would such a vote have been?
- How did Presidential elections impact whether Greenspan got to keep his job?
- Does that seem "democratic" to you? In what sense?
- Tuesday, 12 August, 2008
- kayxyz said...
- but the banking industry mounted such an intense lobbying effort
I've asked before: how many banks have to collapse before the American Bankers Association runs out of lobbying money? One of the newest Fed governors, Elizabeth Duke, is a former president of ABA. Conflict of interest, anyone?
The credit card assets/revenue streams is highly profitable to banks, given how much they've lost in mortgages, until, of course, the card holders declare bankruptcy and stiff the banks, and it's a US phenomenon only. Per a Business Week graphic? US 5 cards per person; India 30 people per every one card; China 60 people for every one credit card.
On the other hand, there are bloggers discussing just not paying the monthly amounts and letting the banks collapse. Let the people working at the banks find real jobs.
- Tuesday, 12 August, 2008
- Anonymous said...
- You have highlighted another example of why we need lobby reform in this country. The lobby system is a bunch of ex politicians that continue to run this country without a democratic voice.
- This same group is invested in some of the big government outsourcing companies like Halliburton & Blackwater. The Iraq war is bringing millions to this clandestine body labeled as "lobbyists".
- We have lobbyists running our government and outsourced mercenaries fighting our oil wars.
- It is too bad that our country has so many "red" states where ignorant and the religious right preside.
- This demographic is blindly voting republican, which proves de-evolution is occurring as our democracy vanishes.
- Tuesday, 12 August, 2008
- Anonymous said...
- I want to echo b. dewhirst. I've got a lot of respect for your opinions, Prof. Reich, even when I disagree. But, I really can't understand your calling our system a democratic capitalism, unless you are being disingenuous to avoid alienating the know-nothings who think we have such a system.
Our economic system is responsive to multiple authorities:
- 1. The Fed -- which transfers debt burden from corporations onto the people (i.e. socializes economic loss to protect private gain) and over which the people have zero control.
- 2. The Executive -- which, de facto, can choose to be responsive or not without consequence. Our current executive has chosen to implement and preside over the most corrupt crony capitalism in our history. Congress and the judiciary have let it act without accountability.
- 3. The Legislature -- which may appear democratic, but, de facto, has been corrupted by lobbying money. The will of the people has NO power in the face of millions in lobby money. Oh, sure, people can vote, but only for the candidates the lobby money has put forward.
- 4. The Judiciary -- which, de facto, continues on its path of giving corporations more rights than people.
We may in some principle have a republican democracy that controls our economic system. But, in reality, we have a corrupted crony capitalism with authoritarian aspects.
- Tuesday, 12 August, 2008
- Anonymous said...
- All the anti-capitalist wackos have turned this blog into a lunatics asylum.
You have not heard of "appointed" officials? You are truly saying that someone who controls monetary policy should be elected by the brainless and the toothless? Who vote for the guy who has stapled a flag to his chest? Or the guy who appears "likeable?" Or who has not cheated on his wife, as if that is related in the most remote sense to competence?Please give us the total number of failed banks and please compare that number to the total. Are you serious? A couple of people in a town have the flu and you are calling it an epidemic?
Please cite whatever catastrophic decissions the Fed took in recent years. None?
Well, cite some pretty bad decsisions... hard to prove?Now cite some catastrophic decisions by elected officials. A couple of huge ones spring to mind.
Imagine the prospective president of the Fed having to campaign and promise what?
Oh sweet Lord, give me strength to keep on reading...
- Tuesday, 12 August, 2008
- kayxyz said...
- The Raleigh News & Observer has a Sunday article that includes www.helpwithmybank.gov and a pending bill in Congress regarding the Consumer Financial Hotline Act for filing complaints. Wachovia and Bank of America, both located in Charlotte, were the impetus for the consumer complaints article.
Carl Levin (D-Mich) seems to have the best track record with credit card/bank CEOs, hauling them in front of Congress to testify, and kudos for going after UBS and their rich folks's illegal accounts. I saw today on Yahoo that UBS customers are fleeing to other banks. Let's hope Levin is tracking them. Honest, where does it end? As North Carolina's unemployment rate was recently listed as 6% on UNC-TV, North Carolina Now, I had to sit back and laugh. I received a reply from Elizabeth Dole (R-NC) stating that banks are going to change to font size and re-arrange the paragraphs to make the credit card interest rate charges as easy to read a cereal box. I saw the Fed website for credit card complaints; I didn't waste time filling it out. I'll stick with Carl.
- Tuesday, 12 August, 2008
- Anonymous said...
- Sometimes I think I'd like to see another Andrew Jackson ride his horse into the White House and give it to the aristocracy on behalf of the common man.
- Tuesday, 12 August, 2008
- Timmy the Clown said...
- The fact that Federal reserve can set "interest rate" lower than inflation because they want to bail out big banks to save market mechanism" (aka, bailing out wallstreet buddies) at the expense of hardworking people's saving is obvious to anybody who is paying attention that the people have no control over the economy. They pour money on to big banks while ignoring inflation that burns average folks to save their buddies.
So what if One can freely buy 5 different type of breakfast cereals at grocery stores or 12 different big SUV at car dealers, but start talking about "real money supply, interest rate", free competition of capital and energy supply. the "freedom" ends there.
It's pretty obvious to everybody that when push come to shove, plutocracy is the order of the day. Preserving how status quo making their money is what really count.
Enron economy is freedom, sensible green energy policy is not.Greenspan/Bernanke bailing out big banks is freedom, protecting average working people's wage & saving are not.
Corrosive neoliberalism trade policy exporting externalities to developing country is freedom, sensible trading is not.
Supporting gigantic military industrial policy is protecting freedom, creating peaceful international relationship is not.
HMO, health insurance are free market, sensible government health policy is not.
... etc etc.
The government is broken. It is utterly controlled by large corporations and bg money interest. (I mean seriously, just look at the wealth transfer from middle class to corporation and the super rich.)
--------
We'll see how it all plays once budget deficit reaches $1Trillion/year. Right now it's projected to be $700B+, before end of year crashing retail sector.
They are going to further lower the interest rate to defend, freedom and democracy I am sure.
Eat your inflation with Ketchup. It's what good democracy is about.
- Tuesday, 12 August, 2008
- Anonymous said...
- Wow. So, let me understand the conspiracy, because I'm just learning.
The Fed is part of a group of unelected Wall Street pals who are conspiring to lower wages and take away savings? And big business and lobbyists are behind all of this?
Holy crap! I'm going into the backyard right now to start digging the shelter.
Give me a break.
Letting Bear, Fannie, Freddie, etc. fail would result in an overall economic collapse that few of us (unless we were at least 10 or 12 years old in the 1930s) can fathom, despite what we've read in books or on the Internet.
And, at least in the case of Bear, it wasn't paupers who lost their savings/livelihoods. It was guys who were buying $150/lb lobster salad in the Hamptons a few years ago (and their $100k/year admin assistants). I know that few of the tender hearts on this blog are going to shed a tear for all of those people.
Now, let's talk about inflation and its causes. Basically (and I'm simplyfing here) you've got two kinds of inflation. The first is monetary-based when there are too many dollars floating around. The second is commodity-based, which is supply/demand related. Currency can be inflationary or deflationary depending on how one currency is performing against another, which is primarily due to interest rate parity.
Monetary-based inflation usually manifests itself in all goods, but is typically most observable in wage rates. This is when you will see the Fed getting concerned about inflation.
Supply-demand inflation occurs when demand increases or supply decreases. In our case, we have global GDP growing faster than the world's ability to supply oil--this has been happening for a few years. Think of the curves...prices go up. Oil is a part of our supply chain and in many of the products we purchase, which is causing input prices to rise. We also have food being diverted to fuel production, which is causing those prices to rise.
Another factor at work is Chinese economic development and social policy. Chinese factories are moving upstream to more value-added products, which is causing supply for cheaper goods to decline, thus causing prices to go up. China also has social insurance initiatives kicking in this year, which all employers must pay. This is getting passed along and since most of the plastic goods, shoes, apparel, and electronics you buy are produced in China you get price inflation.
The Fed, through its powers to manipulate rates, can do nothing about supply/demand inflation or Chinese economic development or social policy. You could make an argument for its ability to impact currency, but I would suggest that this is more a treasury policy issue than a central bank policy issue.
Finally, let's talk about wealth transfer. What about the transfer of wealth from the United States to Middle Eastern countries that don't like us very much?
I'm out of this blog. I like debate, but the irrational conspirist bent is becoming ridiculous.
Peace.
Anonymous Matt
- Tuesday, 12 August, 2008
- Frank Thomas said...
- Anonymous Matt,
You're right that it sometimes becomes more of an aberration to have rational, balanced discussions on this blog that confront pragmatic, creative solutions to our problems .... Austrian economic theory and a possible conspiracy here and another one there,, how does Joe Doe relate to these farcical concepts and paranoia let alone a graduate in advanced economics?
Dr. Reich should be explaining why the EU central bank is raising bank discount interest rate with inflation at 3.7% while he is suggesting even lowering this already very low rate rate in the US with an inflation rate of over 4.0%? How is a continuance of Greenspan's 5-year cheap money policy going to extricate us out of a possible long recession when cheap monetary policy caused all the Debt explosion and resultant housing crisis we're in today?
I favor this sort of policy discussion than subtly feeding the paranoia of Authoritorian Capitalism, for example, which only brings out disjointed, divisive, useless conspiracy hyperbole... utterly divorced of factual content.
- Wednesday, 13 August, 2008
- Frank Thomas said...
- Art, Notsovast, Athena, Kayxyz, Matt and many Others:
Some of us have addressed each in his or her own way the "ME" vs. "WE" dilemma in American culture that appears to be one of the prime root causes of our divisions and inability to communicate across idealogical lines to come to equitable societal and economic policy programs benefitting Mainstream as well as Upstream Americans.
Some of our posts have suggested in so many words that in a 360 degree circle where the higher range is "ME" (the individual) and the lower range is "WE" (society as a whole), America has left the 180 degree point and is pushing the 320 degree level... while Europe is in the 120 to 180 degree range as a cultural norm ... the latter resulting in a more unified economic-social society in contrast to out `Two economy, Broken Society΄ so well diagnosed by Mike Hudson recently.
Well, David Brooks has just written a very thought-provoking version of this cultural dichotomy with the Asian `WE΄ choices. He alludes to latter΄s novel potential positive dimensions vs. the discordant path we are on in an excellent essay published yesterday entitled, `HARMONY AND THE DREAM΄.
His reflections are also a small microcosm of Europe΄s social-economic-political harmony where the usual robotic snap cliches of `Socialism΄ have no relevance whatsoever ... contrary to the propaganda of radical pundits or conservative dogmatists. Capitalism with a Social Conscience is working well in the Old Continent.
If you haven΄t read this article already, dear people, then I highly recommend it!
Frank Thomas, The Netherlands- Wednesday, 13 August, 2008
- Frank Thomas said...
- Readers,
Miner Correction: 2nd paragraph, next to last sentence: `out΄ should be our.
- Wednesday, 13 August, 2008
- Frank Thomas said...
- Readers:
Correction: Mike Hudson should, of course, be Mike Whitney.
- Wednesday, 13 August, 2008
- Anonymous said...
- Handing economic management over to central banks is not only undemocratic. It leads to a set of decisions with profound distributional consequences. Price stabilisation policy means allowing or helping the value of assets held by the rich to rise and stepping in to tighten policy whenever wages show a sign of catching up. This provides a macro ratchet increasing inequality and boosting the share of national income going to profits. The US is not alone in this. Indeed, the ECB is even worse in some ways
- Wednesday, 13 August, 2008
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Forgiveness might be divine, but forgetting is just bad reporting. When former Fed Chairman Alan Greenspan warns the public that the financial markets will not be set right until the housing bubble has fully deflated, it is worth reminding readers that Mr. Greenspan was a vigorous bubble denier during his tenure as Fed chair. He refused to take any steps to head off the growth of the bubble and repeatedly insisted that there was nothing out of line in the housing market.
--Dean Baker
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Amazon.com
Indispensible guide to the 1980's and beyond,
August 23, 2000 By Douglas Doepke (Claremont, CA United States) - See all my reviewsPhillips has documented in some detail the massive income shift of the Reagan years. In almost all categories the upper 10% of American families soared, while the remaining 90% either stagnated, or at the lower end, actually declined. The author's exhaustive charts demonstrate statistically what popular opinion could only entertain: the rich got richer and the poor got poorer. An interesting question to pose is why a Republican strategist like Phillips would document this adverse result in such unsparing fashion. Perhaps like some far-seeing conservatives he views a growing income gap as destabilizing to the country, and hopes to bring forth moderating influences.
In any event, the book stands as an excellent reference for understanding the impact of those years. That Phillips does not delve beyond surface movements for deeper explanation is not an objection to the work as a whole. For what he succeeds in doing with considerable authority and as "one of their own", is to revive class bias as the focal point of American politics. Being a conservative, he is not about the business of endorsing class-struggle as a premise of human history or American politics. Nevertheless, his linking of the Reagan era to previous eras of capitalist overreach helps to revive the long submerged story of class-struggle in America. This is an indispensible book for understanding the 1980's and years beyond.
An accurate and detailed account of a socio-economic tragedy, May 17, 1999 Kevin Phillips has all the credentials necessary to speak on this subject and for those who seem unaware of it; happens to be a republican. His detailed coherent account of what is, in the hands of most authors, a murky story - how the rich really got richer at the expense of the majority during the 80's - is fact filled, copiously notated, and hard to fault without resorting to a willfull ignorance to believe ideology over evidence. A must read book for anybody who got taken at that Three Card Monty table that was the american economy of the 80's
By Tim Dailey (Ringwood, NJ USA) - See all my reviews
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The Guardian
Even more confusing for those who like their politics to consist of nicely pigeonholed leftwingers criticising rightwingers, and vice versa, will be the incendiary essay that introduces Krugman's new collection of columns, The Great Unravelling, published in the UK next week. In it, Krugman describes how, just as he was about to send his manuscript to the publishers, he chanced upon a passage in an old history book from the 1950s, about 19th-century diplomacy, that seemed to pinpoint, with eerie accuracy, what is happening in the US now. Eerie, but also perhaps a little embarrassing, really, given the identity of the author. Because it's Henry Kissinger.
"The first three pages of Kissinger's book sent chills down my spine," Krugman writes of A World Restored, the 1957 tome by the man who would later become the unacceptable face of cynical realpolitik. Kissinger, using Napoleon as a case study - but also, Krugman believes, implicitly addressing the rise of fascism in the 1930s - describes what happens when a stable political system is confronted with a "revolutionary power": a radical group that rejects the legitimacy of the system itself.
This, Krugman believes, is precisely the situation in the US today (though he is at pains to point out that he isn't comparing Bush to Hitler in moral terms). The "revolutionary power", in Kissinger's theory, rejects fundamental elements of the system it seeks to control, arguing that they are wrong in principle. For the Bush administration, according to Krugman, that includes social security; the idea of pursuing foreign policy through international institutions; and perhaps even the basic notion that political legitimacy comes from democratic elections - as opposed to, say, from God.
But worse still, Kissinger continued, nobody can quite bring themselves to believe that the revolutionary power really means to do what it claims. "Lulled by a period of stability which had seemed permanent," he wrote, "they find it nearly impossible to take at face value the assertion of the revolutionary power that it means to smash the existing framework." Exactly, says Krugman, who recallss the response to his column about Tom DeLay, the anti-evolutionist Republican leader of the House of Representatives, who claimed, bafflingly, that "nothing is more important in the face of a war than cutting taxes".
"My liberal friends said, 'I'm not interested in what some crazy guy in Congress has to say'," Krugman recalls. "But this is not some crazy guy! This guy runs Congress! There's this fundamental unwillingness to acknowledge the radicalism of the threat we're facing." But those who point out what is happening, Kissinger had already noted long ago, "are considered alarmists; those who counsel adaptation to circumstance are considered balanced and sane." ("Those who take the hard-line rightists now in power at their word are usually accused of being 'shrill', of going over the top," Krugman writes, and he has become well used to such accusations.)
Which is how, as Krugman sees it, the Bush administration managed to sell tax cuts as a benefit to the poor when the result will really be to benefit the rich, and why they managed to rally support for war in Iraq with arguments for which they didn't have the evidence. Journalists "find it very hard to deal with blatantly false arguments," he argues. "By inclination and training, they always try to see two sides to an issue, and find it hard even to conceive that a major political figure is simply lying."
Krugman can expect many more accusations of shrillness now that The Great Unravelling is on the bookshelves in the US. Already, he says, Alan Greenspan, the chairman of the federal reserve, is refusing to talk to him - "because I accused him of being essentially an apologist for Bush". And there will be plenty of invective, presumably, from the conservative commentator Andrew Sullivan, who hauled Krugman over the coals for accepting a $50,000 (£30,000) adviser's fee from Enron. (Krugman ended the arrangement before beginning his New York Times column, and told his readers about it.
"I was a hot property, very much in demand as a speaker to business audiences: I was routinely offered as much as $50,000 to speak to investment banks and consulting firms," he wrote later, by way of justification - demonstrating the knack for blowing his own trumpet that even politically sympathetic colleagues find grating. They say he has had a chip on his shoulder since failing to get a job in the Clinton administration.)
Still, there's an important sense in which his views remain essentially moderate: unlike the growing numbers of America-bashers in Europe, Krugman doesn't make the nebulous argument that there is something inherently objectionable about the US and its role in the world. He claims only that a fundamentally benign system has been taken over by a bunch of extremists - and so his alarming analysis leaves room for optimism, because they can be removed. "One of the Democratic candidates - who I'm not endorsing, because I'm not allowed to endorse - has as his slogan, 'I want my country back'," Krugman says, referring to the campaigning motto of Howard Dean. "I think that's about right."
Or, to quote a state department official who put it pungently to a reporter earlier this year, describing the dominance of the Pentagon hawks: "I just wake up in the morning and tell myself, 'There's been a military coup'. And then it all makes sense."
· The Great Unravelling is published by Penguin
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The Left Coaster
[Part I of my interview with Paul Krugman.]
Paul Krugman is a hero for many of us because he is willing to speak truth to power even when there is enormous pressure to keep quiet. Fortunately for us, he has a very big megaphone through his twice weekly op-ed columns in the New York Times.
Writing the column is something Krugman does after his day job as one of America's best known economists and as professor of economics at Princeton. He was offered the column to write about international economics and globalization for the New York Times. Not only is this his area of expertise, but he had already shown a talent for explaining complicated issues in ways that lay people can understand.
Although this was the original charter for his column, Krugman began to write about the politics that shaped the policies. In particular, in 2001 he wrote about the proposed Bush economic policies because they were so obviously not based in reality. And since then, he has found more reasons to be concerned about how deceptive the Bush policies were.
Krugman wrote to correct the record and to expose the distortions. And he started to investigate and reflect on what was going on. This led to his writing The Great Unraveling where he strove to knit the various strands together. When preparing the book, he found a doctorial dissertation that he found very relevant to the current political situation in this country.
Back in 1957, Henry Kissenger -- then a brilliant, iconoclastic young Harvard scholar, with his eventual career as cynical political manipulator and, later, as crony capitalist still far in the future -- published his doctoral dissertation, A World Restored. One wouldn't think that a book about the diplomatic efforts of Metternich and Castlereagh is relevant to U.S. politics in the twenty-first century. But the first three pages of Kissinger's book sent chills down my spine, because they seem all too relevant to current events.
In those first few pages, Kissinger describes the problems confronting a heretofore stable diplomatic system when it is faced with a "revolutionary power" -- a power that does not accept that system's legitimacy. ... It seems clear to me that one should regard America's right-wing movement -- which now in effect controls the administration, both houses of Congress, much of the judiciary, and a good slice of the media -- as a revolutionary power in Kissinger's sense. That is, it is a movement whose leaders do not accept the legitimacy of our current political system. [pp 5-6]
With this introduction, Paul Krugman begins to lay out the evidence to show why this is so.
Here is part one of my interview with Paul Krugman last week.
When did you find out about Kissinger's paper that pulled this whole thing together so well?
It was actually very close to the point when the hardback edition was being put to bed. My wife had somehow seen a reference to it in another book she was reading and she took it out of the library and started reading the introduction. She said, "You've got to read this. It is what you have been saying." [And I found it] better written basically, or clearer. So that's how we got it. It turned out to be a fortuitous stroke which turned out to crystallize what I'd been saying. Not so much about the radicalism which I had already gotten, but about the blinkered approach of a lot of people who just can't bring themselves to believe that what is happening is in fact happening.Yes, I think that this has happened to a lot of people. It explains a bit more about why it is so strange to have a government that acts like it does.
Yet, once you face up to the extreme radicalism, you realize that that this thing has been building up for a long time. The Bush administration is the culmination of a long drive for power by the hard right. And you can see foreshadows from a long way back. But the reality is, moderates and liberals aren't yet ready to face up to that. So they keep downplaying the extremism.I had seen in your book about your concerns about electronic voting systems and your last column was also about that. Do you have any recommendations on where people can actually help with that?
Well, my understanding is that in Florida, anyone can vote absentee and my recommendation would be to definitely do that if you possibly can. From everything we see says that these machines are very unreliable. And just today the Miami Herald got a hold of a secret memo which indicates that the Florida election officials were aware well before it was released that the felon list was garbage.So, there is no reason to trust their intentions, no reason to trust the machines. Security is a joke and we had the whole farce of the records that were lost and then found. It's a funny thing about the records involving Florida's officials. And the end result of this is, it's somewhat silly to think they wouldn't do that. Those are the famous last words that we've heard over and over again for the last four years.
With a national consensus, we could very easily have a crash program to put in paper receipts before the next election, or paper ballots. Funny [about that] technology.... And if you ask if that wouldn't cost a lot of money, the answer is, compared to what? I haven't seen anyone suggesting that a totally secure, error-free election system could possibly cost more than one week in Iraq.
But it's probably too late given the actual situation, the fact that one side doesn't want to solve this problem. Rush Holt has been pushing verified voting, and he's a really good guy, he happens to be my congressman. But I think it is too late to do this. I'm going have to write about this next week on what we can do. I'd like to see backup paper ballots made available because I suspect that all hell will break lose.
Do you know about the work being done by David Dill and about his site called VerifiedVoting.org?
I've actually read their stuff. I've gone to their website. I'm actually planning to sit down and go through all their proposals, probably next weekend, to write up something about what can we do in the little time that remains.Tomorrow: What should John Kerry first when he is elected.
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Amazon.com
Amazon.com The Great Unraveling Losing Our Way in the New Century Paul R. Krugman Books
The Great Unraveling is a chronicle of how "the heady optimism of the late 1990s gave way to renewed gloom as a result of "incredibly bad leadership, in the private sector and in the corridors of power." Offering his own take on the trickle-down theory, economist and columnist Paul Krugman lays much of the blame for a slew of problems on the Bush administration, which he views as a "revolutionary power...a movement whose leaders do not accept the legitimacy of our current political system." Declaring them radicals masquerading as moderates, he questions their motives on a range of issues, particularly their tax and Social Security plans, which he argues are "obviously, blatantly based on bogus arithmetic."
Though a fine writer, Krugman relies more heavily on numbers than words to examine the current rash of corporate malfeasance, the rise and fall of the stock market bubble, the federal budget and the future of Social Security, and how a huge surplus quickly became a record deficit.
He also rails against the news media for displaying a disturbing lack of skepticism and for failing to do even the most basic homework when reporting on business and economic issues.
The book is mainly a collection of op-ed pieces Krugman wrote for The New York Times between 2000 and 2003. Overall, this format works well. Krugman writes clearly about complicated issues and offers plenty of evidence and hard facts to support his theories regarding the intersection of business, economics, and politics, making this a detailed, informative, and thought-provoking book. --Shawn Carkonen --This text refers to the Hardcover edition.
it is so blatantly obvious that many in the political process don't give a hoot about the truth or making the country better, they just want to win at any cost. Krugman's book should be judged by its ability to persuade open-minded, independent-thinking people. Against this standard, the book is thought provoking and important but flawed.
Let me be specific. Krugman is a serious economist with a serious concern about Bush's fiscal policy, and-if he is right-there is potentially a serious consequence. To boil it down and oversimplify, his argument on fiscal policy: 1. The Bush team cooked up its tax cut plan (which favors the wealthy) as a political maneuver largely to fend off Steve Forbes ahead of the 2000 election. 2. Then the Bush team remained inflexibly attached to the plan and it became the centerpiece of Bush's economic policy. 3. The tax cut was flawed especially on two counts: it could have better spurred consumer spending by giving more relief to ordinary Americans and it turned a surplus into a permanent deficit. 4. Bush then blamed the ensuing deficit on the war, but that was a scapegoat, because the tax cut had a much larger effect than the war (in any case, Krugman says that many of the war dollars are misdirected toward conventional weapons). 5. The ensuing fiscal squeeze will especially hurt Medicare (in particular, its extension to prescription drugs) and Social Security, which will have serious funding problems in the future as the ratio of workers-to-retirees decreases.
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July 27, 2008 | The Big Picture
Our earlier look at Age of Turbulence as well as the criticism by Gramlich and Poole created a lot of very interesting comments. You folks (obviously) have some things to say about this.
Here's our Sunday night challenge: How much blame does Alan Greenspan deserve for all of the current mess we are in? What percentage of responsibility lay at his feet?
I weighed in on this when Greenspan retired 30 months ago (Myths of the Greenspan Era) -- but since then, a lot more evidence has come to the fore.
I want details: Specifically, what bad policy decisions, miscalculations, ideological foibles, and just outright poor judgment did Greenspan show over the course of 18 and a half years as Fed chair?
~~~
What Say Ye?
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Greenspan made money cheap. Investors thought they could do better. New instuments, new ways of laying fees to up the return and pad the exercise. Should have he know how innovative WS could have become. I think not.
Lax lending led us down this road. Period. Greed led us down this road. Period.
Posted by: OnSideRestorationSucks | Jul 27, 2008 6:48:09 PM
History is not likely to judge Mr. Greenspan very well. He got lucky in the 1990's with a productivity surge, but it ended badly with the dot com collapse. He lowered rates to save the economy in the 2000's and then got side swiped by the mortgage collapse once he left office. The truth is, however, if Congress had passed a law mandating 10% down on all mortgages and outlawing teaser rates, would we be in this mess? If the crowd that qualified at 2.5% had to qualify at 6% or 7% would this have happened? I blame Congress first.
Posted by: Ames Tiedeman | Jul 27, 2008 7:20:40 PM
Barry,
Greenspan must be accountable for much of the housing crisis...certainly not all, and my point is what I have written before and many others here feel the same.
I will make my point by parts of other posts I have written here over the last several months.
Greenspan saw the tech bubble, coined the term "irrational exuberance", and told us, if we would listen that the tech mania was going to end on his watch. My personal experience was to put my entire retirement portfolio into just a few tech names in October of 1998 and when Greenspan started making noises about raising rates, paid attention. I sold all my shares in April of 2000, and all my investment buddies told me I was crazy...the fed tightened..Aug 24, 1999, Nov 16, Feb 2, and Mar 21...I sold in early April believing "the Maestro"..
I contend that this (beginning of the tightening cycle) was the event that began the popping of the tech bubble...
http://www.newyorkfed.org/markets/statistics/dlyrates/fedrate.html
So, we go forward to the credit crisis...here we see an entirely different handling (or non-handling) of the crisis...and we all see that Bernanke takes over the fed, and the mess is in his lap from day one...Greenspan has done little in this crisis...
Now, had Greenspan aged so much that he did not see the similar distortions of the tech and housing markets? I think not...
As I have written before, a man I bought my farm from told me before the real estate crisis began that he was not buying any additional East Tennessee real estate, that he thought the good times were over, at least a year prior to the first national malaise over these markets.. This man is self made and simply follows the news, and could see this coming, when the MBA's and CPA's could not...and I know, as many of my friends are in both crowds...
Greenspan didn't treat the financial health of the country like it was his own house...he wasn't proactive enough..
Just my opinion...
Bruce in Tennessee
Posted by: Bruce | Jul 27, 2008 7:49:16 PM
I don't think it matters what Greenspan did or didn't do. What matters is, how come there are no more protests, civil uproar when confidence surveys are so low.
One of the major side-effects of "ownership society" or "American dream" is that people can't even stand up for anything anymore, because now they are "owners". They can't stand up to their bosses at work, to corrupt politicians, because now they have mortgages to pay.
Remember the movie "picture perfect"? Mr. Mercer is giving advice to Jennifer Aniston something to the effect of "that guy has a wife, a huge house, a huge mortgage, so I know he is going to be loyal to me...you, you are single and renting"
Too much of anything is never good. If America is to grow strong, it needs to break loose its chains, feel the hunger and recreate the passion (not to become individually rich but) to unite as a nation again.
Currently it looks more like a grand bazaar where everybody is yelling around with no common goal to work towards (other than the goal of finding band-aids hoping to avoid collective failure)
People look at you disapprovingly when you say "system needs a flush, stop delaying the inevitable, you're making it worse", they think "you want IXIC 1881". I don't want IXIC 1881, but I will see it as a sign of admitting reality if US were to eventually recover. First step to recovery is self-realization. I don't see that yet other than on a few blogs.
Posted by: Mich(^IXIC1881) | Jul 27, 2008 7:59:43 PM
How can you believe in adjustable rate mortgages then raise rates?
He should have stuck w. music...
Posted by: bc | Jul 27, 2008 8:03:42 PM
Let's not forget his shilling for the Bush tax cuts. He forgot he was supposed to be independent--as did the Supreme Court.
Put another way, he didn't create the monster, but he surely Fed it in the end. He failed to do his job, overly low interest rates led to the short term feeding frenzy that his monthly trips to Congress ignored.
He is not the most guilty because his was failure by omission, Bushco literally was run on/for commission. He can be thought of as the police captain on the mafia payroll.
Posted by: Mel | Jul 27, 2008 8:11:03 PM
I'd lay 80% of our current dilemma at Greenspan's feet. He allowed Glass-Steagall to be repealed, he lowered rates unnecessarily in 1997, juicing the economy into 2000, creating a market bubble. In 2002, he looked the other way while the housing bubble and poor lending practices took hold. In his position, he had enormous opportunity for influence over all of these and he failed miserably.
Posted by: SteveC | Jul 27, 2008 8:11:12 PM
Greenspan is a bureaucrat. To believe that a lifelong bureaucrat caused this mess is gross oversimplification at best.
Certainly his Keynesian policies didn't help matters (although they should not have surprised anyone considering he was appointed by Ronald "Voodoo Economics" Reagan, the pioneer of modern Keynesian deficit spending).
The fact is, however, the credit boom which led to the current mess has its roots in a time well before Greenspan was even appointed (at least the early 1980s, probably much further back) - the present real estate crisis is merely the final culmination.
Even if Greenspan had had the power to raise rates to 10% in 2001 (doubtful for various political and economic reasons) we would merely have had the great credit unwind sooner and in a much more condensed version...in which case our mild 2003 recession would have instead been a monster depression which we would probably still be feeling the results of today.
Posted by: KeynesWasAFraud | Jul 27, 2008 8:12:07 PM
Based on a comprehensive review of all comments on this topic it is obvious that it is foolhardy to think that anyone can really do anything and anything and it is foolish to hold anyone to blame for anything.
Posted by: Douglas Watts | Jul 27, 2008 8:25:43 PM
I blame him a lot. He sold utter non-sense with his untested beliefs around the depression. He was the snake oil master sales man of the century.
You just look back at the stepping down of interest rates back to the 80s when he got power.
I wasn't paying attention to the big picture, but what I saw declining interest rates doing to younger people was horrendous. They got stuck with inflated home prices that gradually inflated relative to wages over 20-25 years.
Lower interest loans that require a percent of your income to service are far more burdensome then if the rates stayed constant preventing the asset inflation. People are more motivated to pay off debt when rates are higher and that simply makes for a stronger foundation.
Greenspan didn't see an ounce, or grain of the massive problem he was creating. That makes him an utter moron.
Posted by: Deborah | Jul 27, 2008 8:29:18 PM
Isn't the crux of the problem the Greenspan/Bush mix? The problem lay in the fact that interest rates were dropped to historically low levels at the same time we had massive deficit spending.
The Fed and the government worked together to dilute dollar value, while at the same time making interest rates excessively low. This fueled massive speculation in order to preserve wealth-ie: housing bubble, and perhaps outsourcing.
I'm not so sure Greenspan is solely to blame. Voodoo economics also played a role.
Posted by: Rich_Lather | Jul 27, 2008 8:55:20 PM
He did his best thinking and writing in the bath tub, for God's sake. Now we know that HE WAS ALL WET.
He held too much power over the Federal Reserve Board. Not enough dissention.
Posted by: magnolia | Jul 27, 2008 8:56:20 PM
According to an article in the Independent, John Paulson has hired Greenspan. Appears Greenspan will be profiting from his 'time' as FED Chair.
"The man who made a personal $3.7bn (£1.85bn) fortune by predicting the credit crisis is hoping to make another killing by helping to prop up financial companies brought to the brink of ruin by the chaos in the debt markets."
John Paulson hedge fund now looks to buy banks
"With its new-found influence, Paulson & Co has been able to sign up Alan Greenspan, a former head of the Federal Reserve, as an adviser and he is likely to be helpful to the new fund in assessing the capital needs of the banking sector for which he was once the chief regulator.
The appointment raised a chuckle in dealing rooms across Wall Street when it was announced in January, since Mr Greenspan is being damned as the architect of the housing market's disastrous bubble."
Posted by: BlackSwan2008 | Jul 27, 2008 9:05:17 PM
Greenspan pulled the trigger, but if he hadn't they simply would have assigned someone that would.
Fact is that when people want something for nothing their governments attempt to give it to them. Fiat is the favorite tool always has been.
Only when the people rid themselves of the something for nothing mentality will it be possible to elect representatives that will respect money, credit, and inflation.
Posted by: David | Jul 27, 2008 9:18:53 PM
He was correct in his irrational exuberance belief. But after the dot com bust he kept interest rates too low for too long.
Posted by: Tom | Jul 27, 2008 9:19:28 PM
No one put a gun to the heads of banks and told them to loan money to people who couldn't pay it back.
No one put a gun to a home borrower and told them to take out a loan they couldn't handle.
Greed and stupidity are the causes. Greenspan just made it more easy. Just like gun makers make killing more easy, but it's the idiots who can't control their own emotions or don't think logically about the outcomes of their behaviors who are to blame for the deaths.
Posted by: Duke | Jul 27, 2008 9:22:21 PM
Bill Clinton started this financial mess.
In Summary Bill Clinton laid the foundation. Alan Greenspan greased the wheels.
Then, extremely unscrupulous mortgage lenders and banks took full advantage of
gullible, unsophisticated borrowers.
By replacing Glass-Steagall with Gramm-Leach-Bliley, banks and investment brokers
were permitted to consolidate, and the natural system of checks & balances was
destroyed. Not to mention the conflicts of interest that were born. Yes, Greenspan aided
the situation by lowering rates and keeping them low, and S&P encouraged risky loans
by giving them AAA ratings, and many idiot Americans who thought prices would keep
appreciating need to check themselves into gamblers anonymous, but if I had to go
back to the beginning, to where this mess started, it would be with Bill Clinton's
signature on November 12, 1999.http://leavittbrothers.com/chartspeak/ChartSpeak_072708_How%20Did%20We%20Get%20Into%20This%20Financial%20Mess.pdf
Posted by: Sean | Jul 27, 2008 9:31:43 PM
Who said that "people have to much equity in their homes"? Hmmm!
Posted by: JL | Jul 27, 2008 9:46:04 PM
Greenspan was not a central banker. He was a political tool. Think of his comments re spending the "surplus". A cental banker would have considered the coming Medicare/soc Sec bill, but not Dr G. Look no further except to say that anyone that had as many one on one meetings w/bush should have figured out that he was a lightweight.
Posted by: larster | Jul 27, 2008 10:11:38 PM
alan greenspan led the commmitee to reform social security in the early 1980's, that led to increased regressive taxes on the citezenry. he remained silent as the political class spent the money that was supposed to have been saved, and was rewarded with the chairmanship of the federal reserve.
I consider mr greenspan and many others in both parties guilty of treason for fleecing the american people and their children out of the american dream.
Posted by: harlynman | Jul 27, 2008 10:16:45 PM
He famously said back in 2002 that mortgage lending controls were unnecessary because the free market has learned how to securitize risk. And that boys and girls, pretty much sums it all up.
Posted by: renoDino | Jul 27, 2008 10:17:18 PM
Reading the comments, it seems that everyone is truly focused on the policies of his FED. To me, the worst thing that he did was lead the Federal Reserve into the arena of politics. He was afraid that the Clinton administrations successful attempt to develop a surplus and actually start paying down the debt would bolster Social Security and make the dollar, and thus government, stronger. To a true believer of supply side economics I guess that is a frightening prospect.
Because of this fear he actively led an effort to endorse the Bush tax cuts. Without his express endorsement they would have never sailed through and thus secured the eternal rise of debt he so cherished. A lower debt would have meant the the corporate interests would not be able to maintain the control they had come to enjoy. The low interest rates being continued far too long were just icing on the cake. Add in an off budget war and the phrase "Of, by, and for the corporation" has been secured well into our great grandchildrens' lifetime.
Posted by: Drich | Jul 27, 2008 10:18:02 PM
Current Mess... Greenspan and the Federal Reserve deserve about 70% of the blame for the housing crisis due to the oddball handling of monetary policy that brought interest rates to all time lows, as well as, the bubble blowing power of the LTCM bailout and associated interest rates.
As for the dollar, the "War on Terrorism" plus the above Housing issues have substantially weakened the dollar. Maybe half on the wars, and half on the fed.
Posted by: Dan | Jul 27, 2008 10:31:04 PM
This is tough one to comment on....
It's like kicking a beat dog when it's already down. A.G. has already been so undressed the last few years, it's not even worth my time to be piling on now.
He will be known as one of the WORST Fed Chiefs ever. Period.
Now. OT:
So....
We are throwing 300 billion directly at the "housing crisis".
The Fed and gov't backed institutions have basically fronted $1 Trillion to stop the bleeding.
We bailed out JP Morgan (the real bailout) by sort of bailing out BSC.
Hank Paulson wants a Bazooka to protect poor ol' Freddie and Fannie.
The SEC made it more onerous to short "certain" sensitive stocks.
The Federal Reserve has tainted it's balance sheet by taking on questionable paper.
We sent out $100bn in checks to "stimulate" the economy.
And....for all of this effort, the SP500 fell 24% from highs to recent lows and has managed a measly 4% bounce of the lows? What the hell would have happened if the government had done nothing?
Is anyone else feeling a little nervous? Does anyone else feel like we're pissing on an inferno here? Either the market has it totally wrong and the Feds have indeed saved the day....or we're totally screwd....like economic Depression/civil unrest type screwd.
- AT
Posted by: Andy Tabbo | Jul 27, 2008 10:50:27 PM
Am I missing something here?
The Fed can effectively set short term interest rates but this housing bubble has been driven by cheap long term money, much of it foreign. (What did you expect the chinese to do with all those dollars?) The inverted yield curve of recent years showed that long term rates had a mind of their own. I don't see how Greenspan could have controlled that.
I blame him for lots of other things - but it seems like the housing bubble was not driven primarily by fed rates.
What about the SEC and whatever regulators let the brokerages play bank without the capital requirements that banks have?
I suspect it would be illuminating if someone would post the donations received by each congressman from lobbyists on behalf of the brokerages and banks and Fanny and Freddie. Greenspan seems more like a symptom of the problem than the root of it.
And if we're all so smart why didn't we throw the bums out years ago? Truth is - everybody enjoyed it while it lasted and no one wanted play the prophet and get stoned. Can you imagine any candidate of either major party running on a platform of 'tougher credit, more austerity, hard times coming?' How would they raise money and get elected?
So clear that up for me, would ya please?
Posted by: Ron | Jul 27, 2008 10:51:16 PM
Duke and mac appear to have let the point whiz right by them. Greenspan was head of one of the most powerful institutions in the world. He had an obligation to at least try to minimize the seeds of disaster that are slowly rising to the surface. He didn't do that. He failed. Move on.
Posted by: Anon | Jul 27, 2008 10:54:41 PM
..Blame Greenspan Bush parade never gets tired? ..just keep marching in circles to the same old song...my vote is nay..a better place to look might be at who runs them...Corporations with no loyalty, sense of community, (yes how quaint..lol) integrity or care for following laws or even sensible business practices ..an certainly no care for human beings of any country in any other way than a resource to tap...a market to open, cheap labor, resource utilization ect ect..How inspiring..!! ..Yes if we were to really look for full responsibility we might have to start with the stars of last weeks CNBC Hampton's show from Sag Harbor..that lovely group of insecure small minded posers ... hiding behind $20 million dollar 2nd homes and $4 million dollar boats ...laughable.. that would require some insight..to not applaud, or admire or wait on every word as if they had some wisdom to share ..they don't...these sycophant seeking hypocrites are an embarrassment to humanity...by my eye..and the real cause...yet to admit that would be to admit that our own values and desires have to be reckoned with..
Posted by: brasil | Jul 27, 2008 10:59:51 PM
mac - or PC? Every DAMNED DAY.
Bush is the worst president in the history of the republic. He and his cronies, by sins of omission and commission, have tanked every asset we have ever built.
As for Greenspan and your swipe at liberals... bwaaaaaaaah. If you can't see the outright manipulation in every part of today's macro-economy, then you're blind. Roosevelt was a piker compared to these social engineers. It's all about ripping off the taxpayer to backstop the crooks when TSHTF.
January can't come fast enough.
Oh yeah - regarding the post, the last correct thing Greenspan said was "irrational exuberance."
Posted by: wilson | Jul 27, 2008 11:00:39 PM
People are free to their own opinion, though, this: "Most reasonable people believe this was the last thing Bush wanted in that it would force him into the type of activist foreign policy he had campaigned on avoiding. His pre-911 actions back that up, BTW. No one wanting to engage in risky foreign adventures would ever have picked Colin Powell for SecState." doesn't square with readily available information from people like Paul O'Neil, Secretary of the Treasury that came in with, along with aforementioned Powell, GWB's first Cabinet.
http://www.ustreas.gov/organization/bios/oneill-e.html
Posted by: Mark E Hoffer | Jul 27, 2008 11:00:59 PM
The problem is the fiat system; All paper returns to its intrinsic value: Zero. Who the actors are in is irrelavant.
Posted by: Jeff B | Jul 27, 2008 11:01:05 PM
>> 911's fallout could have been a HELL of a lot worse for America, in many ways, than it was. The credit for avoiding a lot of that damage goes to Bush and Greenspan.
The threat of significantly more harm has to be *credible*. The neocons and their media allies ignored all evidence suggesting their concerns were overblown. Yet, you persist in these claims? Sorry, but this merely demonstrates how firmly rooted you are in your partisanship.
"The only thing we have to fear is fear itself" isn't always true. But, in the present fiasco, it turned out to be the primary risk. And risk realized! In their zeal to prevent "ultimate calamity", the neocons and their media allies bungled everything.
Given the enormous power and influence of the US as the starting position, you could not be any more incompetent.
The neocon overreaction to 911 has been far more damaging than Osama's attack. And, since Osama's plan was probably to involve the neocons in the manner he fought the USSR in Afghanistan, our current situation means the neocons fell into Osama's trap. Yet, you persist in your claims?
It boggles the mind to hear anyone defend the neocons' execution.
Don't get me wrong. As to their motivations, I very much understand the neocons and believe their hearts are in the right place. The disagreement is not over the overall goals of defeating religious extremism. We must face these threats. My criticism of the neocons lies in their strategy. There's the old addage: the road to hell is paved with good intentions. With their "good intentions" but a disregard for truth, justice, the Constitution, and US laws pursuant to ratified international treaties, the neocons are a danger to everyone.
Posted by: wunsacon | Jul 27, 2008 11:05:03 PM
I have read each of the 28 posts before I came to the conclusion - your first post and comments was better.
Alan Greenspan was One Man - he made decisions based upon Economic Models. He was a theoretician, who was a master of political manipulation - He was naive to the Corruption, deceit, and every negative concept of Greed - that was exponentially present in the big lobbies, Bankers, Money Manipulators - you name it - he didn't, I think, realize that his greatest "users" were the ugly underground - That have been present (out of hiding) since the early 80's - he is a victim of his own naivety
And This is a wonderful country that will stone him to death and hang him with "who didn't flush the toilet?" BUT - he put himself there!Posted by: paul | Jul 27, 2008 11:12:00 PM
"...the candid assessments of former U.S. Treasury Secretary Paul O'Neill, for two years the administration's top economic official, a principal of the National Security Council, and a tutor to the new President. He is the only member of Bush's innermost circle to leave and then to agree to speak frankly about what has really been happening inside the White House."
http://www.amazon.com/Price-Loyalty-George-Education-ONeill/dp/0743255453
http://www.cbsnews.com/stories/2004/01/09/60minutes/main592330.shtmlThis man, O'Niell, had the Honor to try to tell us what he knew of what was up. That many did not hear, is not, necessarily, his fault.
Posted by: Mark E Hoffer | Jul 27, 2008 11:16:02 PM
Regarding Greenspan, I'm against "diluting" the blame and passing it around. I believe every participant in this deserves blame "full strength".
Consider a legal concept known as "joint and severable liability". At a 4-way intersection, if 2 drivers run a red light and "Malachi Crunch" a driver going thru the green, many states hold those 2 red-light runners "jointly and severably liable" for the damages. Why? Regardless of what the other did, each was required by law to observe driving laws. And what it means is: each is "100% liable" for the damages caused. If one can't pay, the other is completely responsible.
In the analogy, the 2 drivers' acts of negligence occurred with unity of time, unity of place, and unity of "responsibility". In Greenspan's case, the acts of negligence occurred across time, across space, and across many zones of responsibility. Yes, in Greenspan's case, many people ran red lights. (For the sake of gross simplicity, I estimate more than half the country is responsible for this mess, including most politicians and partisans supporting our 2-party duopoly.) But, when we talk about Greenspan being the serial bubble blower, keeping interest rates too low, and not sounding alarms (ala David Walker for a nice contrast), then I consider Greenspan 100% responsible for those actions.
Posted by: wunsacon | Jul 27, 2008 11:26:46 PM
I would have more respect for this thread if the people posting read AG's book. Saying "I don't need to read his book because I know he's an idiot" strikes me as haughty.
Posted by: Robert | Jul 27, 2008 11:30:38 PM
also, why do people think this:
The problem is the fiat system; All paper returns to its intrinsic value: Zero. Who the actors are in is irrelavant.Posted by: Jeff B | Jul 27, 2008 11:01:05 PM
is a theory?
it, too, is readily provable with easily accessible factsets.
facts, happily enough, are still readily knowable.
Posted by: Mark E Hoffer | Jul 27, 2008 11:32:00 PM
The problem is this insane belief that such a small group of men (the Fed) can possibly be capable of 'fine tuning' monetary policy and not make lots of mistakes.
The market makes billions of decisions every second and these guys are supposed to analyze all the data and 'tune' things just right?
Look at the history: The Fed was created to smooth out the business cycle and avoid the wild swings experienced in the first part of the 20th century. But, after the inception of the Fed these swings have been *far* worse than before.
Design flaw. And a very expensive one. Fiat currency - bad. Fractional reserve banking - bad. Government deficit spending - bad. High taxes - bad. Public insurance - bad. Central bank control - bad.
Abolish the Fed and debate how to exist without it.
Posted by: ssm | Jul 27, 2008 11:36:20 PM
"By replacing Glass-Steagall with Gramm-Leach-Bliley, banks and investment brokers were permitted to consolidate, and the natural system of checks & balances was destroyed."
Note that 'Gramm' above is none other than Phil Gramm, McCain's economics advisor until recently.
McCain is running with by and for crony capitalists. Be afraid. Very afraid.
Posted by: lark | Jul 27, 2008 11:50:04 PM
Greed and stupidity are the causes. Greenspan just made it more easy.
I have to get this message through if it kills me...this crisis is 20 years in the making (BTW, Greenspan chaired the Fed practically the whole time). It boils down to the same old argument...can the Fed chairman discern when a bubble exists and prevent it from further expanding out of control? The chart looks to me that on his first day in 1987, a smart Fed chairman would have noticed a debt bubble forming. By 2000, a 5 year old could have seen it. What he did was simply allow the greatest debt bubble in the history of mankind. Now what?
Posted by: Steve Barry | Jul 27, 2008 11:51:55 PM
ssm,
>> Abolish the Fed and debate how to exist without it.
I hear ya! But, I propose we reverse the order of these two steps! ;-)
Posted by: wunsacon | Jul 27, 2008 11:52:33 PM
Mich said:
"Too much of anything is never good. If America is to grow strong, it needs to break loose its chains, feel the hunger and recreate the passion..."Reminds me of that cool animated short film, "More":
http://despair.com/more.html
Posted by: Mr. Bubbles | Jul 27, 2008 11:52:43 PM
Greenspan's biggest crimes are:
1 - testifying before Congress that the Bush Tax cut would not be deficit creating; which was an outright lie. This big lie was the green light for the why me worry spending you have seen out of Bush and Congress.
2 - interfering so that state regulators could not fix lax lending standards in the mortgage market.
I actually don't think he was that bad on rates. He just under regulated banking and took a devil may care attitude that was bound to lead to overheated credit and a bust. He is Ayn Rand's joke on America.
Posted by: Northern Observer | Jul 27, 2008 11:58:51 PM
Design flaw. And a very expensive one. Fiat currency - bad. Fractional reserve banking - bad. Government deficit spending - bad. High taxes - bad. Public insurance - bad. Central bank control - bad.
Abolish the Fed and debate how to exist without it.
Posted by: ssm | Jul 27, 2008 11:36:20 PMBuy a good book on the history of banking in England and America. Preferably one that is not from the Austrian economists out of Alabama because they are preaching a religion, not economics.
What you will see is that private money systems are prone to even more frequent and violent boom bust cycles. There is a reason the institutions that exist today were created; it was not some back room plot to control the world.
What we are seeing today is what happens when someone who doesn't believe in the system (greenspan) gets to run it. What you get is self destruction of the credit structure as the head honcho fails to do his job because he doesn't 'believe in it'
Only in America...Posted by: Northern Observer | Jul 28, 2008 12:06:01 AM
As I posted in the other thread, a picture is worth a thousand words.
That graph is net household mortgage lending, 1995-2008.
Note that 2008 is on track to be back to 1998 levels.
See that $600B line? Everything above that has the potential to be dead loss IMO, recoverable for 30-50c on the dollar if the system can recover soon.
Posted by: Troy | Jul 28, 2008 12:25:01 AM
As someone above says the problem was the Greenspan/Bush mix. To use Bush's metaphor: Greenspan gave the drunks the keys to the liquor store, and Bush sent the cops on vacation.
Philosophically Greenspan is, or perhaps was, a doctrinaire conservative economist and disciple of the free market philosophies of Ayn Rand and others. And not all of these are bad some are positive and reflect reality. His hands off attitudes didn't matter too much when Bush senior and Clinton were in office because basically they both pursued sound money, fiscally conservative, free trade policies with a fairly tight regulatory climate and as Greenspan's book make's clear he had a total rapport with Clinton/Rubin/Summers. They all had a stroke of luck with the dotcom boom which produced a huge spurt in productivity and whose long term effects despite the bust at the end were generally benign. Despite a lot of paper wealth and shareholders money disappearing down the drain the numbers of people employed in the failed ventures were relatively small and the impact on the wider economy fairly slight. The problem was the dotcom bust actually happened on Bush's watch, although the signs were already there, and he and Greenspan were desperate to avoid a major economic slowdown on his watch. So while Bush and his allies in the congress cut taxes and ramped up public spending at the fastest rate since Johnson, Greenspan rapidly reduced rates and kept them low long after it was clear the contraction was actually going to be brief and shallow. At the same time the regulatory climate was greatly relaxed despite outrages like Enron and the consequent Sarbox which produced the appearance of tightened standards. In fact because all the key agencies were stuffed with extreme conservatives, many of them totally incompetent, serious regulation became a dead letter. Greenspan issued nary a peep about the huge tax cuts, the Keynesian increase in public spending, the huge increase in M3, or the lax attitude of regulators. Partly this was philosophical, he many times for example said that it was not the job of central bankers to deflate speculative bubbles, and part of it was he wanted to keep his job (ie. get reappointed).
In summary then the charges against him are that post 2000, because his record up until then was fairly good, he ushered in a period of extreme loose monetary policy and colluded with, or at least turned a blind eye to, fiscally irresponsible and lax regulatory policies by Bush. There's no doubt he's guilty as charged because who can doubt that if he'd tightened money and made a fuss a lot of this stuff wouldn't have happened. He probably wouldn't have been reappointed either.
So I'd say he carries 40% of the blame. The administration gets another 40%. And the rest can be allocated between the financial institutions and the small fry who sold mortgages etc.
Posted by: John | Jul 28, 2008 8:54:44 AM
It's becoming harder and harder to convince people Greenspan is the root of all evil as the people start to realize the criminality of what has happened across a multitude of topics. This has nothing to do with housing and more and more of this will become apparent as time goes by. Housing is simply a symptom. This is Wall Street's mess Barry. And, I don't know why you are so reticent to say so other than so many of your acquaintances work there.
Greenspan didn't throw money out the windows in private equity deals, commercial real estate, residential real estate, emerging markets, credit cards, consumer loans, highly leveraged investments, loans to highly leveraged hedge funds, derivatives and on and on. And, not only did they do so, but they used our deposits to do all of this after the Chinese Wall was broken after deregulation and after they learned to provide unlimited loans by skirting regulation. And, this is not a consumer problem either. We have consumer protection laws to keep oorporations from preying on them as has been happening. Were individuals greedy? Sure. But Banks did all of this.
Posted by: bdg123 | Jul 28, 2008 9:01:42 AM
Northern Observer:
Concur broadly with your observations about what happened after 2000 but they don't explain why his free market philosophies didn't prove corrosive in the late 80's/90's. I really think it's one of those situation where you have two chemicals that are harmless or even benign on their own but when combined become toxic. The reasons were complicated.Posted by: John | Jul 28, 2008 9:04:39 AM
bdg23:
All you say about banking greed and irresponsibility is true(so what's new) but you're loosing sight of the wider strategic reality. None of this would have happened if they hadn't had access to cheap money and an almost total absence of oversight.Posted by: John | Jul 28, 2008 9:13:39 AM
Greenspan - The Fed chairman advocated going to war to protect the Strait of Hormuz from attack and control by Saddam. Greenspan was truly delusional back in 2003, which was long after Gulf War I and Saddam had no Navy or Air Force to attack with, Greenspan should have been removed from office at that point, since he obviously was not thinking clearly.
Posted by: Sean | Jul 28, 2008 9:15:50 AM
It is not coincidence, I think, that we have come to the end of the cheap oil bonanza concurrent with the end of empire and all that portends. Mr. Greenspan played his part as we all did in the age of excess made possible by cheap energy. Many things are coming to an end no matter our collective "wish" that they continue. I have been more than critical of the era of cheap money, which leads to cheapness in all things societal, however, Greenspan is only the point man who gets the most arrows, we are all to blame. The Jiminy Cricket economy is about to get slapped upside the head by reality.
Posted by: mark | Jul 28, 2008 9:21:14 AM
His worst call was to urge people into adjustable mortgages when rates were at the lowest level.
Bill Fleckenstein describes in detail Greespan's incompetence in his book. A great read.
Posted by: Kat | Jul 28, 2008 9:29:54 AM
John, I see you are the poster child for clowns as you chase my comments around. If you had read my blog, you'd know I said this would happen on some level years before it unfolded and I have been writing about the deregulated environment that created it for years as well. So, please don't take my three sentences I post on here as my perspectives in their entirety and put words in my mouth to show your vast knowledge of nothingness. I already know you don't know what's going on based on your last attempt to do so. All of this said, to blame Greenspan - as you did in your last comments directed at me - shows your lack of knowledge of how systemic this problem is and how little you know about what is going on.
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Financial Armageddon
. Pollyannaism has been rampant since the financial world first began to unravel more than a year ago.First there was the asinine belief -- espoused by central bankers and Wall Street "strategists" alike -- that the problems in the subprime credit market would remain "contained." Wrong.
Then TV pundits, ivory tower economists, equity traders and other clueless observers asserted that the government -- the Fed through monetary policy, and legislators by way of fiscal policy -- would somehow manage to save the day. Wrong again.
And finally, the "experts" started arguing that even if things went sour in the U.S., the rest of the world would still manage to keep on truckin', thus muting the impact of any falloff in demand in the world's largest economy. Wrong once more.
In reality, the dominoes have fallen more-or-less as anticipated by those who actually looked at the facts and honestly assessed what they meant before the meltdown started. For this group -- and yes, I include myself -- the developments detailed in the following Reuters report, "Global Credit Crisis Undermining Economy," are not a surprise.
The global credit crisis is continuing to undermine the world economy, putting the squeeze on Japanese exports, unravelling European business confidence and deepening the U.S. housing slump.
Economic data from the United States on Thursday showed the housing market remained weaker than Wall Street's already grim estimations, with existing-home sales tumbling to a 10-year low.
In Europe, key measures of business activity and company sentiment fell more than expected in Germany, France and Italy, as well as in a survey of the 15-nation euro zone.
The Ifo institute's gauge of German business sentiment, based on a survey of about 7,000 companies, suffered its biggest drop since soon after the September 11 attacks on the United States in 2001.
Japanese exports, which are heavily dependent on U.S. demand, shrank in June for the first time in nearly five years and Bank of Japan policy-maker Atsushi Mizuno, said there was a chance that Japan could slip into a recession although he did not expect a deep one.
Thursday's data was also the latest reminder that the malaise in the world's largest economy originated in the U.S. housing market, and the rising inventory of homes for sale does not bode well for the prospects of economic recovery.
"This is not something we are going to snap out of quickly," said Richard Sparks, senior equities analyst at Schaeffer's Investment Research in Cincinnati.
U.S. and European stocks fell. The U.S. dollar slid against the Japanese yen but rose against the euro.
Oil prices fell to a 7-week low early Thursday during Asia's trading hours, but by midday in New York, crude had reversed course and turned higher. In volatile early afternoon trading in New York, U.S. crude futures were up $2 at $126.44 a barrel.
Government bond prices jumped in the United States as investors trimmed bets on a near-term rate increase from the Federal Reserve. The 10-year U.S. Treasury note was up 21/32 in price; its yield, which moves in the opposite direction, fell to 4.04 percent from 4.12 percent late on Wednesday. Euro-zone government bond prices also gained.
BAD TIMING IN EUROPE
In the euro zone, signs of weakness could not come at a worse time for the European Central Bank, which raised interest rates earlier this month by a quarter percentage point to 4.25 percent to combat inflation that is double the upper limit of its target and likely to rise further.
Germany's Ifo business climate index dropped to 97.5 in July from 101.2 in June, and was weaker than the 100.0 economists had expected.
If there were not enough gloom for Europe, British retail sales had their biggest monthly fall on record, plunging 3.9 percent and wiping out an almost equally large surge in sales the month before.
Recession risks are rising in Britain, where the housing market is plunging. A Reuters poll of economists on Wednesday put the probability of recession at a significant 40 percent, double where it was at the start of the year.
Spanish unemployment rose to 10.4 percent in the second quarter, much more than expected, as a reeling construction industry eliminated jobs.
In Scandinavia, Danish consumer confidence plunged much more than consensus forecasts to a 16-year low while Swedish unemployment staged an unexpectedly large spike to 8.1 percent in June from 5.9 percent.
CLOUDS OVER JAPAN
Data on Thursday from the world's second-largest economy were also disappointing.
Japanese exports to the United States and the European Union both fell, as did exports to other countries in Asia. That news comes against a backdrop of growing concerns that domestic spending will not be able to carry the torch for the Japanese economy.
In the United States, a surprisingly large number of people sought jobless benefits last week. Some analysts blamed seasonal factors, but the data come in the context of a jobs slump in which employers cut workers for a sixth consecutive month in June.
The Federal Reserve began lowering interest rates quickly after the credit crisis erupted late last year. More recently the U.S. central bank has signalled worries about rising inflation, which could require tighter monetary policy.
Meanwhile, news of further deterioration in the U.S. housing market came a day after the U.S. House of Representatives passed a massive rescue package.
The bill, which is awaiting Senate approval, would let the government extend an emergency lifeline to mortgage finance giants Fannie Mae and Freddie Mac.
Meanwhile, Mexico's annual inflation rose to 5.37 percent in early July, its highest level in more than three years, bolstering expectations that the central bank will raise interest rates to cap soaring food prices.
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nakedcapitalism.com
The headline of this International Herald Tribune article (hat tip reader Saboor) is a real sign of the times. The short answer is our policies assume the answer is yes, but if we don't course correct, that assumption is likely to be tested.
Specifically, the argument goes, our trading partners will continue to be willing to finance our trade deficits because they depend on the US as an export market. But the flaw in that logic is that our friendly money sources are not only providing the dough for the trade deficit, but also for the interest we pay on their debt. As our external obligations keep growing, a higher proportion will go to interest. At some point, the benefits are going to look less clear.
From the International Herald Tribune:
In the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government's job description....So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government-sponsored mortgage companies, Fannie Mae and Freddie Mac. The reasoning behind this rescue ... The mortgage giants were too big to be allowed to fail...
Commercial banks from South Korea to Sweden hold investments linked to American mortgages. Their losses would mount if American homeowners suddenly couldn't borrow. The global financial system could find itself short of capital and paralyzed by fear, hobbling economic growth in many lands...
All through Japan's lost decade of the 1990s and afterward, American officials chided Tokyo for its unwillingness to let the forces of creative destruction take down the country's bloated banks and the zombie companies they nurtured. The best way out of stagnation, Americans counseled, was to let weak companies die, freeing up capital for a new crop of leaner entrants.
But as Japan's leaders engaged in bailouts and bookkeeping fictions to keep banks and companies breathing, they offered those words of justification now heard here: The companies were too big to fail...
Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.
For one thing, this argument goes, taxpayers - who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel - will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money - a step that encourages further inflation.
"They are going to raise the cost of living for every American," said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments. "The government is debasing the value of our money. Freddie and Fannie need to fail. They are too big to save."
Using public money to spare Fannie and Freddie would increase the public debt, which now exceeds $9.4 trillion. The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf. Were they to become worried that the United States might not be able to pay up, that would force the Treasury to offer higher rates of interest for its next tranche of bonds. And that would increase the interest rates that Americans must pay for houses and cars, putting a drag on economic growth.
Meanwhile, as American debts swell and foreigners hold more of it, nervousness grows that, someday, this arrangement will end badly. The dollar has been declining in value against other currencies. Some foreigners have begun to hedge their bets by buying more euros.
"Obviously, this is going to come to an end," Schiff said. "Foreigners are not charitable organizations, and they're going to demand that we pay them back."
No single country owning large amounts of dollar-based investments is inclined to dump them abruptly; nobody aims to start a panic. But fears have begun to grow that one day a country may get spooked that another is about to dump its dollars - and that could trigger pre-emptive panic selling.
"Foreigners could decide it's just not worth the risk and sell," says Andrew Tilton, an economist at Goldman Sachs. "The really dire scenarios have become a lot more likely than they were a year or two ago."
Still, as Tilton and others are aware, one fundamental reality continues to offer assurances that foreigners will still buy American debt: In the global economy of the moment, the United States itself is too big to fail.
The logic for that assurance goes like this: The American consumer has for decades served as the engine of world commerce, using borrowed cash to snap up the accouterments of modern living - clothes and computers and cars now manufactured, in whole or in part, in factories from Asia to Latin America. Eliminate the American wherewithal to shop, and the pain would ripple out to multiple shores....
In other words, in the estimation of people in control of money, the United States cannot be allowed to collapse, just as Fannie and Freddie cannot be allowed to fail. Too much is riding on their survival.
The central truth of that logic still seems to be apparent as the Treasury keeps finding takers for American debt.
So the government offers its rescue of the mortgage companies, and foreigners keep stocking the government's coffers. "They don't want the U.S. to go into the worst downturn since the Depression," Tilton says.
But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.
Bailouts amount to mortgaging the future to stave off the wolf howling at the door. The likelihood of a painful reckoning is diminished, while the costs of a reckoning - should one come - are increased.
The costs are getting big.
11 comments:
- Anonymous said...
- "So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government-sponsored mortgage companies, Fannie Mae and Freddie Mac."
"STRANGE"? Pas du tout! George W. Bush has been a replay of Lyndon Johnson's inflationary guns 'n butter policies, though under a different party banner.
Such a spectacle is strange only to those who believe there are real differences between the two U.S. parties. The IHT, as an accredited member of the MSM, of course must promote this long-running myth to receive its official favors and subsidies. You and I are free to take a more jaundiced view.
- July 20, 2008 8:05 PM
- bigD said...
- Things were so much easier when their was the Evil Empire. Countries were either for us for them (OK, I exaggerate).
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Jul 10, 2008 | FedViews
John Fernald, vice president at the Federal Reserve Bank of San Francisco, states his views on the current economy and the outlook:
- Housing and credit markets remain troubled, and commodity prices have risen further. These factors are likely to weigh on the outlook for some time. In addition, reflecting surging food and energy prices, inflation is an increasing concern.
- Housing wealth has continued to plunge, with home prices down sharply over the past year. The Case-Shiller ten-city home-price index has fallen about 15 percent over the past year and about 20 percent since its peak. The futures market on this index suggests that prices have considerably further to fall before leveling off.
- Inventories of both new and existing homes-measured as the supply of homes on the market relative to the current monthly sales pace-are very high. Falling prices and an overhang of home supply are a drag on new home construction.
- Mounting losses on securities tied to sub-prime and other mortgages helped spark the ongoing financial turmoil and financial market stress still remains high. In general, risk-adjusted interest rates on private debts remain at, or above, their levels from last summer, despite substantial reductions in the federal funds rate and resulting declines in rates on Treasury securities.
- Business surveys do not suggest a major deterioration in overall conditions. For example, the Institute for Supply Management surveys purchasing and supply executives each month. For both manufacturing and non-manufacturing, these diffusion indices are currently close to 50, which is below their typical values. Hence, current readings appear consistent with slightly below-trend growth.
- In contrast, falling employment suggests more deterioration in economic conditions. Over the past year, employment in goods-producing industries (mainly construction and manufacturing) has fallen about 3-1/2 percent. In previous recessions, job losses have always been more severe than we've seen so far. Employment growth in services-producing industries has slowed, but employment remains above its year-ago level.
- Through February, household spending appeared quite weak. For example, the year-over-year growth rate of non-durables consumption-a category that includes food, apparel, and gasoline-had slowed to levels comparable to the 2001 recession. The non-durables category omits the purchases of durable goods, which tend to be volatile, as well as services, where the monthly data are likely to be less reliable.
- Since March, however, consumer spending has bounced up notably. Some of the bump-up in May presumably reflects the effects of the $50 billion in stimulus checks that were delivered that month. Although it is possible that the increases in March and April reflected consumers spending early-knowing that they would soon be receiving a stimulus check-it could also reflect resilience on the part of consumers.
- Vehicle sales have plummeted in recent months, reflecting gasoline prices that have risen above $4/gallon as well as tighter credit conditions.
- Business capital investment spending is holding up. Orders and shipments for non-defense capital goods excluding aircraft-i.e., durable equipment goods-have been edging steadily up over the past year and a half. Some of that strength appears to reflect exports of capital goods in addition to domestic capital formation. Exports, in general, have been a source of strength for the economy.
- The relatively strong incoming data suggest that growth in the second quarter was close to trend, after two anemic quarters. Going forward, the continuing and, indeed, intensifying pressures from housing, credit markets, and commodity prices, are likely to weigh on activity for some time. However, the fiscal stimulus program should help support growth in the current quarter.
- A more solid recovery should take root in 2009, reflecting some waning of the drags on the economy. In particular, housing should begin to stabilize; credit conditions should gradually ease; and energy and food prices are expected to level off. In addition, the earlier policy easing by the Federal Reserve should provide some cushion for the economy.
- Soaring food and energy prices have pushed up overall consumer inflation. With the recent surge in energy prices, headline inflation is likely to spike further before coming down. Core inflation has been better contained, but has still been running a bit high. Some pass-through of input costs for energy and transportation, as well as increases in non-fuel import prices, is likely to put continued upward pressure on core inflation.
- Assuming that commodity prices will level off, as implied by the futures markets, core as well as headline inflation should moderate next year, as more slack in labor and product markets emerges.
- A risk to the inflation forecast is that inflation expectations could rise. Such an increase could lead to a wage-price spiral, in which workers demand wage increases in an attempt to cover their increased living expenses, and firms grant these wage increases in the expectation that they can pass on those costs by raising their own prices.
- Have inflation expectations risen? The Michigan survey of households shows higher long-term inflation expectations. However, there is some evidence that the Michigan survey responses are highly sensitive to the current inflation rate, so it is likely that this measure will come down once oil and food prices stop rising. In contrast, the Survey of Professional Forecasters sees the same long-term inflation trend as they've been seeing since the late 1990s. And inflation compensation five-to-ten years out, derived from a comparison of nominal and inflation-indexed government securities, has come down from its highs earlier this year.
- Since last month, markets have pared back expectations about the pace of monetary-policy tightening. A month ago, markets thought the federal funds rate would rise steadily over the course of 2008. They now expect only one rate increase this year.
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Amazon.com
In this excellent, highly readable book, Charles R. Morris combines legal and financial experience with literary craft. No ideologue, no partisan and certainly no salesman, Morris traces the roots of the 2007-2008 mortgage securities crisis to its distant origins in the 1970s.
He argues that policy missteps under the Nixon, Ford and Carter administrations, when Arthur Burns chaired the Federal Reserve, led to dollar debasement. He contends that the decline of America's currency and its business sector at that time led in turn to the Reagan administration's zeal for deregulation and Chicago-school economics. He details his belief that Alan Greenspan's policies took America from a relatively healthy financial status to a position perhaps as dire as in the late 1970s.
Morris also reveals the privileges enjoyed by an out-of-control financial services system.
I was very much impressed by Charles R. Morris's "The Coming Global Boom" in the early 1990's, so this book was quite a disappointment. "The Trillion Dollar Meltdown" is an example of the phase Charles Kindleberger describes in his "Panics, Manias, and Crashes" as "looking for the scapegoats." Here the principal scapegoats are Milton Friedman and Alan Greenspan. Morris both decries and predicts the demise of Friedman's free market "ideology" and Reagan's idea that government is part of the problem and not the solution.
Morris sets up his argument by describing how liberalism and fiscal Keynesianism lost credibility by the end of the 1970's with what has been described as stagflation. Fiscal stimulus no longer stimulated an economy mired in so much debt. Morris then describes how Paul Volker implemented Friedman's Monetarism policy, but according to Morris, it worked because Volker didn't believe in the ideology. Volker just wanted to demonstrate to the world he was serious about inflation.
While I think Morris brilliantly critiqued the Liberalism of the 1970's, I disagree with his argument that it went away. Reagan promised to abolish the Energy and Education Departments and that went nowhere. Republicans talked about "government as the problem" but then expanded most government programs. The liberal interest groups that proliferated in the 1970's turned their attention to the Federal Courts and achieved many of their goals there. Interest group Liberalism didn't go away in the 1980's. It's agenda was still advanced merely by changing venues.
My point is that big government never died, Morris's claims notwithstanding. Nor did financial regulation end with the repeal of Glass-Steagall Act. In the aftermath of the Dot.com boom-bust, the Sarbanes Oxley Act---which Morris doesn't mention---put heavy restrictions on new stock issuances. So, the money went where the regulations aren't. As it usually does.
I would also say that in dealing with the current crisis, Fed Chairman Bernanke is not using the Milton Friedman approach of letting the "fire burn itself out." Instead, Bernanke is using the Walter Bagehot strategy of finding the lender of last resort to bail out the ailing institutions.
Now, I agree with Morris that many of these `investments" he describes are scams. I think variable rate mortgages are a bad idea because most people who agree to one have no idea that they are placing a bet on what the Fed will do over the life of the loan. They are signing up for what could be a rather bumpy ride.
I also agree with Morris's criticisms of Sallie Mae and the student loan mess, but I would point out that the colleges themselves are considerably to blame for these problems. Many colleges have accumulated vast trust funds while doing little to help their students. It sometimes seems to me that a college education has become like home ownership: having one is better than not having one but too many bucks have been chasing too little bang for some time now.
I think the institution that is most profoundly in need of reform in America is the United States Congress. When the Republicans forgot what they had been elected to do, they were turned out of office. But, when the Democrats returned to power, I saw that many faces of the Committee Chairs were the same as those who were turned out of power in 1994. Do you think they learned anything in the interim? I don't.
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