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'Bubbles' Greenspan to blame for current market woes

by Jerome a Paris Tue Jul 31st, 2007 at 09:29:03 AM EST

The FT is printing today a straightforward opinion piece by Tim Price, chief strategist with a Swiss private banking institution:

It was Mr Greenspan who, in the aftermath of the dotcom bust, practically drowned asset markets with a tidal wave of liquidity and easy money. It was Mr Greenspan who drove the Federal funds rate – the rate charged by US banks for lending to their peers – down to 1 per cent in 2003-2004, a four-decade low. And it was Mr Greenspan who opened the floodgates of liquidity that might have saved the US equity market, for a time, but that also triggered an unsustainable boom in government and corporate debt, residential property, and a carnival of mortgage lending unimpaired by anything approaching prudence.


Mr Greenspan (...) has form as a serial inflationist, willing to slash interest rates to bail out investors who should not need rescuing from themselves: one thinks of the stock market crash of October 1987; the Savings and Loan crisis; the Asian crisis; the collapse of hedge fund Long-Term Capital Management; the feared Y2K crisis. No central banker has done more for the concept of moral hazard – the risk that the perceived support of the monetary authorities will cause financial institutions to play fast and loose with other people’s money.

It is abundantly clear that, having gorged on overly easy money for years, Anglo-Saxon financial markets are suffering from indigestion.

As in previous financial debacles, the regulators will be found to have been asleep at the wheel.

All the items we've been fuming against are there: the easy money, the carelessness about asset price inflation (the markets know best, whereas wage increases are necessarily bad), the greedy bankers, advisers and assorted parasites taking advantage of the situation to take silly risks and claim they are creating value when they are just moving imaginary money around - but capturing a very real chunk for themselves along the way.

Funny how such articles are published now that we have incontrovertible proof that things are turning sour - with German banks warning about losses in US subprime markets, prices for taking corporate risk more than doubling in the past month, and banks cutting off credit to private equity firms (and to mortage lenders) altogether. Things have gone so extravagantly far that the recent pullback has not brought us yet into negative territory, as has been pointed out by many optimists, but that's about as convincing as the guy falling from the 50th floor and who thinks "so far so good" upon reaching the 3rd floor...

But at least the article makes the important point that these trends did not come out of nowhere - they were actively fed by Greenspan's Fed, who never missed an opportunity to bail out financiers that had lost (other people's) money taking bad risks.

How else to explain the lax standards implicit in the lending activities of US subprime financiers – or the conflicts of interest at the heart of the ratings agencies tasked with appraising structured debt vehicles that now resemble pyramid schemes? Or the “price-to-model” evaluations of illiquid debt securities that allowed investment banks and hedge funds to price their portfolios pretty much wherever they wanted to?

The problem for financial markets now is that a functioning financial system ultimately comes down to trust. When trust is in short supply, there is no obvious price base for securities and credits that during the good times seemed to offer unimpeachable quality.

Trust is so quaint. And as we moved more and more towards self-policing and self-regulating financial institutions, trust became all the more vital just as it became devalued:

  • The Basel II framework which is meant to regulate the kinds of risks banks can take is structurally built on the notion that financial institutions are the best judges of the risks they take and that no blunt external rules need to be applied to evaluate their capital requirements;
  • the increasingly unavoidable role of rating agencies as arbiters of how risks should be assessed has put them, commercial entities at the heart of intractable conflicts of interest. Their sales are driven by their willingness to provide acceptable credit ratings to the deals cooked up by their financier clients; these ratings are protected only by their reputation, an evanescent notion that can be, like in Arthur Andersen's case a few years back, a few years back, overcome by greed - or by the vain hope that "this time, things are really different", and bull markets will not be followed by more bearish ones;
  • the qualitative ability of banks to sift between business models and price (or deny) their financial support properly has been crushed by the cascades of liquidity that allowed even the weakest entities to find ever more money and repay their loans even when their underlying economics would not have permitted it. Why bother with risk analysis when you expect to be bailed out by ever more aggressive lending, made possible, again, by Greenspan's spigots and his proven guarantee to bail evevyone out should anything happen?

Ultimately, trust is earned when you prove your capability for restraint and your willingness to not abuse positions of power, in order to build long lasting relationships. Why bother, in a world where lack of restraint or lack of scruples is not punished (quite the opposite) and the political world demonstrates every day that you can get away with blatant abuse of power (or money) by simply abandoning all capacity for shame or embarrassment because counter-powers (whether political institutions or regulators) are unable or unwilling to punish you for it?

Even as the giant pyramid scheme new comes to an ugly end, do not expect its supporters and enablers to give up without a fight. They will blame critics for the end of the gravy train (just like domestic opponents of the war are blamed for "losing it"), and they will make sure that they are not the ones to pay the consequences.

If Greenspan is not punished, the whole rigmarole will happen again in the future. Thus my insistence to call him "bubbles" Greenspan all along. If he cannot be put in jail, or forced to repay all those that will lose out in the crash, let's at least make sure that his name lives in infamy, as that of the man who helped destroy the middle classes.

The final straw for me in regard to "Bubbles" Greenspan was when, as mortgage interest rates were at a decades-low figure, he advised people to finance their home purchases with Adjustable Rate Mortages. !!!  Why on earth would anyone get an ARM at a time when the rates are near the lowest they can get, when the "adjustment" will almost certainly be to a higher, and then higher and higher, rate?

We were constantly being informed that he was a genius, so this advice of his made me realize he was also corrupt.

Karen in Austin

'tis strange I should be old and neither wise nor valiant. From "The Maid's Tragedy" by Beaumont & Fletcher

by Wife of Bath (kareninaustin at g mail dot com) on Tue Jul 31st, 2007 at 09:46:08 AM EST
The ARMs have imploded the mortgage market in the U.S. and could have long term consequences on the overall housing market. Speculation is a dangerous game particularly when it involves people with lower income and luring them into a trap of short term low rates that ultimately end in foreclosure of their house. This has become a scandal. There are even companies like Ameriquest who have committed a litany of fraudulent acts and have multi-district lawsuits across the country that place the company on the brink - as well as their banks. The result of this speculative cycle is that now first time home buyers are having a far more difficult time getting a mortgage inspite of their credit rating.
by BJ Lange (langebj@gmail.com) on Tue Jul 31st, 2007 at 12:40:38 PM EST
[ Parent ]
Arthur Andersen's case a few years back, a few years back

Can the last politician to go out the revolving door please turn the lights off?
by Migeru (migeru at eurotrib dot com) on Tue Jul 31st, 2007 at 10:12:34 AM EST

My brother is/was a mortgage broker.  He came into work yesterday and service was cut to everyone's blackberries and laptops.  So, his company is folding...  I really don't know a lot about it all, but it is not just the subprime lenders who are going out of business.  Interest rates are keeping people in good standing from refinancing now, so there is just no customer base left.  

Also, to get all realpolitik, we can all shake our heads and ask how we let this happen.  But when people can make a lot of money very quikly and easily and people are approved for the homes of their dreams, well, this is a country where immediate gratification is the mentality.  Live for today.  Plus, look at all of the people who trusted that if they worked hard and delayed gratification it would pay off in their golden years.  Now their pensions are vanishing, they can't pay for their homes, and healthcare costs are sending them back to work.  If there is no trust left in the system, why not try to game it and get out?

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.

by poemless on Tue Jul 31st, 2007 at 11:58:53 AM EST
Bubbles was instrumental in the Reagan era deal to "stabilize" Social Security, but without insisting on controls to restrain raids on the Trust Fund - and then (worst of all) pushed for the Bush tax cuts to make sure the Trust Fund(s) would never do what they were intended to.

Like most of the Reagan/Bush crowd (and he is a card-carrying member of that cabal, don't forget), he wants to destroy the commonweal, so that he and his anorexic missus can ride off into the sunset over the bodies of the hoi-polloi.

To be kind to him, as he would be to me, he truly deserves to rot in hell.

In every age it has been the tyrant ... who has wrapped himself in ... patriotism, or religion, or both to deceive and overawe the people. Eugene Debs

by fatbear (fatbear < > aol.com) on Tue Jul 31st, 2007 at 04:27:35 PM EST
I yield to no one in my disgust with Ayn Rand Greenspan.  I have thought him mad since the Ford administration.

However, unlike the thundering throngs who assure us he is some sort of criminal because he pumped too much "easy" money into the system, I disagree.  In fact, pumping all that "easy" money was perhaps the MOST enlightened thing he did in his otherwise wasted life.

The problem was not an excess of "easy" money.  The problem is that the rest of us didn't do very much of value with this easy credit.  Derivatives are NOT an investment any more than playing roulette is an investment.

If all those absurd "investments" had been replaced by the real thing (i.e. windpower and other necessary technologies), it would have been clear that "easy" money could have lead to a golden age.  But no, thanks to our demented ideas of economics, our golden age bought MacMansions, The Iraq occupation, and arrogant gazillionaires who have driven the wait time for Ferraris to over two years.

Our economics are certainly absurd.  The thieves on Wall Street are so odious they demand a return of the guillotine.  And another worthless asset bubble is about to pop.

But strangely enough, NONE of this is the fault of Alan Greenspan.

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Tue Jul 31st, 2007 at 06:29:05 PM EST
Nouriel Roubini: Are We at The Peak of a Minsky Credit Cycle?

Hyman Minsky was an American economist who died in 1996. His main contribution to economics was a model of asset bubbles driven by credit cycles. In his view periods of economic and financial stability lead to a lowering of investors' risk aversion and a process of re-leveraging. Investors start to borrow excessively and push up asset prices excessively high. In this process of releveraging there are three types of investors/borrowers.

  1. First, sound or "hedge borrowers" who can meet both interest and principal payments out of their own cash flows.

  2. Second, "speculative borrowers" who can only service interest payments out of their cash flows. These speculative borrowers need liquid capital markets that allow them to refinance and roll over their debts as they would not otherwise be able to service the principal of their debts.

  3. Finally, there are "Ponzi borrowers" cannot service neither interest or principal payments. They are called Ponzi borrowers as they need persistently increasing prices of the assets they invested in to keep on refinancing their debt obligations.

The other important aspect of the Minsky Credit Cycle model is the loosening of credit standards both among supervisors and regulators and among the financial institutions/lenders who, during the credit boom/bubble, find ways to avoid prudential regulations and supervisions.

. . . the experiences of the last few years suggest another Minsky Credit Cycle that has probably now reached its peak. . . .

by TGeraghty on Tue Jul 31st, 2007 at 08:37:59 PM EST

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