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.