Greenspan Shrugged

by John M. Curtis
(310) 204-8700

Copyright October 23, 2008
All Rights Reserved.                    

     Former Federal Reserve Board Chairman Alan Greenspan told Chairman Henry Waxman (D-Beverly Hills) in the House Oversight and Government Reform Committee that he was “shocked” by the collapse of U.S. credit markets.  Greenspan has been blamed for supporting the deregulation that caused the current economic mess.  Despite warning investors in 2005 that risks were overlooked, Greenspan encouraged  packaging, by Fannie Mae and Freddie Mac, abstract investment instruments called derivatives, unregulated mortgage-backed products.  “The crisis, however, has turned out to be much broader than anything I could have imagined,” Greenspan told Waxman.  Greenspan had no such naiveté when he told a bloated stock market Dec. 5, 1996 that investors suffered from “irrational exuberance.”  Greenspan made no warnings about the recent real estate bubble.

            Waxman tried his best to get the “maestro” to admit that the past permissive regulatory system hastened the collapse of risky mortgage-backed investments.  “Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity—myself included—are in a state of shocked disbelief,” Greenspan told Waxaman.  Greenspan never put his faith in the stock market even during former President Bill Clinton’s go-go‘90s, investing only in U.S. treasuries.  During Clinton’s bull-market, where governments, federal, state and local, collected unprecedented tax revenues, balanced budgets and, even some cases, generated surpluses. Government revenues never fully recovered from the 2001-2003 market crash, taking the Dow Jones Industrials down from 11,750 to 7,700.  Today’s crash dropped the Dow in record time from 14,000 in Nov. 2007 to 8,200 this month.

            Today’s market decline is far steeper than the nosedive following Sept. 11, 2001.  It took nearly two years for the Dow to drop 4,000 points.  In the latest collapse, it took less than one year to drop the Dow almost 6,000 points, decimating pension funds and 401(k)s, driving small investors into fixed income.  Despite attempts to prop up the market, small investors remain guy-shy, unwilling to risk more savings or retirements in the stock market.  During the last bull market lasting between 2003 and 2007, the real estate market saw robust growth, witnessing home values steadily rise.  U.S. Gross Domestic Product and record low unemployment also soared from unprecedented consumer spending from expanding real estate wealth.  Home equity lines kept the economy booming.  Since the real estate bubble popped, home equity lines evaporated crushing GDP.

            Most economists estimate that consumer spending accounts for two-thirds of GDP.  When defaults and foreclosure began to rise last year, the nation’s cash-flow—driven by generous home equity lines—evaporated, hitting the nation’s financial system like a deadly torpedo.  With the stock market melting down and homeowners defaulting on mortgages, banks lost revenue streams, creating the worst credit-crunch since the 1930s.  When President George W. Bush signed the $700 billion bailout plan Oct. 3, he cautioned patience, that the rescue package needed time to work through the system.  Interim bailout czar Neel Kashkari told the Senate Banking committee today that he saw progress in resolving the nation’s liquidity crisis.  Homeowners facing foreclosure aren’t yet part of Kashkarai and his boss Treasury Secretary Hank Paulson’s plans to fix the nation’s credit crisis.

            Waxman held Greenspan’s feet to the fire, asking him whether he was wrong not to regulate derivatives, the mortgage-backed securities sold to financial institutions around the planet.  For many investors, derivatives offered the illusion of collateralized investments, more secure than stocks because they were backed by real estate.  Greenspan admitted reluctantly that he was “partially” wrong not to regulate credit default swaps, instruments designed to act as default insurance for bond-holders.  More regulation and oversight would have imposed stricter lending standards, avoiding the risk associated with subprime mortgages, loans made to borrowers with poor credit.  Blaming Greenspan now for keeping interest rates low misses the problem behind the real estate bubble:  Predatory lenders, requiring nothing down, artificially low teaser-rates and negative amortization loans.

            Pointing fingers at the former Fed chief won’t fix today’s economic mess, threatening to drive the nation into a painful recession.  Since we know what kept the economy booming, we also know how to fix the problem.  So far, Fed Chairman Ben Bernanke and Paulson have figured out only half the puzzle:  Banks must have cash-flow restored.  Federal Deposit Insurance Corporation Chairwoman Sheila Bair figured out the other part:  Provide mortgage-relief to borrowers in distress.  Bair advocates using some of the bailout funds to help banks restructure bad mortgages.  Keeping homeowners from foreclosure should help restore banks’ credit, reverse the real estate slide and improve cash-flow, enabling homeowners to stimulate the economy.  Calling Greenspan on the carpet makes a good “dog-and-pony show” but does nothing to fix the nation’s current economic mess.

  John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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