Maestro Greenspan, The Black Swan by Navin Doshi (October, 2008)

The week of September 19th 2008 was a turning point for the USA, accelerating us away from dominance in matters of the world economy and politics. I believe the main culprit for the current financial mess is maestro Greenspan. Presidents and the congress of the last two decades were also responsible to a lesser extent because of their ignorance of markets and economy. If they are able to stabilize the housing market, only then we may see the light at the end of the tunnel. We have not yet seen the after effect of last week’s financial market collapse. There was a report on the Drudge web site that we were only about 50 trades away from total collapse that could have brought the sale of $250 billion worth of shares. If that had happened, DJIA would have fallen from over 11000 to possibly around 8000, a drop of about 27% in a day. So far so good; let us hope that the president, the congress, and the Fed are working in unison to bring some stability in financial markets.

Greenspan’s first sin in the early 1980’s was to advise the Reagan Administration to increase social security taxes on working people and use these funds to lower the deficit as described in detail by Professor Ravi Batra in his book, Greenspan’s Fraud. Batra believes that this may be one of the most significant causes of shrinking middle class with bigger polarization in America. Fed Chairman Paul Volcker (1978-1987) succeeded in bringing down the inflation rate and should have been reappointed. However, he was replaced by Greenspan, thanks to his political skills. The real estate lobby and Wall Street were against Volcker due to his very tight monitory policy. Some Republicans believe that he sided with Democrats and the Jewish lobby to defeat George H. Bush by tightening money supply that caused recession in 1991-92. If it is true, he is more of a politician than an economist, as Batra claims.

Where Greenspan bears biggest responsibility is his role in ensuring the era of cheap money policy that created two speculative bubbles. He created them in spite of the fact that he was warned of the risks. He even acknowledged the warning by his famous “irrational exuberance” speech in 1996, but did not do any thing about it. He could have brought some control by increasing the margin requirement. He was warned a second time in 1998 by the Commodity Future Trading Commission about the explosive rise in derivative instruments described by Warren Buffet as “investment instruments of mass destruction.” Please note that these derivative products also include sub-prime mortgage instruments. He was against any new regulation arguing that it would disrupt the capital markets.

With no move to keep any control, share prices went up to the moon in 1999 and early 2000, creating a giant tech bubble. As prices rose, more brokers were willing to lend more money to buy more shares, and prices kept rising until the bubble burst. Then came the misfortune of 9/11. The Dow Jones Index went from about 12000 to 8000. “The man who saved the World”, Mr. Greenspan, knocked down the Fed fund interest rate below one percent. Bruised by the stock market losses, Americans started to buy houses. Wall streeters, we know, are experts in creative financing. They came up with instruments like securitized bonds and collateralized debt obligations (CDO). They packaged these instruments at different risk levels and created a market for them. Mr. Greenspan this time got involved in favoring these investments; he would say repeatedly that housing was a safe investment because prices do not fall, and if they do, a home owner could wait things out till the price comes back. He even encouraged people to borrow at a variable mortgage rate, which, I believe is quite risky. Over 30 percent of houses, in 2003 to 2005, were purchased either as a second home or for investment purposes; these houses were mostly unoccupied. Mr. Greenspan dismissed the argument that a new bubble was emerging. He would describe it as “froth” in a few areas. Later, when investments in CDO’s started to fall apart in 2007, he conceded that bubble should have been used in place of “froth”. When froth keeps integrating, it evolves in to an ever expanding bubble. It is amazing that no one in financial markets, congress, or the Bush Government saw the problem associated with wildly imprudent lending to any one, credit worthy or not. It is pure lunacy to lend to totally unworthy applicants by assigning finite risk when we know that the risk is infinite. They did it by creating subprime, meaning lower credit worthiness than prime, mortgages and variable interest rate.

Mr. Greenspan, as a Fed Chairman, was a regulator of the banking industry for almost two decades. Federal Reserve, as an institution, is responsible to maintain sound money policies so that the inflation rate, and interest rates are in control. In 2002, he was knighted by the British Queen for promoting “economic stability”. Six years later, markets are gyrating as if the world is coming to an end; AIG, the largest insurance company, Fannie Mae, and Freddie Mac, the largest mortgage companies have in effect been nationalized to avoid financial catastrophe. Government is in a process of creating a trust fund of about a trillion dollars so that the cancer created by subprime mortgages does not kill the banking industry. Mr. Greenspan describes this “Black Swan” event as the one that occurs “once in a hundred years”. I would describe Mr. Greenspan himself as a “Black Swan”, and a politician of politicians gifted with unusual communication skill. Please note that a “Black Swan”, defined by the author Taleb, is a highly unpredictable, and unquantifiable event that carries a massive impact.

(Nassim Nicholas Taleb, The Black Swan, Random House, 2007)

Navin Doshi (October, 2008)
(Mr. Doshi is a financial market trader, writer, and a philanthropist)

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  1. […] back in a short period of 16 years, thanks to former Federal Reserve (Fed) chairman Alan Greenspan (Maestro Greenspan, the Black Swan, by N. Doshi). The technology bubble occurred from 1992 to 2000 while the commodities were going […]

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