Alan Greenspan Bears Blame for Intensity of Financial Crisis

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Finally, Alan Greenspan is getting beaten up in the press.

More than any other man – living or dead – Alan Greenspan bears the blame for the intensity of the current financial crisis. Booms and busts are inevitable, but the former Fed chief made this one much worse than it should have been. This he accomplished by acts of omission as well as acts of commission.

As to the commission, he almost single-handedly caused the great real estate bubble by lending money far below the inflation rate. The housing market is extremely sensitive to changes in interest rates; Greenspan’s “emergency” low rates hit it like a shot of whiskey on an empty stomach. Within months, bulldozers were scraping new roads…and thousands of nail guns made the suburbs sound like a battle zone.

But it was the omission that the New York Times thought was important:

“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,” said “the maestro” in 2004.

Greenspan was talking about derivatives – the complex financial instruments that are now blowing up in accounts all over the world.

The NYT:

“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.

“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.”

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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Comments

  1. Alan Greenspan is well versed in Austrian economics and if his essay Gold and Economic Freedom is any indication, he is as big a fan of gold as our editor. He knew the consequences of his commissions/omissions and acted purposefully. What we are experiencing is probably close to what he intended. Perhaps Atlas is Shrugging? It will be interesting if Congress has Greenspan testify and he recites a John Galt type speech.

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