Friday, September 3, 2010

The Prosecution’s Case Against Alan Greenspan

Should Alan Greenspan, the former Chairman of the Federal Reserve Board (1987–2006), be tried for Crimes Against the Economy, put up against a concrete wall, handed a cigarette, offered a red blindfold, and then executed by firing squad?
  
“What, me worry?”
Yes—absolutely. No question. (And this coming from an anti-death penalty, anti-abortion Catholic.) Herewith, the case for the prosecution. 
  
There are four main charges against the so-called “Maestro”: 
  
OneIrresponsible Market Liquidity, Which Created Rampant Moral Hazard:
  
The Accused was instrumental in creating the pernicious policy mentality of “providing markets with necessary liquidity”—essentially, throwing money at every problem. 
  
This first started within days of Greenspan’s assuming the role of American central banker: The frenzy that caused the stock market crash of October 1987 was doused by Greenspan’s pledge to provide “all necessary liquidity, should the need arise”. This instantly soothed the markets as surely as a hit soothes a heroin junkie—within a few months, it was as if the panic had never happened. 

  
After that, and throughout his tenure and that of his successor, Greenspan applied the same remedy, time after time, to every single problem. He became the living embodiment of that old saw: “If all you have is a hammer, every problem looks like a nail”. Or maybe Curtis Mayfield’s famous refrain would be more apropos: “I'm your pusher-man”. 
  
This addiction to market liquidity reached a peak with the Long Term Capital Management (LTCM) fiasco of the Fall of ‘98. LTCM made a series of bad bets that went sour due to the Russian Crisis—therefore, to pay off its losses, LTCM would have to stage a fire-sale to come up with the cash. To avoid this disorderly unwind and subsequent fire-sale—which would have led to an across-the-board run on LTCM’s counterparties, and eventually a wholesale market panic—the Fed under Greenspan organized LTCM’s counterparties, and effectively underwrote the firm’s break-up, providing essentially a bridge loan to finance the whole mess. 
  
Whether LTCM should have been bailed out by the Fed in order to effect an orderly unwind is debatable. Some believe that LTCM had to be bailed out, others believe it should have been allowed to fail, and let the chips fall where they may. 
  
What is not debatable, however, is that, as a direct result of LTCM, two things happened: One, every Wall Street firm realized that, if they were ever hard-up for cash, Easy Al would come through with liquidity—which meant effectively that firms could begin figuring out ways to leverage themselves even more, in the pursuit of profits. They were one and all confident that Uncle Al would bail them out with liquidity, if they ever got into any real trouble. 
  
The other thing that happened was what didn’t happen. Once the bail-out and liquidation of LTCM was carried out, Greenspan failed to learn the obvious lesson from the experience: Sophisticated financial products created under his chairmanship had directly led to the collapse of the firm, and put at risk the entire U.S. financial markets. 
  
If brainiacs like Merton and Scholes, with killer-traders like John Meriwether at the wheel, could drive LTCM off a cliff, what about the hoi polloi of Wall Street, strapping the same financial weapons of mass destruction as Merton, Scholes & Meriwether had been wielding? What kind of trouble could they get themselves into, with all of these fabulous “innovations”?
  
Did Greenspan put a stop to such suicidally risky practices after LTCM? 
  
In a word: No. Which leads directly to the second charge—
  
TwoThe Fed’s Do-Not-Touch-the Financial-Services-Sector Policy:
  
The Accused was instrumental in creating a Do-Not-Touch attitude towards the banks, both investment and commercial—which of course led the financial sector to pursue incredibly stupid products and strategies: All in the name of “maintaining financial markets’ ability to innovate”. These “innovations” were directly to blame for the Global Financial Crisis, as they created unsustainable liabilities which sooner or later would lead to system-wide collapse. As what happened. 
  
LTCM was the canary-in-the-coal-mine: What occurred in 2007–‘08, and the virtual freezing of the financial markets on September 18, 2008, was a direct result of the Fed’s failure to regulate the financial markets. It’s what happened when the aforementioned hoi polloi on Wall Street did more or less what Merton, Scholes & Meriwether had done—only magnified. 
  
Not only that, in this urge to “innovate”, Greenspan was key in having the Glass-Steagall Act repealed in 1999. This allowed commercial lenders to act as investment banks. 
  
The timing of this repeal has to be emphasized: This was just over a year after the LTCM fiasco. Effectively, repealing Glass-Steagall meant that commercial banks could build their own LTCM’s right in the comfort of their own back yards. Yet here was Greenspan, egging on the repeal of the Act. 
  
There was a reason why Glass-Steagall existed: Precisely so as to prevent large commercial banks from using their assets to become gigantic LTCM’s. 
  
But Alan Greenspan—knowing full well the history of Glass-Steagall, and ignoring the object lesson of the LTCM debacle of a mere fourteen months earlier—ushered in the era of commercial banks as hedge funds with a smile: Or in other words, he was the midwife of the monsters now known to us all as the Too Big To Fail banks. 
  
All in the name of “financial innovation”. I'm sure Dr. Victor Frankenstein said something similar, back in his day. 
  
ThreeSubsidized Money, Which Radically Distorted The Economy:
  
This is probably the biggest crime Alan Greenspan committed as Federal Reserve Chairman: The so-called “Greenspan Put”. 
  
For the twenty years of his tenure, the Accused—supposedly an avowed free marketeer—subsidized the cost of money. Rather than let the Fed funds rate more or less mirror what banks were lending among themselves, and tighten interest rates when the economy overheated (as his predecessors had done), Greenspan instead goosed the markets: His “targeted” Fed funds rate was forever undercutting what the financial markets were dictating, as to the true price of money. 
  
What happenes when a good—any good, including money—is subsidized? Simple: It creates market distortions. And the higher the subsidy, the greater the distortive effect. 
  
  
The market distortions Greenspan’s monetary policies created led to one asset bubble after the other—each of which was bound to pop, as they eventually did. Each of which was worse than the last, which they were: Equities, dot-coms, tech, real-estate—they all ballooned, then they all popped. The latest bubble—which I have argued is the Final Bubble—are of course Treasury bonds. 
  
The reason these bubbles popped was that the “market innovations” previously discussed, combined with Greenspan’s guarantee of liquidity, as well as the subsidized money, led to an unprecedented expansion of credit through various non-regulated, over-the-counter products, such as Mortgage Backed Securities and other Collateralized Debt Obligations. 
    
This is why there was such a severe distortion in asset prices in the American economy starting in 1987: Rampant credit creation, a product of the Greenspan Put. It was not supply-and-demand that led assets to accrue value exponentially and seemingly without reason: It was the unregulated, uncontrolled expansion of credit, brought about by the cheap, subsidized money Greenspan was pumping out into the economy. 
  
Furthermore, the Accused was aware of the serial bubbles blistering through the U.S. economy, and in fact warned against these bubbles—and yet did nothing, even though he had the power as Fed Chairman to stop them
  
Who can forget that famous line: Irrational exuberance. Nobody can—it’s simply too memorable, too on-the-money. However, everyone seems to forget when Greenspan uttered that famous line: December 5, 1996. 
  
Before all the bubbles—that’s when Greenspan said those famous words. He anticipated the bubbles—yet allowed them to percolate, and then pop. 
  
This regime of subsidized money not only created the various bubbles—dot-com, tech, real-estate—which finally burst in September 2008 with the Global Financial Crisis. This regime has created the condition for the final bubble—the bubble in U.S. Treasury bonds. 
  
The subsidy in money that Greenspan created allowed the U.S. Federal government to go into more debt than it can possibly repay in real terms. It allowed the Federal government to go into much more debt than it would have been able to, if interest rates had been market-dictated. Current U.S. debt pays interest of 25¢ for every dollar borrowed—that interest would have been higher much earlier, had Greenspan not subsidized money. This would have curtailed U.S. Federal government borrowing at a much more manageable level to GDP, instead of the 100% debt-to-GDP ratio it is today, and 110% ratio it will in all likelihood be next year. 
  
This excessive debt level of the U.S. Federal government insures that Treasury bonds will never be repaid in real terms. The market is aware of this situation—the bond market is aware that Treasuries are in a bubble, floating on nothing but air. Therefore, when—not if—the bubble in Treasury bonds finally bursts, there will be a run on comodities, most likely, which will start the hyperinflationary phase of the current Global Depression. From here, the endgame of the U.S. economy. 
  
Unfortunately, the profession and academic discipline of Economics—and all of its current practitioners—are unaware and unprepared for the popping of the final bubble. Which leads to our final charge against the Accused—
  
Fourth and finallyTurning Economics Into a Religion with the “We Are Right Because Our God—Math—Is On Our Side” Fallacy, and Marginalizing the Heterodox
  
Because of the length of his tenure, and because of the prestige that the Federal Reserve has traditionally embodied within the academic discipline of Economics, the Accused created a rigid, inflexible, and supremely arrogant mind-set within the Federal Reserve itself, as well as in the Economics profession as a whole. 
  
Greenspan didn’t accentuate currents of thought within Economics. Rather, he fomented a near-religious approach to math-based macro-economics, while ignoring the human aspect of society and of people. In other words, Greenspan fell for the McNamara Fallacy—and made sure that the rest of the discipline of Economics fell for the same fallacy as well, by dismissing the ideas of the heterodox, and marginalizing them from professional consideration. 
  
Greenspan certainly didn’t invent math-based macro-economics. Math has been part of the game since Adam Smith. (And by the way, don’t let my history and philosophy degrees fool you—I’m a big old math geek. High-end philo eventually turns into math, JSTYK.) But Greenspan certainly made math-based macro reasoning not only de rigueur—he effectively excommunicated anyone who did not share his McNamara Fallacy. 
  
Such a meretricious approach gave priority to quantitative measurements of macro-economic performance, rather than qualitative distinctions among policy options. In other words, “more in numbers is good, better in quality is irrelevant”. 
  
This has led economists and Economics as a discipline—across all schools of thought—to value aggregate levels of whatever metric they were interested in, rather than qualitative differences which are not so easily measured. 
  
On the political Left and Right—especially among the elites, to which Greenspan shamefully catered to—each side has become addicted to measuring the health of the U.S. economy by its aggregate demand levels (on the Left), and by its aggregate asset levels (on the Right). 
  
Yet during the twenty years of Greenspans’s tenure, though both metrics improved drastically, there is no question that the American economy deteriorated. Why?
  
My brothers and sisters on the non-elite Left complained—bitterly—about how workers in third world countries were being exploited worse than slaves, to make the goods and products which American consumers were herded like cattle into demanding. 
  
Meanwhile, my brothers and sisters on the non-elite Right complained—bitterly—about how American workers were being laid off in massive numbers, entire industries ripped out of the country and outsourced overseas, leaving only fast-food jobs and dead cities, all in the name of “Globalization”. 
  
Both of these complaints are perfectly true and accurate. Both of these complaints stem from the same drive that Greenspan had such an integral part in encouraging: Quantitative improvements in aggregate demand levels and aggregate asset value levels as the only measures of economic “progress”. 
  
These two metrics were considered by the Fed under Greenspan as the only “serious” metrics by which to measure economic performance. And thus it was inculcated among America’s political and business elites as the only measure of an economy’s worth. 
  
But they are most certainly not. Anyone with eyes that see and a mind that works can tell you that a healthy economy is not how much you buy, or how much your stock price rises. A healthy economy is dependent on the worth of the work: The sense that people in the economy have that they are building something worthwhile, and not merely selling something worthless, or providing a meaningless “service”. 
   
But these human measures of worth were dismissed by Greenspan’s calculations. They did not fit his equations, or the equations of all the other economists who wanted to be taken “seriously” by the high-priests of the Federal Reserve. 
  
His famously opaque pronouncements as Chairman also led Economics as a discipline to favor opacity over clarity, obscurantism over elucidation. It wasn’t Greenspan’s fault that his Congessional testimony and various speeches were so famously hermetic; as a central banker, he had to maintain a poker player’s dispassion, so as not to unnecessarily influence the markets. But it was his fault that he seemed to encourage such oracular dictates from the profession itself. Ask any reader of technical Economics papers: They are incomprehensible. And that’s being kind. 
  
Thus his Delphic opacity, combined with the undue reverence for math-based ratiocinations, plus the near-religious dismissal of all criticisms from the “uninitiated heathen” outside the white marble halls of the Fed and academia, led Economics as a profession to completely miss out on the Global Financial Crisis, and the subsequent (and currently under way) Global Depression. 
  
In other words, because of Greenspan, Economics failed to call the biggest crisis in our lifetimes. 
  
Regarding the past three years of crisis: Collectively, economists and Economics have tried to wash their hands of the whole mess, by acting completely surprised while shouting to the rooftops, “Whocouddaknownit?!?” (For my foreign friends and readers: “Who could have known it?!?”, or in other words, “Who could have predicted that this once-in-a-lifetime crisis could have happened?”)
  
Well, the fact is, a lot of people knew this was going to happen—and they said so. They in fact bet that it would happen. Michael Lewis’ fine new book describes three such people who made fortunes off of these bets. But not only traders, many people outside of Wall Street realized something was rotten in Denmark. 
  
Many housewives realized that there was something wrong—I personally know one, in fact: My mother. She was approached by her bank, and offered (cajoled, wheedled and sweet-talked, actually) into getting a second mortgage on her home: “Rates are so low! And house prices in your area are booming! Go on! Give yourself a treat! Take out a second mortagage and spend-spend-spend!” 
  
To this, my mother asked the obvious question: “But what if house prices fall?” She was answered, “They can’t fall.” And she asked, “Why not?” “Because they can’t.” “Yes, but why not?” Back and forth it went for a while, until the loan officer shook his head, said my mother was “difficult” (I could have told him that), and didn’t call her again. He probably found an easier mark. 
  
But my point is, If a housewife, without any sophisticated training in economics, could figure out the obvious, yet an entire discipline failed . . . then maybe the discipline’s torch-bearer has led them down the wrong path. 
  
Greenspan: It’s Greenspan. 
  
To conclude: The Accused—Alan Greenspan—reneged on his sworn mandate to maintain low inflation and full employment, and instead pursued a policy of maintaining—and increasing—aggregate asset values, whatsoever the cost. In other words, he actively pursued bubble-creation and inflated asset values, to the benefit of the financial services industry, and to the detriment of the U.S. and world economies as a whole. 
  
He furthermore created rampant moral hazard, and declined to carry out his sworn duty to regulate and monitor financial markets, and to curb usurious or unsafe financial products and services. Finally, he created the conditions that—quite possibly—will lead to a Treasury bond collapse and a hyperinflationary catastrophe. 
  
The Prosecution rests. 

14 comments:

  1. Señor Lira:

    After your concise erudition on hyper inflation, now, you are "jumping the shark...." I say that with all due respect to you....

    Greenspan is a douche bag, we already knew that. so is Rubin, Summers, Geithner, Bernanke, Dodd, Schummer, Clinton, and that's just the Democrats. There's not enough room here if I have to start naming Republicans....

    Best regards,

    Econolicious

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  2. Wow. I can't rebut your arguments Gonzalo.

    As an American, I am saddened and ashamed of what's gone on in my country. Born to a family of little means, I worked hard to get a medical degree (200K of student loans), start my own business (200K SBA loan), and did my duty and pursued the American Dream (bought a house with a 400K mortgage.)

    Now I'm waking up to the nightmare. I'm barely above water on my mortgage after 10 years of payments, my new office building recently appraised for 1/2 of my construction costs, my patients and the local businesses that employ them can't afford insurance, my income is down, and each year my taxes go up. Not to mention my 401K that's now a 201K. (Not that I have much in it anyway.)

    The stores of value that little guys like me have depended on(real estate, education, and the whole American financial enterprise, like stocks, IRAs, 401Ks blah, blah, blah) have been nothing but bubbles in search of a needle. Now I'm scrambling to put enough cash together to buy a few dozen gold coins as my only defense against a system that seems more vulnerable and worthless by the hour.

    To use your phrase Gonzalo. I've had my "moment of clarity."

    Most Americans, however, assume that our currency is stable, that our politicians represent us, and that minor downturns are "just the market working out the kinks." When in fact, we are slaves serving an economic and political system run by an oligarchy of global kleptocrats that, as you noted in this excellent article, removed the human element from their equations some time ago.

    As much as I hate to admit it, I'm scared, confused, and angry. I've woken up, but most Americans still think we live in a democratic republic, with business and political leadership, that while occasionally feckless and sometimes corrupt, still share common values with the common man, when in reality they're sucking the very last drops of blood and money they can get from us.

    If the Fed has indeed blown it's last bubble, everything I have worked for and the value and goodwill I've injected into this corrupt system, will have meant nothing.

    Pull me back from the brink, 'cause I'm either jumping off a building or toting a pitchfork and a torch to Washington. (Or make that Wall Street, whichever I get to 1st!)

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  3. Gonzalo,

    Excellent article, keep it up!

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  4. What??? Greenspan is a hero! I believe that, as an acolyte of Ayn Rand, he deliberately set out, in the 1960s, on a multi-decade mission to destroy the no-longer-constitutional U.S. Government by destroying its bogus fiat currency.

    All of Mr. Greenspan's fine work is about to come to fruition, and all you can do is bitch and moan? That's not how a true patriot would act!

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  5. Mr. Lira;

    I'm afraid I'd have to disagree, in part, with you're opening question. I mean, come on now: have you seen the price of cigarettes or bullets lately? As for the blindfold; he knew going into this (with his eyes wide open, I might add) what was going to happen; no economist could be that dumb so he deserves to see the stones coming at him.

    So stand him up against the wall with his hands tied behind his back and stone him.

    H'mmm, mayhaps I spoke too quickly above as there appears to be plenty of economist that ARE that dumb.

    Great article!

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  6. Glad to see you differentiate between the Elite Left and Right and the "non-elite Left" and "non-elite Right." You mother was obviously a member of one of the last two. One of the reasons your writings here are so powerful is that you also belong to one (or like most of us - both) of the "non-elite." Love the clarity and force of your blogs.

    I think you are doing more important work here than you realize...

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  7. I used to think that way too - Punishment for the chief architect of the Crisis. But now I think differently : Humilition, might be better. Either one would discourage others from repeating Greenspan's folly. But the humiliation is more humane and maybe more lasting.

    What do I suggest? I think that Greenspan should be pelted with tomatoes - preferably rotten tomatoes everytime he appears in public. It's a sort of review of his awful performance as Fed Chairman, which a large number could participate in, not just a small firing squad.

    DrBubb

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  8. bestquest, well said.

    I hold similar opinion. It is fairly obvious that Greenspan intentionally destroyed the dollar, - the anti-constitutional and counterfeit currency.

    However, let us say that he did it not out of great planning and strategy skills, but out of pure incompetence.

    The result is still the same. Would you rather wish that the unholy counterfeit system survived for 100 more years? It is far better to end it than to slowly bleed under it for much longer.

    If you say that Greenspan did bad thing (irrespective of his intentions), then you also must say that you either believe in counterfeit money or in a tooth fairy (that the FED would just end itself voluntarily).

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  9. I really think Greenspan's actions along with the tax cuts, deregulation, wild deficit spending and etc were in fact a very deliberate money/resource grab with the military posed to crush anyone who didn't want to play along. All of this fits together too perfectly to be mere incompetence--at least on Greenspan's part. The question to ask is what would have occurred had he and others not set up this system of financial alchemy. I think the answer is that we would have continued to muddle along as we were coming out of the 1970's or worst. That clearly was not of benefit to the elite, so they had to replace the old manufacturing base with something and this is what we wound up with. Basically, they've raped the nation's treasury and left the rest of us holding the bag while we argue over whether to follow Glenn Beck, Sarah Palin Obama or the damn preacher who's about to burn a stack of Korans. Our descent into economic chaos can be tracked by the increasing amount of idiocy that's bantered in the press weekly.

    We've really only got ourselves to blame for this mess. We purchased the tickets they were selling.

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  10. I disagree GregL. Read John Taylor Gatto. They have been training the American public for the last 100 years. They finally achieved their goal... They killed the American spirit and turned us all into helpless patsies who have to beg them for crumbs... And pray to our Obamas and Becks for guidance. I noticed there were some Beck fans reading... I ask you to read lewrockwell.com everyday for three months and see if that doesn't cure you.

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  11. "Whether you agree with me or not, thank you for your comment."

    So why I are you removing comments that you do not like. You are a very unfair person.
    You know nothing about economy just spread dirt around. Shame on you.

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  12. I read Greenspan's book 'The Age of Turbulence' and it was a long and at times an interesting read. But my respect for Greenspan's judge of character ended on page 266 where he describes Gordon Brown as a 'good friend'. I wish this had been mentioned within the book's preface - it would have saved me $30!!

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  13. The whole bunch -- and I mean ALL -- should be put in front of a firing squad. I want to be one of those with rifles.

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  14. They will never be prosecuted
    They will never be in front of a firing squad

    So far those things are unthinkable for the Jewish elite that rules America.

    ReplyDelete

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