Taking Hard New Look at a Greenspan Legacy

NYT ^ | October 9, 2008 | PETER S. GOODMAN

[vietvet67]

“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.” — Alan Greenspan in 2004

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.

Today, with the world caught in an economic tempest that Mr. Greenspan recently described as “the type of wrenching financial crisis that comes along only once in a century,” his faith in derivatives remains unshaken.

[stocksthatgoup]

Greenspan, Barney Frank, Chris Dodd, Nancy Pelosi, etc. all MIA

[April Lexington]

My grandfather warned me years ago... if you can't understand all of the parts of a deal, DON'T DO THE DEAL.

That was good advice. He was a businessman during the Great Depression and the memory of those days never left him. He lived well, but cautiously and frugally all of his 80+ years. I am so thankful that he shared his wisdom with me as a young boy.

[Travis McGee]

"The crisis of the abuses of banking is arrived. The banks have pronounced their own sentence of death. Between two and three hundred millions of dollars of their promissory notes are in the hands of the people, for solid produce and property sold, and they formally declare they will not pay them. This is an act of bankruptcy, of course, and will be so pronounced by any court before which it shall be brought. But cui bono? The laws can only uncover their insolvency, by opening to its suitors their empty vaults. Thus by the dupery of our citizens, and tame acquiescence of our legislators, the nation is plundered of two or three hundred millions of dollars, treble the amount of debt contracted in the Revolutionary war, and which, instead of redeeming our liberty, has been expended on sumptuous houses, carriages, and dinners. A fearful tax! if equalized on all; but overwhelming and convulsive by its partial fall. Everything predicted by the enemies of banks, in the beginning, is now coming to pass. We are to be ruined now by the deluge of bank paper, as we were formerly by the old Continental paper. It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who, instead of employing their capital, if any they have, in manufactures, commerce, and other useful pursuits, make it an instrument to burthen all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs. Prudent men must be on their guard in this game of Robin's alive, and take care that the spark does not extinguish in their hands. I am an enemy to all banks discounting bills or notes for anything but coin. But our whole country is so fascinated by this Jack-lantern wealth, that they will not stop short of its total and fatal explosion."

~~Thomas Jefferson to Dr. Thomas Cooper, 1814

[xcamel]

As did mine. Amen.

(Owner of a 5th generation family business, with Gen6 coming along nicely)

[Jo Nuvark]

[... Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences...]

THIS IS NOT THE PROBLEM, but they make it sound like one.

If we would let the economy find it’s level without interfering,
the boat would right itself. But nooooohhhhhh... somebody
might lose their job, or their house, or whatever. Yes, that’s
what happens when the economy makes an adjustment and the
further government stays away, the sooner we get back on course!

[Carley]

Yes, and no income no job applicants are well qualified for mortgages too.

And ARM’s are a good way for homeowners to buy homes they can’t quite afford.

Thank you Mr. Andrea Mitchell.

[Texas_shutterbug]

It’s not just the housing, you know. The derivatives market is a ponzi scheme worth trillions of dollars on paper. Of course, they’re mostly worthless. Gambling should be regulated.

[Jo Nuvark]

Hubby and I have always regarded the stock market as
gambling. You only risk what you can afford to lose.

[ridesthemiles]

The dirty little secret that most people don’t think about is:

Greenspan’s wife is ANDREA MITCHELL who is always cutting McCain every time she opens her pie-hole.

I think she has a serious conflict of interest, and shouldn’t be even working on political items.

[Armando Guerra]

"Governments and central banks," he wrote, "could not have altered the course of the boom."

He is either lying on this one or nowhere near as intelligent as he has been given credit for. The problem is that the government did alter the course of the boom by their conduct. In a totally free market, derivatives might work because there is a limit to the risk other parties are willing to take on. Where, however, the government has guaranteed the risk there is NO limit to what other parties are willing to take on. Hence, the derivative market exploded because profits remained private while any potential loss would be public. Capitalism did not fail, Socialism failed. Greenspan did not see the failure built in to these quasi-public institutions.

[SBprone]

Too bad this article didn’t get more attention here on FR. It was reprinted in this morning’s San Diego Union Tribune and that brought me to search for it on FR.

Yes, you summed it up pretty well: Private profit with public risk is the dream of every rent seeker on Wall Street. What is so interesting about this article is that it links Greenspan’s pronouncements over the years with critical regulatory decisions that appear so obviously wrong given the benefit of hindsight.

Now, I’ll admit that I want to wring Greenspan’s scrawny neck just as bad as the next guy, but he has been so consistently wrong about the costs versus benefits of derivatives that his blunders in this area may provide us with a road map to follow in fixing the problem. Just look at the things he has said in the past and consider the contemporaneous actions taken (or not taken) by regulators and Congress. Then consider changing or implementing rules to do the exact opposite of what Greenspan was in favor of.

You could do a lot worse in identifying things that need to be done over the next couple of years.

[Cronos]

My understanding of derivatives is a future price for goods. Say for wheat, it’s selling today at $100 a bushel. You take a contract to buy one bushel next year for $100. Now, if it rises to $120, you save $20, while if it falls to $90, you lose $10, but since it’s the same price you would have paid a year ago, you’re ok. Isn’t that a derivative?

[vietvet67]

The problem is that derivatives have been created on just about everything and then repackaged and sold down the line.

A domino effect occurs when one fails.

http://en.wikipedia.org/wiki/Derivative_security