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Who should face the music - Alan Greenspan

Looking at the causes of the financial meltdown, one name keeps popping up. Gonzalo Lira has this to say:

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?

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”:

One—Irresponsible 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—

Three more well documented cases at the site. Well worth reading. Posted by DaveH at September 5, 2010 12:59 PM | TrackBack