Learning from the past/paying for the future

William Henry

The credit crunch has devastated markets. Corporate Finance goes to the route of the problem, and explains why one man has been at fault

The beginning of the 21st-century was marvellous. It seemed that everyone was able to afford whatever they desired, enjoying themselves on the back of cheap loans and easy repayment plans. Money was easily accessible through countless different channels. Debt was never an issue, even though it was ubiquitous: the garage attendant fuelling one’s Mercedes; the builder who always seemed to arrive on schedule to finish that extension to your semi-detached.

So as the collection agency tow away the five door saloon, whilst CEOs and the world’s biggest and best traders move back into their mother’s apartments, those suffering should be afforded an opinion on which direction the finger of blame should be pointed. Not only do the world’s borrowers and lenders deserve an explanation, it makes sense that we learn from the mistakes that have leaked from the credit catastrophe of late. So who do we blame? If the jury have any idea about human nature whatsoever they’ll know that borrowers are guilt free: give people the opportunity to spend and they will. It’s the same situation with lenders, who took the opportunity to make a bit of cash when the time was right. Arguably, those most at fault have been high level government.

Times of crisis
Think about it. Who sets those all-important rates? Who controls central banks and the state of the legal system? Yet one can never rely on the government in times of crisis. Perhaps obviously, the only thing world economies need and must have to arise from the current financial coma is individual government intervention and movements by which said governments become market lenders for a short period of time: invest in their own markets and give businesses a chance. Most governments despair at such an idea, instead consulting advisors and delving into foreign exchange.

With that in mind, we need to home in on the government that started it all, the real source of the recent devastation amongst world markets. As the crunch spreads throughout Europe, one must follow the tributary that snaked its way through the Atlantic and back to the US of A, Washington, and the Federal Reserve.

As in many occupations, one rarely retires and leaves the job alone. When the chairman of the Federal Reserve announced his retirement in January 2006, his successor Ben Bernanke was still somewhat in the shadows, playing second fiddle to the man whose chair he sits in. Alan Greenspan, who held the position from 1987 – pulling the US economy into near-recession and near catastrophe time and again – is still synonymous with the Federal Reserve, still directing the course of events, still whispering in the ear of clueless politicians, and still causing global markets to suffer through his incompetence. How the man responsible for mistake after mistake is still considered one of the US economy’s most valuable assets hasn’t only been a huge flaw in judgement, his presence has been a twenty year mystery.

The alarm bells are loud and clear
First appointed under the Reagan administration directly by the actor-come- president- come- fraudster, alarm bells should have been ringing from the word go. Whilst working under Lincoln Savings & Loan in 1973, just as the worst US recession was threatening since the Great Depression, he announced that “it is very rare that you can be as unqualifiedly bullish as you can be now”. Another example of his ineptitude: his unflinching support for the deregulation of the S & L industry which cost the US taxpayer over $100bn when it all went off (which has since been forgotten due to his latest involvement in bursting the most recent housing bubble to float right over his head). His forecasting has always been further off the mark than the current president’s grasp on reality.

The interesting thing is that he is quite a patriotic American, even by average standards, and has always offered his support when the economy needs it. In other words he isn’t making outlandish and irrevocable clangers on purpose. What isn’t exactly headline news is his recent article in which he begins with the decree, “I am puzzled”. He goes on: “The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent.” One wonders how the world goes round: just as lenders aren’t supposed to lend, and borrowers aren’t supposed to borrow, according to the great man’s philosophy, but regulators aren’t supposed to regulate to the propensity by which they are expected.

Reading his article (or defence of his most recent ill advice to US movers and shakers), Greenspan almost convinces the reader that he wasn’t actually present at the other housing bubbles that have transpired someway or another during his time at the head of the Federal Reserve – of which there have been many. It seems that he has washed his hands of every mistake ever made at the Federal Reserve, even though the buck has stopped with him over America’s recent history. As evident from his article, he is still due the infamous Greenspan sidestep: “I trust our views are subject to the same standards of evidence that apply to all rational discourse.” Unfortunately, the rationality went out the window the day Greenspan was first consulted post-retirement.

Basic financial tips
What is clearly beyond Greenspan’s grasp is some basic advice to financiers and the general population, never mind those within the Senate and White House who so value his opinion. Some basic tips: pay back debts instead of defaulting on them, which causes financial intermediaries to implode; spend, although wisely, in order to boost the economy; and be careful with assets, thus avoiding further financial meltdown.

These are simple economic procedures that will ensure both private and business success short and long term. Microeconomic policy in its simplest and finest terms. On the macro front, the government needs to take the economy in her bosom and offer support. Considering Greenspan is still in such an influential position with Washington heavyweights, he just hasn’t done his job and that government may still listen to him. The bottom line is he needs to retire to Florida, tearing up his economics PhD on the way. And that may happen should a democratic nominee take the presidency toward the end of this year, so long as Billary and Obama stick to what they have promised.

As for the rest of the world, lenders and borrowers must wait in hope for their governments to intervene, contriving to follow the rules set out above. Aside from benefiting the economy, it might give Greenspan just enough time to pack his bags. That, or put himself forward for a fifth disastrous term at the Federal Reserve.


Alan Greenspan’s curriculum vitae of shame:

The stock market crash of 1987
Greenspan had recently taken over from Paul Volcker, a man who worried about the soundness of the dollar and the external financial system above all else. Rather than take a loss, financial institutions wanted to be bailed out. One of Greenspan’s favourite solutions – financial deregulation – provoked one of the greatest stock market crashes in history.

The Savings and Loan crisis
Lincoln Savings and Loan was seized by Federal regulators in 1989. Its eventual cleanup would cost the taxpayer over $2.5bn. The reckless policies pursued by many S&Ls led to the collapse of that entire industry – an event that figured prominently in the recession the country experienced in 1990 and 1991. Shortly before regulators moved in, Greenspan showed his unflinching support for Lincoln.

The collapse of Long Term Capital Management
The combination of the collapse of the Russian rouble and the implosion of Long Term Capital Management in 1998 caused the stock market to decline. Greenspan lowered interest rates in September to 5.25 percent, and in a surprising inter-meeting manoeuvre cuts them again 16 days later despite a healthy market, kicking off a wave of speculation larger than any the United States has ever seen. This is just one example in a vast list of compromising decisions Greenspan has made, that show not only indecisiveness, but a willingness to gamble with both the short and long-term economy.

The tech bubble of 2000
“So as far as I can judge just looking at the data, it is not evident that we are seeing, as yet, a cresting in the growth of productivity.” …technology can be a powerful aphrodisiac. It certainly had its way with the Chairman; it blinded him to the bubble that should have been obvious to anyone.

The feared Y2K disaster
As for Y2K, the fear about what terrible developments might trip up the financial system when clocks changed to the year 2000, which caused the Fed to explode the monetary base by an annualised rate of 44 percent over the last 10 weeks of the year—it was essentially treated as a non-event by the FOMC. Amazingly, after all that money printing, no Fed governor expressed any real angst about it, but several thought it was a yawner… no one was worried.

The credit bubble and real estate crisis of 2007
Greenspan’s lack of understanding regarding the out-of-control lending practices of those institutions was one reason he did not recognize that economic contraction as it was unfolding – though he would later claim that not only did he see it coming, but that his swift actions prevented it from becoming worse. In some ways, the S&L crisis was a precursor to the undisciplined, runaway lending that led to the housing crisis of 2007.