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The Shellacking of Greenspan Begins

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Ah, this is one of those days where there way too many good points for departure for commentary and here I am with a pricey and pokey Internet connection, and competing holiday activities.

Finally, the reassessment of Greenspan’s tenure has begun. Not surprisingly, the Brits are more pointed in their critique. From “Greenspan has left more than a wall of worry to overcome” by Tim Price in the Financial Times:

Whenever investors are unable to rationalise market trends, they resort to cliché. The latest hoary old chestnut to be trotted out to justify extraordinarily robust equity valuations (until last week, at any rate) is that all bull markets climb “a wall of worry” – a platform of problems that perversely boosts stock prices to fresh highs.

There is doubtless something to the “wall of worry” conceit. There are certain successful investors (one thinks of the likes of George Soros, John Templeton and Marc Faber) who have spun widespread disenchantment about market returns into gold. It is easier said than done, for example, to buy when there is blood on the streets. But heuristics, those rules of thumb that traders use as shorthand to parse the financial runes, can only take us so far. And there are times when widespread conventional fears about the market’s prospects will turn out to be wholly justified. Now feels like one of those times.

We can trace the market’s current tremors back to the previous Federal Reserve chairman, Alan Greenspan. It was Mr Greenspan who, in the aftermath of the dotcom bust, practically drowned asset markets with a tidal wave of liquidity and easy money. It was Mr Greenspan who drove the Federal funds rate – the rate charged by US banks for lending to their peers – down to 1 per cent in 2003-2004, a four-decade low. And it was Mr Greenspan who opened the floodgates of liquidity that might have saved the US equity market, for a time, but that also triggered an unsustainable boom in government and corporate debt, residential property, and a carnival of mortgage lending unimpaired by anything approaching prudence. It is now left to his successor, Ben Bernanke, to reap the whirlwind.

The post-millennial stock market rescue was not the only time Mr Greenspan stepped in to “save” Wall Street. He has form as a serial inflationist, willing to slash interest rates to bail out investors who should not need rescuing from themselves: one thinks of the stock market crash of October 1987; the Savings and Loan crisis; the Asian crisis; the collapse of hedge fund Long-Term Capital Management; the feared Y2K crisis. No central banker has done more for the concept of moral hazard – the risk that the perceived support of the monetary authorities will cause financial institutions to play fast and loose with other people’s money.

It is abundantly clear that, having gorged on overly easy money for years, Anglo-Saxon financial markets are suffering from indigestion.

As in previous financial debacles, the regulators will be found to have been asleep at the wheel. How else to explain the lax standards implicit in the lending activities of US subprime financiers – or the conflicts of interest at the heart of the ratings agencies tasked with appraising structured debt vehicles that now resemble pyramid schemes? Or the “price-to-model” evaluations of illiquid debt securities that allowed investment banks and hedge funds to price their portfolios pretty much wherever they wanted to?

The problem for financial markets now is that a functioning financial system ultimately comes down to trust. When trust is in short supply, there is no obvious price base for securities and credits that during the good times seemed to offer unimpeachable quality. Nor is this crisis of trust restricted to the corporate sector – national Treasuries have been busily debauching their own currencies with the help of the printing press. As Mr Greenspan himself admitted in 1999: “Gold still represents the ultimate form of payment in the world. Fiat money, in extremis, is accepted by nobody. Gold is always accepted.”

So the US now nurses concerns about credit quality and a possible credit crunch, a housing crisis, the sustainability of corporate profit margins and the logical response of consumer spending to deteriorating fundamentals. US lenders, mortgage brokers, investment banks and ratings firms will all, one suspects, enjoy their day in court.

But when the central bank itself was complicit in the funny money boom of the new millennium, one is left to wonder just how sizeable the “correction” and cross-market contagion could ultimately become.

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