Greenspan has at points proven to be the bane of Bernanike’s existence. Now it appears Paulson is getting a dose of the same.
A reader pointed us to this article in Emerging Markets, which features an exclusive interview with the former Fed chairman Alan Greenspan. The Maestro warned that the SIV rescue program, the so-called Master Liquidity Enhancement Conduit, could backfire, weakening rather than restoring confidence.
Even though the interview focused on the potential for further drops in securities markets, Greenspan was comparatively upbeat about the economy, seeing the odds of a US recession as less than 50%.
From Emerging Markets:
Former Federal Reserve chairman Alan Greenspan has warned that plans announced this week to launch a so-called “super fund” – a dramatic attempt by major investment banks to ease the crisis facing credit markets – could have dire repercussions.
In an exclusive interview with Emerging Markets, Greenspan said that the $75 billion so-called Master Liquidity Enhancement Conduit (MLEC) – proposed by Citigroup, Bank of America, JPMorgan and Wachovia to take on the assets of troubled investments – runs the risk of further undermining already brittle confidence in besieged markets.
“It’s not clear to me that the benefits exceed the risks,” Greenspan said. “The experiences I’ve had with that sort of intervention are two-sided.”
Greenspan drew a distinction between the bail-out of a single large hedge fund to prevent the widespread sell-off of assets – as happened with Long Term Capital Management (LTCM) in 1998 – and efforts to prop up an entire asset class, as in the case of the proposed superfund.
In the case of LTCM, “a single company” that was “excised out of the market”, there had been a potential for “a dangerous firesale of those assets”. When shareholders came in and took out LTCM, that “eliminated that aspect of market disruption”.
In contrast, “here we’re dealing with a much larger market,” he said. “They’re not talking about going in and absorbing sub-prime mortgage asset backed [securities]. They’re talking about essentially increasing the liquidity of those who have the SIVs [structured investment vehicles] and the like.”
JP Morgan Chase chief executive Jamie Dimon said on Wednesday that the fund – which will buy securities most notably ABS (asset backed securities) – could relieve some market pressure caused by the problems of SIVs. The plan is designed to prevent SIVs being forced to dump assets in a weak market because nervous investors are refusing to buy their new commercial paper.
But Greenspan argued that that a delicate market psychology could be speared by the move. “It could conceivably make [conditions affecting investor psychology] somewhat adverse because if you believe some form of artificial non-market force is propping up the market you don’t believe the market price has exhausted itself.
“What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and they’re wildly attractive bargain prices there,” he said.
“If you intervene in the system, the vultures stay away,” he said. “The vultures sometimes are very useful.”
He said that the ultimate problem is that events “where we go from euphoria to fear virtually overnight are built into human nature and you cannot really defuse them until the speculative fever breaks.”
“When it breaks, it’s very abrupt and you just have to wait it out,” he added.
The former Fed chairman also warned that the credit crisis is far from over—and that falling US home equity values could cause further profound shock waves. “The critical problem is how the resolution of the American home market comes about,” he said.
“Prices are falling and consequently home equities are contracting. But these are essentially the support under the $900 billion of collateralized sub-prime [debt]. Even though there are a lot of those sub-prime [securities] that are expected to go into default, that’s already priced into the market.
But Greenspan cautioned that if prices of homes fall faster than the market expects, “it could result in a secondary reaction problem for the holders of those [securities].”
He said rising global stock prices could help “offset the negative effects of declines in home equity” and thereby help cushion a US slowdown. But he reiterated forecast that the probability of a US recession is “still less than 50/50.”
But stock prices themselves are prone to excess, he noted, warning that a “lack of historical market experience” posed the biggest threat to markets including Shanghai and Shenzen stock exchanges.
“There will be a crash in China, I just don’t know when,” he said.