Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (46 page)

²
“Terror Threat Responsible for High Gold Price—Greenspan,”
The Times
, February 8, 2007.
³
Roddy Boyd and Niles Lathem, “Want Alan Greenspan to Come to Dinner? That’ll Be $250,000 . . .”
New York Post,
February 9, 2006.

301 criticism: “I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.”
⁴
He was also well paid for his private advice. Deutsche Bank, Pimco, the worlds largest bond manager, and John Paulson, a hedge fund manager who profited magnificantly from the real estate crash, all hired Greenspan as an advisor.

T
HE
P
EAK

All asset classes were inflating. This worldwide credit bubble developed after the stock market crash in 2000. Now, stock markets around the world, and also bonds, commodities, and art (of all periods), were rising.
⁵
As markets rose and credit spreads shrank, there seemed to be one explanation: liquidity. This is a word with several meanings. Probably most timely was that practically anything was tradeable. Houses and dining-room sets were securitized, as were trees and art. Of course, there had to be a willing buyer and there was no shortage of purchasers for the most dubious of assets. (Home-equity loans was bundled and sold. They were backed by rising house prices. Thus, the word
liquidity:
assets flowed like a river after a monsoon.

In 2005, U.S. house prices stalled. In 2006, prices fell. “Illiquidity” followed. Many of the other asset classes (if not all the others) were supported by the higher level of collateral and credit that spilled back from elevating house prices. When house prices peaked, so did the collateral. But credit kept rising.

Banks and brokerages borrowed to lend. By 2007, brokerage firms were leveraged at 30:1 and 40:1. (At 40:1 leverage, the firm becomes insolvent if the prices of its assets fall more than 2.5 percent.) Investment banks and brokerages lent to those who were already highly leveraged: hedge funds, funds of funds, and buyout funds. Leveraged structures were compounded on top of other leveraged structures. The global derivative market rose above $500 trillion: some now calculate that it is over a quadrillion dollars, but what was the point of counting? To both institutional investors and mortgage recipients, there was no limit to what they could borrow.

⁴
James M. O’Neill, “Greenspan’s Long Shadow Needs to Shrink, Management Gurus
Say,” Bloomberg.com, March 7, 2007, http://www.bloomberg.com/apps/news?pid=2067
0001&refer=home&sid=aXFdEFhGhKrI.

⁵
The general observation was made in Marc Faber’s
Gloom, Boom & Doom Report
, March 1, 2007, p. 8.; Zimbabwe’s currency was an exception to the rise.

Alan Greenspan reportedly received $8.5 million for a book contract. The
Age of Turbulence
was published September 2007.
⁶
This was shortly after public awareness of financial problems arose. Greenspan was talking to everyone. He was full of insights. Greenspan claimed that “the abrupt upheaval in markets due to the subprime crisis ‘was an accident waiting to happen.’”
⁷
This was true, but it was Greenspan, in 2005, who extolled “techniques for efficiently extending credit to a broader spectrum of consumers [which has] led to rapid growth in subprime mortgage lending.”
⁸

Greenspan would accept no blame for the rapidly deteriorating American landscape. Greenspan’s prophecies no longer moved markets. He received withering criticism from some well-known economists. Greenspan then complained about the economists who complained about Greenspan.

The former chairman was called before the Committee of Oversight and Reform on October 23, 2008. Greenspan looked withered. Congressmen filleted and roasted the man who once was God. The attacks on Greenspan were well deserved, but the prosecuting politicians were most intent on saving their own hides.

Greenspan opened his testimony by stating, “[W]e are in the midst of a once-in-a-century credit tsunami.”
⁹
The real once-in-a-history-of-theuniverse stimulant was Greenspan.
¹⁰

Greenspan admitted to a “flaw” in his model that impugned “40 years or more of considerable evidence.” Until this latest model problem, he thought that financial institutions were the best regulators.
¹¹
Did he really believe this? He saw that bank risk departments did not monitor counterparty holdings with LongTerm Capital Management.

⁶
A non-definitive number proposed by
Publisher’s Weekly
: http://www.publishersweekly.
com/article/CA6469524.html?q=“age+of+turbulence”.
⁷
Reuters, “Highlights—Speeches from UK’s Brown and Darling; Greenspan,” October 1, 2007,
http://www.reuters.com/article/companyNewsAndPR/idUSBROWN20071001?sp=true.
⁸
Alan Greenspan,
Consumer Finance
At the Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8, 2005.
⁹
Testimony of Dr. Alan Greenspan, Committee of Oversight and Reform, October 23, 2008, p.1.
¹⁰
Caroline Baum at Bloomberg listed Greenspan’s once-in-a-century proclamations. Greenspan had told us a few years back that we were in the midst of a “once-in-a-lifetime” technological boom. In July 2002, he announced a “once-in-a-generation frenzy of speculation” was over. In the summer of 2008, he ordained the solvency crisis a “once-in-a-century phenomenon.” Caroline Baum, “No Limit to Greenspan’s Once-InA-Century Events,” Bloomberg, August 18, 2008.
¹¹
Scott Lanman and Steve Mathews, “Greenspan Concedes to ‘Flaw’ in Market Ideology,” Bloomberg, October 23, 2008.

Greenspan blamed his model. It had miscalculated his input that the “self-interest of lending institutions” protected shareholder interests. He may have believed this, but a moment’s reflection would have reminded him the “bank holding companies that control an increasing proportion of all the commercial banking in our country”—as Senator Proxmire had lectured Greenspan 21 years earlier—acted exactly as the senator had warned. They used their bulk to indulge their own desires and left their institutions (and the United States) on the precipice of collapse.

H
IS
C
ONTRIBUTION

It was not just Alan Greenspan’s model that failed. There were many parties at fault. The erosion started long before Greenspan’s chairmanship. He ignited a keg of dynamite under a financial system that was already wobbling. When the economy faltered, Greenspan drove the Fed funds rate below the rate of inflation. Annual borrowing, by all parties in the United States, rose from $1 trillion in 1988 to $4.1 trillion in 2006.
¹²
During Greenspan’s time at the Fed, the nation’s debt rose from $10.8 trillion to $41.0 trillion.
¹³
He was the Federal Reserve chairman who increased the money supply from $233 billion to $792 billion.
¹⁴

Greenspan was not wholly at fault. Banks did not have to lend the money. Debtors did not have to borrow. Bankers and brokerage houses are to blame for reckless lending and reckless leveraging.

He took orders as well as issued them. Congress bullied Greenspan, but that had been true of all Federal Reserve chairmen. New during Greenspan’s chairmanship was the path of former politicians to hedge funds, privateequity funds, and banks. Greenspan spurred the financial economy, and those who interrogated him took advantage of it.

¹²
Federal Reserve, Flow-of-Funds Accounts, Z-1.
¹³
Figures from year end of years he entered and left office. “Beginning of office” is December 31, 1987: “End of office” is December 31, 2005; From Federal Reserve, Flow of Funds Accounts, Z-1
¹⁴
Federal Reserve Publication,
Aggregate Reserves of Depository Institutions and Monetary Base,
Table 1.

The United States has been devaluing its currency for the past century. What one could buy with $1 in 1913 (the year the Federal Reserve Act was passed) costs about $20 today. William McChesney Martin’s battles against Congress and influential economists, chronicled in the early chapters, were losing efforts. Congress was not entirely at fault for pestering the Fed. The American people lived inflationary lives. They bargained for wages and benefits that could not be paid in constant dollars. They worked fewer hours. Americans were buying more from abroad than they were selling. The government was spending more than its revenues by the 1960s.

The economists kept revising their theories to rationalize these practices. The theories were new and beguiling. The imbalances were as old as civilization. These contradictions have always ended in tears.

By the 1970s, the gold standard had to go. Economists offered new theories. The influential academics bolted to the head of the class. Barely mentioned was the immense liberation of a paper-currency world. Imbalances no longer had to be settled in gold. Governments found deficit financing to be an opium to the masses. Government programs abounded. The masses grew accustomed to inflation and borrowing in currencies that tended toward depreciation. Thus, debtors paid back less real money than they had borrowed. Bankers could lend more after the link to gold was severed, since no final settlement of claims existed. This was also a platform to launch speculative derivative products.

Other central banks decided to degrade their currencies in coordination with dollar devaluations. The bonfire of the paper currencies is a matter of time. Then, the institution of central banking will wear no clothes. Nobody contributed more to the denouement than Alan Greenspan.

H
IS
S
UCCESSOR

Ben S. Bernanke succeeded Alan Greenspan as Federal Reserve chairman. When Bernanke is evaluated, the wreckage he inherited should be a consideration. If Bernanke had followed Paul Volcker, his Fed would still have possessed a substantial degree of influence over the nation’s credit system and over the large financial institutions.

Nevertheless, his influence in the economy and markets has amplified the United States’ problems. The “Greenspan put” has become the “Bernanke put.” Its consequences are far more pervasive than Greenspan’s. (It might be argued that Greenspan would have done much of the same, but such a debate is unfruitful It is acts that count.)

Bernanke did not just cut interest rates to ward off a recession. He lent money to brokers, bought the largest insurance company in the world (AIG), allowed overleveraged investment banks to convert themselves into commercial banks, thus permitting them to snuggle underneath the Fed’s too-big-to-fail umbrella.

When the commercial paper market floundered, the Federal Reserve decided it would lend to corporations. (Commercial paper is used by large corporations to fund short term obligations.) Thus, General Electric, General Motors Acceptance Corporation, and American Express were among the companies fortunate enough to sell their paper to the Fed.

Bernanke opened more borrowing facilities (at last count there were 16). Even when the credit markets heal, the precedent has been established, just as Continental Illinois was the precursor, in 1984, to too-big-to-fail-banks.

General Electric Chairman Jeffrey Immelt wrote in his company’s 2009 annual report: “The interaction between government and business will change forever… [T]he government will be an industrial policy champion, a financier, a key partner.”
¹⁵

The Mortgage Machine (see Chapter 22) showed what can happen when government plays a role similar to what Immelt envisioned. The other troubling aspect is what happens to companies that are not one of the government’s champions? In a very different context, President George W. Bush said: “You are either with us or against us.”

Consequences of the “Bernanke put” will be interesting to watch.
¹⁵
General Electric, 2008 Annual Report, Letters to Shareowners; released early March 2009.

2006

[I]ncreases in home values, together with a stock-market recovery that began in 2003, have [aided] … [t]he expansion of U.S. housing wealth, much of it easily accessible to households through cashout refinancing and home-equity lines of credit[.]
¹

—Federal Reserve Governor Ben S. Bernanke, 2005

What did Alan Greenspan bequeath to his successor?

Foremost was a recovery that distorted the American economy more than ever. Americans borrowed from abroad and spent at home. In 2000, the U.S. imported about $400 billion more than it exported. By 2004, this had risen above $600 billion, and was close to $800 billion by 2006.
²

Personal consumption drove the economy. Between 2001 and 2006, Asha Bangalore, economist at Northern Trust, estimated that 40 percent of new jobs were related to housing.
³
This was not sustainable.

The manufacturing economy kept shrinking. From the end of 2000 to 2004, manufacturing wages and salaries fell from $819 billion to

¹
Ben S. Bernanke, “The Global Savings Glut and the U.S. Current Account Deficit,” Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, March 10, 2005.

²
OECD.StatExtracts. Dataset: balance of payments, United States. Annual data. Actual numbers: $417 billion in 2000, $624 billion in 2004, and $788 billion in 2006.
³
William A. Fleckenstein with Frederick Sheehan,
Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve
(New York: McGraw-Hill, 2008), pp. 193–194; information from
Grant’s Interest Rate Observer
, April 21, 2006.

307

$683 billion.
⁴
Manufacturing profits fell from $144 billion in 2000 to $96 billion in 2003.
⁵
The attenuation of manufacturing was a reason that Americans were falling behind. In 2008, goods-producing jobs (manufacturing, mining, and construction) paid an average of $21.54 an hour while service workers earned $11.22 an hour.
⁶