“Could the breakdown that so devastated global financial markets have been prevented? I very much doubt it.” Alan Greenspan, February 2010

“We conclude this financial crisis was avoidable.” From the Majority Opinion of the Financial Crisis Inquiry Commission Report, January 2011

Again, this is an older, but I believe important document if you are trying to understand the true, root-causes of the financial crisis, which is not the government’s view (parroted by the press to become ‘conventional wisdom’), that it was caused by reckless and greedy bankers and Wall Street and poor government regulation.

Alan Greenspan, the former Federal Reserve Chairman, wrote his paper “The Crisis” (attached below) in February of 2010 and I read it the time and provided my defense attorneys with the analysis and important excerpts below. I did post “The Crisis” in the FDIC section of my blog when it was launched in the Fall of 2011, but my attorney’s advised me not to provide any of my commentary (or key excerpts) given pending and threatened litigation against me at the time.

I am providing this now, so that a more accurate understanding of the true-root causes of the financial crisis may be known. I think the government, and the majority opinion of the Financial Crisis Commission were wrong: blaming reckless and greedy bankers, Wall Street, and poor government regulation. Greenspan in this paper, Bernanke in FCIC testimony (which is now public), and the Minority Report of The Financial Crisis Inquiry Commission (and many others, some of whom I have posted on this blog) in my view refute this ‘conventional wisdom’. Read my excerpts and commentary and the detailed testimony or papers and decide for yourself.

 Here are just a few Greenspan excerpts of the excerpts:

 “…analyst’s ability to time the onset of deflation (a bubble bursting) has proved illusive.”

“…we had to rely on an international ‘invisible hand’ to bring equilibrium to such undecipherable markets. The high level of market liquidity (erroneously) appeared to confirm that the system was working.”

 “Central Banks have chosen to set Bank capital and reserve standards that exclude once or twice in a Century crisis.”

 “Is the current crisis a 100 year flood? It is the most severe global financial crisis ever.”

 “The current crisis has demonstrated that neither bank regulators, nor anyone else, can consistently and accurately forecast whether…mortgages will turn toxic, or to what degree…or whether a tranche of a CDO will default…or even if the financial system as a whole will seize up. A large fraction of such difficult forecasts will invariably be proved wrong.”

 “Could the breakdown that so devastated global financial markets have been prevented? Given inappropriately low financial intermediary capital (excessive leverage) and two decades of unrelenting prosperity, low inflation, and low long-term interest rates, I very much doubt it.”

“Given history, we (the Fed) believed that any decline in home prices would be gradual. Destabilizing debt problems were not perceived to arise under these conditions.”

My full email to my defense attorneys in March 2010:

I quickly read through Greenspan’s paper last night after you sent it to me.

I thought his central theme was pretty accurate.

“Financial intermediation tried to function on too thin a layer of capital, owing to a misreading of the degree of risk embedded in ever-more complex financial products and markets.”

I also thought his assessment….that the roots of the financial crisis being the result of 500 million additional relatively well-educated (now a total 800 million worldwide) people being freed to work productively with developed world tools (as a result of the end of the Cold War) and their productivity and incomes (without any system of credit or culture to spend) resulted in a global savings glut in Developing Countries at the same time there was a shortfall of investment in Developed Countries, resulting in long-term Global rates moving to historically low levels and fueling a housing bubble in 20 developed Nations…..was both elegant and mostly correct. While later on, he notes that nonconforming home loans in the USA made the bubble worse….this does not bear out with his evidence that “USA price gains at peak were no more than the Global peak average”…and clearly even if he was correct, the dramatic increase in nonconforming lending was really more a symptom of global savings glut and low rates. The following sentences by him summarize: “Asset prices, particularly house prices, accordingly move dramatically higher in the 20 developed Nations. Geopolitical events led to the fall in rates and in turn, with lag, in an unsustainable boom in house prices globally.”

I do think he is wrong that the Fed’s short-term interest rate policies during this time were not a factor. Short-term interest rates….which is primarily the Fed’s view on inflation and the economy can have a serious impact on investors in long-term bonds. In addition, with short-term rates so low and Greenspan telling everyone they would be smarter to utilized ARM loans….the ARM market share expanded dramatically and these consumers/buyers were not using a long-term fixed rate to determine their cost of funds and the price they would pay for the home. Lastly, and most importantly, because of these low short and long-term interest rates…investors went seeking yield and to do so meant seeking additional risk….this, combined with the Fed never allowing the normal business cycle to occur, (an inadequate ratings and capital requirements from government rating agencies and regulators) caused investors to bid the risk premium to an unsustainably low level. Remember, there are many, many short-term tranches of debt that are created from a mortgage securitization structure (due to prepayment speeds)….these were priced off short-term rates set by the Fed. So, I think the Fed’s short-term interest rate policies had a huge impact on fostering the bubble (and causing investors to chase yield/risk) not just in housing but in all sorts of other investments (just look at the public and university pension funds and the kinds of nutty and illiquid investments they got involved in).

He notes that the private sector and government regulators and rating agencies failed because their models did not incorporate a Black Swan-type (once or twice in 100 years) event in them and that it is impossible to accurately forecast or predict events like this occurring and because the benign economic environment and low rates of the last 20+ years lulled everyone into more and more risk taking. The Fed believed that home price declines, if they occurred at all, would be gradual and not destabilizing.

He also in a footnote makes an argument against making our mortgage system safer for creditors/investors/banks…..by making it more conservative. He says this will make home ownership only available to the affluent. Basically, he justifies our business model….even alluding to the fact that subprime lending is needed (as we discussed, more than one Fed Governor has said this and one recent one personally told me this at a Fed dinner). There is a great quote below on the fact that no one could predict when a subprime loan or a tranche in a CDO could become toxic.

He also said that this event is not only a Black Swan (a once or twice in 100 year event), but the worst global financial crisis ever (including the Great Depression…which was a bigger economic crisis, but not financial crisis). In addition, he notes that Central Banks have deliberately established a private financial system that does not maintain adequate capital levels for this type of crisis and therefore sovereign governments must temporarily come to the rescue.

Lastly, he does not believe this event could have been prevented given the macroeconomic conditions that persisted for decades.

So, US home lenders like Indymac did not cause a housing bubble…global macroeconomic factors did. This was the worst financial crisis in history….centered in housing and mortgages….and the Central Banks deliberately structured a private financial system with capital levels inadequate to withstand this type of event without sovereign assistance. Indymac received no help (and in fact received inappropriate disclosures by an elected official….the press had to sue the Fed to get the names of banks who previously borrowed from them, because the Fed was so worried it might cause a bank run or other adverse conditions for an institution) and so it did not survive. This event was rapid, and with a harsh and major down move, and could not be predicted (Greenspan’s words but I agree). Therefore, where is the banking negligence and where is the securities fraud? There is none. mike

Here are some other excerpts that I thought were important:

“Almost all market participants of my acquaintance were aware of the growing risks, but also cognizant that risk had remained underpriced for years.”

“Financial firms were extremely fearful that should they retrench to soon they would almost surely lose market share, perhaps irretrievably.”

Greenspan buried some important things in his footnotes (often a Mea Culpa):

Footnote 16:

“Failing to anticipate the length and depth of emerging bubbles should not have come as a surprise. Though we like to pretend otherwise, policymakers, and indeed forecasters in general, are doing exceptionally well if we can get projections essentially right 70% of the time. But that means we get it wrong 30% of the time. In 18 ½ years at the Fed, I certainly had my share of the latter.”

 “The financial firms risked being able to anticipate the onset of crisis in time to retrench. They were mistaken.”

“Eschewing all objective risk is not consistent with life.”

“…analysts’ ability to time the onset of deflation (a bubble bursting) has proved illusive.”

 “Bubbles with higher debt leverage (mortgages) in the financial sector are a bigger risk.”

“The 1987 stock market crash and the dot com bubble bust led the Fed and sophisticated investors to believe another bubble would not have a big impact.”

 “An inordinately large part of investment management subordinated to ‘safe harbor’ risk designations of the credit rating agencies…government-sanctioned ratings organizations.”

 “Credit rating agencies were no more adept at anticipating the onset of the crisis than the investment community at large.”

 Footnote 23 Mea Culpa and Excuse:

 “I often argued that because of the complexity, we had to rely on an international ‘invisible hand’ to bring equilibrium to such undecipherable markets. The high level of market liquidity (erroneously) appeared to confirm that the system was working.”

 “A financial intermediary cannot profitably operate without risk.”

“Financial intermediaries therefore have no choice but to operate with leverage and accept the risk that entails.”

“There is always some risk that cannot be covered by Bank capital.”

“Central Banks have chosen to set Bank capital and reserve standards that exclude once or twice in a Century crisis.”

“Is the current crisis a 100 year flood?”

“It is the most severe global financial crisis ever.”

“I assume, with hope more than knowledge, that was (the current crisis) indeed the extreme of possible financial crisis that could be experienced by a market economy.”

“Designated pools of self amortizing home mortgages are the safest of private investments.”

“Because financial intermediation requires significant leverage to be profitable, risks, sometimes large risk, are inherent to this indispensable process. And on very rare occasions, it will bring down and may require the temporary substitution of sovereign credit for private capital.”

 “Facing prices that are too low (too low a cost of capital), systemically important firms will take on too much risk.”

“Businesses that are based out of having competitive market and cost of funds advantages, but not efficiency advantages, over firms not thought to be systemically important.”

“The current crisis has demonstrated that neither bank regulators, nor anyone else, can consistently and accurately forecast whether, for example, subprime mortgages will turn toxic, or to what degree, or whether a particular tranche of a CDO will default, or even if the financial system as a whole will seize up. A large fraction of such difficult forecasts will invariably be proved wrong.”

Footnote 58 (Greenspan now changes his mind and admits “you can see bubbles”):

“There has been confusion on the issue, to which I may have been a party. With rare exceptions it has proved impossible to identify the point at which a bubble will burst, but its emergence and development is visible in credit spreads.”

“Indeed, these developments reinforce a truth of a key lesson from our banking history….that private counterparty supervision remains the first line of regulatory defense. Regrettably, that first line of defense failed.”

 “But in retrospect, it appears that the decision to buy homes preceded the decision of how to finance the products.”

“Market demand obviously did not need ARM financing to elevate home prices during the last 2 years of the expanding bubble.”

“Could the breakdown that so devastated global financial markets have been prevented? Given inappropriately low financial intermediary capital (excessive leverage) and two decades of virtual unrelenting prosperity, low inflation, and low long-term interest rates, I very much doubt it.”

 Footnote 72:

“Tight regulations on mortgage lending, for example, down payment requirements of 30% or more, the removal of the mortgage interest deduction, and eliminating home mortgage non-recourse provisions would surely severely dampen enthusiasm for homeownership. But that would delimit home ownership to the affluent, unless low and moderate income ownership were fully subsidized by the government. Since January 2008, the subprime origination market has virtually disappeared. How will HUD’s affordable housing goals be achieve in the future?”

“Given history, we (the Fed) believed that any decline in home prices would be gradual. Destabilizing debt problems were not perceived to arise under these conditions.”

ALAN GREENSPAN, Greenspan Associates, The Crisis

Posted on September 24, 2013, in Postings. Bookmark the permalink. Leave a comment.

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