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Hernando Today

Shocked Disbelief

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By JOHN REINIERS, More Than Words

Hernando Today

Published: November 21, 2008

Some years back the very idea of transplanting a human heart seemed like science fiction until Dr. Christian Barnard did just that on Dec. 3, 1967. On 9/11 the free world was shocked when Muslim extremists attacked the Twin Towers and the Pentagon. In football circles everyone was stunned last year when No. 5 Michigan lost its opener to Appalachian State. (Appalachian who?)
But all this pales in significance when compared to former Federal Reserve Chairman Alan Greenspan's admission that a "once -in-a-century credit tsunami" caused our recent financial meltdown; that he was "shocked because I'd been going for 40 years or more with considerable evidence that it was working exceptionally well." In prepared remarks before a House oversight committee he noted, "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity — myself especially — are in a state of shocked disbelief..."
Here's the point: While I did get my mind around what were then the shocking facts detailed in the first paragraph, I cannot yet understand how this financial meltdown went undetected for so long. (This is not the political harangue of a Republican conservative. Let's keep politics out of this discussion.) Greenspan is hailed as the most accomplished central banker in U.S. history — relatively apolitical — having been nominated twice to be fed chairman by both Bill Clinton and George Bush.
Greenspan's "shocked disbelief" doesn't pass the credibility test. It was well known that sub-prime mortgage originations were surging for years; that securitizing mortgages was getting the interest of Wall Street; that they were highly leveraged; that HUD directed Fannie and Freddie to target market more than 50 percent of their financing to borrowers with income less than the median in their area; that Fannie and Freddie owned or guaranteed about half of U.S. Mortgages. And Greenspan testified in 2004 that they needed a regulator "with authorization on a par with banking regulators." (This from a man who supposedly is not a fan of regulation.) In 2005, he testified that "the strong belief of investors in the implicit backing" of Fannie and Freddie by the government "creates a systemic risk for the U.S. financial system." Furthermore, "If we fail to strengthen ... regulation, we increase the possibility of insolvency and crisis."
Hello! That's exactly what happened three years or so later, so how could he be in a state of "shocked disbelief?" Furthermore, in Greenspan's memoir, "Age of Turbulence," published in 2007, he observed, "To be sure, the "invisible hand" presupposes that market participants act in their self-interest, and there are occasions where they do take demonstrably stupid risks." (Referring to how "shaken" he was by "credit default swaps" on page 490.)
So, on the one hand he believes that "lending institutions will act in their own self interest" to "protect shareholder's equity," but on the other hand "they do take demonstrably stupid risks."
The most obvious answer is probably the correct one. It is all about the Wall Street culture — and that means bonuses — six figures and beyond. Salaries are for ordinary people, to Wall Streeters it's an asterisk. And then there's the exuberance of being a creative Wall Street shaker and mover — a "rainmaker" extraordinaire.
While Greenspan devoted most of his professional career to government, he launched his professional career as a Wall Street bond trader. All these financial wizards are joined at the bi-partisan Wall Street hip. Treasury Secretary Henry Paulson was a former chairman of Goldman Sachs. So was Treasury Secretary Robert Rubin, Bill Clinton's man from Wall Street. Larry Summers, Rubin's replacement at Treasury was his deputy at Treasury, and a close personal friend. Greenspan and Rubin promoted loose regulatory policies. Rubin's crowning achievement was the repeal of the Glass-Stegall Act, which got investment banks out from under government supervision. He has close ties to Sen. Chuck Schumer, D-N.Y, — who never held a job outside of politics and had been a congressman from New York City for 18 years. You are not successful in New York politics — in either major party — unless you are supportive of the Wall Street lobby. It is bi-partisan. Greenspan is a product of that environment — not from corporate America or academia.
According to the British media, the Archbishop of Canterbury blamed "human greed" for the financial crisis. But it goes beyond that. While the root cause globally was the insane housing boom/bubble that infected everybody; and in the U.S., from the lowest predatory "ninja" buyer — no income, no job, no assets — to the predatory real estate agent, appraiser, loan officer and Wall Street broker; the fly in the ointment was the complexity of the innovative financial derivatives, that were so leveraged and complicated, that — and I believe it was Greenspan who admitted this — the risk could not be understood. So we either had infectious speculative insanity or rampant greed, as the archbishop observed. It probably was both.
On the other hand, while ordinary investors understood that the housing bubble had a limited life span, they couldn't fathom its relationship to these crazy hedge funds and derivatives. The 1990s investor didn't have to be a genius to sense that the "dot-com" and "tech" booms couldn't last either — and they didn't. But the point is at least the risks were understandable.
Thomas Henry Huxley (1825-1895) unwittingly summed up Greenspan succinctly when he noted, "If a little knowledge is a dangerous thing, where is the man who has so much to be out of danger?" It looks as though nobody ever knows enough, because Greenspan admitted he found a "flaw" in his "model." But he hasn't fully explained it yet. When he and the rest of the global luminaries of finance figure it out, we'll need sensible regulation to protect us from these Wall Street clowns, because they are incapable of self governance.
We would also be well served if Treasury and the Federal Reserve had experts on their staffs with corporate backgrounds in producing products — making things for a profit — to counterbalance those wizards of finance whose expertise is in moving money and debt around the globe for a profit and only making mischief.

John Reiniers, a regular columnist for Hernando Today, lives in Spring Hill.

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