Bernd Debusmann is a Reuters columnist. The opinions expressed are his own.
By Bernd Debusmann
WASHINGTON (Reuters) - At the height of Alan Greenspan’s fame, a Washington magazine portrayed him on its cover as a Buddha figure, clad in a purple robe, sitting in the Lotus position before adoring worshippers. “The Cult of Greenspan,” said the headline. Inside, the story provided riveting detail of the cult.
For example: A software program called “the Talmud of the Federal Reserve” which translates every Greenspan sentence into a predicted market reaction. A room at a Wall Street firm turned into a Greenspan shrine, featuring quotations from 30 of his speeches under a sign that reads “Greenspan’s Teachings.” On a trader’s desk, a small rock carved into a Greenspan profile. A roped-off red leather chair where he once sat.
The March 30, 1998, issue of the magazine, The New Republic, has become a collector’s item. The names of Wall Street houses in the article were invented, the cult fictitious, the author disgraced, the story purged from databases. But it sounded so plausible at a time of exuberant Greenspan adoration, the article was not questioned for many weeks.
A decade later, the U.S. economy is ailing and has begun to infect the rest of the world. In the hunt for a scapegoat - standard operating procedure in Washington - many fingers point at Greenspan and critics say his 18-year leadership of the U.S. Federal Reserve led to today’s troubles in the housing markets.
Instead of the fawning praise heaped on Greenspan when the economy was booming, there are now websites portraying him in dark colors. One site is called The Mess That Greenspan Made, another Greenspan’s Body Count. Greenspan’s memoirs, The Age of Turbulence, prompted hedge fund manager William Fleckenstein to write a book entitled Greenspan’s Bubbles, the Age of Ignorance at the Federal Reserve. It’s in its fourth printing.
America’s present problems go deeper than the housing market and Greenspan, who denies responsibility, is not alone in having helped create what critics call the shadow financial system. It runs on private, out-of-sight transactions involving complex financial instruments that account for more money than the combined value of stocks and bonds traded on transparent markets.
A major milestone on the road to “what is fast becoming the worst financial calamity since the Great Depression,” in the words of Morgan Stanley’s Stephen Roach, was the Commodity Futures Modernization Act (CFMA) of 2000. The way it was written, introduced and passed speaks volumes about the Washington intersection between politics, finance, and lobbyists.
The 262-page piece of legislation was added as a last-minute rider to an 11,000-page omnibus bill on the afternoon of December 15, the Friday before the Christmas recess. “I would say there was no one, except the drafters of the bill, who understood what it did,” said Michael Greenberger, who served in the Commodities and Futures Trading Commission in the late 1990s. “And the drafters were Wall Street lawyers, not legislators.”
What the bill did was to largely deregulate many complex derivatives - financial instruments traded privately over the counter or on futures exchanges - that gain or lose values as an underlying rate, price, or other variable changes. Using derivatives, traders bet on future trends in financial assets - stocks, currencies, commodities, energy, mortgages - without owning them.
Signed into law by Bill Clinton a week after its stealthy introduction, “the bill freed the (derivatives) system from any regulation and set the stage for financial fiascos,” said Greenberger, now a professor at the University of Maryland. “The trouble now is not just with mortgages, it’s with all kinds of loans,” he said in an interview. “Derivative products have been spread all over the world.”
The man who introduced the bill, Phil Gramm, then a Republican Senator from Texas, had close links with Enron, where his wife Wendy served on the board of directors. Enron, which went bankrupt in 2001, had lobbied vigorously for the new legislation which exempted most trading on electronic energy markets from regulatory oversight.
It is no longer fashionable for Wall Street movers and shakers to publicly sing the praise of greed, as did the arbitrageur Ivan Boesky in 1987, not long before he was tried and imprisoned for insider trading. (The villainous Gordon Gekko of the film Wall Street was patterned on Boesky). But judging from the zest with which players plunged into dubious derivatives, greed is alive and well and often trumps common sense.
It’s not as if there had been no warnings. “In our view...derivatives are financial weapons of mass destruction, carrying dangers that while now latent are potentially lethal,” Warren Buffett wrote as early as in 2002 in the annual letter to shareholders in his Berkshire Hathaway group. “We view them as time bombs, both for the parties that deal in them and the economic system...”
As Buffett, the world’s richest man in 2008, explained it, the range of derivatives contracts is limited only “by the imagination of men, or madmen.”
“The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.”
Greenspan disagreed. In 2003, he wrote that he believed derivatives had spread risks and thus softened the recession of 2001 which followed the bursting of the dotcom bubble. Greenspan’s mantra has been that regulation puts a brake on markets and markets left alone know best.
Will Wall Street and the government draw lasting lessons from the present mess? Don’t bet on it.
(You can contact the author at Debusmann@Reuters.com)
Editing by Sean Maguire