Wall Street’s Crisis: What Greenspan Got Wrong

January 30th, 2011 at 3:54 am David Frum | 22 Comments |

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Let’s face it: You won’t read every page of the Financial Crisis Inquiry Commission report. But FrumForum will, over the next days. So let’s proceed together, page by page, identifying the key points.

Click here to read the entire series.

An editorial in National Review criticizes the FCIC report as an exercise in “evil-man economics.”

[T]he commission’s report is both implausible and nakedly political: The Evil Men are greedy corporate executives and Wall Street moneymen, and the crisis might have been averted if only they had been endowed with sufficient moral fiber — or had an appropriately mindful policeman appointed over them, which is the real point of the Angelides report.

Yet as of page 61, the report’s main culprit is not an executive or a money man. It is Federal Reserve chairman Alan Greenspan.

The “Greenspan put” was analysts’ shorthand for investors’ faith that the Fed would keep the capital markets functioning no matter what. The Fed’s policy was clear: to restrain growth of an asset bubble, it would take only small steps, such as warning investors some asset prices might fall; but after a bubble burst, it would use all the tools available to stabilize the markets. Greenspan argued that intentionally bursting a bubble would heavily damage the economy. “Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences,” he said in 2004, when housing prices were ballooning, “we chose . . . to focus on policies ‘to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.’”

This asymmetric policy—allowing unrestrained growth, then working hard to cushion the impact of a bust—raised the question of “moral hazard”: did the policy encourage investors and financial institutions to gamble because their upside was unlimited while the full power and influence of the Fed protected their downside (at least against catastrophic losses)? Greenspan himself warned about this in a 2005 speech, noting that higher asset prices were “in part the indirect result of investors accepting lower compensation for risk” and cautioning that “newly abundant liquidity can readily disappear.” Yet the only real action would be an upward march of the federal funds rate that had begun in the summer of 2004, although, as he pointed out in the same 2005 speech, this had little effect.

And the markets were undeterred. “We had convinced ourselves that we were in a less risky world,” former Federal Reserve governor and National Economic Council director under President George W. Bush Lawrence Lindsey told the Commission. “And how should any rational investor respond to a less risky world? They should lay on more risk.”

Still, the report does point out on page 62, that sometime around 1980, people in the financial sector did begin awarding themselves more pay.

From 1945 until 1980, people in finance did not significantly outearn on average people in other sectors. After 1980, nonfinancial pay flattened, while financial pay accelerated. By 2008, the average employee in finance was earning double the average employee in non-finance.

The trouble was not just that such people were arguably overpaid. (Although in the wake of revelations that CEOs at major financial institutions knew little or nothing about what was going on at their firms, it’s hard to avoid the conclusion that such executives were indeed paid too much. Like everything about the first $1.) The trouble rather was that the widespread use of stock options as pay systematically misaligned executive incentives, encouraging them to run risks in the knowledge that profits would be shared with them in the form of higher pay, while losses would be borne by shareholders alone.

Worse yet, pay structures could encourage outright fraud, as happened at Fannie Mae and Freddie Mac.

Former Fannie Mae regulator Armando Falcon Jr. told the FCIC, “Fannie began the last decade with an ambitious goal—double earnings in 5 years to $6.46 [per share]. A large part of the executives’ compensation was tied to meeting that goal.” Achieving it brought CEO Franklin Raines $52 million of his $90 million pay from 1998 to 2003. However, Falcon said, the goal “turned out to be unachievable without breaking rules and hiding risks. Fannie and Freddie executives worked hard to persuade investors that mortgage-related assets were a riskless investment, while at the same time covering up the volatility and risks of their own mortgage portfolios and balance sheets.” Fannie’s estimate of how many mortgage holders would pay off was off by $400 million at year-end 1998, which meant no bonuses. So Fannie counted only half the $400 million on its books, enabling Raines and other executives to meet the earnings target and receive 100% of their bonuses.

More to come…

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22 Comments so far ↓

  • balconesfault

    Wow – salaries in the financial sector really took off during the 1980′s.

    What happened?

    Oh – huge cuts in the capital gains and unearned income tax rates. America hung out a sign that we were fine with jobs leaving for overseas, as long as the financial sector got their cut of each transaction.

  • armstp

    Greenspan was a sad tragedy for America. He is a good representation of what America has become.

    “The Greenspan put” was the running joke on Wall Street. Basically, Wall Street could take as much risk as they wanted because they knew Greenspan would bail them out. That was his track record. He bailed out the S&Ls and he bail-out Long-Term Capital. “The Greenspan Put” basically undercut everything that Wall Street and Ayn Rand types believe, as it said underlying everything there was no free market or strict market forces and at its base everything was supported by government. No one was free to fail, except maybe the Taxpayers. So much for the “moral hazard” of the capitalist system.

    From my previous posts I have gone through the many many things that Greenspan got wrong regarding this crisis, but Greenspan had a long moronic history of getting almost nothing right and frankly not knowing what he was doing. He was a joke in serious economic circles. He only got the job by being a good politician and rubbing the right backs. He was Mr. Hollywood and not a serious economist, despite outward appearances and seemingly complicated talk. Only politicians took him seriously.

    Alan Greenspan was an Ayn Rand disciple. The problem is that Ayn Rand was wrong. Markets are not efficient and they do not always work. Unfortunately, we all had to find that out the hard way during nearly 20 years of Greenspan. He kind of Atlas Shrugged us all.

    Some of Greenspan’s terrible predictions over the years (his entire career was full of them):

    * In NYT January 1973 he said “It’s very rare that you can be as unqualifiedly bullish as you can now,” The market proceeded to lose 46% of its value over the next two years.

    * Not only did he misread the beginning of the recession, but he got the end of the recession wrong too. In April 1975, Greenspan told a New York audience that the recession wasn’t over, that the “worse was yet to come.” The economy swiftly improved, and the National Bureau of Economic Research later placed the end of the recession at March 1975. What a complete moron.

    * In July 1990, as the start of the recession which ultimately destroyed the presidency of George HW Bush, Greenspan opined: “In the very near term there’s little evidence that I can see to suggest the economy is tilting over [into recession].” Months later, as the bad new continued, Greenspan said: “Those who argue that we are already in a recession I think are reasonably certain to be wrong.” By October, the U.S. was in its sixth month of ten consecutive months of job losses he said “The economy has not yet slipped into recession.”

    * Greenspan was a big supporter of Charles Keating, saying that Keating’s Lincoln Savings and Loan “has developed a series of carefully planned, highly promising and widely diversified projects” and he added that the firm “presents no foreseeable risk on the Federal Savings and Loan Corporation.”

    * In 1994, after a few small-scale disaster involving derivatives, Greenspan told Congress that the risk involving derivatives, of the type that destroy the financial markets in 2008, were “negligible”, saying this was the key reason the government left them unregulated.

    * His misreading of the tech bubble of the late nineties is legendary. In 1995 as the Tech bubble was beginning Greenspan said: ” One can say that while the stock market is now low, it clearly is not anywhere close to being as elevated as it was a year or so ago,” It is not the job of the Fed Chairman to promote the stock market. Greenspan then cut rates to get the Tech bubble really going, which was the start of the biggest stock market bubble in U.S. history. Then by December 1996 he famously said that perhaps “irrational exuberance” has overinflated asset values. In January 2000 at the height of the Tech bubble, at a time when companies like theglobe.com went from $9 to $63.50 on the day of its IPO, Greenspan said this:

    ” When we look back at the 1990s, from the perspective of say 2010, the nature of the forces currently in train will have presumably become clearer. We may conceivably conclude from that vantage point that, at the turn of the millennium, the American economy was experiencing a once-in-a-century acceleration of innovation, which propelled forward productivity… at a pace not seen in generations, if ever.”

    Of course we know what happened after that. We had the biggest crash in the stock market since 1929. The Tech bubble exploded.

    * He also fell completely for the Y2K scare. He flood the economy ahead of Y2K with about $150 billion of extra cash to pump up the economy. He said: ” The crucial issue… is to recognize that we have a Y2K problem,” ….”It is a problem about which we don’t want to become complacent.”

    * During George W. Bush’s presidency Greenspan actually worried alound that the national debt might be repaid too quickly.

    etc. etc. etc

    Not all economist are going to get it right, but Greenspan’s errors were historic, idiotic blunders and evidence of a fundamental misunderstanding of problems that led to huge disasters. Anyone else in the private sector that failed this often with his predictions would have been fired right from the start.

    All Greenspan really did was use the Fed/Government to create bubble economies with easy money and then he used the Fed/Government/Taxpayers to bail-out his Wall Street buddies when that bubble popped. He did this over and over again.

    We could not have had a better guy in charge during the housing bubble. He pushed for the elimination of Glass-Steagall, which directly resulted in too-big-to-fail and the corresponding systematic and contagion risk which resulted in the massive bail-outs. Greenspan also aggressively stopped derivatives from being regulated after the Long-Term Capital failure, which directly resulted in the massive financial and economic meltdown after the housing/mortgage bubble collapsed. And finally Greenspan was onside to weaken capital requirement rules in 2004, so the banks could leverage up as high as 40-to-1, which directly resulted in collapse of Bear Stearns, Lehman, Merrill, Wachovia, etc.

    Greenspan was also an active cheerleader for the housing bubble. He began encouraging households to use their homes as ATM machines. He said: “Low rates have also encouraged households to take on larger mortgages when refinancing their homes,”… ” Drawing on home equity in this manner is a significant source of funding for consumption and home modernization.” He went further and encouraged people to take-out adjustable rate mortgages over fixed mortgage, saying this in a speech, just before he raised rates from 1% to 4.5%, screwing those variable rate mortgage holders.

    After the Fed was warned by many of the dangers of the housing bubble and all these fancy sub-prime mortgages Greenspan had the gall to say:

    “Technological advances have resulted in increased efficiency and scale within the financial services industry… With these advances in technology, lenders have taken advantage of credit-scoring models and other technologies for efficiently extending credit to a broader spectrum of consumers.”

    Of course we know what happened to the those AAA technical advances and credit-scoring models. They were a wrong and in most cases a fraud, which resulted in the biggest collapse in the housing market of all time, wiping out roughly 40% of the world’s wealth.

    Greenspan finally left in 2006. He left about 20 years too late.

    His final testimony before Congress:

    Waxman: “Were you wrong?”

    Greenspan (always the ass): “Partially,..”

  • JimBob

    Markets are not perfect, but in the long run they do get it right. Greenspan blames Asians for saving too much money for the crisis. Nonsense. Because he knows better. Flooding the economy with cheap money is responsible for the mess we are in today.

    Gold and Economic Freedom


  • N Myles

    You know the funny thing about Greenspan..?

    His book … hahahha … it was actually pretty good (he’s not a bad writer, other than his A Rand thing of course …) But in his book Gspan gets a call form Rush Limbaugh one day (he was returning a call Gspan had placed) and Gspan talks about how passive and mellow RL is (it’s all a show with RL ), a real pussycat apparently.

  • COProgressive

    One woman’s thoughts on Greenspan…..

    By David J. Lynch, USA TODAY

    Commission member Brooksley Born, however, blistered Greenspan with a catalog of what she described as the Fed’s failures: “The Fed utterly failed to prevent the financial crisis. The Fed and the banking regulators failed to prevent the housing bubble. They failed to prevent the predatory-lending scandal. They failed to prevent our biggest banks and bank holding companies from engaging in activities that would bring them to the verge of collapse without massive taxpayer bailouts. They failed to recognize the systemic risk posed by an unregulated over-the-counter derivatives market, and they permitted the financial system and the economy to reach the brink of disaster. You also failed to prevent many of our banks from consolidating and growing into gigantic institutions that are now too big and-or too interconnected to fail.”

    While Ms. Born lays the blame at the feet of Alan Rand Greenspan, in the financial markets there were any number of player who took to hear the words of advice from a fictional character, Gordon Gekko, when he said the infamous lines,

    “Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.”

    We all know how Gordon Gekko ended up. The question I haven’t had anyone answer for me is

    “Why aren’t a whole bunch of people in jail yet?”

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  • balconesfault

    But in his book Gspan gets a call form Rush Limbaugh one day (he was returning a call Gspan had placed) and Gspan talks about how passive and mellow RL is (it’s all a show with RL ), a real pussycat apparently.

    Pussycat? When someone is willing to savage people in public over the air, then are passive and mellow when speaking to them in person – that’s called being a coward.

  • qingdao

    As with the crash of an airplane, the crash of an economy is never the result of one failure but a series of failures, usually connected, but discreet. Certainly ONE of the multiple causes was the rise of China (beginning in 1980), whose trade imbalance added trillions of dollars to financial markets, which then created an unprecedented demand for collateral – to which the market responded….and we know the rest of the story. This is what Greenspan was referring to and of course he was correct.

  • pnumi2


    Are you suggesting that the rise of China (in 1980) was one a “series of failures” that lead to the crash of our economy or just one of the “multiple causes” of the crash?

    When the sun rose in Belgium on 18 June 1815 there was no failure of any of the physical principles governing our Solar System, yet that particular sunrise was one of the causes of the defeat of Napoleon.

    China was no more complicit in the “housing bubble” that tore down the economies of the West, than was the sun that shone at Waterloo that day complicit in Wellington’s victory.

    • qingdao

      Yes; I am suggesting that the rise of China contributed in a significant way to America’s (and Europe’s) housing bubbles and the financial systems’ attempts to re-cycle China’s $3TRILLION foreign exchange reserve and further there are almost certainly more reverberations to follow.

      • pnumi2


        Yes, China contributed in a significant way to the collapse of America’s housing bubble in the same way WalMart contributed to he collapse of KMart and Sears.

        China had legitimately earned the 3 trillion in reserves in its Treasury. Inflation was eating away at that portion denominated in dollars, America’s Treasury was paying .25% interest and, according to the precepts of Capitalism, China could do whatever the F**K it wanted to do with its liquid assets; as long as it was legal and what could be more legal than loaning money at a low rate of interest?

        You seem to be saying is that while it is legal to sell liquor to man man with a severe drinking problem or to loan money to man with a severe gambling problem, it’s not nice.

        Well, if you can’t stand the heat, get out of the kitchen. And stop paying for your addictions with bonds you’ll never be able to pay off.

  • Kurlis

    Alan Greenspan isn’t to blame whatsoever. Everyone knows precisely where to place 100% of the blame for the financial crisis: The American Left and its enablers in Congress: Chris Dodd and Barney Frank. They blocked reform of Fannie Mae and Freddie Mac and turned a blind eye when clear warning signals were apparent.

    Alan Greenspan is only one man with limited tools at his disposal and a mandate to maintain a stable money supply. He was failed by a political apparatus that sought to ingratiate and enrich its constituents to the detriment of the American commercial free enterprise system by fraud and outright chicanery.

    The entirety of the American Left is guilty and fully responsible.

    • pnumi2

      So Chris Dodd and Barney Frank and the Democrats, who were not in the majority in the Senate and House, from January 1995 to January 2007 are fully responsible for the boom and bust of the housing bubble.

      Or just the bust. We can give the Republicans credit for the boom.

      A very interesting theory. I’ll tell my dog and see what she thinks.

  • balconesfault

    “Alan Greenspan isn’t to blame whatsoever. “

    So, when Greenspan in 2001 warned against paying down the Federal Debt too quickly, and encouraged tax cuts so that our sustained Federal Budget Surpluses wouldn’t endanger the bond market … he was being a positive force?

  • valkayec

    After reading a lot on this subject, I have only one question: what did Greenspan get right?

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  • armstp


    Greenspan got very little right over his entire career. As I stated in my above post, he was largely a joke among serious economists and real market observers. It is funny that he preached an extreme Ayn Rand view of absolutely free markets, but then he ironically was very very hands on with government policy, in terms of Wall Street bail-outs and flooding the economy with cash at times. What he preached was largely the exact opposite with what he did on the monetary policy side. In the end he finally admitted that he was wrong. Bernanke is doing a much better job. Bernanke has done an amazing job at stabilizing the financial system and the economy. Most non-partisan observers think both Geithner and Bernanke have done a good job in very difficult and unprecedented times.

  • pnumi2


    With Fed Chairmen I think its is not so much what they get right, but what they don’t get wrong.

    Greenspan’s reputation got off to a good start with he way the Fed handled that huge drop in the Dow in October 1987. Nothing untoward happened during the Savings and Loan crisis.

    Fresher in our minds was the comeback of the stock market after 9/11. These events, plus a booming economy, contributed to the public’s idea that Greenspan knew what he was doing. And all of which reinforced Greenspan’s own belief that he knew what he was doing.

  • armstp


    Savings and Loan crisis, which should have been prevented in the first place by guys like Greenspan, resulted in the failure of 747 savings and loan associations.

    “The ultimate cost of the crisis is estimated to have totaled around $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government via a financial bailout under the leadership of George H.W. Bush. The remainder of the bailout was paid for by charges on savings and loan accounts[1]—which contributed to the large budget deficits of the early 1990s.

    The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990–1991 economic recession. Between 1986 and 1991, the number of new homes constructed per year dropped from 1.8 million to 1 million, which was at the time the lowest rate since World War II. ”

    That was real money back in those days.

    Like every other crash (tech bubble and mortgage crisis) Greenspan was a big promoter and cheerleader with regard to these bubbles.

    “He wrote reports to the the congressional oversight committee for Charles Keating in 1985 which proclaimed that Keating’s Lincoln Savings & Loan was quote:

    “a financially strong institution that presents no foreseeable risk to depositors or the government.”

    Greenspan also wrote similar favorable reports for other banks that also soon failed.”

    As for the crash of 1987:

    ” In October 1987 when Greenspan led a bailout of the stock market after the October 20 crash, by pumping huge infusions of liquidity to prop up stocks and engaging in behind-the scene manipulations of the market via Chicago stock index derivatives purchases backed quietly by Fed liquidity guarantees. Since that October 1987 event, the Fed has made abundantly clear to major market players that they were, to use Fed jargon, TBTF—Too Big To Fail. No worry if a bank risked tens of billions speculating in Thai baht or dot.com stocks on margin. If push came to liquidity shove, Greenspan made clear he was there to bail out his banking friends.”

    ” Under the Greenspan regime, after October 1987 the Fed increasingly became the “lender of first resort,” as the Fed widened the circle of financial institutions worthy of the Fed’s rescue from banks directly—which was the mandated purview of Fed bank supervision—to the artificial support of stock markets as in 1987, to the bailout of hedge funds as in the case of the Long -Term Capital Management hedge fund solvency crisis in September 1998.

    Greenspan’s last legacy will be leaving the Fed and with it the American taxpayer with the role as Lender of Last Resort, to bail out the major banks and financial institutions, today’s Money Trust , after the meltdown of his multi-trillion dollar mortgage securitization bubble.”

    “On November 18, 1987, only three weeks after the October stock crash, Alan Greenspan told the US House of Representatives Committee on Banking, “…repeal of Glass-Steagall would provide significant public benefits consistent with a manageable increase in risk.”[4]

    Greenspan would repeat this mantra until final repeal in 1999.

    The support of the Greenspan Fed for unregulated treatment of financial derivatives after the 1987 crash was instrumental in the global explosion in nominal volumes of derivatives trading. The global derivatives market grew by 23,102% since 1987 to a staggering $370 trillion by end of 2006. The nominal volumes were incomprehensible.”

    “Greenspan’s adamant rejection of every attempt by Congress to impose some minimal regulation on OTC derivatives trading between banks; on margin requirements on buying stock on borrowed money; his repeated support for securitization of sub-prime low quality high-risk mortgage lending; his relentless decade-long push to weaken and finally repeal Glass-Steagall restrictions on banks owning investment banks and insurance companies; his support for the Bush radical tax cuts which exploded federal deficits after 2001; his support for the privatization of the Social Security Trust Fund in order to funnel those trillions of dollars cash flow into his cronies in Wall Street finance—all this was a well-planned execution of what some today call the securitization revolution, the creation of a world of New Finance where risk would be detached from banks and spread across the globe to the point no one could identify where real risk lay.

    When he came in 1987 again to Washington, Alan Greenspan, the man hand-picked by Wall Street and the big banks to implement their Grand Strategy was a Wall Street consultant whose clients numbered the influential J.P. Morgan Bank among others. Before taking the post as head of the Fed, Greenspan had also sat on the boards of some of the most powerful corporations in America, including Mobil Oil Corporation, Morgan Guaranty Trust Company and JP Morgan & Co. Inc. His first test would be the manipulation of stock markets using the then-new derivatives markets in October 1987.”

  • pnumi2


    Thanks for more details about Greenspan. It’s amazing how he hoodwinked four presidents and, more to the point, Wall Street itself during his tenure as Chairman of the Fed.

    With me you’re preaching to the choir as you may know from some of the other threads here. I was astonished when he didn’t raise margin requirements at the end 1996 when he made his ‘irrational exuberance’ speech. I said it then and didn’t hear anyone else make that charge until after the debacle we just endured.

    I hope you didn’t read my post here as an endorsement of the man. Valkayec wanted to know what he got right. I only described why she would have liked him if she were CEO of Goldman Sachs or someone with a huge stock portfolio.

    Maybe I should have added his unique delivery of the Fed’s message to the House and Senate.

    Laurence Olivier as Richard III could not have given a better performances.

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