The House That Greenspan Built

Alan Greenspan is the unfortunate position of having gone from acclaimed sage to one of history's great screwups in the past couple of years. I might even be sympathetic if he hadn't cost me so much money.

Peter S. Goodman, writing in today's New York Times, has a long analysis of how influential Greenspan was in the rise of the unregulated derivatives market. Greenspan, the Ayn Randian free market fundamentalist was, and still apparently is, convinced that regulation of derivatives was a bad idea. One of the problems we have today is that this vast market in derivatives dwarfs the value of the underlying assets.

The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.

Not all these derivatives are related to the mortgage market, but consider the fact that the total "value" of all these derivatives is nearly 50 times the value of all US mortgages. It seems to me that anyone who could not see a potential problem here is hopelessly blind.

Greenspan has his own ideas of course:

The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.”

We regulate pharmacists rather strictly of course. I guess that it didn't occur to Mr. Greenspan that a policy that depended on investment bankers not getting greedy might have an underlying problem.

While Greenspan, Robert Rubin, and the rest of Wall Street campaigned relentlessly against regulation, some wiser heads were not fooled:

George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”

And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

I think we can now see pretty clearly who was right and who was deluded. I strongly recommend the whole article.