Now Greenspan doesn't like bailouts?
The former Fed chief's criticism of the rescues of Bear Stearns, Freddie and Fannie is infuriating because he created the mess that led to them.
By Bill Fleckenstein
Last Thursday, the government reported that the Consumer Price Index was running at 5.6% year over year, the highest rate in about 16 years. Given that inflation is as high as it is, many folks are probably puzzled as to why, at the same time, home prices are collapsing.
That confusion became clear to me last week when I did an online chat. It is an odd mixture, one that was not only preventable but foreseeable.
In the shameless-self-promotion department, this is exactly why I wrote "Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve."I would encourage folks who are still puzzled about how these terrible problems can coexist to pick up a copy. Not because I need the book royalties but because I think it might be helpful.
The sorry state that we find ourselves in is a function of the Fed's interest-rate-targeting policies. More specifically, it was caused by the policies of Alan Greenspan, the Fed chief from 1987 to 2006. Just as this column was being filed, he graced the front page of The Wall Street Journal with some, shall we say, interesting observations.
Time for a new eyeglass prescription
In an article headlined "Greenspan sees bottom in housing, criticizes bailout," he said, "Home prices in the U.S. are likely to start to stabilize or touch bottom sometime in the first half of 2009." (He did leave himself some wiggle room, as he also noted that "prices could continue to drift lower through 2009 and beyond.")
Of course, we shouldn't forget that this is the same man who in October 2006 opined, "I think the worst of this (housing problem) may well be over."
s I also note in the book, while Greenspan was in office he went to great lengths to suggest that housing couldn't experience a bubble. And, as The Journal pointed out, he also tried to make the case in 2004, when many of us were already certain a disastrous bubble was in full bloom, that "a national severe price distortion seems most unlikely in the United States, given its size and diversity."
This illustrates my strongly held (and well-documented) view that when it comes to matters of economics, Greenspan is utterly clueless and unable to learn from his mistakes.
However, what really sent my blood boiling was his criticism of the government bailouts of Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs). Now, you might wonder why I'd be angry that he said something I agree with, especially: "They should have wiped out the shareholders (instead)," referring to the bailout of Bear Stearns as well as that of Fannie and Freddie.
The reason I'm so angry is his logic, which The Journal paraphrased as follows: "The Fed-financed takeover of investment bank Bear Stearns also made government backing of Fannie and Freddie debt 'inevitable'" (his adjective, my emphasis). Then Greenspan went on to tell the newspaper: "There's no credible argument for bailing out Bear Stearns and not the GSEs (government-sponsored enterprises)."
Own up to your bubble
The problem with that line of logic: Greenspan made the Bear Stearns bailout inevitable when he set the precedent of rescuing Wall Street during the collapse of hedge fund Long-Term Capital Management in 1998.
Of course, those actions led to the massive blowoff to the stock bubble, the response to which led to the real-estate bubble. Thus, had he not bailed out Wall Street, I don't believe we would ever have been in a situation in which a Bear Stearns bailout would have been required or even considered.
In sum, it was Greenspan who set this train wreck in motion, with his specific policies regarding Long-Term Capital, dramatically altering the financial landscape by creating what's known as the "Greenspan put." Making matters worse, in the wake of that "warning shot," he advocated the deregulation of the financial system and championed securitization at every chance he got. While in charge, he never tried to put a stop to any dangerous policy but, rather, pursued it aggressively.
They live and they die by the square root of pi
Delusions of infallibility bring me to another subject: quantitative trading. Quantitative analysts have pursued a strategy based on the notion that the money to be made in stocks comes via mathematics rather than from company fundamentals. I believe that this strategy is responsible for much of the pandemonium we see on a regular basis. (For more on this subject, see "Market hackers running out of ammo.")
No market seems to be safe from these maniacal, algorithm-wielding computer beasts. In a way, their systems have made it possible (in the short run) for almost anything to trade at any price, whether foreign exchange, stocks or commodities in general.
A friend who is a quant educated me on the broader picture and what needs to be done:
"The problem is not quants per se but funds of funds and short-term performance focus. So investors got what they bargained for: high returns and low volatility for a short while, until payback time. Large quants that likely caused this current dislocation got capital allocated to them by fund-of-fund/clueless pension-fund managers.
"Capital is being allocated by nearly incompetent, self-righteous folks, and that's where the problem is. Hiring of competent managers for our mutual and pension funds should be given a priority.
"Quantitative portfolio construction based on sound macro/value ideas and risk management is here to stay. Kill short-term-profit focus, kill calendar performance boogies, and quants will again become liquidity providers -- smoothing instead of exaggerating volatility. Kill the system that allowed quants to get so big. Don't shoot the quants -- they are the messengers of a broken system of values. We just don't like the message they brought to us."
My friend's view notwithstanding, I believe that when the book is written on 2004-08, a key feature of what went wrong -- besides the mistakes made by the Federal Reserve, which brought us the stock, housing and credit bubbles in the first place -- will be the damage attendant to the incorrect notion that quantitative systems were infallible.
At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column.
Thanks a Lot Greenspan
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