Greenspan and the credit crunch

Two of the keynotes at this year's BAI Retail Delivery Show are Bob Geldof and Alan Greenspan. 

Bob
Geldof, the liberating freedom fighter for justice for Africa, wiping
out third world poverty and forcing politicians and bankers to give him
their f***ing money, whose six-figure pay cheque for his speech is
obviously going to Africa ... or is it his f***ing pocket.

Alan
Greenspan, the sage and dour federal banker who oversaw one of
America's most prosperous periods in history before handing over to
Bernanke, whose name kind of rhymes with stank ... or is that the
steaming pool of sub-prime credit that Greenspan left him with?

Now
that I've completely blown my chances of either keynote speaker even
talking to me, I can enjoy the show, free from any sense of awe.

What we are seeing is a moment in history however.  This moment is related to banks that have blown over $300 billion
in bad loans over the past decade, some estimate it may even be $500
billion, and yet they've only declared $30 billion of those losses so
far.  That means there's another $470 billion to be declared at max,
and banks that include great names from Citi to Merrill, from Barclays
to WaMu, Morgan Stanley to BNP Paribas, are all being forced to admit
that they have been caught in this storm ... and yet they are all
declaring themselves at a loss as to how this could have happened.   

Well, Greenspan presented his views today and it was interesting.

First, the subprime market was unavoidable.

Second, it won't happen again.

The
subprime market was unavoidable because Dr. Greenspan stated that it
dates back to the end of the cold war.  This was the trigger that led
to the subprime issue.  The reason is that all those countries that had
had central planning regimes - Russia and China in particular - began
to move to the American capitalism model in the 1970's and threw away
their central planning model in the 1990's. 

Suddenly a huge
release of people who were previously not motivated by capitalism
were.  We're talking two billion people or more.  Just look at the
movement of people from West to East China for an example.

This
huge release of people led to a production revolution that created
lower and lower prices.  That’s why we enjoyed twenty years of low
interest over the past decade.

Whenever you have a long-term
low-interest environment, you have a low-cost environment for real
estate.  As a result, a housing boom occurs and, as the boom swept
across America, it meant that banks were being pushed harder and harder
to find new mortgage business.

The hedge fund managers were
therefore putting pressure on mortgage securitisers to deliver results,
who then put pressure on the banks to deliver mortgage market growth,
who then reduced risk measures to allow subprime through the door en
masse.

From 10% of the loan book to over 20% in five years,
subprime built the asset bubble but it was hidden as there were few
foreclosures.  After all, you can remortgage when you have an
increasing asset price. 

But then that asset price stopped
increasing because inflationary forces are afoot.  China's prices of
imports to the USA have been decreasing for two decades but have now
plateaued.  The low interest rate environment has therefore plateaued
with it, and is now on the rise.  So your house was no longer a money
creator but a money burner.  It is no longer an increasing asset but a
decreasing one for the next few years.

Result: the subprime kicked in.

This
was unavoidable from a Federal Reserve viewpoint because it couldn’t be
regulated.  Regulators understand risk models and interest rates, but
the subprime model was criminal and fraudulent mis-selling of loans to
deliver returns.  Hence, the issue lies more with the Attorney General
than the Federal Reserve. 

Equally, the Fed tried to increase
interest rates to slow things down, but that didn’t work either. To the
extent that you can judge house price rises in the USA, the Fed thought
it was based on long-term mortgage rates and those went down over the
last decade.  The thing is though that the Fed does not control those
rates.  The Fed had complete control over the spot markets, but their
impact on the long-end was not there. 

The ultimate test of
that was at the end of 2004 when they tightened the long rates from 1%
to 5%.  Greenspan thought the impact would be significant but what
happened is everyone went net short and the long-end of the market
collapsed instead.  The result is that the USA moved into 2005 with
things still going higher on long rates. That’s when he realised they’d
lost control of the long end of the market and that’s when subprime,
through a mixture of criminal lending activities combined with no
control capability centrally, became an accident waiting to happen.

It
won’t happen again because we’ve all learnt our lesson so CDO’s, SIV’s
and other exotics are now off the table.  Something else will come
along but not another subprime.

It won’t happen again
because we’ve all learnt our lesson so CDO’s, SIV’s and other exotics
are now off the table.  Something else will come along but not another
subprime.

He said loads of other stuff that was
interesting too, but that’s for me to know and you to find out … by
buying his book I guess.  Alternatively you could read this Blog from the Price of Everything.  A very good read it is too.