Alan Greenspan, the formerchairman of the US Federal Reserve, has dramatically repudiated large parts of his laissez-faire ideology and joined the chorus of voices saying that the credit crisis reveals a need for more regulation of the finance industry.
Returning to Capitol Hill to testify before Congress, where lawmakers were once in awe of his intellect and his reputation as a steward of the economy, a bewildered-sounding Mr Greenspan admitted that his view of the world had been flawed.
Self-regulation by Wall Street had failed, he said. “Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity ”“ myself especially ”“ are in a state of shocked disbelief.”
Oh, please. Alan. The Master of the Incomprehensible Sentence, the Purveyor of Obfuscatory Prose, now wants us to believe his simple claim: Hey, don’t blame me. I was shocked to discover that there were greedy people in corporations and banks, who wanted to steal as much money for themselves as possible. Because they kept hearing that Alan wanted them to escape the scrutiny of regulators. 80+ years, and we’re supposed to believe that Alan is as naive as a four year-old.
I think that the Treasury knew this current “economic tsunami” was coming. In May of 2008, they changed the fixed rate portion of the I-Bond from 1.20% to 0.0%. That means that the U.S. Treasury considered the value of borrowing real dollars to be zero. They only provided a 4.84% inflation rate portion. BTW, if inflation actually is 4.84%, why is the Social Security and Federal Retirement Pension Cola for this year 5.8%? So, the I-Bond inflation adjusted portion is not even equal to the actual inflation rate and the currency is so debased that the U.S. Treasury is not willing to pay anything to borrow via savings bonds. If the current interest on any financial vehicle is less than 5.8%, you are making NOTHING on it in terms of purchasing power.
They knew. They knew this was coming.
People are GREEDY????!!! You can’t trust people to regulate themselves??? I stand in stunned disbelief right next to Greenspan. Who could POSSIBLY have guessed this???
Actually, he didn’t say he was stunned that people are greedy. He said he was stunned that companies would do stupid things so clearly not in their long-term interests. But this has been known since the beginning of ANY government regulation. I mean — why would a company make or market a defective product that could result in tremendous injury to people when they know that there is a possibility that they could be sued for millions of dollars? But the fact is, they sometimes do. So we have laws which regulate product and drug safety — we don’t leave it up to the manufacturers to do what would appear to be in their best interests (make a fully tested, fully safe product) because we know they frequently get so greedy (or just careless, or the employees responsible for testing have a sufficient motive to lie) that they don’t regulate themselves properly. So we require independent testing and we regulate. But apparently in financial services we say “we trust you not to do anything so stupid that it would destroy you and the rest of the economy in the process.” THIS is actually the stunning part.
“In May of 2008, they changed the fixed rate portion of the I-Bond from 1.20% to 0.0%. That means that the U.S. Treasury considered the value of borrowing real dollars to be zero. They only provided a 4.84% inflation rate portion” —Sick & Tired [#2]
You make it sound like the Treasury did this unilaterally. Doesn’t the Treasury sell its securities through auctions? The Treasury can sell securities only insofar as investors find them attractive enough to buy.
This is not the fault of Capitalism but the intrusion of government into the marketplace. Wall Street firms will not regulate themselves so long as they know the Fed will bail them out no matter what they do.
Whatever Greenspan’s role in abetting the current debacle, his written statement to the committee shows great insight.
It’s short (4 double-spaced pages) and WORTH READING IN FULL:
http://oversight.house.gov/documents/20081023100438.pdf
_ _ _ _ _ _ _ _ _ _ _ _ _
This is the money quote:
“In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today.”
Treasury Inflation-Protected Securities [TIPS] are sold at auction. I-Bonds are not.
The most recent TIPS auction sold them for $89.111177 per $100 and the interest rate was 1.375% for a yield of 2.850%. They mature in 2018. Note that their 2.85% yield is 2.95% BELOW the Social Security COLA, which is ostensibly the “inflation rate”. Of course, the real inflation rate for actual people that eat food and use energy is higher than the “official” inflation rate used to calculate the COLA. This, despite the recent reduction in gasoline prices.
http://www.treasurydirect.gov/indiv/products/prod_tipsvsibonds.htm
So yes, Treasury sort of did do this [set the I-Bond rate] unilaterally such that the percent above inflation they would pay would be zero and the inflation rate was set below actual inflation. The point is, they did this back in May…5 months before the “crisis” of September/October.
They knew.
It was working great up to the point that it stopped working. The patient was doing wonderfully right up to the point that they died. Or, as I say to my kids, when they tell me that something “always” turns out OK (“the neighbors do such-and-such and there’s never been a problem”)
It does until it doesn’t.
[i]Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today.[/i]
This is a fool’s errand. Among other things, the models never account for the self-interest and greed of their developers.
Economies are not equations. They are computers that are constantly being fed new data.
“Models never account for the self-interest and greed of their developers” —Byzantine [#9]
If financial institutions develop models to guide their own profit-motivated investments, they have a long-term self-interest in getting the models right.
But of course “financial institutions” have no minds of their own; they rely on individual human minds, from the programmer to the analyst to the CEO. These individuals’ self-interests don’t necessarily coincide with the long-term interests of the firm’s shareholders. You as a Wall Street whiz kid can get ahead by taking outsized risks and reaping big profits now—at the risk of leaving your firm worse off. But by then you’ll be on to your next job.
The problem is not self-interest (which is ineradicable) but a culture of short-sightedness.
Sick & Tired [#7]: The Treasury is responsible for financing the public debt as economically as it can. In setting the interest rate on savings bonds, the Treasury needs to make reasonable estimates of investor demand—and set the interest rate just high enough to sell the volume of bonds it aims to sell. Right?
_ _ _ _ _ _ _ _ _ _
“They knew”
Maybe so. But what’s your larger point? Are you hinting at some sort of conspiracy?
Irenaeus,
We agree. This is entirely correct, and exactly what I meant:
[i] But of course “financial institutions†have no minds of their own; they rely on individual human minds, from the programmer to the analyst to the CEO. These individuals’ self-interests don’t necessarily coincide with the long-term interests of the firm’s shareholders. You as a Wall Street whiz kid can get ahead by taking outsized risks and reaping big profits now—at the risk of leaving your firm worse off. But by then you’ll be on to your next job. [/i]
There is a whole ball of yarn to be unwound here, starting with the extremely attenuated forms of corporate ownership incentivized by government tax policy. But it would also be nice to see academic economists start teaching their students that human action cannot be reduced to quantitative models. Perhaps then finance majors would look at fundamentals rather than abstract equations.
Byzantine [#12]: The separation of ownership from control in publicly owned corporations poses the most fundamental problem in corporate governance. Corporate managers are supposed to act as stewards for shareholders—yet the managers have effective control of the firm and have incentives that may conflict with shareholders’ interests.
But what’s the evidence that the separation of ownership from control results from “government tax policy� The separation was well-established by the beginning of the 20th century, when there was no federal income tax at all.
This separation arises for two key reasons, both benign. First, many corporations (e.g., General Electric or Exxon Mobil) are so huge that no one individual can afford to own them. When you see one individual owning a large firm, it’s usually an entrepreneur who turned a small firm into large one—rather than an investor who bought an already-large firm.
Second, even the very wealthy benefit from diversifying their investments. Why put all your eggs into one basket? Prudence counsels diversifying your portfolio—and thus limiting how much you invest in any one firm.
If we want to strengthen investors’ hand over corporate managers, we might begin by adjusting the rules that govern proxy voting (i.e., voting by shareholders who do not personally attend the firm’s annual meeting). Management controls the proxy machinery and can use the corporate treasury to promote its own slate of candidates. If you sign the proxy card you receive from the firm, you can vote for management’s candidates or abstain, but you can’t vote against those candidates. Giving shareholders the right to vote against those candidates would (modestly) strengthen shareholders’ ability to hold management accountable. So would requiring anti-takeover devices to obtain shareholder approval. But so-called free-marketers have caterwauled at the prospect of proxy reform.
The endless “accounts” (IRA’s, 401k’s, etc.) distort savings toward Wall Street rather than elsewhere, as does the government’s relentless policy of monetary inflation, so the hoi polloi have to shovel money into a mutual fund and hope to at least have enough to buy a bag of groceries in 20 years. If our money held its purchasing power, public companies would have to compete harder for investment dollars: dividends, as opposed to capital appreciation, which rests on the dubious premise that stock prices will rise forever. (Well, actually they do–Zimbabwe’s stock exchange is at an all-time high.)
Also, the elimination of deductions for cash compensation above $1M has given us the stock options that senior executives pump and dump to lucrative effect.
Byzantine [#14]: You can’t invest IRA or other tax-deferred money in collectibles (e.g., baseball cards). But the IRS does not limit you to investing in large-company stocks. You can, for example, invest in bonds, real estate funds, or shares of small firms.
_ _ _ _ _ _ _
If we had no inflation, corporations and other bond issuers would pay lower interest rates. Bondholders would not necessarily come out ahead.
“If we had no inflation, corporations and other bond issuers would pay lower interest rates. Bondholders would not necessarily come out ahead.”
Yes they would because they’re not being paid back in depreciating dollars.
#5 – if you’re a free-marketeer, a government wouldn’t have to bail you out, because the system works perfectly anyway. Banks thought these were worthy risks based on pretty complicated computer algorithms that thought housing prices would rise continually. Nothing government led about this. It was optimism about the future – a necessary aspect of a commercial society.
Besides, the government only guaranteed $100,000 per bank. And if you recall, the date the markets really fell was when Paulson told Lehman he wasn’t bailing them out. That’s when all those banks who once believed in the free market suddenly realized that they needed the government.
And now the Pope of the free market has become a Protestant.
Its like Jesus becoming a Muslim.
“Are you hinting at some sort of conspiracy?”
Why do you ask? Do you think there was one?
The only “broader point” I was “hinting” at was that it would have been nice of them to let the rest of us in on it by telling us plainly rather than arcanely through an interest rate cut. I think I got their message subliminally, though.
I was sort of waiting for the other shoe to drop, economically, all summer. I pulled my $$ out of the market on 17 September. I got a little bit of a burn, but managed to avoid the general bloodletting that has since ensued. In fact, I have been nibbling for a week now, purchasing little bits here and there while the rocket sled continues down to the bottom…most likely, sometime next year.
We could all be down there for a while. I’m just glad that I didn’t take the 30% + plunge.
I remember that I wrote an angry letter to my congressman back in May, asking what the Treasury was trying to do by cutting the interest rate on the I-Bond [in conflict with the stated goal of the bond, which is to give investors/savers a return above inflation]. Now we all know.
I think you need to look elsewhere for a tinfoil hat.
Byzantine [#16]: Let’s compare a world of zero inflation with a world of stable, steady 2% inflation. In the world of 2% inflation, bonds will carry a higher interest rate (an “inflation premium”) to offset inflation. Thus if a bond issuer would pay 3% interest in a no-inflation would, it might have to pay 5% interest in a world of 2% inflation. As long as the inflation premium equals or exceeds the inflation rate, the bondholder is no worse off.
“As long as the inflation premium equals or exceeds the inflation rate, the bondholder is no worse off.”
But the bonds [U.S. at least] are not equal to or exceeding inflation. The Fed is creating the inflation and there is no safe harbor.
The Social Security COLA is 5.8 percent for 2009.(1) The COLA is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The Federal Retirees COLA is also 5.8%, based on the increase in the Consumer Price Index. This is a pretty close approximation for actual inflation, but still fails to account for energy/food/medicine. But for the sake of argument, let’s use this as the inflation gauge.
Treasury Real Yield Curve Rates [or “Real Constant Maturity Treasury” rates], on Treasury TIPS (Treasury Inflation Protected Securities) at “constant maturity” are interpolated by the U.S. Treasury from Treasury’s daily real yield curve. The yields are as follows for 10/24/08: 5 yr/3.44%, 7 yr/3.52%, 10 yr/3.02%, and 20 yr/3.05%.
Do you see a trend? None of these rates even match inflation.
The Long-Term Real Rate Average is the unweighted average of bid real yields on all outstanding TIPS with remaing maturities of more than 10 years. The Long-Term rate for 10/24/08 is 3.12%, still well below inflation.
Series I Savings Bonds are yielding 4.84%.
Series EE bonds are yielding 1.40%.
Both are yielding below the inflation rate.
T-Bills are also paying out below the rate of inflation.
So, in my humble opinion, the bond holder is worse off. The Fed is inflating the currency (with the blessing of the Treasury and the rest of the powers that be), and that is a “hidden tax” on all of us. It robs retirees of their life savings and reduces the purchasing power of their pensions. It discourages saving. It erodes purchasing power for everyone. We all end up paying higher taxes as our wages (not our purchasing power) rise with inflation; so the Government gets control over an increasing proportion of society’s resources without formally getting the approval of Congress to raise taxes.
This isn’t happening by accident. It is happening by committee.
“But the [interest rates on U.S.] bonds are not equal to or exceeding inflation” —Sick & Tired [#20]
True. But we don’t have “stable, steady 2% inflation” [#19]. We have accelerating inflation coupled with slack demand.
The Fed bears major blame for the real estate bubble and current inflationary trends. But you always seem to forget your friend Bush and the mammoth deficits he engineered—deficits that helped balloon our trade deficit, fuel the real estate bubble, and rekindle inflations; needless, pointless deficits that will unjustly burden future generations.
“But you always seem to forget your friend Bush and the mammoth deficits he engineered…”
What are you talking about? I am really angry with the current adminstration and with Republicans in general for the mammoth deficits. So much so, that I am no longer giving to the RNC [I stopped last year] and I will be changing my party affiliation to Libertarian right after the election. I would do it now, but I am concerned that it might affect my eligibility to vote.
Do you have me confused with someone else?
“Do you have me confused with someone else?” —#22
Oh, no.
“But you always seem to forget your friend Bush and the mammoth deficits he engineered…â€
Then would you please explain your comment. It would be best if you could provide an actual quote or specific example that inspired you to write such a comment. Otherwise, I think you should consider withdrawing it. I don’t think it is true. For about a year now, I have been pretty critical of the Bush administration. I know that I was late to the party for some, but better late than never.