by F. William Engdahl
Global Research, January 16, 2008
Originally titled: The Financial Tsunami: The Financial Foundations of the American Century
This piece from William Engdahl of Global Research is a brilliant historical narrative of the evolution of the credit markets in the 20th century culminating in the machinations of the Fed under Alan Greenspan. It traces the path from industrialization to asset securitization in fostering a series of asset bubbles through the root causes that are the cornerstone of our site-fiat currency and dollar hegemony, and reveals an agenda quite unknown to most of the public. Engdahl weaves a tapestry blending government, corporate and social policy directives over the past century that have molded the environment in which we are now engaged.
Part 1: Deutsche Bank’s painful lesson
EVEN EXPERIENCED BANKER FRIENDS tell me that they think the worst of the US banking troubles are over and that things are slowly getting back to normal. What is lacking in their rosy optimism is the realization of the scale of the ongoing deterioration in credit markets globally, centered in the American asset-backed securities market, and especially in the market for CDO’s—Collateralized Debt Obligations and CMO’s—Collateralized Mortgage Obligations. By now every serious reader has heard the term “It’s a crisis in Sub-Prime US home mortgage debt.” What almost no one I know understands is that the Sub-Prime problem is but the tip of a colossal iceberg that is in a slow meltdown. I offer one recent example to illustrate my point that the “Financial Tsunami” is only beginning.
Deutsche Bank got a hard shock a few days ago [this was Jan 2008] when a judge in the state of Ohio in the USA made a ruling that the bank had no legal right to foreclose on 14 homes whose owners had failed to keep current in their monthly mortgage payments. Now this might sound like small beer for Deutsche Bank, one of the world’s largest banks with over €1.1 trillion (Billionen) in assets worldwide. As Hilmar Kopper used to say, “peanuts.” It’s not at all peanuts, however, for the Anglo-Saxon banking world and its European allies like Deutsche Bank, BNP Paribas, Barclays Bank, HSBC or others. Why?
A US Federal Judge, C.A. Boyko in Federal District Court in Cleveland Ohio ruled to dismiss a claim by Deutsche Bank National Trust Company. DB’s US subsidiary was seeking to take possession of 14 homes from Cleveland residents living in them, in order to claim the assets.
Here comes the hair in the soup. The Judge asked DB to show documents proving legal title to the 14 homes. DB could not. All DB attorneys could show was a document showing only an “intent to convey the rights in the mortgages.” They could not produce the actual mortgage, the heart of Western property rights since the Magna Charta of not longer.
Again, why could Deutsche Bank not show the 14 mortgages on the 14 homes? Because they live in the exotic new world of “global securitization”, where banks like DB or Citigroup buy tens of thousands of mortgages from small local lending banks, “bundle” them into Jumbo new securities which then are rated by Moody’s or Standard & Poors or Fitch, and sell them as bonds to pension funds or other banks or private investors who naively believed they were buying bonds rated AAA, the highest, and never realized that their “bundle” of say 1,000 different home mortgages, contained maybe 20% or 200 mortgages rated “sub-prime,” i.e. of dubious credit quality.
Indeed the profits being earned in the past seven years by the world’s largest financial players from Goldman Sachs to Morgan Stanley to HSBC, Chase, and yes, Deutsche Bank, were so staggering, few bothered to open the risk models used by the professionals who bundled the mortgages. Certainly not the Big Three rating companies who had a criminal conflict of interest in giving top debt ratings. That changed abruptly last August (2007) and since then the major banks have issued one after another report of disastrous “sub-prime” losses.
A new unexpected factor
The Ohio ruling that dismissed DB’s claim to foreclose and take back the 14 homes for non-payment, is far more than bad luck for the bank of Josef Ackermann. It is an earth-shaking precedent for all banks holding what they had thought were collateral in form of real estate property.
How this? Because of the complex structure of asset-backed securities and the widely dispersed ownership of mortgage securities (not actual mortgages but the securities based on same) no one is yet able to identify who precisely holds the physical mortgage document. Oops! A tiny legal detail our Wall Street Rocket Scientist derivatives experts ignored when they were bundling and issuing hundreds of billions of dollars worth of CMO’s in the past six or seven years. As of January 2007 some $6.5 trillion of securitized mortgage debt was outstanding in the United States. That’s a lot by any measure!
In the Ohio case Deutsche Bank is acting as “Trustee” for “securitization pools” or groups of disparate investors who may reside anywhere. But the Trustee never got the legal document known as the mortgage. Judge Boyko ordered DB to prove they were the owners of the mortgages or notes and they could not. DB could only argue that the banks had foreclosed on such cases for years without challenge. The Judge then declared that the banks “seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test,” the Judge concluded, “their weak legal arguments compel the court to stop them at the gate.” Deutsche Bank has refused comment.
As news of this legal precedent spreads across the USA like a California brushfire, hundreds of thousands of struggling homeowners who took the bait in times of historically low interest rates to buy a home with often, no money paid down, and the first 2 years with extremely low interest rate in what are known as “interest only” Adjustable Rate Mortgages (ARMs), now face exploding mortgage monthly payments at just the point the US economy is sinking into severe recession. (I regret the plethora of abbreviations used here but it is the fault of Wall Street bankers not this author).
The peak period of the US real estate bubble which began in about 2002 when Alan Greenspan began the most aggressive series of rate cuts in Federal Reserve history was 2005-2006. Greenspan’s intent, as he admitted at the time, was to replace the Dot.com internet stock bubble with a real estate home investment and lending bubble. He argued that was the only way to keep the US economy from deep recession. In retrospect a recession in 2002 would have been far milder and less damaging than what we now face.
Of course, Greenspan has since safely retired, written his memoirs and handed the control (and blame) of the mess over to a young ex-Princeton professor, Ben Bernanke. As a Princeton graduate, I can say I would never trust monetary policy for the world’s most powerful central bank in the hands of a Princeton economics professor. Keep them in their ivy-covered towers.
Now the last phase of every speculative bubble is the one where the animal juices get the most excited. This has been the case with every major speculative bubble since the Holland Tulip speculation of the 1630’s to the South Sea Bubble of 1720 to the 1929 Wall Street crash. It was true as well with the US 2002-2007 Real Estate bubble. In the last two years of the boom in selling real estate loans, banks were convinced they could resell the mortgage loans to a Wall Street financial house who would bundle it with thousands of good better and worse quality mortgage loans and resell them as Collateralized Mortgage Obligation bonds. In the flush of greed, banks became increasingly reckless of the credit worthiness of the prospective home owners. In many cases they did not even bother to check if the person was employed. Who cares? It will be resold and securitized and the risk of mortgage default was historically low.
That was in 2005. The most Sub-prime mortgages written with Adjustable Rate Mortgage contracts were written between 2005 and 2006, the last and most furious phase of the US bubble. Now a whole new wave of mortgage defaults is about to explode onto the scene beginning January 2008. Between December 2007 and July 1, 2008 more than $690 Billion in mortgages will face an interest rate jump according to the contract terms of the ARMs written two years before. That means market interest rates for those mortgages will explode monthly payments just as recession drives incomes down. Hundreds of thousands of homeowners will be forced to do the last resort of any homeowner: stop monthly mortgage payments.
Here is where the Ohio court decision guarantees that the next phase of the US mortgage crisis will assume a Tsunami dimension. If the Ohio Deutsche Bank precedent holds in the appeal to the Supreme Court, millions of homes will be in default but the banks prevented from seizing them as collateral assets to resell. Robert Shiller of Yale, the controversial and often correct author of the book, Irrational Exuberance, predicting the 2001-2 Dot.com stock crash, estimates US housing prices could fall as much as 50% in some areas given how home prices have diverged relative to rents.
The $690 billion worth of “interest only” ARMs due for interest rate hike between now and July 2008 are by and large not Sub-prime but a little higher quality, but only just. There are a total of $1.4 trillion in “interest only” ARMs according to the US research firm, First American Loan Performance. A recent study calculates that, as these ARMs face staggering higher interest costs in the next 9 months, more than $325 billion of the loans will default leaving 1 million property owners in technical mortgage default. But if banks are unable to reclaim the homes as assets to offset the non-performing mortgages, the US banking system and a chunk of the global banking system faces a financial gridlock that will make events to date truly “peanuts” by comparison. We will discuss the global geo-political implications of this next.
The financial foundations of the American Century
The ongoing and deepening global financial crisis, nominally triggered in July 2007 by an event involving a small German bank holding securitized assets backed by USA sub-prime real estate mortgages, can best be understood as an essential part of an historical process dating back to the end of the Second World War—the rise and decline of the American Century.
The American Century, proudly proclaimed by Time-Life founder and establishment insider, Henry Luce in a famous 1941 Life magazine editorial, was built on the preeminent role of New York banks and Wall Street investment banks which had by then clearly replaced the City of London as the center of gravity of global finance. Luce’s American Century was to be built in a far more calculated manner than the British Empire it replaced.1
A then top-secret Council on Foreign Relations postwar planning group, The War & Peace Studies Group, led by Johns Hopkins President and geo-political geographer, Isaiah Bowman, laid out a series of studies designed to lay the foundations of their postwar world, already beginning 1939, well before German tanks had rolled into Poland. The American Empire was to be an empire indeed. But it would not make the fatal mistake of the British or other European empires before, namely to be an empire of open colonial conquest with costly troops in permanent military occupation.
Instead, the American Century would be packaged and sold to the world, above all the emerging countries of Africa, Latin America and Asia, as the guardian of liberty, democracy. It would clothe itself as the foremost advocate of end to colonial rule, a stance which uniquely benefited the only major power without large colonies—namely, the United States.
The new American Century world was to be led by the champion of free trade everywhere, which also uniquely benefited the strongest economy in the early postwar years, the United States. It was a brilliant, if fatally flawed concept. As State Department planning head, George F. Kennan wrote in a confidential internal memo in 1948, “We have about 50% of the world’s wealth but only 6.3% of its population… Our real task in the coming period is to devise a pattern of relationships which will permit us to maintain this position of disparity without positive detriment to our national security.” 2
The core of the War & Peace Studies, which were designed for and implemented by the US State Department after 1944, was to be the creation of a United Nations organization to replace the British-dominated League of Nations. A central part of that new UN organization, which would serve as the preserver of the US-friendly postwar status quo, was creation of what were originally referred to as the Bretton Woods institutions—the International Monetary Fund and the International Bank for Reconstruction and Development or World Bank.3 The GATT multinational trade agreements were later added.
The US negotiators in Bretton Woods New Hampshire, led by US Treasury deputy Secretary Harry Dexter White, imposed a design on the IMF and World Bank which insured the two would remain essentially instruments of an “informal” US empire, an empire, initially based on credit, and later, after about 1973, on debt.
New York and the New York Federal Reserve Bank were the heart of the new empire in 1945. The United States held the overwhelming majority of world central bank monetary gold reserves. The postwar Bretton Woods Gold Exchange Standard uniquely benefited the role of the US dollar, then and even now world reserve currency.
All IMF member country currencies were to be fixed in value to the US dollar. In turn, the US dollar, but only the US dollar was fixed to a preset weight of gold at $35 per ounce of gold. At this fixed rate, foreign governments and central banks could exchange dollars for gold.
Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar. It was ingenious and uniquely favorable to the emerging financial power of New York, whose bankers actively shaped the final agreements.
In those days, in stark contrast to the present, the dollar was “as good as gold.” The US currency was effectively the world currency, the standard to which every other currency was pegged. As the world’s key currency, most international transactions were denominated in dollars.
Maintaining the role of the US dollar as world reserve currency has been the foremost pillar of the American Century since 1945, related to but more strategic even than US military superiority. How that dollar primacy has been maintained to now encompassed the history of countless postwar wars, financial warfare, debt crises, and threats of nuclear war to the present.
Important to place the emergence of the asset securitization revolution in global finance which is now impacting the world financial system in wave after wave of new shocks and dislocations, and to appreciate Alan Greenspan’s substantial contribution to preserving the dominance of the dollar as world reserve well beyond the point the US economy ceased being the world’s most productive industrial manufacturer, a brief review of the distinct phases in postwar dollar hegemony is useful.
The Golden Years of America’s Century
The first phase, which we might call the postwar “golden years,” saw the US emerge from the ashes of World War II as the unchallenged global economic Colossus. The US was the dominant world power; no one even came close. Over half of all international money transactions were financed in terms of dollar. The US produced more than half the world output. The US also owned about two thirds of the official gold reserves in the world in 1940.
When various European countries had reserve surpluses, they converted the surpluses into dollar reserves rather than gold because they could earn interest on dollar assets such as US Treasury bonds and dollars could always be converted into gold at $35 per ounce whenever it became necessary. The US dollar was at the center of this system.
American industry, led by General Motors, Ford and Chrysler Motors, the Big Three, were the world class leaders—no one was even close back then. US Steel (before it became USX), machine tool manufacture, aluminum, aircraft and related industries all set the benchmark for global excellence well into the 1950’s.
Above all, the American oil giants—Mobil, Standard Oil of New Jersey, Texaco, Gulf Oil—those key companies dominated the unique energy source which was to become essential to unprecedented postwar growth rates in Europe, Japan and the rest of the postwar world—petroleum.4
In this early postwar period demand for dollars in the world to finance reconstruction was so great that the primary economic problem faced in the 1950’s in Europe, Japan, South Korea and elsewhere was dollar shortages to finance imports of needed US capital equipment, its oil, its consumer products.
The US monetary gold stocks reached a record $24.6 billion in 1949, a huge sum that was comparable today to $211 billion, as gold from abroad poured into the US to pay the deficits in trade run up by foreign nations. New York, backed by gold reserves, was the unchallenged world banker.
This process began to deteriorate after a steep postwar recession in 1957-58. That recession should have been the alarm bell to US economic policy planners and industry that the unique period of profiting from the relative economic dislocation of a war-torn world was at its outer limits. Beginning 1957 the US economy was in need of a substantial regeneration, were it to remain globally competitive. That was not to happen.
By the time of the November 1967 British Sterling crisis, where the British Government was forced to violate IMF rules and devalue Sterling by 14% to maintain their economy amid severe recession, the focus turned on the fact that President Lyndon Johnson’s Great Society and disastrous Vietnam War costs were causing the US government to run record budget deficits. The dollar was vulnerable to a run on US gold for the first time since the 1930’s.
To hide the extent of those deficits, the Johnson Administration introduced creative accounting. For the first time the Budget director added the funds paid by working Americans into the Federal Social Security Trust Fund, a surplus that was to have been set aside to pay future retirement and related benefits for most Americans, to the Consolidated General Budget—a start to budget fakery which by the early years of the next century were to become huge.
Johnson also began manipulation of key government economic statistics used to compute everything from unemployment to inflation to GDP. The statistical manipulations, for reasons of obvious if fateful political opportunism, were endorsed silently by every succeeding Administration, the most egregious of them being the Bush-Cheney Administration. 5
The 1971 dollar coup
Despite all the manipulations, by 1971 US monetary gold reserves had reached a precarious low as foreign trade surplus nations, led by France, had demanded payment in hard gold from the US Federal Reserve for their dollar surpluses. Reality could not so easily be manipulated as government statistics. Europe had emerged, along with Japan, as powerful trade surplus, modern, fast-growing economies.
The United States was becoming a vast rustbelt of decaying, obsolescent manufacture. The spin-doctors of Wall Street and select think-tanks such as the Ford and Rockefeller foundations came up with a linguistic euphemism calling it the “post industrial society,” but linguistics did not change the reality. By the late 1960’s America’s once-booming industrial centers from Detroit to Pittsburgh to Chicago had become sprawling slums of decay, crime and rising unemployment.
Were the United States to lose its last gold reserves, the role of the dollar as unique world reserve currency—the pillar, along with US military superiority, of its postwar American Century imperium—would end abruptly.
To avert such a calamity, in August 1971 President Nixon huddled with his closest advisers, among them a US Treasury official named Paul Volcker, then Under-Secretary of the Treasury for International Monetary Affairs, and a long-time associate of David Rockefeller and the Rockefeller family.
Their task was to come up with a solution. Volcker’s “solution” to the massive demand to redeem US dollars for gold was to be as simple as it was to prove destructive to world economic health.
Nixon announced to a startled world on August 15, 1971 that from that day, the United States would not longer honor its international treaty obligations under the Bretton Woods Agreement. Nixon had suspended convertibility of the dollar into gold. The New York Fed’s Gold Discount Window was locked shut. World currencies went into a free float against an uncertain dollar, a so-called fiat currency. The dollar now was not backed by gold or even silver but only the “full faith and credit” of the US government, a commodity whose marketable value was beginning to be questioned.
Debt becomes the vehicle
Soon, with the implicit threat of withdrawing its nuclear shield as its prime persuasion, successive US Administrations realized that rather than depending on its role as the world’s creditor as it had until 1971, the American Century could theoretically thrive as the world’s greatest debtor, so long as American finance and the dollar dominated world finance.
As long as major US postwar satrapies 6 such as Japan, South Korea or Germany, were forced to depend on the US security umbrella, it was relatively simple to pressure their Treasuries into using their US dollar trade surpluses to buy US government debt. In the process, the US bond or debt markets became far and away the world’s largest. Wall Street primary bond dealers were replacing Pittsburg steel and Detroit car manufacture as the “business of America.”
To paraphrase the famous quip of former GM president Charles Wilson from the 1950’s, the new mantra was, “What’s good for Wall Street is good for America.” It wasn’t. The name financial “industry” even became commonplace, as if to designate money as the legitimate successor to production of real physical wealth in the economy.
Debt—dollar debt—was to be the vehicle for a new role of New York banks, led by David Rockefeller’s Chase Manhattan and Walter Wriston’s Citibank. Their idea was to extend hundreds of billions of dollars in newly acquired OPEC and other petrodollars, which they “persuaded” Saudi and other OPEC governments to bank their new oil surpluses in London or New York banks. Then those dollar deposits from OPEC, called by Henry Kissinger and others at the time, “petrodollars” went in the form of recycled loans to oil importing and dollar-starved Third World economies. 7
The Carter dollar confidence crisis
This second phase, the post-gold era, fuelled by the manipulated 1973 oil shock and US pressure on Saudi Arabia and OPEC to price oil exclusively in dollars, Kissinger’s “petro-dollar recycling,”8 rolled along without major trouble until early 1979 when the dollar faced a major foreign sell-off during the end of the Jimmy Carter Presidency. The American Century faced one of its greatest challenges at that juncture. German, Japanese even Saudi Arabian central banks began dumping US Treasury holdings in what was called a loss of “confidence” in Carter’s world leadership role.
In August 1979, to restore world “confidence” in the dollar, President Jimmy Carter, himself a hand-picked protégé of David Rockefeller’s Trilateral Commission, was forced by the big New York banks, led by David Rockefeller’s Chase Manhattan, to accept Paul Volcker, a protégé of Rockefeller’s from Chase Manhattan Bank, as new Chairman of the Federal Reserve with an open mandate to do what was necessary to save the dollar as reserve currency.
On taking office, Volcker bluntly announced, “the standard of living for the average American has to decline.” He was Rockefeller’s hand-picked choice to save the New York financial markets and the dollar at the expense of the nation’s welfare. The Volcker ‘shock therapy’ Volcker’s shock therapy, begun in October 1979, lasted until August 1982. Interest rates shot through the roof to double digits. The US and world economies were plunged into a monster recession, the worst since World War II. Within a year, the prime rate had shot up to the unheard-of level of 21.5%, compared to an average of 7.6% for the fourteen previous years, a more than threefold rise in weeks. Official US unemployment peaked at 11%, while unofficially when those who simply had given up seeking work were counted, it was far higher.
The Shock Therapy of Volcker doubled US official unemployment
The Latin American debt crisis, an ominous foretaste of today’s USA sub-prime crisis, erupted as a direct result of the Volcker shock. In August 1982 Mexico announced it could no longer pay in dollars the interest rate service on its staggering debt. It, as most of the Third World from Argentina to Brazil, from Nigeria to Congo, from Poland to Yugoslavia, had fallen for the New York banks’ debt trap. The trap was in borrowing what amounted to recycled OPEC petrodollars invested in the major New York and London banks, the Eurodollar banks, which lent the dollars to desperate Third World borrowers initially at “floating rates” tied to London LIBOR rates.
When Libor rose some 300% within months as a result of the Volcker shock therapy, those debtor countries were unable to continue. The IMF was brought in and the greatest looting binge in world history, misnamed the Third World Debt Crisis, was on. Volcker’s shock policy, predictably, triggered the crisis.
After seven years of relentlessly high interest rates by the Volcker Fed, sold to the gullible public as “squeezing inflation out of the US economy,” by 1986 the internal state of the US economy was horrendous. Much of America came to resemble a Third World country, with its growing slums, double-digit unemployment and growing crime and drug addiction problems. A Federal Reserve study showed that 55% of all American families were net debtors. Federal budget deficits were running at then-unheard-of levels of more than $200 billion annually.
In reality, Volcker, a personal protégé of David Rockefeller from Rockefeller’s Chase Manhattan Bank, had been sent to Washington to do one thing—save the dollar from a free fall collapse that threatened the role of the US dollar as global reserve currency.
That dollar reserve currency role was the hidden key to American financial power.
By letting US interest rates go through the roof, foreign investors flooded in to reap the gains by buying US bonds. Bonds were and are the heart of the financial system. Volcker’s shock therapy for the economy meant soaring profits for the New York financial community. Volcker succeeded only too well in his mission.
The dollar rose to all-time highs against the currencies of Germany, Japan, Canada and other countries from 1979 through the end of 1985. The over-valued US dollar made US manufactured exports prohibitively expensive on world markets and led to a dramatic decline in US industrial exports.
Already high interest rates from the Volcker Fed since October 1979 had led to a major decline in domestic construction, the ultimate ruin of the US automobile industry and with it, steel, as American manufacturers moved to outsource production offshore where the cost advantages were greater. Referring to Paul Volcker and his free-market backers inside the Reagan White House, Republican Robert O. Andersen, then chairman of Atlantic Richfield Oil Co. complained, “they’ve done more to dismantle American industry than any other group in history. And yet they go around saying everything is great. It’s like the Wizard of Oz.” 9
By early 1987 the nation’s traditional mortgage banks, the Savings & Loan banks, were in a liquidity crisis that was to ultimately cost US Taxpayers hundreds of billions in government bailouts. The Congress’ GAO watchdog agency declared that the Federal Savings & Loan Insurance Corporation, the guarantor against S&L bank panic, was insolvent. Yet under pressure from the S&Ls, huge bank losses were allowed to build as insolvent institutions were allowed to remain open and grow, allowing ever increasing losses to accumulate. The ultimate cost of the 1980’s S&L debacle came to more than $160 billion. Some calculated real costs to the economy ran as high as $900 billion. Between 1986 and 1991, the number of new homes constructed dropped from 1.8 to 1 million, the lowest rate since World War II.
America’s Second Revolution: the eyes on the Prize
Federal Reserve monetary policy has been typically misrepresented as a series of ad hoc pragmatic responses to recurring crises in post-war banking and finance. The reality is that it has faithfully followed a coherent hidden thread of policy that was first laid out in 1973 by the spokesman then for America’s most powerful establishment family.
The policy was outlined in a little-noted book titled, ominously enough, “The Second American Revolution.” It was written by John D. Rockefeller III, scion of the powerful Standard Oil and Chase Manhattan Bank empire, and, along with his three brothers—David, Nelson and Laurance—architect of the world arrangement after 1945 known as the American Century.
In his book, Rockefeller declared the establishment’s determination to roll back concessions grudgingly granted by the wealthy and powerful during the Great Depression. Rockefeller issued the call in 1973, long before Jimmy Carter or Margaret Thatcher came to office to implement it. He called for a “deliberate, consistent, long-term policy to decentralize and privatize many government functions…to diffuse power throughout the society.” 10
The latter was a witting deception as his intent was not to diffuse power, but just the opposite— to concentrate that economic and banking power into the hands of a tight-knit elite.
Privatization of essential and socially useful government functions that had been established often with great social agitation and political pressure during the difficult crises of the 1930’s, was the Rockefeller agenda. In brief, it was the removal of Depression era government regulations on all aspects of economic and social life in America.
Above all, deregulation of Wall Street and financial markets was the goal, along with a radical reduction in the equalizing of wealth, as seen by Rockefeller and friends, inherent in such programs as Social Security. The George W. Bush “tax cuts for the wealthy” were just a continuation of a three decade agenda of the powerful establishment circles.
Hard as it may be to believe, all major US policy from the 1970’s through the misnamed sub-prime crisis today, had a connecting continuous thread. Key Fed and Treasury and other US policymakers always held their “eyes on the Prize.”
The “Prize” was untold financial gains to be won through a rollback of major concessions to the working blue collar and middle income Americans, concessions granted during the Great Depression by powerful establishment circles led by the Rockefeller and Morgan banking groups, to forestall a more radical revolt.
Social Security was one target for rollback. Financial deregulation and above all repeal of the 1933 Glass-Steagall Act, was another. Here a well-connected Wall Street banker named Alan Greenspan was to play the decisive role on behalf of the financial deregulation agenda in his tenure as Federal Reserve Chairman lasting from 1987 through 2006. Securitization of sub-prime or junk mortgages was to have been his crowning legacy. As it looks at this writing, it certainly will be, though perhaps not as he and others in Wall Street intended. It will more likely be a crown of disgrace.
The Long-Term Greenspan Agenda
Seven years of Volcker monetary “shock therapy” had ignited a payments crisis across the Third World. Billions of dollars in recycled petrodollar debts loaned by major New York and London banks to finance oil imports after the oil price rises of the 1970’s, suddenly became non-payable.
The stage was now set for the next phase in the Rockefeller financial deregulation agenda. It was to come in the form of a revolution in the very nature of what would be considered money—the Greenspan “New Finance” Revolution.
Many analysts of the Greenspan era focus on the wrong facet of his role, and assume he was primarily a public servant who made mistakes, but in the end always saved the day and the nation’s economy and banks, through extraordinary feats of financial crisis management, winning the appellation, Maestro. 1
Maestro serves the Money Trust
Alan Greenspan, as every Chairman of the Board of Governors of the Federal Reserve System was a carefully-picked institutionally loyal servant of the actual owners of the Federal Reserve: the network of private banks, insurance companies, investment banks which created the Fed and rushed in through an almost empty Congress the day before Christmas recess in December 1913. In Lewis v. United States, the United States Court of Appeals for the Ninth Circuit stated that “the Reserve Banks are not federal instrumentalities… but are independent, privately owned and locally controlled corporations.” 2
Greenspan’s entire tenure as Fed chairman was dedicated to advancing the interests of American world financial domination in a nation whose national economic base was largely destroyed in the years following 1971.
Greenspan knew who buttered his bread and loyally served what the US Congress in 1913 termed “the Money Trust,” a cabal of financial leaders abusing their public trust to consolidate control over many industries.
Interestingly, many of the financial actors behind the 1913 creation of the Federal Reserve are pivotal in today’s securitization revolution including Citibank, and J.P. Morgan. Both have share ownership of the key New York Federal Reserve Bank, the heart of the system.
Another little-known shareholder of the New York Fed is the Depository Trust Company (DTC), the largest central securities depository in the world. Based in New York, the DTC custodies more than 2.5 million US and non-US equity, corporate, and municipal debt securities issues from over 100 countries, valued at over $36 trillion. It and its affiliates handle over $1.5 quadrillion of securities transactions a year. That’s not bad for a company that most people never heard of. The Depository Trust Company has a sole monopoly on such business in the USA. They simply bought up all other contenders. It suggests part of the reason New York was able for so long to dominate global financial markets, long after the American economy had become largely a hollowed-out “post-industrial” wasteland.
While free market purists and dogmatic followers of Greenspan’s late friend, Ayn Rand, accuse the Fed Chairman of hands-on interventionism, in reality there is a common thread running through each major financial crisis of his 18 plus years as Fed chairman. He managed to use each successive financial crisis in his eighteen years as head of the world’s most powerful financial institution to advance and consolidate the influence of US-centered finance over the global economy, almost always to the severe detriment of the economy and broad general welfare of the population.
In each case, be it the October 1987 stock crash, the 1997 Asia Crisis, the 1998 Russian state default and ensuing collapse of LTCM, to the refusal to make technical changes in Fed-controlled stock margin requirements to cool the dot.com stock bubble, to his encouragement of ARM variable rate mortgages (when he knew rates were at the bottom), Greenspan used the successive crises, most of which his widely-read commentaries and rate policies had spawned in the first place, to advance an agenda of globalization of risk and liberalization of market regulations to allow unhindered operation of the major financial institutions.
The Rolling Crises Game
This is the true significance of the crisis today unfolding in US and global capital markets. Greenspan’s 18 year tenure can be described as rolling the financial markets from successive crises into ever larger ones, to accomplish the over-riding objectives of the Money Trust guiding the Greenspan agenda. Unanswered at this juncture is whether Greenspan’s securitization revolution was a “bridge too far,” spelling the end of the dollar and of dollar financial institutions’ global dominance for decades or more to come.
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.
The 1987 Greenspan paradigm
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.
The October 1987 crash which saw the sharpest one day fall in the Dow Industrials in history—508 points—was exacerbated by new computer trading models based on the so-called Black-Sholes Option Pricing theory, stock share derivatives now being priced and traded just as hog belly futures had been before.
The 1987 crash made clear was that there was no real liquidity in the markets when it was needed. All fund managers tried to do the same thing at the same time: to sell short the stock index futures, in a futile attempt to hedge their stock positions.
According to Stephen Zarlenga, then a trader who was in the New York trading pits during the crisis days in 1987, “They created a huge discount in the futures market… The arbitrageurs who bought futures from them at a big discount, turned around and sold the underlying stocks, pushing the cash markets down, feeding the process and eventually driving the market into the ground.”
Zarlenga continued, “Some of the biggest firms in Wall Street found they could not stop their pre-programmed computers from automatically engaging in this derivatives trading. According to private reports they had to unplug or cut the wiring to computers, or find other ways to cut off the electricity to them (there were rumors about fireman’s axes from hallways being used), for they couldn’t be switched off and were issuing orders directly to the exchange floors.
“The New York Stock Exchange at one point on Monday and Tuesday seriously considered closing down entirely for a period of days or weeks and made this public… It was at this point… that Greenspan made an uncharacteristic announcement. He said in no uncertain terms that the Fed would make credit available to the brokerage community, as needed. This was a turning point, as Greenspan’s recent appointment as Chairman of the Fed in mid 1987 had been one of the early reasons for the market’s sell off.” 3
What was significant about the October 1987 one-day crash was not the size of the fall. It was the fact that the Fed, unannounced to the public, intervened through Greenspan’s trusted New York bank cronies at J.P. Morgan and elsewhere on October 20 to manipulate a stock recovery through use of new financial instruments called derivatives.
The visible cause of the October 1987 market recovery was when the Chicago-based MMI future (Major Market Index) of NYSE blue chip stocks began to trade at a premium, midday Tuesday, at a time when one after another Dow stock had been closed down for trading.
The meltdown began to reverse. Arbitrageurs bought the underlying stocks, re-opening them, and sold the MMI futures at a premium. It was later found that only about 800 contracts bought in the MMI futures was sufficient to create the premium and start the recovery. Greenspan and his New York cronies had engineered a manipulated recovery using the same derivatives trading models in reverse. It was the dawn of the era of financial derivatives.
Historically, at least most were led to believe, the role of the Federal Reserve, the Comptroller of the Currency among others, was to act as independent supervisors of the largest banks to insure stability of the banking system and prevent a repeat of the bank panics of the 1930’s, above all in the Fed’s role as “lender of last resort.”
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.
By the time of repeal of Glass-Steagall in 1999, an event of historic importance that was buried in the financial back pages, the Greenspan Fed had made clear it would stand ready to rescue the most risky and dubious new ventures of the US financial community. The stage was set to launch the Greenspan securitization revolution.
It was not accidental, or ad hoc in any way. The Fed laissez faire policy towards supervision and bank regulation after 1987 was crucial to implement the broader Greenspan deregulation and financial securitization agenda he hinted at in his first October 1987 Congressional testimony.
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.
Destroying Glass-Steagall restrictions
One of Greenspan’s first acts as Chairman of the Fed was to call for repeal of the Glass-Steagall Act, something which his old friends at J.P.Morgan and Citibank had ardently campaigned for. 5
Glass-Steagall, officially the Banking Act of 1933, introduced the separation of commercial banking from Wall Street investment banking and insurance. Glass-Steagall originally was intended to curb three major problems that led to the severity of the 1930’s wave of bank failures and depression:
Banks were investing their own assets in securities with consequent risk to commercial and savings depositors in event of a stock crash. Unsound loans were made by the banks in order to artificially prop up the price of select securities or the financial position of companies in which a bank had invested its own assets. A bank’s financial interest in the ownership, pricing, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell. It was a colossal conflict of interest and invitation to fraud and abuse.
Banks that offered investment banking services and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in harm to their customers, including borrowers, depositors, and correspondent banks. Similarly, today, with no more Glass-Steagall restraints, banks offering securitized mortgage obligations and similar products via wholly owned Special Purpose Vehicles they create to get the risk “off the bank books,” are complicit in what likely will go down in history as the greatest financial swindle of all times—the sub-prime securitization fraud.
In his history of the Great Crash, economist John Kenneth Galbraith noted, “Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.
“The legislative history of the Glass-Steagall Act,” Galbraith continued, “shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments.”
Galbraith noted that “During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts – Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.”
The major New York money-center banks had long had in mind the rollback of that 1933 Congressional restriction. And Alan Greenspan as Fed Chairman was their man. The major money-center US banks, led by Rockefeller’s influential Chase Manhattan Bank and Sanford Weill’s Citicorp, spent over one hundred hundreds million dollars lobbying and making campaign contributions to influential Congressmen to get deregulation of the Depression-era restrictions on banking and stock underwriting.
That repeal opened the floodgates to the securitization revolution after 2001.
Within two months of taking office, on October 6, 1987, just days before the greatest one-day crash on the New York Stock Exchange, Greenspan told Congress, that US banks, victimized by new technology and ”frozen” in a regulatory structure developed more than 50 years ago, were losing their competitive battle with other financial institutions and needed to obtain new powers to restore a balance: ”The basic products provided by banks – credit evaluation and diversification of risk – are less competitive than they were 10 years ago.”
At the time the New York Times noted that “Mr. Greenspan has long been far more favorably disposed toward deregulation of the banking system than was Paul A. Volcker, his predecessor at the Fed.” 6
That October 6, 1987 Greenspan testimony to Congress, his first as Chairman of the Fed, was of signal importance to understand the continuity of policy he was to implement right to the securitization revolution of recent years, the New Finance securitization revolution. Again quoting the New York Times account, “Mr. Greenspan, in decrying the loss of the banks’ competitive edge, pointed to what he said was a ‘too rigid’ regulatory structure that limited the availability to consumers of efficient service and hampered competition.
But then he pointed to another development of ‘particular importance’ – the way advances in data processing and telecommunications technology had allowed others to usurp the traditional role of the banks as financial intermediaries. In other words, a bank’s main economic contribution – risking its money as loans based on its superior information about the creditworthiness of borrowers – is jeopardized.”
The Times quoted Greenspan on the challenge to modern banking posed by this technological change: ‘Extensive on-line data bases, powerful computation capacity and telecommunication facilities provide credit and market information almost instantaneously, allowing the lender to make its own analysis of creditworthiness and to develop and execute complex trading strategies to hedge against risk,’ Mr. Greenspan said. This, he added, resulted in permanent damage ‘to the competitiveness of depository institutions and will expand the competitive advantage of the market for securitized assets,’ such as commercial paper, mortgage pass-through securities and even automobile loans.”
He concluded, ‘Our experience so far suggests that the most effective insulation of a bank from affiliated financial or commercial activities is achieved through a holding-company structure.’ 7 In a bank holding company, the Federal Deposit Insurance fund, a pool of contributions to guarantee bank deposits up to $100,000 per account, would only apply to the core bank, not to the various subsidiary companies created to engage in exotic hedge fund or other off-the-balance-sheet activities. The upshot was that in a crisis such as the unraveling securitization meltdown, the ultimate Lender of Last Resort, the insurer of bank risk becomes the American public taxpayer.
It was a hard fight in Congress and lasted until final full legislative repeal under Clinton in 1999. Clinton presented the pen he used in November 1999 to sign the repeal act, the Gramm-Leach-Bliley Act, into law as a gift to Sanford Weill, the powerful chairman of Citicorp, a curious gesture for a Democratic President, to say the least.
The man who played the decisive role in moving Glass-Steagall repeal through Congress was Alan Greenspan. Testifying before the House Committee on Banking and Financial Services, February 11, 1999, Greenspan declared, “we support, as we have for many years, major revisions, such as those included in H.R. 10, to the Glass-Steagall Act and the Bank Holding Company Act to remove the legislative barriers against the integration of banking, insurance, and securities activities. There is virtual unanimity among all concerned – private and public alike – that these barriers should be removed. The technologically driven proliferation of new financial products that enable risk unbundling have been increasingly combining the characteristics of banking, insurance, and securities products into single financial instruments.”
In his same 1999 testimony Greenspan made clear repeal meant less, not more regulation of the newly-allowed financial conglomerates, opening the floodgate to the current fiasco: “As we move into the twenty-first century, the remnants of nineteenth-century bank examination philosophies will fall by the wayside. Banks, of course, will still need to be supervised and regulated, in no small part because they are subject to the safety net. My point is, however, that the nature and extent of that effort need to become more consistent with market realities. Moreover, affiliation with banks need not – indeed, should not – create bank-like regulation of affiliates of banks.” 8
Breakup of bank holding companies with their inherent conflict of interest, which led tens of millions of Americans into joblessness and home foreclosures in the 1930’s depression, was precisely why Congress passed Glass-Steagall in the first place.
‘…strategies unimaginable a decade ago…’
The New York Times described the new financial world created by repeal of Glass-Steagall in a June 2007 profile of Goldman Sachs, just weeks prior to the eruption of the sub-prime crisis: “While Wall Street still mints money advising companies on mergers and taking them public, real money – staggering money – is made trading and investing capital through a global array of mind-bending products and strategies unimaginable a decade ago.” They were referring to the securitization revolution.
The Times quoted Goldman Sachs chairman Lloyd Blankfein on the new financial securitization, hedge fund and derivatives world: “We’ve come full circle, because this is exactly what the Rothschilds or J. P. Morgan, the banker were doing in their heyday. What caused an aberration was the Glass-Steagall Act.”9
Blankfein, as well as most Wall Street bankers and financial insiders saw the New Deal as an aberration, openly calling for return to the days J. P. Morgan and other tycoons of the ‘Gilded Age’ of abuses in the 1920’s. Glass-Steagall, Blankfein’s “aberration” was finally eliminated because of Bill Clinton. Goldman Sachs was a prime contributor to the Clinton campaign and even sent Clinton its chairman Robert Rubin in 1993, first as “economic czar” then in 1995 as Treasury Secretary. Today, another former Goldman Sachs chairman, Henry Paulson is again US Treasury Secretary under Republican Bush. Money power knows no party.
Robert Kuttner, co-founder of the Economic Policy Institute, testified before US Congressman Barney Frank’s Committee on Banking and Financial Services in October 2007, evoking the specter of the Great Depression:
“Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s – lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn’t paper at all, and the whole process is supercharged by computers and automated formulas.” 10
Dow Jones Market Watch commentator Thomas Kostigen, writing in the early weeks of the unraveling sub-prime crisis, remarked about the role of Glass-Steagall repeal in opening the floodgates to fraud, manipulation and the excesses of credit leverage in the expanding world of securitization:
“Time was when banks and brokerages were separate entities, banned from uniting for fear of conflicts of interest, a financial meltdown, a monopoly on the markets, all of these things.
“In 1999, the law banning brokerages and banks from marrying one another — the Glass-Steagall Act of 1933 — was lifted, and voila, the financial supermarket has grown to be the places we know as Citigroup, UBS, Deutsche Bank, et al. But now that banks seemingly have stumbled over their bad mortgages, it’s worth asking whether the fallout would be wreaking so much havoc on the rest of the financial markets had Glass-Steagall been kept in place.
“Diversity has always been the pathway to lowering risk. And Glass-Steagall kept diversity in place by separating the financial powers that be: banks and brokerages. Glass-Steagall was passed by Congress to prohibit banks from owning full-service brokerage firms and vice versa so investment banking activities, such as underwriting corporate or municipal securities, couldn’t be called into question and also to insulate bank depositors from the risks of a stock market collapse such as the one that precipitated the Great Depression.
“But as banks increasingly encroached upon the securities business by offering discount trades and mutual funds, the securities industry cried foul. So in that telling year of 1999, the prohibition ended and financial giants swooped in. Citigroup led the way and others followed. We saw Smith Barney, Salomon Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.
“At brokerage firms there are supposed to be Chinese walls that separate investment banking from trading and research activities. These separations are supposed to prevent dealmakers from pressuring their colleague analysts to give better results to clients, all in the name of increasing their mutual bottom line.
“Well, we saw how well these walls held up during the heyday of the dot-com era when ridiculously high estimates were placed on corporations that happened to be underwritten by the same firm that was also trading its securities. When these walls were placed within their new bank homes, cracks appeared and — it looks ever so apparent — ignored.
“No one really questioned the new fad of collateralizing bank mortgage debt into different types of financial instruments and selling them through a different arm of the same institution. They are now…
“When banks are being scrutinized and subject to due diligence by third-party securities analysts more questions are raised than when the scrutiny is by people who share the same cafeteria. Besides, fees, deals and the like would all be subject to salesmanship, which means people would be hammering prices and questioning things much more to increase their own profit — not working together to increase their shared bonus pool.
“Glass-Steagall would have at least provided what the first of its names portends: transparency. And that is best accomplished when outsiders are peering in. When every one is on the inside looking out, they have the same view. That isn’t good because then you can’t see things coming (or falling) and everyone is subject to the roof caving in.
“Congress is now investigating the subprime mortgage debacle. Lawmakers are looking at tightening lending rules, holding secondary debt buyers responsible for abusive practices and, on a positive note, even bailing out some homeowners. These are Band-Aid measures, however, that won’t patch what’s broken: the system of conflicts that arise when sellers, salesmen and evaluators are all on the same team. 11
Greenspan’s dot.com bubble and its consequences
Before the ink was dry on Bill Clinton’s signature repealing Glass-Steagall, the Greenspan fed was fully engaged in hyping their next crisis—the deliberate creation of a stock bubble to rival that of 1929, a bubble which then, subsequently the Fed would pop just as deliberately.
The 1997 Asia financial crisis and the ensuing Russian state debt default of August 1998 created a sea-change in global capital flows to the advantage of the dollar. With Korea, Thailand, Indonesia and most emerging markets in flames following a coordinated, politically-motivated attack by a trio of US hedge funds, led by Soros’ Quantum Fund, James Robertson’s Jaguar and Tiger funds and Moore Capital Management, as well as, according to reports, the Connecticut-based LTCM hedge fund of John Merriweather.
The impact of the Asia crisis on the dollar was notable and suspiciously positive. Andrew Crockett, the General Manager of the Bank for International Settlements, the Basle-based organization of the world’s leading central banks, noted that while the East Asian countries had run a combined current account deficit of $33 billion in 1996, as speculative hot money flowed in, “1998-1999, the current account swung to a surplus of $87 billion.” By 2002 it had reached the impressive sum of $200 billion. Most of that surplus returned to the US in the form of Asian central bank purchases of US Treasury debt, in effect financing Washington policies, pushing US interest rates way down and fuelling an emerging New Economy, the NASDAQ dot.com New Economy IT boom. 12
During the extremes of the 1997-1998 Asia financial crises, Greenspan refused to act to ease the financial pressures until Asia had collapsed and Russia had defaulted in August 1998 on its sovereign debt and deflation had spread from region to region. Then, as he and the New York Fed stepped in to rescue the huge LTCM hedge fund that had become insolvent as a result of the Russia crisis, Greenspan made an unusually sharp cut in Fed Funds interest rates for the first time, by 0.50%. That was followed a few weeks later by a 0.25% cut. That gave the nascent dot.com NASDAQ IT bubble a nice little “shot of whiskey.”
By late 1998, amid successive cuts in Fed interest rates and pumping in of ample liquidity, the US stock markets, led by the NASDAQ and NYSE, went asymptotic. In the single year 1999, as the New Economy bubble got into full-swing, a staggering $2.8 trillion increase in the value of equity shares owned by US households was registered. That was more than 25% of annual GDP, all in paper values.
Glass-Steagall restrictions on banks and investment banks promoting the stocks they had brought to market—the exact conflict of interest which prompted Glass-Steagall in 1933—those restraints were gone. Wall Street stock promoters were earning tens of millions in bonuses for fraudulently hyping Internet and other stocks such as WorldCom and Enron. It was the “Roaring 1920’s” all over again, but with an electronic computerized turbo charged kicker.
The incredible March 2000 speech
In March 2000, at the very peak of the dot.com stock mania, Alan Greenspan delivered an address to a Boston College Conference on the New Economy in which he repeated his by-then standard mantra in praise of the IT revolution and the impact on financial markets. In this speech he went even beyond previous praises of the IT stock bubble and its putative “wealth effect” on household spending which he claimed had kept the US economy growing robustly.
“In the last few years it has become increasingly clear that this business cycle differs in a very profound way from the many other cycles that have characterized post-World War II America,” Greenspan noted. “Not only has the expansion achieved record length, but it has done so with economic growth far stronger than expected.”
He went on, waxing almost poetic:
“My remarks today will focus both on what is evidently the source of this spectacular performance–the revolution in information technology…When historians look back at the latter half of the 1990s a decade or two hence, I suspect that they will conclude we are now living through a pivotal period in American economic history…
Those innovations, exemplified most recently by the multiplying uses of the Internet, have brought on a flood of startup firms, many of which claim to offer the chance to revolutionize and dominate large shares of the nation’s production and distribution system. And participants in capital markets, not comfortable dealing with discontinuous shifts in economic structure, are groping for the appropriate valuations of these companies. The exceptional stock price volatility of these newer firms and, in the view of some, their outsized valuations indicate the difficulty of divining the particular technologies and business models that will prevail in the decades ahead.”
Then the Maestro got to his real theme, the ability to spread risk by technology and the Internet, a harbinger of his thinking about the then infant securitization phenomenon:
The impact of information technology has been keenly felt in the financial sector of the economy. Perhaps the most significant innovation has been the development of financial instruments that enable risk to be reallocated to the parties most willing and able to bear that risk. Many of the new financial products that have been created, with financial derivatives being the most notable, contribute economic value by unbundling risks and shifting them in a highly calibrated manner. Although these instruments cannot reduce the risk inherent in real assets, they can redistribute it in a way that induces more investment in real assets and, hence, engenders higher productivity and standards of living. Information technology has made possible the creation, valuation, and exchange of these complex financial products on a global basis…
Historical evidence suggests that perhaps three to four cents out of every additional dollar of stock market wealth eventually is reflected in increased consumer purchases. The sharp rise in the amount of consumer outlays relative to disposable incomes in recent years, and the corresponding fall in the saving rate, is a reflection of this so-called wealth effect on household purchases. Moreover, higher stock prices, by lowering the cost of equity capital, have helped to support the boom in capital spending.
Outlays prompted by capital gains in equities and homes in excess of increases in income, as best we can judge, have added about 1 percentage point to annual growth of gross domestic purchases, on average, over the past half-decade. The additional growth in spending of recent years that has accompanied these wealth gains, as well as other supporting influences on the economy, appears to have been met in equal measure by increased net imports and by goods and services produced by the net increase in newly hired workers over and above the normal growth of the workforce, including a substantial net inflow of workers from abroad. 13
What is perhaps most incredible was the timing of Greenspan’s euphoric paean to the benefits of the IT stock mania. He well knew that the impact of the six interest rate increases he had instigated in late 1999 were sooner or later going to chill the buying of stocks on borrowed money.
The dot-com bubble burst one week after the Greenspan speech. On March 10, 2000, the NASDAQ Composite index peaked at 5,048, more than double its value just a year before. On Monday, March 13 the NASDAX fell by an eye-catching 4%. Then, from March 13, 2000 through to the market bottom, the market lost paper values worth nominally more than $5 trillions, as Greenspan’s rate hikes brought a brutal end to a bubble he repeatedly claimed he could not confirm until after the fact. In dollar terms, the 1929 stock crash was peanuts by comparison with Greenspan’s dot.com crash. Greenspan had raised interest rates six times by March, a fact which had a brutal chilling effect on the leveraged speculation in dot.com company stocks.
Stocks on margin: Regulation T
Again Greenspan had been present every step of the way to nurture the dot.com stock “irrational exuberance.” When it was clear even to most ordinary members of Congress that stock prices were soaring out of control, and that banks and investment funds were borrowing tens of billions of credit to buy more stocks “on margin,” a call went out for the Fed to exercise its power over stock margin buying requirements.
By February 2000, margin debt had hit $265.2 billion, up 45 percent in just four months. Much of the increase came from increased borrowing through online brokers and was being channeled into the NASDAQ New Economy stocks.
Under Regulation T, the Fed had the sole authority to set initial margin requirements for the purchase of stocks on credit, which had been at 50% since 1974.
If the stock market were to take a serious fall, margin calls would turn a mild downturn into a crash. Congress believed that this was what happened in 1929, when margin debt equaled 30 percent of the stock market’s value. That was why it gave the Fed power to control initial margin requirements in the Securities Act of 1934.
The requirement had been as high as 100 percent, meaning that none of the purchase price could be borrowed. Since 1974, it had been unchanged, at 50 percent, allowing investors to borrow no more than half the purchase price of equities directly from their brokers. By 2000 this margin mechanism acted like gasoline poured on a raging bonfire.
Congressional hearings were held on the issue. Investment managers such Paul McCulley of the world’s then-largest bond fund, PIMCO, told Congress, “The Fed should raise that minimum, and raise it now. Mr. Greenspan says “no,” of course, because (1) he cannot find evidence of a relationship between changes in margin requirements and changes in the level of the stock market, and (2) because an increase in margin requirements would discriminate against small investors, whose only source of stock market credit is their margin account.” 14
On the margin
But in the face of the obvious 1999-2000 US stock bubble, not only did Greenspan repeatedly refuse to change stock margin requirements, but also in the late 1990s, the Fed chairman actually began to talk in glowing terms about the New Economy, conceding that technology had helped increase productivity. He was consciously fuelling the market’s “irrational exuberance.”
Between June 1996 and June 2000, the Dow rose 93% and the NASDAQ rose 125%. The overall ratio of stock prices to corporate earnings reached record highs not seen since the days before the 1929 crash.
Then, in 1999, Greenspan initiated a series of interest rate hikes, when inflation was even slower than it was in 1996 and productivity was growing even faster. But by refusing to tie rate rises to a rise in margin requirements, which would clearly have signaled that the Fed was serious about cooling the speculative bubble in stocks, Greenspan impacted the economy with higher rates, evidently designed to increase unemployment and press labor costs lower to further raise corporate earnings, not to cool the stock buying frenzy of the New Economy. Accordingly, the stock market ignored it.
Influential observers, including financier George Soros and Stanley Fischer, deputy director at the International Monetary Fund, advocated that the Fed let the air out of the credit boom by raising margin requirements.
Greenspan refused this more sensible strategy. At his re-confirmation hearing before the US Senate Banking Committee in 1996, he said that he did not want to discriminate against individuals who were not wealthy and therefore needed to borrow in order to play the stock market (sic). As he well knew, the traders buying stocks on margin were mainly not poor and needy but professional traders out for a free lunch, which Greenspan well knew. Interesting, however, was that that was precisely the argument Greenspan would repeat for justifying his advocacy of lending to sub-prime poor credit persons, to let the poorer get in on the home ownership bonanza his policies after 2001 had created. 15
The stock market began to tumble in the first half of 2000, not because labor costs were rising, but because limits of investor credulity were finally reached. The financial press including the Wall Street Journal, which a year before was proclaiming dot.com executives as pioneers of the new economy, were now ridiculing the public for having believed that the stock of companies that would never make a profit could go up forever.
The New Economy, as one Wall Street Journal writer put it, now “looks like an old-fashioned credit bubble.” 16 In the second half of that year, American consumers whose debt-to-income ratios were at record highs, began to pull back. Christmas sales flopped, and by early January 2001 Greenspan reversed himself and lowered interest rates. In twelve successive rate cuts, the Greenspan Fed brought US Fed funds rates, rates that determined short-term and other interest rates in the economy, from 6% down to a post-war low of 1% by June 2003.
Greenspan held Fed rates to those historic lows, lows not seen for that length of time since the Great Depression, until June 30, 2004, when he began the first of what were to be fourteen successive rate increases before he left office in 2006. He took Fed funds rates from the low of 1% up to 4.5% in nineteen months. In the process, he killed the bubble that was laying the real estate golden egg.
In speech after speech the Fed chairman made clear that his ultra-easy money regime after January 2001 had as prime focus the encouragement of investing in home mortgage debt. The sub-prime phenomenon—something only possible in the era of asset securitization and Glass-Steagall repeal, combined with unregulated OTC derivatives trades—was the predictable result of deliberate Greenspan policy. The close scrutiny of the historical record makes that abundantly clear.
F. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, published by Global Research. The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, http://www.engdahl.oilgeopolitics.net
Posted originally at:
1 Woodward, Bob, Maestro: Alan Greenspan’s Fed and the American Economic Boom, Nov 2000. Woodward’s book is an example of the charmed treatment Greenspan was accorded by the major media. Woodward’s boss at the Washington Post, Catharine Meyer Graham, daughter of the legendary Wall Street investment banker Andre Meyer, was an intimate Greenspan friend. The book can be seen as a calculated part of the Greenspan myth-creation by the influential circles of the financial establishment.
2 Lewis vs United States, 680 F.2d 1239 (9th Cir. 1982).
3 Zarlenga, Stephen, Observations from the Trading Floor During the 1987 Crash, in http://www.monetary.org/1987%20crash.html.
4 Greenspan, Alan, Testimony before the Subcommittee on Financial Institutions Supervision, US House of Representatives, Nov. 18, 1987. http://fraser.stlouisfed.org/historicaldocs/ag/download/27759/Greenspan_19871118.pdf.
5 Hershey jr., Robert D., Greenspan Backs New Bank Roles, The New York Times, October 6, 1987.
6 Hershey, op.cit.
8 Greenspan, Alan, Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking and Financial Services, U.S. House of Representatives, February 11, 1999, in Federal Reserve Bulletin, April 1999.
9 Anderson, Jenny, Goldman Runs Risks, Reaps Rewards, The New York Times, June 10, 2007.
10 Kuttner, Robert, Testimony of Robert Kuttner Before the Committee on Financial Services, Rep. Barney Frank, Chairman, U.S. House of Representatives, Washington, D.C., October 2, 2007
11 Kostigen, Thomas, Regulation game: Would Glass-Steagall save the day from credit woes?, Dow Jones MarketWatch, Sept. 7, 2007, in http://www.marketwatch.com/news/story/would-glass-steagall-save-day-credit.
12 Engdahl, F. William, Hunting Asian Tigers: Washington and the 1997-98 Asia Shock, reprinted in http://www.jahrbuch2000.studien-von-zeitfragen.net/Weltfinanz/Hedge_Funds/hedge_funds.html.
13 Greenspan, Alan, The revolution in information technology, Before the Boston College Conference on the New Economy, Boston, Massachusetts, March 6, 2000.
14 McCulley, Paul, A Call For Fed Action: Hike Margin Requirements!, testimony before The House Subcommittee on Domestic and International Monetary Policy on March 21, 2000.
15 Alan Greenspan as Fed chairman repeatedly asserted it was impossible to judge if a speculative bubble existed during the rise of such a bubble. In August 2002, after his clear strategy of Fed rate rises was obvious to market players, he reiterated this: “We at the Federal Reserve considered a number of issues related to asset bubbles, that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact, that is, when its bursting confirmed its existence.” , at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming August 30, 2002.
16 Faux, Jeff, The Politically Talented Mr. Greenspan, Dissent Magazine, Spring 2001 will more likely be a crown of disgrace.