Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
pp.238-239
In March 1980, he published an essay in Challenge that was equally prescient, but in an eerie way. Reflecting on the fragilities in finance, Greenspan showed how deeply he understood the demons that would haunt him as Fed chairman.29
Greenspan's Challenge essay was prompted by the 15th anniversary of the 1929 crash, which had heralded the Depression of the 1930s. If the nation was vulnerable to a repeat, Greenspan began, it would come not from the equity market but from housing. After all, home prices had nearly tripled during the 1970s, and because that bubble had been built on debt, a reversal would impose a long period of weak growth on the economy. Moreover, the risks from the housing bubble were magnified by the “extraordinarily complex development of international finance.” Bankers' creativity outstripped public understanding of the risks entailed: “There are very likely to be structural inadequacies in these new financial innovations which the standard bailout procedure of the central banks do not fully address”, Greenspan wrote soberly. Banks and quasi banks were increasingly interconnected by daisy chains of lending, so that the failure of one could bring down others, and capital-asset ratios had been allowed to shrink alarmingly. Any bank that got into trouble “would have to be bailed out by its central bank or international agencies, or be absorbed by institutions not yet in difficulty”, Greenspan predicted.
Despite his own record of opposing bailouts, Greenspan reassured his readers that a repeat of 1929 was highly unlikely ── because bailouts were a certainty. At first sign of a banking failure, central banks would ride to the rescue, even if they damaged long-run growth in the process.
pp.501-502
The following week, on December 3, Mike Prell's invited experts trooped into the Fed's boardroom, where Greenspan and his fellow governors awaited them. The chairman opened the proceeding by calling on Abby Joseph Cohen, the chief stock market strategist at Goldman Sachs. Cohen was a reassuringly unflashy figure, a small, plainspoken ex-Fed economist who favored conservative gray suits. But her message was bracingly vivid: there was no need to worry about speculative excess, because the market had plenty of room to rise further. Corporate profits were growing, helping to justify the market's rise; the economy was stronger than the official data showed; and an environment of low interest rates rendered equities attractive to investors.45 In Cohen's estimate, the S&P 500 might be undervalued by as much as a quarter.46
Greenspan listened to Cohen, not giving anything away.43 The fact that Goldman's top strategist was so strikingly bullish proved how hard it was to diagnose a bubble. But there ws another lesson, too. Investors valued equities highly partly because interest rates were low. If there was a bubble, in other words, the Fed might be encouraging it.48
The next speaker was David Shulman of Salomon Brothers. Shulman had attended a similar meeting of outside experts in 1991 ── the one that had brought home to Greenspan the full extent of the real estate market's troubles. As he eyed Greenspan this time, Shulman felt that a change had come over him. The Fed chairman was no longer grappling with a financial system riddled with rotten property lending and bankrupt S&Ls, and he was no longer at loggerheads with the White House. He was comfortable in his job, and he was evidently enjoying himself.
Unlike Cohen, Shulman was bearish. He presented a table showing that the S&P 500 indiex was trading at almost 19 times earnings, a level that signaled danger ── in 1968, 1972, and 1987, the market had crashed after peaking at this sort of level.49 The signs of bubble pscychology were ubiquitous: scarcely a month went by without the appearance of a breathless new stock market publication; and a whole new class of day traders was getting in on the game, using Internet platforms to buy Internet stocks that they discussed in Internet chat rooms.
Greenspan turned next to Morgan Stanley's Byron Wien. He was evidently going alphabetically.
“Wien!” said the chairman.
Wien was 63 years old. He had a bald head and a lined face. He thought to himself, “I haven't been called by my last name since I was in the army”
“You are optimistic, aren't you?”
“Yes”, Wien answered. Like Abby Cohen, he was using a model that compared the valuation of the stock market to interest rates on bonds. Thanks to the low rates engineered by the Fed, the bull market would continue.
Wien saw that Greenspan was listening attentively. He had a feeling that the chairman was nodding in agreement.
After the three Wall Streeters were done, the microphone was passed to the two academics in the group: John Campbell of Harvard and Robert Shiller of Yale. The professors presented a series of charts comparing stock prices to dividends. According to this means of valuing equities, the market was wildly overvalued. If the Fed raised interest rates, the market would crater.
After a morning of meetings, the experts filed into the Fed dining room. They sat down to lunch, and Cohen remarked that the food had improved since her visits to the employee cafeteria in the 1970s.50 Alluding to the question that had been debated that morning, Robert Shiller asked Greenspan when a Fed chairman had last used his bully pulpit to sound a warning about the stock market's level. A Fed staff economist gave the answer ── 1965 ── suggesting a precise knowledge of precedent that would later seem revealing.51
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
During the 1970s, John B. Tipton wrote an article, titled ‘Banks on the brink’, in the magazine PLAYBOY, issue February 1975. I cite John B. Tipton, p.85::
“America's banks are in trouble. Many of the largest and most powerful banks have been on a five year expansion binge, spurred by bankers convinced that bigger is better. In their pursuit of growth, they have jeopardized the safety of your money, not to mention the survival of the entire banking system. Americans, accustomed to entrusting their money to banks without the slightest worry, should begin to worry--now.”
John B. Tipton wrote, page 132- ::
“This is what the financial world calls leverage: It increases earnings, but it also introduces a major element of risk into the formerly riskless business of banking. The conservative banker would have had to see just under 17 per cent of his loans default before his capital would be wiped out; the go-go banker's capital is gone if just over 7 per cent of his loans go bad.”
‘When the leaders of any industry conclude that the old rules no longer apply, that they have discovered new ways to make money that escaped the notice of their less clever predecessors, one of two principles applies: Either it is not true at all or it may be true as long as the new system is practiced only by the brightest, strongest leaders, the true innovators. When everybody jumps on the the band wagon, watch out. In the words of a leading Wall Street bank analyst, "All the followers are trying to play the leaders' game--and they just don't have the ability." ’
“While the plummeting of conglomerate stock prices has few disasterous effects on the general economy, banks occupy a special position: Their problems are a source of worry not just for their shareholders but for everyone with a couple of hundred bucks in a special checking or saving account.”
“Another worrisome matter is "capital adequacy." A bank's capital is what would remain if it paid off all its outstanding liabilities--deposits held by individuals and corporations, money it has borrowed from other banks and money it has borrowed from agencies of the Federal Government. This remainder--capital--is what the bank's shareholders actually own, but it is of interest to more than just the shareholders. Capital provides the margin of safety that ensures the ability of a bank to survive, even in a depression.”
“Back in the 1960, the average U.S. commercial bank had liabilities that were only 11.3 times its capital. By 1970, this ratio had grown to 13 and by the end of 1973, to 14.5 times total capital. However, when we look only at the 30 largest banks, we find a still greater jump. At the end of 1973, their liabilities were 16.7 times their capital. For some of the very largest banks, the figures are still more lopsided: Bank of America, Bankers Trust of New York and Crocker National of San Francisco all had liabilities more than 30 times their capital, and the Union Bank of California and the Republic National of Dallas were very close to that level. This can have dangerous implications. Just before its serious troubles began, the now defunct Franklin National also had liabilities almost 30 times its capital. Even if it had had more capital, it would still have suffered the massive losses it did, but it might have been able to survive them.”
“The tripling of the price Italy had to pay for oil took it off the marginal list and put it on the critical list. But it is not the only financial basket case among the nations of the world; Greece, Mexico and Peru together have a total debt to the banking system that exceeds their reserves.”
“Andrew Brimmer (incidentally, the first black to serve on the board) ... the Fed already has the powers it isn't using and that new legislation alone wouldn't solve the problems.”
“6. Banks are required to maintain special funds to cover potential losses from defaulted loans. These are called loan-loss reserves. These reserves are computed by a method that does not accurately reflect what may be the true condition of a bank's loan portfolio. As an example, last year the First National City Bank had a 32 per cent increase in loans outstanding but only a .25 per cent increase in its provision for future loan losses. The Chase Manhattan from the beginning of 1972 to the middle of 1974 increased its loans outstanding 79 per cent but its loan-loss reserves only 10 per cent. These banks, and all others, are following the letter of the law on this matter, but the law should be changed to require that any increases in exposure to loan losses be matched by equal increases in reserves. Otherwise, banks are misleading the public about their profit ability and possibly even their soundness.”
John B. Tipton wrote in the last line of the article, titled ‘Banks on the brink’, in February 1975 PLAYBOY magazine::
As one banker put it: “It's a game of musical chairs. There are more asses than chairs and everyone wants to be sure he's seated when the music stops.”
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
p.497
by raising interest rates, it would simultaneously reduce inflation, bring growth down to its sustainable level, and let the air out of an incipient stock bubble.
p.498
He would argue that bubbles were impossible to spot. But in 1996, he was quite willing to call one. He would argue, likewise, that bubbles were impossible to deflate. But in 1996 he suggested in passing to his colleagues that increasing “margin requirements” ── that is making it harder to borrow money to buy stocks ── might take the air out of the market. Despite what he asserted later, the real reason Greenspan shrank from acting against the 1990s stock bubble was not that it was impossible to identify, and not that it was impossible to pop.
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
p.593
Growing up as an economist, Greenspan had lived through many of the debates
Thanks to Bill Townsend's focus on finance, he had pondered the interactions between monetary policy and asset prices.
Thanks to Arthur Burns's empiricism, he had developed a lifelong skepticism of models, a trait that set him apart from economists who trained a generation later.
Thanks to John Gurley and Edward Shaw, he had formed a firm conviction that financial innovation was positive for the economy, even though markets were only approximately efficient.
p.593
Alvin Hansen, who predicted “secular stagnation”
p.594
the unfamiliarity of a new world, one in which goods no longer rolled across borders without paranoid inspection.
p.594
Japan in the late 1980s, had succumbed to a wild stock market and investment bubble;
Households were intent on rebuilding their savings, and businesses refused to invest, there was not enough spending to absorb the supply of goods pumped out by factories created during the boom years.
As a result, Japanese prices had drifted downward for eight years.
pp.594-595
Hansen had been wrong to predict secular stagnation in the United States after the war. But his writing had anticipated Japan circa 2000.
p.595
the risk of a Japan style deflation
p.596
Companies and individuals had accumulated vast debts, which would be harder to pay off if deflation increased their real value.
p.597
; and his actions fueled the climb in house prices that built steadily in 2002 and 2003, reaching its wildest and frothiest extremes in the two years that followed.6 John Taylor, the Stanford professor who had worked for Greenspan on Ford's [POTUS administration] Council of Economic Advisers and as a part-timer at his consulting firm, lambasted the Fed repeatedly for cutting rates too much, focusing particularly on the phase starting in 2003.
p.597
In the view of Taylor and his allies, Greenspan's monetary policy in this period was more reckless than anything during the tech boom. In the late 1990s, after all, the chairman had diagnosed productivity correctly, and although the Nasdaq bubble eventually burst, it caused a mild recession rather than a meltdown.
p.597
In the 2000s, by contrast, Greenspan held down interest rates without the justification of the New Economy. And in the place of the shallow recession of 2001, the nation reaped the Great Financial Crisis.7
p.597
This comparison can be reversed, however.8 Greenspan's productivity call of 1996 was brilliantly correct, but it does not necessarily follow that monetary policy itself was correct; there is a reasonable case for saying that Greenspan should have kept interest rates higher in 1997-98 in order to dampen asset markets.9 There is an extremely strong case, moreover, for critizing Greenspan's looseness from late 1998, when he cut more than was necessary following the Long-Term Capital Management's collapse and then failed to undo the cuts until November 1999, by which time the stock market had lost all touch with reality. In contrast, the rate cuts starting in November 2001 had a better rationale, as we have seen: the fear of Japan-style deflation.
p.597
The tech bust proved relatively harmless because the Fed loosened aggressively to avoid stagnation; if this aggressive loosening was partly to blame for the property bubble, it follows that the tech bubble planted the seeds for the 2008 crisis.
p.597
Indeed, by creating a risk of deflation, the tech bust put the Fed in a position where it almost needed frothy real estate to keep the economy going,
([
right after the 11 September 2001, the U.S. engaged in intensive spending to finance two wars in Afghanistan and Iraq.
a piece of truth
war cost estimation: worst-case estimate ─ 4x available cost estimation [4xace]
“War with Iraq would cost 1 to 2 percent of the gross domestic product.
Lawrence Lindsay ... 4 to 8 percent of GDP ... . As Bush [POTUS] and Cheney [administration] prepared to leave office, the war's financial toll quadrupled [Lawrence] Lidsay's worst-case estimate.”, pp.265-266, (Angler: the Cheney vice presidency, Barton Gellman, 2008, )
])
pp.597-598
Writing in his New York Times column in August 2002, the Princeton economist Paul Krugman declared, “Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”10
p.598
Enron had tried to cover up its losses with a series of accounting tricks, hiding them in off-balance-sheet vehicles named after
Shareholders and employees had been bamboozled into thinking that everything was fine.
Now Enron was bankrupt.
Enron fiasco
Enron's failure,
a parade of public corporations had confessed to doctoring their accounts: evidently, the exuberance of the tech bubble had been sustained partly by fraud, and Enron was buy no means a freakish bad apple.
p.598
According to a Fed staff calculation, large public companies had overstated their profits by an avarage of 2.5 percentage points per year between 1995 and 2000.11
p.598
Derivatives and other modern financial tools made it easy to doctor company accounts, and there was no way to uninvent them.
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
p.598
Derivatives and other modern financial tools made it easy to doctor company accounts, and there was no way to uninvent them. ([ not only is there no way to put the idea back into a bottle [once that idea has become viral and keep on circulating], there is a whole business network (platform) that came into existence to enable Derivatives and other financial tools; do not forget about the legal loopholes that make Derivatives and other financial tools possible; what started out as a way to diversified and spread the default risk of moving the corporate debts off the book, and passing on the income stream from those debts obligation; these legal off-shore tax-free activities has been industrialized and morphed into a financially bad monster; to bake bread you need enough sugar, but too much sugar is not healthy; to guard against radiation poisoning, you must monitor the accumulated radioactive radiation exposure; the same can be said about accumulated sugar intake ...; with that in mind, not all sugar or sweet - for that matter - is the same; every sugar is the alike and at the same time, each one is different, depending on the source, supply chain, and origin; for example, purely refined sugar is a completely different animal from sugar that is naturally occurring in fruits, vegetable, and grain; so the same could be said about money, debts, income, and expense; ... ])
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
• Just as with a mortgage for a house, interest on corporate debt is tax deductible.
• tax deductibility of debt
• this tax benefit is effectively a public subsidy of the business, since the rest of us end up making up the difference for revenue that would otherwise come from the LBO-backed companies. (Author and Bloomberg columnist William Cohan)
Jason Kelly, The new tycoons : inside the trillion dollar private equity industry that owns everything, 2012
The Debt
pp.45-46
Private-equity money is somewhat ordinary until it's paired with debt. This borrowed money——the leverage in a leveraged buyout——is what gives private equity the chance to be a wildly lucrative business. Were debt removed from the equation entirely, the entire model would break down, simply because managers couldn't deliver the returns to their investors, and reap the rich fees for doing so. Debt is the jet fuel that makes it all possible. Private-equity managers argue that prudent use of leverage (emphasis on the prudent) is not only reasonable but necessary, and part of running a healthy business that manages its cash appropriately and uses tools including debt to most appropriately grow.
Still, leverage also has been one of the biggest drags on private equity's reputation. As anyone who's ever had a mortgage or a credit card knows, borrowing money comes with inherent risk. Whoever is lending it demands that it be paid back on certain terms. Throughout private equity's history they've found eager lenders, the equivalent of the credit card companies who carpet-bomb college campuses with offers.
When a private-equity firm wants to buy a company, it uses a mix of money from its own fund (equity) and some amount of borrowed money, usually in the form of bonds and loans. The money is borrowed using the target firm basically as collateral and the amount and terms are based on the company's perceived ability to pay the interest, and ultimately repay all the debt.
... [...] ...
... Just as with a mortgage for a house, interest on corporate debt is tax deductible. Author and Bloomberg columnist William Cohan put it succinctly: "Since corporate debt is the mother's milk of a leveraged buyout, there would be no private-equity/LBO industry without this huge tax benefit."2 He went on to argue that this tax benefit is effectively a public subsidy of the business, since the rest of us end up making up the difference for revenue that would otherwise come from the LBO-backed companies. The private equity industry has staunchly defended the tax deductibility of debt, noting that its use is far from limited to leveraged buyouts. Beyond homeowners, corporations not owned by private-equity firms enjoy the same benefit.
p.157
... Carried interest is considered investment income and therefore taxed at a capital gains rate, which in 2012 stood at 15 percent, versus the top ordinary income rate of about 35 percent.
... Victor Fleischer, law professor
... Fleischer wrote a refleshingly straightforward paper that started making the rounds of key offices on Capitol Hill in early 2007. The introduction to the 59-page article, eventually published in the New York University Law Review, says it all: "This quirk in the tax law allows some of the richest workers in the country to pay tax on their labour income at a low rate. Changes in the investment world ... suggest that reconsideration of the partnership profits puzzle is overdue." He goes on even further, asserting he will prove "that the status quo is untennable position as a matter of tax policy."3
(Kelly, Jason, 1973 -, copyright © 2012)
(The new tycoons : inside the trillion dollar private equity industry that owns everything / Jason Kelly, (cloth) (ebk), 1. private equity, p.157)
____________________________________
• tax codes subsidize borrowing
• tax code also encourages borrowing by allowing corporations to deduct interest paid on debt as an expense.
The bankers' new clothes : what's wrong with banking and what to do about it / Anat Admanti and Martin Hellwig.
tax code, bankrupt, exemption (BNC)
pp.226-227
. . . Paradoxically, the tax codes subsidize borrowing, but then capital regulation tries to reduce it. It is as if we provided tax incentives that encouraged reckless driving or pollution while at the same time enacting laws forbidding these behaviors. Giving banks tax incentives to borrow is bad public policy. The tax code should not interfere with financial stability; if anything, it should reduce the distorted incentives.
Other laws also make it easier for banks to borrow too much. For example, many short-term debt contracts that are used in the financial system are exempt from normal bankruptcy procedures. These exemptions can play a role in enabling the type of “borrowing rat race” that we discussed in Chapter 10, which makes the banking system more fragile;57 they should be re examined.
Note 54
p.239
We discuss the flaws in proposed capital regulations in Chapter 11. The tax code also encourages borrowing by allowing corporations to deduct interest paid on debt as an expense. Exemptions from normal bankruptcy provisions granted for derivatives and repurchase agreements used extensively in the finacial industry also encourage fragility. See our discussion of these issues in Chapters 9 and 10.
(The bankers' new clothes : what's wrong with banking and what to do about it, by Anat Admanti and Martin Hellwig, © 2013, )
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
p.55
The Comex was conveniently located just across the street from the Townsend-Greenspan office at 39 Broadway, and Greenspan would show up for ten or fifteen minutes at the morning opening, pop back again at lunch, and make a final appearance at the close of the trading session; he aimed to catch the most active periods in the market without stealing more than 45-minutes from his consulting business. But after a few months of multitasking, Greenspan had to reckon with a rude surpise. Cutting out commission costs by trading directly had somehow failed to pay off. Unschooled traders in the metals pits were running circles around him.33
p.55
The experience shaped Greenspan's understanding of finance. As he watched the frenzied traders on the Comex floor, Greenspan learned that prices reflected economic fundamentals only imperfectly. They were driven, at least in the short term, by screams and hand signals and animal spirits.34 The operators who thrived in this environment frequently knew nothing about the metals they traded or the news that might be driving the prices. Yet somehow they could sense turns in the market, so that they bought at the beginning of an upswing and got out before the market started down again.
p.55
In slow moments in the trading pit, Greenspan would sometimes ask a neighbors how he knew when to buy.
“I felt that the market was bottoming”, the trader would respond gruffly, leaving Greenspan none the wiser.
“What did you do?” Greenspan would wonder to himself. “Feel the market? What, feel the wall? What does that statement meant?”
pp.55-56
The meaning gradually revealed itself as Greenspan spent time on the trading floor.
p.56
His rivals might not know inventories and fundamentals, but they understood two other terms: overbought and oversold. If the big traders in the pit went on a buying spree, sooner or later they would have bought all they could afford; in the absence of fresh buyers, they market's next move would have to be downward. Likewise, if the big men were dumping contracts, there would come a time when they would stop; with no more selling pressure, the next move would be upward. And if the pit was divided between big sellers and big buyers, then psychology kicked in. You had to read the body language of the adversaries: which side had more capital; which side had the balls to bet the biggest? Greed and fear and human ego trumped the dull particulars of inventories. Markets were not completely rational. They were simply too human.35
p.56
Some of this understanding found its way into the long paper that Greenspan presented to the American Statistical Association at the end of 1959. The writing was peppered with the language of traders ── longs and shorts, bulls and bears, overbrought and oversold ── terms that did not appear in other academic papers of the period.36
p.56
And although much of the argument focused on the consequences of bubbles, Grenspan also had some nuanced things to say about their causes. Investors were mainly rational ── they responded to real events with real business consequences, whether these were technological breakthroughs from industrial laboratories or policy proposals from Congress.
p.56
But investors filtered such news through their own moods and emotions; their judgments were too slippery and fragile to be called efficient.
p.56
Anticipating the finding of behavioral economics in the 1970s and 1980s, Greenspan noted that lurches toward fear were generally more sudden and dramatic than lurches toward confidence. Markets could crash instantly, triggered by a modest shift in fundamentals. In contrast, bubbles inflated only gradually.37
p.56
If markets could be irrational, how could an observer know when they were overshooting? Years later as Fed chairman, Greenspan sometimes suggested that bubbles were impossible to recognize, but in 1959 he took the opposite position.
p.57
Because the future is necessarily uncertain, investors who bid risk premiums down to nothing have clearly taken leave of their senses. “When commitments are made on the assumption of certain cost-price stabilities existing for the next 20 years that is clearly irrational optimism”, Greenspan proclaimed. At such moments of confidence, investors were forgetting the limits “of what can be known about future economic relationships”.38
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
p.441
Michael Steinhardt, and he was in the vanguard of a new phenomenon: bond-trading hedge funds.
After the recession of 1990, Steinhardt had seized the opportunity presented by the Fed's loose policy: he took out short-term loans from his brokers, paying the rock-bottom short-term interest rate, then lent money to the government by buying longer-term Treasury bonds, collecting the higher long-term rate. Thanks to the profits in this “carry trade”, Steinhardt and his fellow hedge funders had expanded at a monstrous pace.
p.441
The rise of bond-trading hedge funds, along with hedge-fund-like operators inside Wall Street houses such as Goldman Sachs, was partly helpful to Fed policy.
pp.441-442
by borrowing short and lending long, they were standing in for wounded banks ── partially compensating for what Ben Bernanke, the Princeton professor, had termed the broken credit channel.
p.442
bond portfolios
debt
they lent money to the government by buying bonds, then pledged the bonds to their brokers as collateral so that they could borrow more,
p.442
The result of this leverage was that markets were primed to react fast.
A fall in the bond market of just 1 percent would wipe out Steinhardt's entire equity stake, so he had no choice but to bail out at the first sign of trouble.
p.442
the sharp jump in long-term interest rates that confronted the Fed in the last days of February.
Hedge funders like Michael Steinhardt were rushing to sell bonds, and once the rush began, it cascaded unpredictably.
p.442
WIth the bond market falling, the hedge funders' collateral was worth less, so the brokers changed their terms:
p.442
This abrupt withdrawal of credit put Wall Street into shock. Hedge funds were now forced to dump four fifths of their bond portfolios.
At the Fed's early February meeting, Greenspan had fought his colleagues to avoid an interest rate hike of half a percentage point.
p.442
By March 1, the rates on five- and ten-year Treasuries were up by half a percentage point
p.442
Huge losses at the hedge funds were mirrored by losses on the bond-trading desks of the big banks; and rumors about their viability ricocheted around the Street, causing a temporary suspension of trading in shares of J.P. Morgan and Bankers Trust on the New York Stock Exchange.
pp.442-443
The insurance industry lost as much money on its bond holdings as it had paid out for damages following the recent
p.443
By the end of March, the five- and ten-year interest rates had jumped a further half a percentage point.
p.444
the bond rally of 1993 had indeed been a bubble
p.444
FOMC conference call on the last day of February 1994
“I think we partially broke the back of an emerging speculation in equities .... In retrospect, we may well have done the same thing inadvertently in the bond market .... We pricked that bubble as well”, he concluded.
p.444
On an FOMC conference call on the last day of February 1994, Greenspan recognized the truth he had resisted earlier: the bond rally of 1993 had indeed been a bubble. “Looking back at our action, it strikes me that we had a far greater impact than we anticipated”, he admitted. “I think we partially broke the back of an emerging speculation in equities .... In retrospect, we may well have done the same thing inadvertently in the bond market .... We pricked that bubble as well”, he concluded. Later in his Fed tenure, Greenspan would strenuously resist the notion that a small shift in the federal funds rate could deflate a bubble ── his denial was part of the case he developed for neglecting asset prices. But now he conceded that a modest act of tightening had forced speculators to retrench. Monetary policy could be a powerful tool ── if the Fed chose to use it.
p.444
If the Greenspan of 2004 had acted on the Greenspan observation of 1994, the bubble of 2006 might have been less disastrous.51
p.445
the cycle of 1993-94
equity [stocks] crash of 1987, the bond crash of 1994
p.468
derivatives market
pretty exotic instruments
zero-sum game
leverage
magnify risk
redistributed risk
risk-shifting properties of derivatives
financial exposure
shifting risk to institutions that could manage them most safely
p.469
derivatives two significant downsides
- exotic contracts made it easy to rip off clients: the abusive selling of toxic mortgage securities before the 2008 crash
- complexity made it possible for crazy risks to build up inside financial enterprises.
• 2008
• AIG insurance
• 1994 Charles Sanford
- complex swap
- Proctor & Gamble
- Gibson Greeting Cards
- “ROF factor”, or rip-off factor, back in 1994
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
____________________________________
Sebastian Mallaby., The Man Who Knew: the life and times of Alan Greenspan,
2016
pp.681-682
there are times when it makes sense for central bank to raise interest rates to fight asset bubbles. They should not do this when other considerations point strongly the other way: when unemployment is high or when deflation threatens. But just as it would be wrong to give up on the quest for better regulation, despite the many obstacles that lie in its way, so it is unreasonable to rule out the use of interest rates to fight bubbles at all times and in all circumstances.
p.682
During Greenspan's Fed tenure, he should have raise rates to fight bubbles on two occasions ── in late 1998 and early 1999, and again in 2004-5. In both instances, unemployment was low, deflation was not threatening, and yet markets were evidently too hot. The Fed should have raised rates more aggressively, accepting somewhat lower growth in the short term in exchange for a more stable economy in the medium term.
p.682
A clue to the answer can be found in the 1960s, when another school of economists found itself in an analogous position. At that time, the fathers of modern porfolio theory confronted a highly inconvenient truth: contrary to their efficient-market assumptions, price changes in asset markets do not follow the “normal distribution” depicted by a bell curve; rather, very large price moves occur far more frequently than the thin tails of the bell curve anticipate. At first the efficient marketers responded open-mindedly to this objection, acknowledging that its main proponent, the maverick mathematician Benoit Mandelbrot, was right.
p.682
But then they swept Mandelbrot's protests under the carpet because his message was too difficult to live with. Deprived of their bell-curved assumption, the efficient marketers' mathematical techniques would cease to work.
p.682
Paul Cootner, an efficient marketer,
“If he is right, almost all of our statistical tools are obsolete ── least square, spectral analysis, workable maximum-likelihood solution, all our established sample theory, closed distribution functions. Almost without exception, past econometric work is meaningless.”8
8. Donald Mackenzie, An Engine, Not a Camera: How Financial Models Shape Market (Cambridge, Mass.: MIT Press, 2006), 114.
(The Man Who Knew: the life and times of Alan Greenspan / Sebastian Mallaby.
New York: Penguin Press, 2016., “A council on foreign relations book.”, subjects: Greenspan, Alan, 1926─ | Economists──united states──biography. | government economists──united states──biography.| monetary policy ── united states. | board of governors of the federal resere system (u.s.), HB119.G74 M35 2016 (print), HB119.G74 (ebook), 332.1/1092 [B]──dc23, https://lccn.loc.gov/2016017300, 2016, )
··<---------------------------------------------------------------------------->
