Each day for five days, a different writer from TheStreet.com will make the case for why one of five prime culprits—the banks, Congress, irresponsible home buyers, the Federal Reserve or the rating agencies—is most to blame for the credit crisis and ensuing economic meltdown.
Alan Greenspan was lauded by Wall Street as the maestro for his role in presiding over a 9,000-point rally on the Dow Jones Industrial Average over his 18 years as chairman of the Federal Reserve.
But on the way to becoming "the greatest central banker who ever lived," a funny thing happened: The maestro played a key role in inflating a credit bubble that has put the global economy in its most dire straits since the Great Depression.
Clearly, there is plenty of blame to share among many parties for our current predicament. Homeowners bit off mortgages larger than they could chew, aided and abetted by an overzealous Congress bent on making homeownership dreams come true for record numbers of Americans.
Banks, emboldened by an era of deregulation that minimized risk (for them, unfortunately, not for the global financial system), were only too eager to make home loans to consumers who couldn't afford them, then profit off securitizing and trading them.
But Greenspan's stewardship of the Fed was the most significant constant in the nearly 20 years preceding housing prices hitting their apex in 2006. Appointed by Republican President Ronald Reagan in 1987 and reappointed four times by Republicans George H.W. Bush and George W. Bush and Democrat Bill Clinton, Greenspan occupied the economic bully pulpit at a time the seeds of excess were sown.
The main criticism of Greenspan has centered on his decision to aggressively lower interest rates in the wake of the dot-com bubble's bursting in 2000, and keep them low too long. As the country battled recession, the Fed cut rates to 1% in June 2003, and did not begin to raise them again until a year later.
The result of this cheap availability of credit was money pouring into the housing market, which Wall Street was only too happy to securitize -- allowing banks to spread out the risk of making the new loans and free up capital to make even more. In 2001, when Greenspan's Fed began cutting, $1.35 trillion in new mortgage-backed securities flooded the market, more than twice the amount the year earlier, according to data from Inside MBS and ABS, a trade magazine.
It's these securities that form a large part of what are often referred to as the "toxic" assets today plaguing banks like Citigroup (C) (Stock Quote: C) and Bank of America (Stock Quote: BAC) — (BAC) which digested the country's largest lender, Countrywide Financial, and Merrill Lynch, a big player in the securitized debt market.
Giant mortgage lenders Fannie Mae (FNM) (Stock Quote: FNM) and Freddie Mac (FRE) (Stock Quote: FRE) also had to be placed in conservatorship by the federal government after buckling under their weight. And while the securitized loan market's growth certainly required willing borrowers and lenders, it was the Fed's cheap credit that provided the gasoline for the fire.
But low interest rates were not the Greenspan Fed's only contribution to the crisis.
As the maestro—an economic guru who won the bipartisan trust of four separate presidents—Greenspan held enormous sway over Wall Street, policymakers and the public at large. Evidence of his popularity can be found by typing "Alan Greenspan" into the search queue of the satirical Web site The Onion, which frequently lampooned the central banker's rock star-like status in the late 1990s and early 2000s. In one 1999 entry, a diva Greenspan trashes a Los Angeles hotel room after a request to remove green M&Ms from bowls in his room, while proclaiming, "I'm Alan
"What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so," Greenspan said, adding "it would be a mistake" to burden the marketplace with deeper regulation of the contracts.
Tomasz Piskorski, a professor of economics at Columbia University, who is performing a study to determine what factor contributed the most to the global economic crisis, notes that the U.S. has historically high debt levels, a situation he blames on the Fed keeping interest rates low to maintain a good relationship with China, and to avoid a recession in the early 2000s.
Perhaps it is unfair to ascribe Greenspan's motives for low interest rates to politics. But the idea that his policies—so popular on Wall Street—helped skirt a recession that should have been worse more than seven years ago raises a thought: Maybe the economy doesn't need a Fed chairman Wall Street loves.