Pity the fool

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When Alan Greenspan presided over the Federal Reserve for 18 years, he periodically appeared before Congress to mutter some ethereal bromides about the state of the U.S. economy.

Greenspan’s pronouncements were greeted as Yoda-like pearls of wisdom. Every mumbled word from this financial deity was reverentially parsed ad nauseum by a herd of financial analysts; every time he raised his eyebrows and creased those shar pei-sized folds on his brow, markets jumped.

He even had an official, gushy hagiography penned about him by Washington’s favorite instant historian, Bob Woodward. Woodward called the book ”Maestro.”

Yesterday, the Maestro sat amidst the wreckage of the global financial system and was asked by the chairman of the House Committee on Oversight and Government Reform whether his zeal for unregulated markets might have caused the unmitigated disaster we are now living through.

The answer was pure Greenspan:

”Yes, I’ve found a flaw,” he mumbled. ”I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

One might assume this vague reference to a ”flaw” was the former Fed chief’s way of admitting that the housing bubble he was largely responsible for inflating had fueled a wild speculative orgy that resulted in the collapse of the global financial system. Unfortunately, before we could all reach that conclusion, Greenspan wiggled an eyebrow and added some nuance that gave us a clue as to what he was really trying to say.

The ”flaw,” he explained, was that the banking giants had failed to regulate themselves, causing the ”intellectual edifice” of the ”modern risk-management paradigm” to collapse. ”Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he said.

So Alan Greenspan is shocked, shocked, that unregulated banks might get so greedy that they would act irresponsibly. Pay no attention to the man behind the curtain.

Here’s what happened during all those years that guru Greenspan was struggling to reach this conclusion:

The largest banks in the world, all wanting to gorge themselves on big gooey chunks of speculative moolah cooked up in the overheated U.S. housing market, created a bunch of exotic financial instruments called derivatives. They used these to bundle ridiculous sub-prime mortgages and spread the unsecured debt throughout the global financial system.

Not satisfied with simply owning huge chunks of bad debt they couldn’t even locate on their books, these binge bankers created a market for credit default swaps, insurance instruments that permitted them to double-down their gigantic drunken bets that the whole charade would not go bust.

The investment bankers were still gorging on credit default swaps as the housing bubble was collapsing. One of our favorite economic observers puts it succinctly: ”It’s like buying an insurance policy on a guy when you can see the car that’s about to hit him.”

Since Alan Greenspan apparently still doesn’t grasp the significance of this ”flaw,” here’s a helpful statistic:

According to Fortune magazine, there were approximately $900 billion in outstanding credit default swaps in 2001. This year, the total exceeded the combined gross national product of every nation on Earth.

That’s $55 trillion in greenbacks.

Trillion, with a T, as in Mr. T — whose immortal words now come back to haunt us:

”I predict . . . PAIN.”

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