BullRaid

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By Rachel Beck
ASSOCIATED PRESS

11:20 a.m. September 11, 2007

NEW YORK - Alan Greenspan must really be worried about preserving his legacy. That's the only way to explain his assertion that the current financial turmoil is "identical" to market dislocations that occurred in 1987 and 1998.

The former Federal Reserve chairman told a group of economists in a speech last week that the behavior seen in the last seven weeks amounts to nothing more than deja vu all over again. Back then, financial stress rocked markets and raised worries about slowing economic growth before the Greenspan-led Fed rode to the rescue by cutting interest rates, quickly leading to happy days again.

We'd be lucky for such smooth sailing this time, given the bigger risks embedded in today's marketplace. How convenient for Greenspan to overlook that, since he was the chief cheerleader for the growth of instruments like derivatives and securitizations that are playing a large role in today's credit market dislocations.

Greenspan stepped down from the helm of the Fed nearly two years ago, handing the reins to successor Ben Bernanke. But he has hardly left the spotlight - commanding big speaking fees, the "maestro" still often chimes in on the economy.

Now that Greenspan is in the private sector, he is free to express his views. While he didn't respond to a request for comment for this column, expect to hear even more from him in the coming weeks as his much-awaited book chronicling his 18 1/2 years at the Fed, "The Age of Turbulence," hits bookstores Sept. 17.

That's a day before the current Fed's closely watched meeting to decide how to proceed on interest rates. Its benchmark federal funds target for overnight loans between banks now sits at 5.25 percent. It has been at that level since last summer after 17 quarter-point increases.

Wall Street is desperate for a rate cut, given that stocks have plunged from record highs in recent weeks and there are worrisome signs that the credit crisis set off by the housing and mortgage market collapse is still with us.

Greenspan's view is that this situation largely mirrors what happened in the past. If that is the case, and history serves as a guide, then a few rate cuts by the Fed will turn these trying times around fast.

While those past events were surely financial shocks, they are not the same variety we are seeing today. Economist Ed Yardeni talks about them as "unsettling" differences.

In 1987, a financial meltdown over an overvalued stock market was the primary concern. The situation in 1998 largely stemmed from debt defaults in Russia and other emerging economies, which Yardeni notes were still a relatively small percentage of the global economy. While that led to the failure of hedge fund Long-Term Capital Management, the situation was quickly resolved once LTCM was bailed out by some big banks.

"In both financial crises, the Fed lowered the federal funds rate, the economy and profits continued to grow and stock prices rose to new highs once the financial panic subsided," said Yardeni, in a note to clients of his namesake firm, Yardeni Research Inc.

Things today are more complicated. The marketplace is truly global, and the current crisis in confidence runs deep into financial markets.

One of the biggest areas of concern now is the continued dislocation in commercial paper markets, where companies raise cash to fund their operations. Investors are resisting buying, which has roiled that market. According to Citigroup, commercial paper outstanding has fallen by $209 billion over the last three weeks.

Greenspan should know how we got to this point. He led the Fed during its rate-cutting binge earlier this decade, slashing the federal funds rate over a three-year period to as low as 1 percent and keeping rates depressed for longer than many economists considered necessary. That low-rate environment sparked the boom in the housing and mortgage lending markets, which helped pull the economy out of its 2001 recession.

Greenspan also publicly supported risky loan products, such as adjustable-rate and subprime mortgages. Those areas of the mortgage market have imploded in the last year as adjustable mortgage rates have risen and home prices have dropped, making it difficult for borrowers to keep up with their payments. Default rates have skyrocketed.

Most importantly, Greenspan blessed the increased use of risk-laden financial tools, such as securitizations, which let lenders bundle their risky loans and sell them as bonds known as mortgage-backed securities.

The trouble is such instruments lack transparency in terms of risk, making it difficult to know what could happen should they falter. Investors - including some big hedge funds, investment banks and even German state banks - have gotten a quick lesson in those risks now that the mortgage-backed securities market has collapsed, leaving a trail of significant losses in its wake.

"Not only did Greenspan keep rates too low for too long, but he put his Good Housekeeping seal of approval on such risky activities," said Paul Kasriel, director of economic research at The Northern Trust Co. in Chicago.

Greenspan's talk about how today's events are like the past sounds like a stretch. He should know better.




Rachel Beck is the national business columnist for The Associated Press. Write to her at [e-mail]