Having opposed regulating them, Greenspan blames derivatives

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Having opposed regulating them, Greenspan blames derivatives

Via NY Transfer News Collective * All the News that Doesn't Fit

Financial Times - September 17, 2007
http://www.ft.com/cms/s/0/31207860-647f-11dc-90ea-0000779fd2ac.html


Having opposed regulating them, Greenspan blames derivatives

Greenspan Alert on US House Prices

By Krishna Guha

US house prices are likely to fall significantly from their present
levels, Alan Greenspan has told the Financial Times, admitting that
there was a bubble in the US housing market.

In an interview ahead of the release on Monday of his widely-anticipated
memoirs, the former chairman of the Federal Reserve said the decline
in house prices "is going to be larger than most people expect."

But Mr Greenspan said that his successors at the Fed -- who meet
on Tuesday to set interest rates -- would have to be careful not
to ease rates too aggressively, because the risk of an "inflationary
resurgence" was greater now than when he was Fed chief.

Mr Greenspan said he would expect "as a minimum, large single-digit"
percentage declines in US house prices from peak to trough and added
that he would not be surprised if the fall was "in double digits."

The US Federal Reserve is expected to ease monetary policy this
week, with its main interest rate expected to be cut by up to half
a point on Tuesday. Economists differ about whether the US Fed Funds
rate will be cut by 0.25 per cent or 0.5 per cent from the current
rate of 5.25 per cent. The Bank of Japan is likely to keep rates
on hold at 0.5 per cent on Wednesday.

In the US, the regulator for US government-backed mortgage lenders
Fannie Mae and Freddie Mac said rescue loans were not being arranged
quickly enough for homeowners facing foreclosure.

European Union finance ministers and central bankers also agreed
on a set of principles for bailing out crossborder financial
institutions, in the wake of the Bank of England's rescue of UK
mortgage lender Northern Rock last week.

Mr Greenspan said house prices were probably already down about 2-3
per cent from their peak on a national level.

However, he cautioned that it was very difficult to predict how
large the ultimate decline would be.

As Fed chairman, Mr Greenspan had talked about "froth" in the housing
sector, but never said there was a bubble in the market as a whole.
His successor Ben Bernanke has also avoided the word "bubble."

But Mr Greenspan told the FT that froth "was a euphemism for a
bubble."

He said he still thought froth -- a collection of bubbles -- was a
better description, because of the variation in house price
appreciation in different local housing markets. But he said "all
the froth bubbles add up to an aggregate bubble."

The former Fed chairman said the current turmoil in financial markets
was "an accident waiting to happen."

He said the price of risk had fallen to unsustainably low levels
beforehand, with investors addicted to asset-backed securities that
offered some additional yield over Treasury bonds as if they were
"cocaine." Mr Greenspan said this demand induced the big increase
in the origination of subprime mortgages by mortgage brokers.

The rise in defaults on subprime mortgages was only the trigger
that set off a broad re-evaluation of risk, he argued.

Mr Greenspan said the off-balance-*** investment vehicles that
issued much of the asset-backed commercial paper represented a
"savings and loans disaster waiting to happen" because of the
mismatch between their assets and liabilities. Mr Greenspan thought
the issuance of asset-backed commercial paper "is probably not going
to get back to where it was."

They had "five-year maturity assets financed with 30-day commercial
paper," he said.

The former Fed chairman said collateralised debt obligations --
securities that slice up and repackage loans to meet the risk-appetite
of different investors -- "will never get back to the levels and
structures that they were, because now everybody knows you cannot
price them."

He added that in an innovative financial market "there will always
be products that fail."

However, he said he believed that credit default swaps were "here
to stay" and had demonstrated their capacity to diversify risk.

Mr Greenspan said the flexibility of the US economy would help it
cope with the spillovers from the financial crisis, but said the
prospect of a negative wealth effect from housing meant this crisis
was "trickier" to manage than financial crises that did not directly
touch consumers.

In his memoirs, Mr Greenspan, a lifelong Republican, criticises his
party for abandoning its small-government principles, and warns
that the trade-off between inflation and growth is likely to worsen.

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