Sep 24 2009
Revisiting Greenspan’s Role in the Financial Crisis
I used to think Greenspan was the single most culpable person for the last financial crisis. Gradually, I am not sure anymore.
I didn’t like Greenspan for his libertarian ideology (or his association with Ayn Rand). I thought his monetary policy was too loose, his assumption of “what is good for the financial market is good for the overall economy” wrong headed. I still do but I am just not sure whether it is enough to cause a crisis of this magnitude.
In the end, I think it boils down to the question – what is the relationship between monetary policy and the level of speculation on the credit market? Let’s say the monetary policy is measured by the Federal funds rate, and the risk/liquidity/entropy level by LIBOR-OIS or TED spread. For a broader measurement, we may even look at the growth of some CDS indices. It is safe to say even the most forgiving interpretation can not correlate monetary policy and credit market entropy level.
To take a different look, the Fed’s balance sheet has $900 billion on it as of Sept. 2008). Given a reserve rate of 10%, the money from Fed goes no more than $9 trillion. During the height of the crisis, the Fed pumped in $3 trillion of credit (not money supply). But if I am not mistaken, the credit default swap market alone has $500 trillion. Given those numbers it is hard to assert that central bankers can directly influence the credit market.
Even the effect of “signaling” only goes so far. Greenspan was fairly blunt when he called it “irrational exuberance” back in 1996. The market took a hit but absorbed it as if a Hummer driving over a street bump.
Bernanke raised the “global savings glut” hypothesis trying to fill in the gap (of what else influence credit market other than monetary policy). And Greenspan further explained that in today’s inter-connected global market, central bankers have only limited influence over market excess. I didn’t give them enough credit when I first heard them. But the more I think of it, the more I come around to their point of view.
China’s stimulus package, in some way, may ease the credit crisis by cutting down the savings. If it were the case, we should see a steady appreciation of yuan. Short of that, I don’t see how the credit risk could go away.