FIIM lesson:
Alan Greenspan, the ex Federal Reserve Chairman, played an important role in the global crisis facing us today. Widely perceived to be the 2nd most powerful person after the president, Greenspan's comments are closely followed by the market, a phenomenon known as Greespan-watching. In fact, perhaps knowing this, Greenspan is infamous for his many speeches that leave observers confused about what point he is actually making. Many of the institutions' misgivings are due to a lack of regulations, and Greenspan is an advocate of allowing market forces free interaction, with little intervention from the government.
Ironically, the next few years will probably see much more regulations in the financial markets.
To give credit where it is due, Greenspan has actually seen through many crises in his helm as chairman (~1985-2005). He saw through the 1987 crisis when the AMSE fell 22% by pumping liquidity. More recently, the Long Term Capital Management hedge fund started by John Merriwether, then the biggest fund, collapsed. Who can forget the September 11 terrorist attacks on the World Trade Centre in 2001? The entire banking system was on the verge of collapse as many operations are based in NY and the WTC. He pushed interest rates low to encourage borrowing and spending.
Low interest rates encourage speculation and irresponsible borrowing. But banks are also at fault in the way they handle mortgages. Credit ratings are lowered such that borrowers with dubious track records are also allowed. In addition, to profit more, they repackaged these mortgages and sell to others.
Rating agencies like S&P and Moody cannot rate these instruments properly as there are no proper historical records for such mortgages.
