The Greenspan Put Is Not Enough

A “put” is a financial instrument that speculators or investors use to insure stock against declining prices. An investor who buys a “put” buys the right, but not the obligation, to sell a certain amount of stock at a certain price sometime in the future, regardless of market price. It’s like buying car insurance. When you insure your car you are essentially buying a “put” from the insurance company. If you wreck your car you can exercise your put and sell your car to the insurance company for what it was worth before you hit the tree.

The term “the Greenspan Put” came into use in the financial world in 1998. That was the year the math wizards at Long Term Capital Management nearly brought down the world’s financial system. A long shot statistical anomaly put billions in the hopper faster than you could say “irrational exuberance.”

Fed chairman Alan “Easy Money” Greenspan opened a floodgate of credit to paper over the LTCM debacle. Many believe he saved the world’s financial system from destruction. Others, like this writer, believe he simply prolonged and worsened the inevitable collapse of a financial house of cards.

Easy credit is the hooch the Fed and other central banks throughout the world keep sloshing into the financial derivative punch bowl. The party began when Nixon cut the dollar loose from gold in 1971.  Through the 80s and 90s it turned from a quiet cocktail hour to a hellacious bash that makes the destructive soirée in Steinbeck’s Cannery Row look like a tea party.  On Wall Street today and in stock markets from London to Canton there are dancers on every table, a lampshade on every head, fistfights in the kitchen, and furniture flying though the windows.

That a few revelers are getting woozy and a few more cooling in the gutters outside should surprise no one. The remaining party animals have consumed so much of the Fed’s wonderful punch that they have become delusional. The absurd idea that central bankers can keep the party going forever has gained near universal acceptance. And the new Fed chairman, Ben "Chopper" Bernanke, is doing nothing to dispel the idea.

Bailout is the name of the game. We need to keep those drunks upright and drunk. Too many of them crowding financial district gutters will wreck the whole neighborhood. In the last few weeks the Fed has cut the discount rate and several times shown up just when the party was flagging to spike the punch bowl yet again.

Unfortunately, the Fed didn’t create the worldwide asset bubble all by itself and it has a good deal less control over it than it would like. Banks all over the globe helped pump up the balloon with easy consumer credit, easy investment credit, and, perhaps most dangerous of all, easy mortgage money.

Banks lent to people who never had a chance at paying the money back, against assets whose prices were already inflated to unrealistic levels by previous reckless lending. They bundled up the shaky loans, repackaged and resold them to yield hungry fund managers and foreigners. Looking at a triple A, mortgage-backed bond paying 8% you could never tell it relied for payment on thousands of mortgages on overvalued houses occupied by battalions of overextended cashiers, burger flippers, and cash-free speculators.

The money from the sale of bonds funded another round of loans. This process repeated many times forming a swaying skyscraper of cards resting on the backs of consumers ill equipped to pay and collateralized by fantasy asset values.

This coming October will bring with it a bumper crop of mortgage resets. There is something like $50 billion in adjustable rate mortgages that will have their rates bumped up that month. Within a year after that another $500 billion in mortgages will adjust upward.

Millions of borrowers face payments they simply will not be able to make. They will not be able to refinance either. The days of lending to anyone who could fog a mirror ended shortly after the mass mirror fogging of 2004-2006.

The leverage that caused prices to skyrocket in those years will work just as effectively to correct prices in the months ahead. Just as the entire neighborhood leaped in value each time a house sold at a new record high in 2005, the entire neighborhood will sag in value as each home sets a new five-year-low in 2008.

Only temporary insanity can explain stock that trades at 200 times earnings or tiny Conch shacks that sell for a million dollars. There will be pain and hardship involved in recovering our senses.

Like a hangover after a binge, there’s no avoiding it. It should be allowed to take its course. Central bank or government interference will only prolong and worsen the pain.

It was easy money and credit that got us plastered the first place. The hair-of-the-dog won’t do anything but delay the inevitable hangover. The Greenspan Put may save the hides of a few millionaire Wall Street speculators and investment bankers but it will only make the pain longer and harder for the rest of us.