Alan Greenspan faces new questions about his stewardship of the economy.
The former Fed chairman has been battered by accusations that he helped create the housing mess by keeping rates low and flooding the economy with cash.
Now critics want to know why he still stands by derivatives, the Wall Street concoctions that Warren Buffett famously called "financial weapons of mass destruction."
Derivatives are opaque, but the essential idea is to take a bet on a bet, like buying life insurance is betting that you might die and cease to produce income for your family. A contract provides payment if an investment loses value, and the underlying asset – mortgages, securities, whatever – is the collateral.
Problem is, the underlying asset can lose value, making the derivative as worthless as the paper it’s written on. Meanwhile, Wall Street’s traders have sold, split up, and resold that risk many times over, raising the leverage but also magnifying the chance that no one is covered by the contract at all.
If half a fig leaf is scant protection; a fig leaf cut into a million slivers is virtually no protection.
That’s where we stand today with Wall Street, and Greenspan seems to be okay with that.
In a report in The New York Times, Greenspan is quoted speaking to a Senate Banking Committee in 2003: “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so.”
More recently, according to the Times, he continued to support derivatives. The problem is not the instrument, Greenspan says, but human greed. He considers derivatives sellers no more culpable than the pharmacist filling your prescription.
Unless your pharmacist turns out to be named Lehman.
Business Week figures Lehman spread out its amazing derivatives risk to no less than 8,000 firms. Bankrupted on Sept. 15 – an event that arguably triggered the latest, most ugly turn in the credit markets – Lehman now faces lawsuits in federal and state courts.
It will be a "very awesome task to try to unwind all of that," Lehman's lead bankruptcy attorney, Harvey R. Miller, told the magazine.
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