The Weiner Component Vol.2 #8 – Part 5: Alan Greenspan & the Federal Reserve

Former Chairman of the Federal Reserve Alan Gr...

Former Chairman of the Federal Reserve Alan Greenspan, receiving a Presidential Medal of Freedom in 2005 (Photo credit: Wikipedia)

In 1935, Cret designed the Seal of the Board o...

In 1935, Cret designed the Seal of the Board of Governors of the Federal Reserve System. (Photo credit: Wikipedia)

On August 11, 1987, Alan Greenspan became the Chairman of the Federal Reserve. He was appointed by President Ronald Reagan and served until January 31, 2006, when he retired from that office. There was a rumor that he had lobbied for the position.

 

After four years in office he was reappointed by President George H. W. Bush who later claimed he lost his reelection bid because of Greenspan’s Monetary Policy. Bill Clinton also reappointed him and so did George W. Bush.

 

Greenspan was a Republican conservative with a classical education in economics, who got his P.H.D. from N.Y.U. He supported privatizing Social Security and tax cuts which, according to the Democrats, would increase the deficit. In fact it has been suggested that the easy money policies of the Fed during Greenspan’s tenure there was a leading cause of the subprime mortgage crisis that occurred in 2008, after he left the Federal Reserve as Chairman.

 

Alan Greenspan was nominated by President Reagan on June 2, 1987 and was confirmed by the Senate on August 11 of that year. To Congress he quickly assumed the role of a seer, generally when he was questioned by Republican members of either House of Congress, they spoke to him with a large degree of reverence, as though his answers to their questions were the absolute ones. He was considered the maestro of economics; his words being gems of economic wisdom. This occurred throughout his entire term as Chairman of the Federal Reserve.

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The issue that Greenspan did not deal with, which, in fact, he stated that the Fed could not control or even really deal with was the amount of money in the National Cash Flow. His successor, Ben Bernanke did not have this problem and he both increased the amount available for over a two year period and solved an economic quagmire that the banks had created in 2008 following Greenspan’s easy money policy.

 

According to the late economist Paul Samuelson the process of splitting mortgages began during the late 1970s. For innumerable reasons banks had traditionally allowed people to take out second mortgages on their homes charging them slightly more in interest than they were paying on their first mortgage. Occasionally the banks would sell these mortgages to individuals in order to get their money back for a more profitable use. In the late 1970s many banks broke these mortgages up into large pieces in order to sell them and sold each one to a multitude of Hedge Funds who then used them as securities.

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In 1981 Ronald Reagan became President of the United States. He and his aids believed in a totally free Market where all economic decisions were made by the Market. The basis by which the Market operated was the profit motive. It had been explained by Adam Smith in his preindustrial revolution book that he published in 1776. The Reagan Administration did away with virtually all government regulation that controlled the form and actions of the banks, giving them a complete free hand in dealing with the public; but they kept the FDIC in which the Federal Government insured all bank deposits up to ½ million dollars.

 

Regulations limiting the form and actions of banks were brought in during and after the Great Depression. Among other things many bankers had abused their positions and used depositor’s money to make individual profits for their executives. When the stock market crashed in 1929 so did numerous banks and multitudes of depositors lost their savings. The Roosevelt Administration from 1933 on brought about legislation to stop this from occurring again. Apparently the Reagan Administration in 1981 on believed this was no longer a problem.

 

During the Reagan Administration the major banking houses in the United States like J. P. Morgan-Chase, Bank of America, Wells Fargo, and others decided to break up the mortgages into fractional shares, split the shares among Hedge Funds, and sell shares in the Hedge Funds. This included both first and second mortgages.

 

This was a good bet since people valued their homes. What happened was that the banks encouraged people to use the equity in their houses as bank accounts, mortgaging and remortgaging their homes. With the constant action, following the economic laws of supply and demand, the value of properties continued to rise like hot air balloons. The value of the homes kept growing, allowing people to take more and more money out of their homes to buy anything they desired. By this action the banks created trillions of dollars of new money and presumably everyone prospered.

 

On the one hand Greenspan stated he could not control the amount of money in circulation but on the other hand the Fed’s low interest rates encouraged this behavior. What the banks did was to issue and reissue mortgages which they, in turn, split into hundreds of pieces, placing them into different Hedge Funds from which these funds paid the banks endless service charges. The banks then used the money for new mortgages but serviced the accounts, charging fees for each action.

 

In essence the banks lent the initial funds, sold the mortgages to innumerable Hedge Funds, got their initial investment back, and lent it out again, endlessly repeating the process and endlessly charging innumerable fees for the continuing processing. Many banks also owned many of the Hedge Funds.

 

The bank and everyone in the bank involved in this process did well financially. As home prices rose the homeowners kept getting their equity back and could afford to remortgage their homes. It seemed like an endless Christmas!

 

Ordinarily every change in any property has to be registered in the city or county where it occurs. This is a fairly slow system. The banks were able to set up their own record keeping agency that they could use quickly. The problem here was that there was endless amounts of information. This system made innumerable errors in their bookkeeping. In 2008, when the system crashed, the records were worthless. There was no reliable information on all the transactions.

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By 2007 it was fairly obvious that the system was tottering and could fail. For the last quarter of a century this had been going on. It spanned the entire career of most bankers. They were in a state of denial that the housing bubble could burst. Some banks offered loans of 125 percent of the appraised value of homes.

 

The Housing Bubble burst late in 2008 while George W. Bush was still President of the United States. Suddenly many banks were on the verge of bankruptcy. President Bush and his Secretary of the Treasury lent some of the banks enough money to keep them solvent.

 

The new Chairman of the Federal Reserve, Ben Bernanke, authorized a loan to AIG, the leading insurance company in the United States. It seems they felt left out of all the money making and wanted their share. They insured a number of loans for high premiums. Their actuaries underestimated the risk involved. When the collapse came they didn’t have the funds to pay off the claims and without additional funds would have gone under costing a large percentage of the American public both the premiums they had paid and the protection these premiums bought.

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It is important to note that the flow of money in the United States and the rest of the industrial world, whether credit or cash, is through the banking system. If the major banks were to go under the flow of currency would be a dribble. In addition every bank account is insured up to ½ million dollars by the Federal Government.  The banks paying a small premium to the Federal Deposit Insurance Corporation (FDIC). If the banks go bankrupt the Government is still liable for those monies.

 

In addition AIG (American International Group) is the major insurance company in the nation, insuring, among many other things, millions of insurance policies throughout the nation. If it were to go under billions in premiums paid for years by countless Americans would suddenly be lost. It would be a major negative catastrophe in the country. AIG was literally too big to fail.

 

The failure of both the banks and the insurance company could easily bring down the economy of the United States. These concerns are necessary for the United States to function. They are not only too big to fail but also too important, in relation to the country.

 

This is the position in which President George W. Bush and Chairman Ben Bernanke found themselves in toward the end of 2008. And this is the position that Barack H. Obama inherited when he became President of the United States on January 20, 2009.

 

As Chairman of the Federal Reserve Alan Greenspan had supported an easy money policy. He retired shortly before the results of this policy exploded. Did he foresee the occurrence?   Was he responsible for it?

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From the 1980s on the American economy needed a greater Cash Flow. There literally wasn’t enough money available throughout the economy. Historically the Federal Reserve had never directly supplied money to the overall country. In fact up until 1933 all monies were comprised of gold and silver. All gold mines in the United States were required to sell all the gold they mined to the Federal Government for $16 an ounce. It was then minted into gold coins. Paper money could be issued: ones and five dollar bills were silver certificates and technically could be exchanged for silver coins at any time. Tens, twenties, fifties, and hundred dollar bills, and higher denominations could be exchanged for gold coins. From 1933 on gold disappeared and from ten dollar bills up money became Federal Reserve Notes. Later the five would also become a Federal Reserve Note. Thereafter the gold was stored in depositories and presumably stood behind the dollar.

 

In 1933 Roosevelt raised the value of money by law from $16 an ounce for gold to $32 an ounce. By doing this he doubled the available money in the United States and easily paid for the New Deal.

 

Consequently from that time on gold being behind the dollar was a fiction. Theoretically any Federal Reserve Chairman and his Board thereafter could have added money to easily to the National Cash Flow. But none did. During World War II the Federal Government spent a lot more than it took in in taxes. But it never just added money to the economy. In fact it used various devices such as War Bonds to attempt to limit the amount of money people could spend.

 

From what he has said and written Alan Greenspan did not believe that the government could just add money to the economy. That power was reserved to banks who could do so through their lending policies. Greenspan tended to understand economics as it was and had been. He ran the Federal Reserve on that basis. He lacked the imagination to do things any other way.

 

Possibly he suspected a crash in 2008 and so he retired before it came. Possibly he did not and felt he had been in that office long enough. Only he can answer that question.