ThoughtNGine

The Power of Ideas

Fool Me Once, Shame On You; Fool Me Twice…

Most of those who ask my opinion on the maelstrom in the capital markets know that I believe (rather too strongly) that the prior Chairman of the Federal Reserve bears a significant part of the responsibility for the financial distress many are now encountering.  I won’t repeat the litany of errors here.  But I do have a new mistake to add to the list…Behavioral Economics.  A more popular description is the “Greenspan Put”.

Over the years, we were treated to Greenspan Alchemy in any number of variations.  There was, however, always a similar plot.  Something good would happen in the economy.  Something too good.  The stock market would appreciate in an unprecedented fashion.  Housing prices would soar, spurring record construction.  Everyone could get a mortgage, irrespective of financial condition or income.  Commodity prices exploded.  In sophisticated jargon, we experienced bubbles.  One after the other.  Even Bazooka Joe couldn’t have made the Final Four.  In each instance, this financial wizard would demur if called upon to intercede at an early stage.  In his own mind, it was not this bartender’s responsibility to take away the punchbowl.  In fact, he did not want to stop refilling everyone’s cup.  According to the Chairman, the Fed was not positioned to anticipate bubbles, nor was it positioned to prevent or moderate them (even if easy credit was at the heart of the problem).  However, the Central Bank would be happy to provide the Alka Seltzer for the guaranteed hangover.

Over the years, we were taught, collectively, that financial exagerration was, at worst, an inconvenience and, at best, a “buying opportunity”.  Time and again, like a perfect Pavlovian experiment, we were taught to wag our tongues and tails when in pain.  The “Greenspan Put” was the perfect Milkbone Dog Biscuit.

Unfortunately, it was a bad lesson.  And a lesson learned that may be responsible for this mess.  Leaks in the Sub-Prime balloon started showing up several years ago.  In the early stages, it prompted little concern at any level.  Most importantly, financial institutions saw no reason to react.  As the problems grew, the same behavior continued.  In fact, I would not be surprised if the first few bumps were not viewed as buying opportunities.  As things progressed, problems grew.  But, hey, the Fed was there and they would get aggressive.  Almost nothing was done to prepare for the coming tsunami.  Assets were not sold, debt and leverage was not reduced, duration was not shed.  The system’s response function was broken.  It was a perfect Pavlovian response.  Most of us did what we were taught to…Ignore reality.  We are drowning in it now.

Hopefully it is not too late and we learn our lesson.  Maybe Ben Franklin put it best…”An ounce of prevention is worth a pound of cure.”

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March 10, 2008 - Posted by | Economics, Finance, General Interest, Markets, Politics

1 Comment »

  1. […] Read the rest of this great post here […]

    Pingback by Bad Debt » Blog Archive » Fool Me Once, Shame On You; Fool Me Twice… | March 10, 2008


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