>> Greenspan's $900Billion Survival Formula

Most people are familiar with the sub-prime mortgage crisis. Reader's of this blog have had a humorous look in previous posts:

• >> Dogbert the CEO : Risky Mortgages & Ponzi Schemes

• >> Subprime Mortgage Primer in Pictures

For a more serious look, see this previous post about Bear Stearn's collapse:

• >> Crash Chronicle : The Fall of Bear Stearns

One the problem started, the finger pointing followed not too long after. Lets take a look into a brief history and the solution proposed by Alan Greenspan, who many believe was the chief architect of this crisis.

The Greenspan Put
Once the subprime mortgage meltdown started, there was a lot of "passing the buck" about who was at fault. Greenspan soon became the person most blamed for the crisis:

- Greenspan legacy: erosion of US financial strength , key comments:

• Since Alan Greenspan took office as Fed chairman, it has taken an average of $3.60 of debt growth to generate $1 of nominal gross domestic product growth versus a long-term average of approximately $1.5 to $1.
  

- Reid: It's Greenspan's Fault , key comments:

• Reid's office pointed out that the Fed started to see deterioration in the credit market back in 2003 and 2004, but didn't warn lenders off using the "non traditional mortgages" seen as precursors of what is now a credit crisis until December of 2005, shortly before Greenspan resigned.

But isnt this really a what the Greenspan's put has been all about?
[ Note: The Greenspan put really means that the Fed's monetary policy allowed higher risk taking, becoming a form of privitazing profits and socializing losses ]

For more discussion about Greenspan's "contribution" to the real estate bust such as this chart below, see here:




Greenspan's 1500 word article in the Wall St. Journal

Greenspan, the former Chairman of the Federal Reserve for 19 years, finally spoke out:
- Greenspan's 1500 word op-ed piece in the Wall St. Journal in March 2009: The Fed Didn't Cause the Housing Bubble . Key comments:

• Alan says "Accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble."
• Its all China's fault! Alan says"As I noted on this page in December 2007, the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005."
  

Greenspan's $900 Billion Survival Formula @ Financial Crisis Inquiry Commission
The Financial Crisis Inquiry Commission (FCIC) is a ten-member commission appointed by the United States government with the goal of investigating the causes of the financial crisis of 2007–2010.

Quoting Greenspan from his testimony to the FCIC on 7th April 2010"
- "I believe that during the past 18 months, there were very few instances of serial default and contagion that could have not been contained by adequate risk-based capital and liquidity. I presume, for example, that with 15% tangible equity capital, neither Bear Stearns nor Lehman Brothers would have been in trouble"

[ Tangible common equity is defined as total shareholder equity minus preferred stock, goodwill and other intangibles.]

Rolfe Winkler explains how this will help: "A bigger equity cushion not only buffers bank creditors from losses — preventing cascading bank runs — it by definition would reduce frothy lending that inflates bubbles in the first place."

Extrapolating the 15% TCE requirement to major US Banks, $869 billion would need to raised:

Nearly $900 billion more to be raised is certainly not feasible. Greenspan also explains why 15% TCE would not be too popular:"Increased capital, I might add parenthetically, would also likely result in smaller executive compensation packages, since more capital would have to be retained in undistributed earnings."

In other words, smaller bonuses.

Credits / Further Reading:
- TCE shortfall Image courtesy Rolfe Winkler at Reuters
- Greenspan's testimony to FCIC available here
- Video of Greenspan's testimony available here