Tuesday’s Market Meltdown; Greenspan’s “Invisible Hand”


Richard Moore

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Tuesday's Market Meltdown; Greenspan's "Invisible Hand"
By Mike Whitney

02/28/07 "ICH" -- -- Yesterday¹s stock market freefall has Greenspan¹s bloody 
fingerprints all over it. And, no, I¹m not talking about Sir Alan¹s crystal ball
predictions about the impending recession; that¹s just more of his same 
circuitous blather. The real issue is the Fed¹s suicidal policies of low 
interest rates and currency deregulation which have paved the way for economic 
Armageddon. Whether the Chinese stock market contagion persists or not is 
immaterial; the American economy is headed for the dumpster and it¹s all because
of the wizened former fed-chief, Alan ³Great Depression² Greenspan.

So, what does the stumbling Chinese stock market have to do with Greenspan?

Greenspan was the driving force behind deregulation which keeps the greenback 
floating freely while the Chinese and Japanese manipulate their currencies. This
gives their industries a competitive advantage by allowing them to consistently 
underbid their foreign rivals. Big business loves this idea, because it offers 
cheaper sources of labor and allows them to maximize their profits. It¹s been a 
disaster for Americans though, who¹ve seen their good paying jobs increasingly 
outsourced while US manufacturing plants are dismantled and air-mailed to the 
Far East.

Greenspan has been the biggest champion of deregulation; it¹s another way he 
pays tribute to the Golden Calf of ³free trade", the god of personal 

Yesterday, the Chinese got whacked with their own stick. By keeping the value of
their currency down, they spawned a wave of speculation which inflated their 
stock market by 140% in one year. When the government threatened to tighten up 
interest rates the stock market went into a nosedive and the overall index got a
9% haircut in a matter of hours. If they had been playing by the ³free market² 
rules, rather than pegging their currency to artificially cheap greenbacks they 
could have avoided inflating their stock market.

As it happens, the rumblings in the Chinese market sent tremors through the 
global system and triggered a 416 point loss on Wall Street; the biggest one day
slide since 9-11. Now the world is watching nervously to see if the markets can 
recuperate or if this is just the beginning of America¹s great economic 

Wednesday¹s revised numbers of GDP are not encouraging. The Commerce Dept 
revised their original data from a robust 3.5% GDP to a paltry 2.2. The economy 
is shrinking faster than anyone had anticipated. Also, durable goods plummeted 
beyond expectations and the real estate market continues to swoon. Troubles in 
the sub-prime market are spreading to non traditional loans as more and more 
over-leveraged homeowners are unable to make their monthly mortgage payments. 
(By the end of December 24 sub-prime mortgage lenders had already gone belly-up)
Greenspan¹s empire of debt is bound to come under greater and greater pressure 
as volatility increases.

On Monday, the National Association of Realtors (NAR) reported a 3% jump in the 
sales of existing homes, but it was all hogwash. The housing industry has joined
the media in trying to conceal what¹s really going on by showering the public 
with cheery talk of a recovery. Don¹t believe it. Go to their website and you¹ll
see that ³year over year² January sales were down by a whopping 290,000 homes. 
Add that tidbit to ³new home sales² (announced today) which ³fell by 16.6%, the 
most since 1994² (Bloomberg) and you get bird¹s-eye-view of an industry 
teetering on the brink of collapse.

Greenspan pumped the housing bubble so full of helium; we¹ll be feeling the 
back-draft for a decade or more. Still, the gnomish ex Fed-master had the 
audacity to stand in front of the cameras and say, ³We have not had any major, 
significant spillover effects on the American economy from the contraction in 


Apparently, Greenspan hasn¹t taken note of the skyrocketing rate of foreclosures
or the growing number of people on public assistance. It¹s doubtful that one 
notices the struggles of the working stiff from their manicured sanctuary in the
Aspen foothills.

It¹s not just the housing market that¹s buckling from the expansion of debt, but
the stock market as well. The Associated Press reported last week that, 
³Investors are borrowing at a record pace to sink into the stock market, and the
trend is raising concerns on Wall Street about what might happen if a major 
correction occursŠ.The amount of margin debt, which is how brokers define this 
kind of borrowing, hit a record $285.6 billion in January on the New York Stock 
Exchange. Such a robust appetite, amid a backdrop of complacent market 
conditions, could leave investors badly exposed if major indexes are snagged by 
a market decline. Some could find themselves forced to sell stock or other 
assets to meet what¹s known as a margin call, when a broker effectively calls in
the loan".

That last time margin debt was this high was at the height of the dot.com bubble
in March 2000. We all know how that turned out; the bubble burst taking with it 
$7 trillion in savings and retirement from working class Americans.

It all could have been avoided if there were prudent and enforceable regulations
on margin debt. Of course, that would have been a violation of the central tenet
of free market exploitation: ³There shall be no law inhibiting the unscrupulous 
ripping-off of the American people².

Margin debt is a red flag that the market is over-inflated by speculation. When 
the market hits a speed-bump like yesterday the fall is steeper than normal, 
because panicky, over-leveraged investors start scampering for the exits. This 
probably explains much of what happened on Wall Street after the sudden decline 
in the Chinese market.

The problems facing the stock market will soon play out whether or not we 
recover from this ³dress rehearsal²for disaster. America¹s huge account 
imbalances and the massive expansion of personal (mortgage) debt ensure that 
there¹s more trouble ahead.

The real problem is deep, systemic and difficult to understand. It relates to 
basic monetary policy which has been tragically mishandled by the Federal 
Reserve. A healthy economy requires that money supply not exceed the growth of 
real GDP; otherwise inflation will ensue. The Fed has been cranking up the money
supply at a rate of over 11% for the last 6 years ensuring that we will 
eventually face a cycle of agonizing hyper-inflation.

More worrisome is the fact that the world is about to face a global liquidity 
crisis for which there is no easy solution. See, the Fed loans money to the 
banks by buying government debt. Then, the banks, through the magic of 
³fractional banking², are then able to multiply the amount of money they loan 
out to their customers. In other words, the loans exceed the amount of the 
reserves by a considerable margin.

Grasping the magnitude of this phenomenon is the only way to appreciate the 
storm that lies ahead. This excerpt may shed some light on the issue:

³In the 1970s the reserve requirements on deposits started to fall with the 
emergence of money market funds, which require no reserves. Then in the early 
1990s, reserve requirements were dropped to zero on savings deposits, CDs, and 
Eurocurrency deposits. At present, reserve requirements apply only to 
"transactions deposits" - essentially checking accounts. THE VAST MAJORITY OF 

Consumer loans are made using savings deposits which are not subject to reserve 
requirements. These loans can be bunched into securities and sold to somebody 
else, taking them off of the bank's books.


That¹s why we should not be surprised when we discover that, although there are 
currently $3.5 trillion in bank deposits in the USA, the actual reserves are 
about $40 billion.

This system works fairly well unless there¹s a major market meltdown or a run on
the banks, in which case people will quickly find that there are, in fact, no 
reserves. Even this would not be a concern if the Fed had not increased the 
money supply by leaps and bounds while, at the same time, fueling the housing 
bubble through obscenely low interest rates. Now, millions of homeowners will be
facing default on their loans, the banks will be stretched to the max, and the 
stock market will begin to falter.

Something¹s gotta give.

Last week, in Davos, Switzerland, German banker, Max Weber, warned the G-8 
Summit, ³If you misprice risk, don't come looking to us for liquidity 
assistance. The longer this goes on and the more risky positions are built up 
over time, the more luck you needŠ It is time for financial market to move back 
to more adequate risk pricing and maybe forego a deal even if it looks temptingŠ
Global liquidity will dry up and when that point comes some of this underpricing
of risk will normalize. If there is much less liquidity around, people will not 
go into such high risk.²

It is unlikely that Weber¹s advice will be heeded. The United States has grown 
addicted to ³cheap money² and ever-expanding debt. The Federal Reserve will keep
greasing the printing presses and diddling the interest rates until someone 
takes away the punch bowl and the party comes to an end.

There¹ve been plenty of warnings, but they¹ve all been brushed aside with equal 
disdain. In a recent article on Counterpunch.org, (³Lame Duck²) Alexander 
Cockburn  refers to a report published by the Financial Services Authority (FSA)
³a body set up under the purview of the British Treasury to monitor financial 
markets and protect the public interest by raising the alarm about shady 
practices and any dangerous slides towards instability.²

The report ³Private Equity: A Discussion of Risk and Regulatory Engagement² 
states clearly:

³Excessive leverage: The amount of credit that lenders are willing to extend on 
private equity transactions has risen substantially. This lending may not, in 
some circumstances, be entirely prudent. Given current levels and recent 
developments in the economic/credit cycle, the default of a large private equity
backed company or a cluster of smaller private equity backed companies seems 
inevitable. This has negative implications for lenders, purchasers of the debt, 
orderly markets and conceivably, in extreme circumstances, financial stability 
and elements of the UK economy.²

The problem is even worse in the US where personal and mortgage debt has 
increased by over $7 trillion in the last 6 years! This is not an issue that can
be resolved by a meager 10% correction in the stock market. The reaction on Wall
Street to the sudden downturn in China demonstrates the fragility of the market 
and presages greater volatility and retrenchment.

We should expect to see bigger and more destructive market-fluctuations as 
investors get increasingly skittish over bad economic news and weakness in the 
dollar. Yesterday¹s 400 point somersault is just the first sign that Greenspan¹s
Goldilocks¹ economy is cracking at the seams.

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