tor's Note: James Quinn is Senior Director of Strategic Planning at a respected University. This is Part 2 of a 2-part article. Part 1 can be found here.


Housing Bubble

Between 1998 and 2006, home values virtually doubled. There's no logical explanation for this occurrence. Previous peaks were 60% lower than the one reached in 2006.

Any reasonable person would conclude that home values would therefore fall steeply after reaching such irrational highs. Too bad the reasonable people didn’t include Alan Greenspan, bank CEOs, mortgage companies, rating agencies, homebuilders, Treasury Secretaries, presidents, regulators or Congressmen.

They not only didn’t see the fall coming, they encouraged the party to kick it up a notch. The following words, from Charles Prince, former CEO of Citigroup (C), will be immortalized alongside Gordon Gekko’s “Greed is good” speech:

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

He’s now doing the rumba in the bank-CEO “retirement” home along with James Cayne, Ken Thompson, Angelo Mozilo, Daniel Mudd, Richard Syron, Dick Fuld and Kerry Killinger.

Robert Shiller’s expert opinion regarding the 2005 Black Swan in real estate was:

“Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker.”

Much of the housing frenzy can be attributed to homeowners getting caught up in the media hype about others getting rich “flipping” houses. But, Greenspan's 1% interest rates were fuel for the frenzy.

The final nail in the coffin of Greenspan’s legacy was his speech in February 2004, in which he suggested that more homeowners should consider taking out Adjustable Rate Mortgages. Greenspan's advice came at a time when interest rates had bottomed out, making it a particularly bad time to take out an ARM. A few months thereafter, Greenspan began hiking interest rates, which would reach 5.25% 2 years later.

The triggering factor in the current crisis was the many subprime ARMs that reset at much higher interest rates than what the borrower paid during the first few years of the mortgage. Greenspan gave the bad advice, and Wall Street provided the money and derivative products which have created our worldwide meltdown.

Financial Implosion

In his 2002 letter to shareholders, Warren Buffett described derivatives as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

Being the smartest financial mind on the planet, Buffett saw the bleak end of the credit derivative bubble. Another Black Swan was coming, but those Harvard-educated CEOs on Wall Street chose to ignore it, because they knew that the Federal Reserve and the government would come to the rescue if they went too far.

The Greenspan “put” was well-known on Wall Street. Whenever someone did something stupid and risked worldwide financial collapse, the Fed would ride in on its white horse to save the day.

Is there another Bear Stearns out there?
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