ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. "Everybody missed it," he said, "academia, the Federal Reserve, all regulators."... Mr. Greenspan said that he sat through innumerable meetings at the Fed with crack economists, and not one of them warned of the problems that were to come. By Mr. Greenspan's logic, anyone who might have foreseen the housing bubble would have been invited into the ivory tower, so if all those who were there did not hear it, then no one could have said it.
– Michael J. Burry, New York Times, April 3, 2010
Michael Burry is correct. Alan Greenspan is completely wrong to say everyone missed the housing bubble. Michael Burry recognized it in 2005. I saw it coming in 2002. And Edward Gramlich, a Federal Reserve governor, accurately anticipated the problem as far back as 2000. Moreover, Gramlich personally warned Greenspan about the way in which providing home mortgages to low-income borrowers would lead to widespread loan defaults that would have tremendously negative effects on the national economy. Greenspan, of course, disregarded Gramlich's warning and rejected Gramlich's recommendation to audit consumer finance companies because he correctly feared that shining a light on the widespread fraud being committed by the swarming mortgage brokers would reduce the availability of subprime credit.
Advertisement - story continues below
All of the academics, the Federal Reserve and the regulators are in much the same position now that they were five years ago. In 2005, they were ignoring the vast edifice of debt that was being constructed upon the shaky foundation of low-income home buyers. In 2010, they are ignoring the fictitious accounting being committed by banks of all sizes, in which large quantities of loan assets are being held at massively inflated valuations on their books in order to make the banks look solvent, or even profitable, when they almost certainly are not.
In a column titled "Zombies that Ate America," I described how the equivalent of one percent of U.S. GDP, and 14 percent of all the post-tax corporate profits in America, were going to employees of the banking industry in the form of salaries and bonuses. This is problematic, to say the least, and compounding that problem is the fact that the huge banking profits that supposedly justify those massive compensation packages simply do not exist.
So far this year, 41 banks with a reported $22.9 billion in assets have been seized and shut down by the FDIC. This is nearly twice the 21 banks with a reported $9.6 billion in assets that were seized and shut down in the first quarter of 2009. When a bank is seized, the FDIC is forced to determine the true value of the assets it holds, which it usually does by attempting to sell them. While the FDIC estimates tend to be on the generous side, as can be seen by the gap between FDIC estimated losses and actual losses to its Deposit Insurance Fund, they are nevertheless a far more accurate measure than taking reported bank assets at face value.
Advertisement - story continues below
The amount of asset exaggeration, or to put it less politely, fraudulent reporting, that was committed by a failed bank can be estimated by subtracting the bank's deposit liabilities from its reported assets, then adding the amount of FDIC-estimated losses. In 2009, the 140 failed banks averaged $1,229 million in reported assets, $983 million in deposit liabilities and $260 million in FDIC-estimated losses. This indicates that $505 million of those assets reported, or 41.1 percent, had no value. The equivalent numbers for 2010 are $558 million in reported assets, $483 million in deposit liabilities and $159 million in estimated losses. Because the banks that have failed this year are smaller on average, the amount of worthless assets are likewise smaller at only $234 million per failed bank even though the percentage of them has actually risen slightly, to 41.9 percent.
The four largest banks in America, Bank of America, Citibank, J.P. Morgan/Chase and Wells Fargo, currently report $7.49 trillion in assets. Since there is no reason that the banks deemed "too big to fail" 18 months ago are in any better condition than their smaller competitors, and indeed, numerous reports indicate that they may be in even worse shape due to their greater involvement with the risky financial innovations that sparked the 2008 crisis, the FDIC statistics suggest that $3.1 trillion of their reported assets do not, in fact, have any value.
When one takes into account the fact that the unprecedented spending orgy of the Obama administration that has inspired widespread concern for the economic fate of the country amounted to $2 trillion in new government debt and combines that with the recognition that there are nearly 8,000 other financial institutions facing similar situations across the nation, the scope of the problem becomes apparent. It should also become obvious that due to its size, the problem is well beyond the ability of the federal government to solve.
But whether it is solvable or not, the one thing that is certain that the academics, economists and regulators who failed to recognize the problems created by the housing bubble five years ago are not likely to recognize, let alone resolve, the asset valuation problems that now threaten to create a larger and more serious economic crisis than the Credit Collapse of 2008. Alan Greenspan is now attempting to rewrite history to avoid being cast – quite properly – as the primary villain of the piece.
Unfortunately, it would appear to be safe to anticipate similar historical revisionism from Ben Bernanke in the not-too-distant future.