Greenspan: The Pot Calling The Kettle Black?

Among Alan Greenspan's most memorable sound bites as Chairman of the Federal Reserve was his description of the stock market as a symptom of "irrational exuberance." His 1996 warning was a bit pre-mature, the stock market correction didn't begin until four years later.

However, it should now be obvious that Mr. Greenspan was looking the wrong direction, as well as barking up the wrong tree, with his warning.

Rather than pointing to a market where the Fed's influence is indirect and its responsibility diffused, as it is with equities, the Chairman should have been paying a little more attention to the nation's credit markets, an area of direct influence and responsibility.

During his tenure, the flood of dollars into the banks flowing from Mr. Greenspan's printing presses sought its own level and almost immediately began floating the nation's real estate markets to levels never before dreamed.

The fuel that drove the historic inflation in residential home prices was debt, easy debt, encouraging investors to throw apparently unlimited amounts of paper dollars at tangible assets in the expectation of eternal increases in dollar values.

Just as the founding Rockefeller is said to have bailed from stocks when he received a hot tip from his shoe-shiner, so prudent investors should have limited their exposure to real-estate and real-estate lending when stories first appeared of school custodians in southern California qualifying for $500,000, no cash-down home mortgages.

As economist Robert Shiller's numbers make clear in the accompanying graph (click to enlarge), the real estate markets have a long way to go for correction. The eventual return to normal will be a matter not of days and weeks but of months and years. Every dime of that nearly $1 trillion correction will be wrung from the banks, investment banks and hedge funds—and their individual investors—that greedily lapped up the high-rates of return offered by the too-high octane mortgages.

Unfortunately, Mr. Greenspan's error is not the only cause of this difficulty, perhaps not even the largest. While the Federal Reserve provided the fuel, others set the course for the good Rocket Ship Credit using all the tools at their disposal, including cooked books and crooked applications. Investors haven't yet realized the depths to which they have been screwed by the chain of mortgage brokers, aggregators, packagers and investment houses, all of which were focused solely on their short-term profits, for which they have forfeited their reputations and long-term stability. The weaknesses deliberately baked into the subprime and Alt-A portfolios created and sold at ever-increasing velocities will not become apparent for some time yet. When they do, recriminations will follow.

While the bodies of some of the corporate small fry are beginning to litter the landscape, the carnage will include some of Wall Street's largest players before it is done.

The corrections and punishments that Congress or the regulators will eventually dish out will be too little, too late and probably, misguided. The marketplace will do a more accurate, more precise job correcting the errors as well as a delivering devastating punishment to those who lied and cheated their ways to commissions, bonuses and market capitalizations on the backs of those who now face the loss of a home.