The Crimes of Alan Greenspan

As the Noble economist Coase put if 'If you torture the data long enough, it will confess' and this is where the neoclassical focus on data to avoid subjective bias of the economist comes unstuck. The data going into the models of the economy and the data coming out has been continually redefined to make the model paint a pretty picture. The assumed though unseen productivity gains based on new technology needed to justify the monetary expansion were made appear using hedonic adjustments (if the computers CPU is faster then add this into the productivity figures). Definitions such as unemployment and inflation were continually revised to make the data looks good (for example rent increases as opposed to house price increases was taken in the inflation figures). Then of course variable inputs that were based on assumptions were always positive (house prices never fall). At the centre of all this the neoclassical belief in the efficient market hypothesis meant that unregulated behaviour of markets such as derivatives that used similar models for valuation was considered optimal. Whether the market prices are always correct as the efficient market hypothesis claims or not, any short run efficiency is prevented when the market is prevented from working correctly and is prevented from punishing incorrect decisions. When Greenspan intervened to bail out Long Term Capital Management when its trading model created gigantic loses it undermined one of this key efficiency assumption of the models and created new incentives for reckless behaviour and a new market in betting on such companies that would be too big to fail and would bailed out by tax payer money.

So the environment for trouble was set and in this environment the real conditions for disaster were entered into. When the picture looked good the prices went up and when the prices went up the amount of capital investment banks and funds could lend out went up. The longer the models painted a pretty picture the more outlandish the assumptions and the more capital could be leveraged. The problem is that at such high degrees of leverage only a small fall in stock prices means that the required ratios of capital to lending are no longer there. Now with the new emphasis on meeting these regulatory requirements funds all over the world are falling below these ratios and with people increasingly demanding their money from the funds wide scale liquidations are inevitable and with multiple sellers of assets the prices can only collapse. As the central banks pull the same rabbit of interest rate cuts out of the same hat and in a new regulatory falling stock price/deflationary environment the chance of its effectiveness is slim. It's simply pushing on a string.