The former chairman said the current turmoil in financial markets was “an accident waiting to happen”.
He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were “cocaine”. Mr Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers.
The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued.
Mr Greenspan said the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a “savings and loans disaster waiting to happen” because of the mismatch between their assets and liabilities. Mr Greenspan thought the issuance of asset-backed commercial paper ”is probably not going to get back to where it was.”
They had “five-year maturity assets financed with 30-day commercial paper”, he said.
The former Fed chairman said collateralised debt obligations – securities that slice up and repackage loans to meet the risk-appetite of different investors – “will never get back to the levels and structures that they were, because now everybody knows you cannot price them”.
He added that in an innovative financial market “there will always be products that fail”.
Greenspan FT interview
Financial Times has interview with Greenspan , ahead of publication of his book The Age of Turbulence: Adventures in a New World. He predicts further drop in home prices and dim future for collateralised debt obligations. Interesting perspective from the former Fed chief.