The Flaw

The bursting of the nation's housing bubble adds up to a...

It's a shake up on Wall Street.

...bankruptcy protection.

...the government takeover of mortgage giants.

Fannie Mae and Freddie Mac.

Alan Greenspan calls it a once in a century financial crisis.

Approve a 700 billion dollar bailout

or face dire consequences.

I have talked to the heads of almost

every single one of these firms in the last 72 hours

and he has no idea what it's like out there. None.

Yes I found a flaw. I don't know how significant

or permanent it is but I've been very distressed by that fact.

Welcome to New York City!

Financial capital of the world.

Welcome to Wall Street.

This is the heart of American capitalism.

Before I begin, a few things about the tour:

One is uh -

I'm not used to the camera in front of me...

One is uh - let's make this tour interactive.

Feel free to ask me questions.

One of the things I love the most

is you guys getting the "aha" moment.

If you can walk away today

with a better understanding of Wall Street,

better understanding of the financial crisis,

I've done my job.

Committee will please come to order.

I will start with the questioning.

Dr. Greenspan I want to start with you.

And my question for you is simple.

Were you wrong?

It would be sure that the mic is turned on.

Partially, but let's separate this problem into

its component parts.

We're talking about explaining History,

major world historic events.

This is as much a wealth crisis as a debt crisis.

Is a problem of wages as much as investment.

It's a debt crisis but it's also very much a crisis of

economic theory.

I think the income distribution was the initial step

in the dynamic that drove the debt crisis.

It's horrifying.

This is, you know, all the people that we trusted

have turned out to be completely untrustworthy.

This crisis is a total failure of markets.

So it's not simple.

In a short span of time between March 2008 to September 2008

so many things happened.

Fear was in the market place.

And if someone was going to tell you in six months

two of the top investment banking would fail

and they would tell you the top US insurance company would fail.

And they'd tell you Fannie and Freddie,

top mortgage issuers: Bankrupt.

Oh Iceland: Bankrupt.

Bankers around the world.

If someone would tell you this would happen

in as short as six months, you'd think they were crazy.

But that's essentially what happened.

Doctor Greenspan, you had an ideology.

You had a belief that

that free competitive markets are by far

the unrivalled way to organise economies.

"We've tried regulation. None meaningfully worked."

That was your quote.

Do you feel that your ideology pushed you

to make decisions that you wish you had not made?

Well remember that what an ideology is,

it's a conceptual framework

with a way people deal with reality.

Everyone has one. You have to exist you need an ideology.

The question is whether it is accurate or not.

And what I'm saying to you is yes I found a flaw.

I don't know how significant or permanent it is

but I've been very distressed by that fact.

You found a flaw in the reality -

A flaw in the model that I perceived

is the critical functioning structure

that defines how the world works, so to speak.

It wasn't so long ago in the history of man's voyage

to a better world that ships were carrying eager passengers

towards the shores of a new nation

that was just in the building.

Our forefathers were constructing

the foundation of this nation

by interlocking inseparably the blocks

of our political and economic freedom.

In some sense economics, standard economics,

is a very optimistic view of human nature, right?

Everybody's wonderful. Everybody's great.

Every person is a perfect calculator.

And that's basically what it means is that we have

lots of actors, each of them doing the best thing for them

and that creates some kind of social benefit for everybody.

The way of life our forefathers established

on this foundation of freedom

drew people from the far corners of the earth

and all those who set foot on these shores

had the opportunity to build a better life for themselves.

Even young Jonathan, an unskilled lad

from across the sea hoped to find a job

where he could progress according to his ability

and enterprise.

Well there's many factors that ultimately underlie

the current financial crisis but,

one thing that comes across in my mind

is the intellectual change.

An idea. Mm an idea.

In the 1970s the so-called efficient markets hypothesis

began to be received doctrine in the universities.

The simple version of the efficient market hypothesis

is that you have a value of something in the market

whatever it is.

If it's too low people would recognise it

and then you would bid the price up.

If it's too high people would recognise it

and then they'll bid the price low.

So you might have one opinion. I might have the other opinion.

But the opinion of all of us in average

is going to be kind of the correct opinion.

What's called the wisdom of crowd.

This is a hypothesis that

all financial asset prices are correct at all time.

Well correct in the sense that they accumulate

all of the information, pool the information

and then become wiser than any one individual

so that it would be foolhardy to ever question a market price.

While the main street of today doesn't look much like

the main street of Jonathan's time

the principles about business system remain the same.

But businessmen still compete with one another

for the consumers supply of spendable dollars.

And Mrs Consumer is still mighty critical

of everything she buys.

So under that thesis prices are always at the correct price.

You can't have an asset price bubble

in the efficient market hypothesis.

So let me tell you a bit more about myself.

After MIT I went to Silicon Valley

and so I was there before the bubble, during the bubble

and slightly after the bubble, the internet bubble that is.

And so you know, after the bubble I was like looking around

and I was like wow you know, what I'm doing is really risky,

I've got to find something more stable.

What I became is I became a bond trader

of essentially sub-prime mortgages bonds.

I think we know what a bubble is.

It's a phenomenon that has been repeating many times in history.

If you look at the Oxford English dictionary

I think it says something like: A speculative price increase

that's not justified.

It's filled with air like a bubble and it eventually bursts.

Economists would like to come up with a good explanation.

Why did we have a stock market bubble in the 1990s

and then a real estate bubble in the 2000s?

I like to give explanations that sound right to me

and maybe a little disreputable in our own profession.

And they're cultural explanations.

One thing that strikes me as having been very formative

for people's thinking was the explosion of capitalism.

Government is not the solution to our problem.

Government is the problem.

It started with the Margaret Thatcher

and Ronald Reagan revolutions

that brought free markets to more prominence.

And then it moved on with the breakup of the Soviet Union.

The advent of capitalism in China.

It seemed like there was an intellectual revolution.

That people believed in markets.

And so people thought that we're in a new world:

Private property reigns!

It struck a tone of fear in people

that I better get on this or I will be left behind.

I'd call it a gold rush mentality.

And it led to people changing their self-image.

They thought that I have to change to become part of this,

to be smart and stay afloat in this world.

I'm going to be an investment genius.

- Dot com. - Dot com.

It looked like the dot com, all those tech stocks

were a great way to invest your money and so money flooded in.

Today I'm talking to some city pets.

Ooh, ooh, hey poodles

And, lo and behold, you can't make money

selling pet food on the internet.

But people thought it was this new opportunity for investment.

Doctor I think you should see this.

Why what it is?

He's got money coming out the wazoo.

What do we have?

Money out the wazoo.

Move this man to a private room.

It's time for e-trade.

Unfortunately we were embarrassed by the fall

in stock prices, so we had to turn to some way

of maintaining the ego we had just developed.

I think we had a smart response called sector rotation.