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Alan Greenspan lit the fuse of the credit crisis
when he extolled the revolutionary virtues of the
'Net-and redefined risk and responsibility_

By PAUL KEDROSKY

OMETIMES A BRIEF EXCHANGE CAN CAP-

ture an essential truth better than reams of
explanation. That happened recently when a
Financial Times reporter suggested to an in-
vestment banker that the credit crisis had snuck up on
investors and regulators because of how hard people
like him made it to get good information. The banker,
with evident irritation, pointed out that all the infor-
mation you needed was widely available. Why should
he be blamed if nobody paid attention?
It was an eye-opening comment. Financial mavens
have long had access to comprehensive data on credit
markets and subprime mortgages. It apparently didn't

ILLUSTRATION BY E.\llLIAi\'O PONZI FOR NEWSWEEK

25
WORLD AFFAIRS
Collision Course I Therise of the Internet and complexfinancial derivativesturned out to be a toxic combination.
1982: Michael
Bloombergsells
an electronic
desktop terminal
for trading in
securities.
Merrilllynch,
his first cus-
tomer, buys 20.
1983: FannieMae
issues the first
collateralized
mortgage obligation,
makingthe secondary
mortgage market
much more attrac-
tive to investors
and lenders.
cross this banker's mind that the average
LCD-TV-buying consumer can't afford to
shell out $1,700 a month for a Bloomberg.
But in a sense, he was right. The informa-
tion is out there-free, on the Internet.
The Internet has broadly delivered on
its promise to bring information to the
masses. All the information needed to
diagnose the current credit crisis-the lat-
est and best information about the collaps-
ing prices of mortgage securities, balloon-
ing numbers in the subprime mortgage
market, bizarre behavior on the part of
bond rating firms and so forth-has been
freely available to anybody who knows
how to use Google. But what good is it all
if the data went unnoticed?
For more than a decade the Internet
has been hailed as the great democratizer
of information. It was supposed to em-
power individual investors, make murky
financial markets more transparent, and
create a new generation of citizen in-
vestors who were free to put their savings
in everything from the S&P 500 to palm oil
futures. It was supposed to shrink the
world and turn it into a village, where
everything happened in the public square
and corruption and greed would have no
place to hide. As the 1990s mantra goes,
"information wants to be free." The 21st
century was supposed to be the culmina-
tion of this philosophy.
One of the biggest proponents of this
o Which
our bankshavebeenhit
listat hardest?View
xtra.Newsweek.com
26
1988: MCIMail 1993: Thefirst
gets hitched to Webbrowser,
the Internet, Mosaic,makes
the first navigatingthe
commercial Internet as easy
inroad intothe . as pointingand
government- clicking.AIGore
run research pushed through
network. the financing.
1989: Tim 1994:
Berners-lee,a Charles
physicist, creates Bowsher,
the WorldWide the U.S.
Web,whichuses comptroller,
hypertext, or warns that de-
links,to connect rivatives trading
electronic needs oversight;the Fed's
documents. Greenspan disagrees.
change of ... complex financial products
on a global basis." In short, Greenspan
saw that the tandem of the Internet and
fast computers were perfect for splitting
mortgages into tiny pieces, repackaging
them and then shunting them to yield-
hungry investors across the country and
around the world. But he should have
known it would create what his fellow
economists call an "agency problem": Re-
mote owners of teensy mortgage pieces
didn't police loans, didn't worry enough
about loan quality, and were impossible to
negotiate with should a loan become trou-
bled. They just wanted cash flow. And so
the fuse for a future credit crisis was lit.
To be clear, the Internet has done
At the peak of the many important and useful things for the
dotcom bubble, world financial system. Earnings calls are
available to all comers, not just analysts;
Greenspan saw an electronic trading has driven commis-
Internet 'revolution' sions to near zero; trading can happen
wirelessly from anywhere at any time. In-
in finance. vestors can track stock picks and stock
pickers on Web-based scoreboards. These
innovations were long overdue. But by
view was Alan Greenspan. Most econo- accident, the Internet was also an enabler
mists now agree that Greenspan, as chair- of the current credit crisis. It brought us
man of the u.s. Federal Reserve, kept in- together, but it also did the reverse, creat-
terest rates too low for too long. What's ing communities with narrow affinities.
less widely appreciated is his role as a These are often echo chambers where
technology booster. In March 2000, at the people can find others like themselves-
peak of the dotcom bubble, he gave a scrapbook makers or train-spotters or
speech about a revolution being built on builders of exotic new products for the
the Internet. It was transforming finance, now $668 trillion (not a misprint) deriva-
he said, making it possible to "reallocate
risk" via the "creation, valuation and ex-
tives market.
At the same time, in making informa-
LEFTTO RIGHT: 1'1;'1'1
BOYLE-GETTY J:'IIAG~:.s,AP, LARRY DO\VNIl\'G-REUTERS.LANDOV, CATRINA GENOVES~:-
GETTY Ii\IAGES. GETTY IM.-\GES, LARRY DOWNING-CO RBIS, TERRY ASHE- T1J\IE LIFE P1Cl'URES-GE'ITY IMAGES
 1995: Blythe 2000: Green- 2007: BradyDougan
Masters of span persuades becomes the first deriv-
J.P. Morgan U.S.legislators to atives trader to reach
invents credit strip the federal the top spot of a major
default swaps, oversight agency bank.Whenhe became
a method of ofthe power to CEOof Credit Suisse,the
insuring against regulate the grow- companymade eight

--_..
loan defaults. ing market for trades about every four
derivatives. seconds.

1999: The 2001: Country- 2003: Respond-

dotcom bubble, wide begins its race ingto a recession
fueled by 'irrational to the top of the brought on by the
exuberance,' mortgage-lending aftermath of the
bursts, spelling market by designing terrorist attacks of
doomfor many new securities un- 9/11,Greenspan low-
high-flyingtech der looser guide- ers short-term in-
companies. lines. Its revenues terest rates to 1per-
start to soar. cent, a 50-year low.

tion free, the Internet has buried us in
data, keeping most people from seeing the
building credit storm. Rather than turning
the world into a global village of empow-
ered investors, the resulting data fog
helped some Wall Street wiseguys hijack
the global economy as easily as playing
videogames-with instant messages and
trillions of dollars in complex derivatives.
The dotcom crash of 2000 and 2001
may have involved Internet stocks, but
the underlying cause was old-fashioned
"irrational exuberance" (at least Green-
span got that one right). It was a kind of
adolescence period for the Internet. Now,
by contrast, we are in the midst of the first
financial crisis of the mature Internet
age-a crisis caused in large part by the
tightly coupled technologies that now un-
dergird the financial system and our soci-
ety as a whole.
The fiasco raises important questions
about how to regulate financial markets. If
information is freely available, does that
mean the onus is no longer on Wall
Streeters to tell the rest of us what's going
on? What role do regulators play in keep-
ing tabs on all these complex financial
shenanigans?
The Internet has made it possible for
anybody with an online brokerage account
and a broadband connection to become a
global investor, but with that freedom has
come a great responsibility: to know what
you're doing without relying on govern-
ment oversight. And in a world where our
ability to trade exotic financial instru-
J.EFTTO RIGHT: RICHARD SHEINWALD-BLOOL\IBERG
STEPHEN J. CARRERA-AP, SIGGl BUCHER-REUTERS-L-\.!"'DOV,
ments vastly exceeds our ability to under-
stand and value them, that is a very dan-
gerous thing indeed. It behooves us to
pause and take a look at the forces that led
us here, and what we might do to prevent
another occurrence.
The information was out there, and
this problem had been building for years,
so why did no one notice? Part of the prob-
lem is that the relevant data, while avail-
able on the Web, is spread around in a zil-
lion places. You can go to Yahoo Finance
to check the recent share price of Wal-
Mart, its market capitalization and its cur-
rent sales. There is no one free place where
Perhaps $1 trillion
in electronic swaps
are undocumented,
unseen, like virtual
Post-it notes.
you can do the same thing across subprime
mortgages, asset-backed securities, credit
swaps and all the other arcana inherent in
taking the temperature of modern global
markets. Instead, you have to wander from
site to site, sort of like building a jigsaw
puzzle from disguised pieces strewn
around an entire city. It is part treasure
hunt and part puzzle- building.
That's not the end of the problems. In-
formation about financial time bombs,
NEWS·U.NDOV. CHRIS HONDROS-GETTY 1i\IAGES,
ROBERT GIROUX-GEm" IMAGES
like derivatives, is veiled in acronyms that
make you want t{) gouge your eyes out.
(Consider two different measures of the
performance of mortgage securities:
ABX.HE.AA.06-2 and ABX.HE.AA.06-
I-such lovely and lyrical names!) There
is an entire language required to under-
stand this new generation of financial
technologies, from credit default swaps to
collateralized debt obligations to residen-
tial mortgage-backed securities, not to
mention the corresponding three- and
four-letter abbreviations. There's also data
on current account deficits and yield
spreads. Most people, faced with this
tsunami of data, do the only rational
thing: they give up.
The trouble with giving up, however, is
that the world goes on without you. And
one of the obligations of being a citizen in
a free society is vigilance-watching what
is happening in your neighborhood,
whether it's financial or physical. A lack of
regulatory oversight certainly played a role
in the current crisis, but over-relying on
regulators is a dangerous practice. Citi-
zens need to take responsibility. Apathy
and indifference in the face of a complex
and fast-changing world is a path to ruin.
Nevertheless, if the Internet's data
smog has bludgeoned the average con-
sumer into indifference, it has also enabled
traders to act more swiftly and decisively.
Traders, bankers and financial engineers
have built up the mental shortcuts needed
to keep track of a hundred credit default
swap spreads, or 10 favorite bonds to
27
 WORLD AFFAIRS

watch, or myriad structured-mortgage fi-

nance product prices. This generation of
bankers is the first to be truly Web aware, The Pathways of the New Con1 ~-~-~-~--~~~
and they use the technology to the maxi- There was once talk of "decoup ling, " the idea that the RUSSIA
mum. That's meant lower costs and faster
growing surpluses of emerging markets made them Russia wins the prize for the
trading, but it has also helped aid and abet new bastions of stability, protected from financial emerging market worst hit
the current crisis. We have used the Inter- storms in the West. Not now. From Russia to South by the financial crisis. The
net and modern communications tech- stock market has lost two
Korea, emerging -market stocks have plunged, often thirds its value since May.
nologies to create a shadow-banking sys- further than Wall Street, as recessionfiar spreads.
When things
tem, an unregulated lending network that . Year-to- turned seri-
was, by 2007, as large as the traditional date decline ous, the
banking system. It is now shrinking, but Gauging the Damage:
its remnants must be dragged into ~ # ---~---~- - " ------ fered $70 bil-
0' .' 0

the light, with over-the-counter VENEZUELA ~. Kremlin

derivatives pushed onto central
clearinghouses.
Consider that many unregu-
lated financial transactions are
carried out over instant messag-
ing. Want to set up a $100-mil-
lion credit default swap on the
bank of your choice? No problem. Just
lion of-
in soft
Venezuela looks particularly vulnerable as the credit loans to the banking sector
crunch spreads. As oil demand slackens, the price of and pledged government
crude is plummeting, and it closed at a one-year low money for stock buybacks.
Those attempts were sabo-
last week. That has a huge impact on this oil-dependent
economy. Inflation is the highest in the region (more taged by declining oil prices,
than 20 percent), and president Hugo Chavez's popu- which fell below $70 a barrel
larity, already at a low ebb, could fall further. last week. The impact shows
just how dependent the
country really is on oil.

1M a few trader friends at other hedge

funds or banks, propose the idea, and
then seal the deal with whoever likes
--- ---
~~~-~-~~~~ ---
BRAZIL
your terms. No phone conversations, no A month ago, Brazil's presi-
messy paperwork, just a few quick mes- - ~~ - - -~------
dent predicted the crisis
DUBAI
sages and it's done. This kind of easy ac- would produce only "a i'-
cess to peers has turned trading into a ripple" in Brazil. He was
high-stakes, low-documentation video- wrong. On Oct. 16, the Boves- the newly disciplined emerg-'

I
pa index lost more than 11
game, and in doing so it has encouraged
percent, its biggest single-
and facilitated many risky behaviors, like ~~gc~ea;t~e~i~~~~~~il::~O~I~~;,
Dubai
day drop in a decade. The Dubai took
was aonstandout
debts that now ·..•
among 1

having too many overlapping trades to real has slid

keep straight. "I bought credit protection Year-to- 30 percent ~:~::~u~~:~~nd the emirate ~'
on Wells Fargo, and sold it on AIG, so date decline against the able to a Year-to.- ~.
slowdown as date decline "
I'm now hedged! Or did I do both twice
Aug. 1. But the
and accidentally double up? Ooooh!" By o 0' 0

•' bankingsince
dollar system
some estimates close to a trillion dollars
is shielded by
in credit default swaps out there were ultraconservative lending are cooling,
created electronically and are now un- practices (credit accounts and the U.A.E. has announced
documented and little understood.
Think of them as virtual Post-it notes
for just 34 percent of GDP),
and inflation is pinned by
m~~~~r~;s
•
plans to inject $30 billion into ,'.
hawkish interest rates. Brazil crisis. For now
local banks though,
to avert a real
somewhere in the ether, waiting for I"

someone to notice. may still be the emerging $25,000-a-night rooms at the !

market best positioned to new Atlantis resort are still
'STOCK INDEX FOR
The trend toward treating derivatives weather the crisis. THE
getting
UNITED
customers.
ARAB
E.\IIRATES:\S
as a cross between gossip and videogames A WHOLE

is insidious. Trivial conversations over in-

stant messaging can mutate into trades.
Everything gets flattened, with chatter
about the weather right alongside setting swaps. While it would make for boring a smart and savvy quantitative finance
up a $100 million default swap. What television, the race is terrifYing as hell if guru, the site's forums have long been a
matters when everything looks the same you're part of it. hotbed of discussions about engineering
and is bookended with a happy face? While the Web reduces economy- financial instruments. Back in 2005,
In recent months most firms have raced wracking derivatives to the level of a when swaps were newer and really
to get this derivatives mess under control. quick 1M chat about baseball, it also al- booming, if you wanted to get in on the
Company CEOs and boards have all read lows people to find and support one an- action you could just post a message
the stories about there being in excess of other, whether they are history buffs or there and wham, within hours, if not
$50 trillion in credit default swaps out financial engineers. Just as it's easier to minutes, you'd have a host of people
there, and they are in blind panics to un- find fellow fans of the Flying Banana, it steering you to working papers, re-
derstand their financial risks. They rightly is easy to find someone who can quickly sources and all the latest information on
see it as a race between them getting their steer you through creating a collateral- building your own bomb. There's noth-
derivative exposure straight, and owing ized debt obligation. Just head on over to ing wrong with hosting an online discus-
billions on defaulting companies to which the forums at financial engineering sites sion forum about finance. But without
they are overexposed because of ill-hedged like Wilmott. com. Run by Paul Wilmott, the help of forums and related resources,
28 NEWSWEEK I OCTOBER 27, 2008
 SOUTH KOREA at least make sure you know enough not
South Koreansthought it couldn't happen again.They to be surprised.
had workedso hard at reform after the collapse of Instead of gwmg everyone a
their currency in1998.But last month Bloomberg workstation, we can ask that
Year-to-

the wonfell20 percent, as Koreans
datedecline
began hoarding U.S.dollars in their
home safes, fearful ofthe globalmar-
"ket swoons.Thefirst current account
deficit in a decade nowlookscertain.
Andthe ghosts of '98 are back.
•'
our personal-finance providers build us a
better dashboard over the Web. We need
,, , , something that lets us know more than
the balance of our 401(k)s, something
that connects us to the ebb and flow of
live financial markets around the world.
It wouldn't be hard. No new technology is
required-people just need to demand it
(loudly). All that is required is our active
interest in making sure that the world
doesn't come down around our ears. We
are part of this system, and we need a
window into it.
One window must look in on what
goes on between traders-including in-

Without the Net,

I'
Indiafigured it was immune,too, before the foreigners
started fleeing and the layoffsbegan. Firedemployees
of GrazianoTrasmissionimurdered the
Year-to-
CEO.Jet Airwayshired back 1,900
datedecline workers after stewardesses staged
rallies in stiletto heels. Prime Minister
ManmohanSinghurged the Westto
consider the developingworld in its
rescue plans.
SOURCES:
most of which never really see the light
of day, the credit innovations (and I use
that word advisedly) that helped spur the
current crisis would never have gotten
off the ground so quickly.
The Internet, of course, is just a tech-
nology, to be used for good or ill. Is there
a technological fix that would help pre-
vent a similar mess? One of the ways of
averting the next crisis is to make the In-
ternet better at consolidating informa-
tion. Right now when you go to financial
sites you are deluged with information
about stocks and major market indices,
plus some news headlines, and on and
AN
Japan shows howAmerica's
subprime credit is taking
downevenmarkets that had
little exposure to subprime.
Mostbanks still boast solid
balance sheets thanks to the
discipline
learned after Year-to-
the Asianfi- datedecline
nancialcri-
sis. Unfound-
ed fear for
the financial
sector is nowmorphinginto
more realistic fear about the
"real economy,"whichwillbe
hurt by a globalslump. On
Oct.16,the Tokyomarket saw
its biggest one-day drop in
20years-11.4 percent.
YEAR-YO-DATE STOCK MARKET PERFORMANCE BASED ON MSCI
on. What if, instead, you saw something
akin to the dashboard of a car-with dials
and knobs corresponding to what's going
on in credit markets, derivatives, com-
modities and stocks. Instead of giving
endless tables-the sort ofthing that used
to clutter newspapers-imagine heat
charts (red is bad, green is good) and
simple graphs. The financial dashboard
would interpret information: here is what
is currently working properly in financial
markets, here is what isn't, and here is
what you should be terrified about. If
you want to know more you can click and
find out. A well-designed dashboard will
many of these credit
innovations would
never have launched
so quickly.
stant messages. By all means let the 20-
something traders set up derivative trades
via 1M-just make sure all the trades take
place in full view. Compliance regulations
from the SEC and the exchanges already
force messages to be archived, but firms
need to do a better job of making trades,
however they happen, go straight from
private electronic channels onto public
exchanges. We simply can't have opaque
financial instruments traded via 1M
turn into trillion-dollar markets that no
one understands or can see. No more
"whoops!" should be allowed. Instead, the
solution is to use the Web to force the out-
comes of traders' actions into the open,
even if their private conversations them-
BARRA'S COUNTRY INDICES
selves remain private.
Instead of helping cause a financial cri-
sis, next time around the Internet needs to
be part of the solution. And it's up to us-
engaged citizens, at least as much as gov-
ernment and flawed regulators-to make
sure change happens long before the next
inevitable financial crisis breaks. We can
use technology to make financial markets
safer. And that includes making them safer
from the collateral damage of Alan
Greenspan's irrational exuberance for
risky financial technologies.
KEDROS KY is Senior Fellow at the Kauffinan
Foundation and an adviser to institutional
monq-management firms. He edits the blog
Infectious Greed (paulkedrosky.com).

NEWSWEEK I OCTOBER 27, 2008 29