However, while it's true that Greenspan and the Wall Street mandarins knew full well how the bubble-game was being played; they had no intention of blowing up the whole system. They simply wanted to inflate the bubble, make their obscenely huge profits, and get out before the inevitable crash. But, then something went wrong: When Lehman collapsed, the entire financial system suffered a major heart attack. All of the so-called "experts" models turned out to be wrong.
Here's how it went down
Before the meltdown, the depository "regulated" banks got their funding through the repo market by exchanging collateral (mainly mortgage-backed securities) for short-term loans from the so-called "shadow banks" (investment banks, hedge funds, insurers). But after Lehman defaulted, the funding stream was severely impaired because the prices on mortgage-backed securities kept falling. When the bank-funding system went on the fritz, stocks went into a nosedive, sending panicky investors fleeing for the exits. As unbelievable as it sounds, no one saw this coming.
The reason that no one anticipated a run on the shadow banking system is because the basic architecture of the financial markets has changed dramatically in the last decade due to deregulation. The basic structure is now different -- the traditional stopgaps have been removed. That's why no one knew what to do during the panic. The general assumption had been that there would be a one-to-one relationship between defaulting subprime mortgages and defaulting mortgage-backed securities. That turned out to be a grave miscalculation. The sub-primes were only failing at roughly 8 percent rate when the whole secondary market collapsed. Former Treasury Secretary Paul O'Neill explained it best using a clever analogy. He said, "It's like you have 8 bottles of water and just one of them has arsenic in it. It then becomes impossible to sell any of the other bottles because no one knows for sure which one contains the poison."
And that's exactly how it happened. The market for structured or packaged debt crashed, stocks began to plummet, and the Fed had to step in to save the system.
And now, unfortunately, that same deeply-flawed system is being rebuilt brick-by-brick without any substantive changes
The Fed and Treasury support this effort because, as agents of the banks, they are willing to sacrifice their own credibility to defend the primary profit-generating instruments of their industry leaders (Goldman, JPMorgan, etc.). That means that Bernanke and Geithner will go to the mat to oppose any additional regulation on derivatives, securitization and off-balance sheet operations -- the same lethal devices that triggered the financial crisis first time around.
In conclusion, there was no conspiracy to blow up the financial system, but there was, and still is, an implicit understanding that the Fed will serve the interests of Wall Street by facilitating asset bubbles through "accommodative" monetary policy and by opposing regulation. It's just "business as usual." And it's far more damaging than any conspiracy because it ensures that the economy will continue to stagnate, that the gigantic upward transfer of wealth will continue without pause, and that the chasm between rich and everyone else will continue to grow.
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