In his testimony before the US House of Representatives, former Federal Reserve chairman Alan Greenspan said: “We are in the midst of a once-in-a-century credit tsunami.” He denied responsibility for the current global meltdown in equities and commodities and predicted that the United States would emerge from the current credit crisis with “a far sounder financial system.”

His remarks did not faze investors at home, and the Dow index rose 3.0 percent. However, it caused a massive sell-down everywhere else. The next day, Hong Kong’s Hang Seng index dropped 8.3 percent, Japan’s Nikkei 9.60 percent fell to a 16-year low, the euro zone market went down 5.0 percent, the Saudi Arabia market dropped to a four-year low, the Nasdaq to a 5.5-year low, and the Kospi down 10.6 percent on Friday.

Worst week

It was the worst week that anyone can remember.

The commodity markets have also suffered severely with copper plunging from $4 a pound to $1.79 in 18 months and nickel plummeting 80 percent from $25 a pound to less than $5. What is worse is that the commodities index has tripled and looks as if it could fall further. Part of the reason is that Beijing closed its factories ahead of the Olympics to prevent air pollution and as a result stockpiled large amounts of metals. The factories have reopened and the surplus stockpiles should be exhausted by Chinese New Year.

Some recovery in commodities is therefore expected but they will not return to their highs because the Chinese economy is slowing.

Greenspan is shocked and doesn’t know what went wrong with his economic model. I think greed and gross misrepresentation caused the problem perpetrated by Wall Street and the people associated with it. Let us start with the real estate brokers who sold naive investors homes with adjustable mortgages. For one or two years, they paid two-percent interest, which they could afford, but after that the interest rate tripled they were unprepared for that and it was often beyond their ability to pay.

Major cause

The real estate brokers worked on commission so they didn’t care and the banks did not properly scrutinize the documents, as they wanted to lend. There were many homeowners who bought a house and when it appreciated sharply in value, they were advised, again for commission, to take out a second mortgage.

These subprime mortgages have to be a major cause of the meltdown in house prices and the 80,000 foreclosures that took place last month. Of course, you might argue that the fault was with the buyer who was not financially savvy, and I would agree with you, but sadly people who trust their advisers too much are often taken advantage of.

Stockbrokers kept telling their clients to buy and impressive circulars issued by their research departments backed this up. The brokers also work on commission and they would only tell their clients to sell if there was a good profit and an alternative investment in which to reinvest. The research departments never sent out sell recommendations because the companies would never again talk to the analysts.

Even now, 98 percent of all recommendations of US brokers are buys! As most investors balk at cutting losses (big mistake), they end up losing heavily in markets like this. The only analysts who can tell the truth without fear of the consequences are technical analysts. They are not interested in the companies, only in their charts.

The rating agencies aided and abetted the stockbrokers by giving higher ratings than many companies deserved and not cutting them until it was far too late. My comments regarding stockbrokers also apply to commodity traders and forex trades where clients rely on them for advice. They all work on commission and sometimes performance fees.

Hedge funds work the same way using higher leverage to increase income and they get huge salaries and 20 percent of the profits. The exotic derivatives, which were designed to protect risk are misused and years ago, a single trader, bankrupted Barings, a bank that had been around for 100 years.

Derivatives

The only derivatives I endorse are options. These allow you to buy or sell shares for a cost of five to 10 percent, depending on the time frame and if the trade goes wrong, that is all you can lose. On the other hand, if you hit the jackpot, your profit can be many times your option premium. Mining companies use options to protect their selling prices for a year or more ahead whenever they feel that they are vulnerable. They pay a premium for the privilege of doing a put option but it secures their profit during that time period. Philex Mining uses hedging on copper and possibly gold. I was an option trader in London for three years, so I understand the concept very well.

Another major cause of the financial crisis were credit swaps in which a buyer makes a series of payments to a seller in exchange for the right to a payoff if the credit instrument goes into default. The problem is that these swaps pass from person to person so when trouble comes, there is no connection between the buyer and the seller. There are currently $58 billion swaps at sea and they are impossible to trace. They should be abolished permanently and will probably never be sorted out.

In that excellent movie, “Wall Street,” the villain Gekko says, “Greed is good.” To sort out this mess will take a long time and with the election only a week away, there will be a bipartisan stimulus package of at least $150 billion to tide people over and possibly another rate cut. Time is of the essence in trying to save people from losing their homes but the period from the election to the swearing in of a new President is 11 weeks, far too long.

If credit swaps and adjustable mortgages are abolished and brokers, real estate salesmen, banks and rating agencies regulated, I agree with Greenspan that we will emerge leaner, fitter and more efficient than before. It will mean a lot of effort by the regulators but with Bernanke as Fed chairman, he can guide them through the maze.

I would like to thank readers for their advice on my computer. After six months of calling DSL and getting no help, my article caused the company to send a repairman and I have no more problem. This confirms the saying, “The pen is mightier than the telephone.”

Today, the market went limit down at 10 percent for the first time ever and ceased trading for 15 minutes but it continued to decline in thin trading. There are rumors that a large pension fund is selling its portfolio.