hopefully ease the transition to the next expansion.‘‖ This conclusion was based on the view that the degree of uncertainty about the nature of the economic environment in which monetary policy was operating had significantly risen owing to a number of structural economic changes, in particular rising productivity. Consequently, Greenspan advocated an approach to monetary policy that basically viewed the risks of intervention in potential bubbles to significantly outweigh the benefits. This view was based on an extremely optimistic assessment of the American economy and its long-term prospects driven by deep and positive structural change.

81. The Fed Chairman‘s statement that it was not possible to know a priori whether a bubble existed and it was therefore only possible to intervene ex post created the so-called ―Greenspan put‖, essentially a belief among traders that the government would always bail out traders that needed to be rescued after a bubble had burst, but not intervene to stop it from rising.<sup>56</sup> So, effectively the Fed was providing insurance against the possibility of a market crash, a situation referred to as ―meta moral hazard‖ by Miller, Weller and Zhang (2002).

82. Miller et al. cite evidence for such a meta moral hazard from: (i) a small survey of major fund managers and chief economists in London and New York carried out in early 2000 and (ii) a national opinion survey by the Securities Investor Protection Corporation (SIPC) of more than 2,000 individual investors. The former investigated the hypothesis that ―confidence in an everincreasing stock market is due to the belief that monetary policy will be used to support the market and that corrections will elicit reductions in interest rates until the market turns around‖. The result was that respondents believed that the Fed reacted more to a fall of the stock market than to its rise, and all except two believed that this type of reaction was in part responsible for the high valuations on the U.S. market.<sup>57</sup> It was this rather asymmetric conduct of the monetary authorities that reduced the risk premium and played a key role in lifting the whole market. It was as if investors came to believe that diversified equity instruments were insured subject to a deductible, i.e., with a market floor somewhat below current prices, but no ceiling.<sup>58</sup> In the particular case of the subprime market, the Fed refused to intervene in the market even after the Fed had received relevant warnings.<sup>59</sup> The subprime market was considered to be a good thing, the natural consequence of letting markets go free.

83. The system resulting from these financial innovations was characterized by (i) lack of transparency; (ii) underestimation of risk; and (iii) lack of understanding about how new

> 56 Financial Times, January 4, 2001.

> 57 Cecchetti et al. (2000): p. 75.

> 58 Miller, Weller and Zhang (2002) provide empirical evidence for a decline in the risk premium. Survey was conducted by the company Securities Investor Protection Corporation (SIPC).

> 59 “For example, Bronx-based Fair Finance Watch commented to the Federal Reserve about the practices of now-defunct non-bank subprime lender New Century, when U.S. Bancorp bought warrants for 24% of New Century's stock. The Fed, rather than take any action on New Century, merely waited until U.S. Bancorp sold off some of the warrants, and then said the issue was moot.” Quote from Inner City Press of September 28, 2008.

57