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Contrarian Chronicles6/30/2008 12:01 AM ET

The end of the superbubble

That sound you hear is the popping of a financial bubble in housing, the economy and the market. And you can trace it all to Alan Greenspan's Federal Reserve.

By Bill Fleckenstein

Reading the papers, it's quite clear that the enormity of the problems facing Americans (and the world, for that matter) has emerged to the fore. Consequently, I decided a quick recap of our troubles might be useful.

There is a budding realization that the housing bubble's collapse will be more difficult than the masses and Wall Street had believed. You could see this last week as the market moved back toward the lowest levels since the collapse began last fall.

It's now obvious that this is a problem not only for the consumer but for the financial system itself, which is in dire straits as it tries to deleverage, thereby compounding the problem.

In addition, it has become common to see stories about runaway inflation somewhere around the globe, with riots and protests against high food prices being a binding theme.

A magnificent mirage unmasked

For quite a while, many believed that because sovereign wealth funds were deemed to be flush with money, the banks and brokers could just grab some capital from overseas investors and cash-rich nations and go back to doing what they had done before. That has clearly turned out not to be the case.

However, leverage is quite capable of creating the illusion of liquidity. Thus what many had seen as excess liquidity was simply massive leverage, which is now being unwound. (The surfeit of savings, which is what "liquidity" alludes to, never existed.)

All of these problems trace their roots to Alan Greenspan's years at the head of the Federal Reserve.

What began as small bailouts along the way ended with the blowoff of the stock bubble in March 2000. In an attempt to ease the effects of the bubble's collapse, interest rates were taken to the absurdly low level of 1% and held there far too long. That engendered a housing bubble, which was nourished by the abdication of lending standards in the banking system -- as securitization, spearheaded and championed by Greenspan himself, and deregulation of the banking system were thought to be the solutions to any imbalances.

Meanwhile, the aftermath of this housing/credit bubble is far different from that of the stock bubble. Now the lending institutions are swimming in bad debts. Homeowners have mortgages they can't pay, just as the assets (houses) behind those debts are dropping in price.

As if that weren't enough, consumers' paychecks are eroding, thanks to galloping inflation created by the money printing that fomented the housing bubble (and by the credit that Greenspan's replacement, Ben Bernanke, has subsequently thrown in to ameliorate the aftermath).

Behold the wretched beast he created

The truly sad part is that this outcome was foreseeable.It was possible to anticipate a catastrophe of such dimensions even when the housing boom was still in full swing. Unfortunately, the very institution that had the regulatory authority to supervise the banking system was the one leading the cheering -- namely the Fed, in the form of Greenspan. (That was sort of like putting a bartender in charge of adjudicating disputes over breathalyzer readings.)

The collapse of the housing bubble is taking the economy with it and pressuring the stock market as well. Thus we will have all three markets feeding on each other as each deteriorates.

Video on MSN Money

Judging Bernanke
Bill Fleckenstein, the author of "Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve," and Jack Malvey of Lehman Bros. discuss Ben Bernanke's job as Fed chief.

Unfortunately, the Fed is going to be faced with a Hobson's choice: trying to respond to that triple threat while its hands are tied, to some degree, by inflation. When push comes to shove, the Fed will choose lowering interest rates over fighting inflation, but it won't matter.

In his latest book, "The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means," George Soros makes the case that we are witnessing the end of a 25-year superbubble.

I certainly agree with his observation and would note that the time frame of this superbubble roughly approximates the career of Alan Greenspan, who in my opinion was responsible for its creation -- and the enormous pain caused by its collapse.