See Alan Run

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Greenspan: What is he running from?

Alan Greenspan doesn't hurry often-- at least not in front of the cameras. But a few weeks ago the paparazzi caught the cucumber-cool Fed chairman hustling across Constitution Street in Washington, dodging traffic on his way to announce the Fed's first interest-rate cut in three years. Wall Street had seen it coming, and in New York the markets yawned. But Greenspan wasn't done running. He cut rates again on Thursday without waiting for the next Fed meeting, a dramatic move that caught Wall Street off guard. It was almost unprecedented in Greenspan's term as helmsman of the U.S. economy. If the Fed has a big red panic button, this was it: Clearly Father Greenback had seen something that couldn't wait for November 15. But what?

The Fed isn't saying, exactly. But the safe bet is that Greenspan believes U.S. banks are in trouble. Big trouble. Maybe on the brink of a disaster to rival that of the S&L crisis (and subsequent government bailout) of the late 1980s. "The Fed did an internal investigation to see how much exposure the banks had to hedge funds and other high-risk investments," says TIME senior economics reporter Bernard Baumohl. "The cut was a clear signal that conditions are more severe than most of us realize."

In the '80s it was junk bonds; this time it's derivatives. Buying a derivative is taking a bet -- called an option -- on the price of a stock at some future point. The plutonium of the financial world, derivatives are complex financial instruments that, in steady economic times, can churn out megatons of money for investors. Bet badly, though, and you get a meltdown. When Long-Term Capital Management, a high-risk, high-rolling hedge fund based on the formulas of two derivatives Nobelists, went belly-up last month, Greenspan realized that the damage wasn't restricted to the brandy-and-cigars crowd. Banks and financial institutions were deep into hedge funds, and when Merrill Lynch or BankAmerica takes a $100 million hit, a lot of ordinary folks -- from bank customers to businesses to a homeowner looking to take out a second mortgage -- get contaminated.

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