Greenspan’s about face on regulation

About time.. Not so long ago, he was a hero. Perception can change rapidly..

We’ve argued that the single most important reason for the present financial mess is under-regulated (a preponderantly Republican sin), or badly regulated (more likely a sin by the Democrats) financial markets, stemming from what we called ‘market fundamentalism‘, the belief that markets are not a means, but an end, and that they regulate themselves, basically.

Greenspan has been a major proponent of this belief (only read numerous Krugman columns bundled in the book we promote on the right side of our website). As such, and because of his position as Fed chairman, he shares more blame than most.

Greenspan Admits Flaw in Regulation Stance (Update)
Lauren Tara LaCapra

  • Former Federal Reserve Chairman Alan Greenspan told a congressional committee on Thursday that the financial crisis is a “once-in-a-century credit tsunami” on Thursday and acknowledged “a flaw” in his perception of the boom period that he oversaw as Fed chief.
  • Greenspan has received much criticism for supporting low interest rates and lax regulation, which helped fuel the subprime lending spree that led to the current economic malaise. The former Fed chief noted that he raised concerns in 2005 that prevalent risk-taking could have “dire consequences,” but said he did not expect the level of panic that has occurred.
  • “This crisis … has turned out to be much broader than anything I could have imagined,” he said in remarks to the House Committee of Government Oversight and Reform. “It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount. Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment.”
  • Legislators hammered away at Greenspan, criticizing his laissez-faire ideology and his failure to predict how excessive risk-taking on risky mortgage securities and their complex derivatives could create a financial meltdown. Committee Chairman Henry Waxman (D., Calif.) pointedly asked the former Fed chief whether he was wrong, and Greenspan acknowledged that he had been “partially” wrong about the need to regulate credit-default swaps.
  • Greenspan predicted a rough road ahead for the U.S. economy, as consumer spending further contracts, lending standards remain strict and home prices continue to fall for at least “many months.” Greenspan said he was in “a state of shocked disbelief” that his theory about lending institutions was flawed. He believed financial firms would act responsibly on their own to protect their viability and shareholders’ interest.
  • Instead, strong demand for securitized subprime mortgage loans led lenders to believe that the market liquidity did not expose them to great risk. Greenspan noted that credit-ratings agencies also failed to see the ensuing storm once that liquidity dried up. That caused more uncertainty about securities’ pricing and quality, as more delinquencies, defaults and foreclosures stacked up.
  • To counteract this trend, Greenspan said it will be necessary to require institutions that securitize mortgages to “retain a meaningful part” of those assets. While other regulatory changes are needed, Greenspan predicted that they will “pale in comparison” to the impact that the market’s own aversion to risk and tightened standards will have.
  • While lawmakers were quick to point out Greenspan’s role in inflating the housing bubble, others say there is plenty of blame to go around.
  • Indeed, the failed mortgage-finance giants Fannie Mae and Freddie Mac were government-supported entities whose main objective was to promote homeownership to low-income and minority Americans. The GSEs were pushed by lawmakers to loosen standards and buy riskier mortgages whose debtors may not have documented their income or provided other evidence that they could afford the home.
  • “That’s one of the gross misperceptions here,” says Rich Yamarone, director of economic research at Argus Research. “You have these lawmakers waving their fingers at [Greenspan], but they’re the ones who adopted all the policies that turned into this. When do we get to turn the tables and wave our fingers at the lawmakers who allowed anybody who wanted to have a home to buy a home — whether they had a job or income or anything else?”
  • Yamarone says he has “the highest respect” for Greenspan because he did “an incredibly great job,” but adds that “to think he could sidestep any blame for this, that would be inappropriate.”
  • Rep. Ron Paul (R., Texas), a free-market conservative and former presidential contender, goes a step further to say that the existence of a federal bank that sets monetary policy — rather than the market setting interest rates itself — is flawed. Paul says the housing bubble was “preventable,” but that the Fed and Congress created the financial crisis because they set “artificially low interest rates” while “insisting that subprime mortgages should be made.”
  • “I don’t think he offered any solutions and I don’t think he admitted that he caused all the trouble,” Paul says of Greenspan’s testimony. “I think it’s more of the same.”
  • Robert Shapiro, chairman of Sonecon and former undersecretary of commerce under President Bill Clinton, says that as Fed chairman, Greenspan undoubtedly knew that the demand for securitized mortgages was “based on a bubble” and that risky assets were being purchased with excessive leverage.
  • Indeed, some of the country’s biggest financial institutions, including Bear Stearns, Countrywide Financial, IndyMac, Lehman Brothers, Fannie, Freddie, AIG, Merrill Lynch, Washington Mutual and Wachovia, have collapsed or been rescued due to the enormous burdens of housing-related assets.
  • Stronger firms like Bank of America, JPMorgan Chase, Citigroup, Morgan Stanley and Goldman Sachs are still standing, but also suffered losses as a result.
  • Shapiro says the “single most important thing” Greenspan could have done as Fed chairman would have been to “go to Congress and Treasury and insist that these derivatives be regulated and that there be capital requirements for them and for the purchase of securitized mortgages.”
  • Still, Greenspan on Thursday took effort to lament the need for stricter regulation, as well as the loss of the subprime mortgage market, which opened the doors of homeownership to citizens otherwise barred from that American dream. But he also predicted that once the crisis passes, the country will “reemerge with a far sounder financial system” without the risky financial instruments that helped cause the decline.
  • “The financial landscape that will greet the end of the crisis will be far different from the one that entered it little more than a year ago,” said Greenspan. “Investors, chastened, will be exceptionally cautious.”