Alan Greenspan, We Hardly Knew Ye

In what has to be the most shocking ideological shift caused by the American sub-prime lending crisis, Alan Greenspan has tentatively reversed his position on the ability of financial institutions to regulate themselves.  A stalwart defender of the free-market and deregulation during his 18-year tenure as chairman of the Federal Reserve, Mr. Greenspan testified on Thursday before the House of Representatives in order to stem the tide of criticism obviously heading his way.  His comments come as a deft blow to advocates of permanent market deregulation, who have steadfastly relied on his reasoning and argumentation to advance a variety of equity-generating mechanisms now under intense fire.

Mr. Greenspan began his testimony by reading a prepared statement to the House Committee on Government Oversight, chaired by Henry A. Waxman of California, in which he acknowledged that an excess of demand for the “securitization of home mortgages” was “undeniably the original source” of the market collapse.  He continued that it was the failure of institutions to properly assess risk to credit-default swaps, part of the nascent culture of credit derivatives on Wall Street, that ultimately inflated the housing bubble to its catastrophic size.  In his statement, a paltry 4 double-spaced pages, Mr. Greenspan spent most of his words trying to divert a great deal of the blame away from himself, reminding everyone that he had “raised concerns that the protracted period of underpricing risk…would have dire consequences” in 2005.  After nearly two decades as the most powerful and well-respected economist in the American government, such comments can only be viewed through the 20-20 lens of hindsight.

Perhaps the most telling line of Mr. Greenspan’s prepared statement occurred when he placed his fundamental belief in the sustainability of self-interest into question.  He said, with reverberating echo, “those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief.”  Indeed, when watching your professional legacy turn into a Jimi Hendrix lyric – “and so castles made of sand / collapse into the sea / eventually” – one is usually confined to that position.  Who would have thought that hedge fund managers and their ilk, squeezing every penny out of the American economy, would bankrupt it?  Allow me to fake shock for a moment.

The real blow to deregulation advocates, however, came during a heated exchange, at Mr. Waxman’s prompting, that followed shortly after these initial comments.  Mr. Greenspan tensely explained, “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” Making reference to his underlying economic philosophy, Mr. Greenspan continued: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”  Mr. Waxman immediately jumped on him, demanding a further explanation.  “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.  “Absolutely, precisely.  You know, that’s precisely the reason I was shocked,” Mr. Greenspan responded, “because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

I think I speak for everyone when I say, “Whoops.”

I suppose that Mr. Greenspan lost sight of the real powers intrinsic to the markets – fear and greed.  Neither of those emotional states are conducive to a healthy individual or a society not in decline.  For sure, risk assessment and pricing are necessary to the continued functioning of a complex economy, but not without the oversight of knowledgeable social scientists in the government.  I think that Andrew Lahde, a hedge fund manager who recently decided to quit amidst the firestorm, put the viewpoint of investors during the reign of Mr. Greenspan best into focus.  He summed up his personal role in the American market in a resignation letter to his investors: “I was in this game for the money…I have enough of my own wealth to manage.”

I feel the cold hand of history on my back.

20 thoughts on “Alan Greenspan, We Hardly Knew Ye”

  1. The free-market may have produced these needlessly complex and deceptive financial instruments, but what about the regulations themselves? Fannie and Freddie are government organizations, they are instruments of regulation/manipulation. Greenspan isn’t rejecting the free market: he’s saying that banks and financial organizations could not protect their equity and shareholders by themselves. He didn’t address the environment under which they couldn’t protect themselves.

    Clearly sensible regulation would have helped. I’m simply stating that this isn’t a fundamental flaw with the free market. Rather: it’s a fundamental flaw with the way the economy functioned.

    The good Dr. Ron Paul, a more staunch advocate than Greenspan for the free market, predicted all of this stuff in the late 1990s.

    As the top comment in that article states: “[Ron Paul’s] level of predictive power doesn’t come by mere guesswork. It can only be the result of taking a sound principle to its logical conclusion. Paul’s economic principles are looking pretty sound about now.”

  2. It’s still not clear to me how Greenspan’s testimony is a blow to libertarians and deregulation advocates. The regulation/deregulation narrative, though an easy talking point, is glaringly incomplete.

    Financial markets in the United States have been and continue to be heavily regulated. Fannie Mae and Freddie Mac (two of the most heavily regulated companies in the country) were some of the biggest failures. Investment banks (also heavily regulated) were hit hard while hedge funds (lightly regulated) have not done demonstrably worse. On an international level, some countries with far more government involvement in their economies have suffered as badly if not worse than the United States (see: Iceland).

    In other words, the claim that a lack of regulation is at the root of this crisis does not hold up under scrutiny. Greenspan’s testimony is an indictment of the current regulatory environment, but that doesn’t mean it’s an indictment of free markets. We have plenty of regulation, just not good regulation. Unfortunately, given that government intervention played a large role (though not the only role) in this crisis, I am pessimistic that we will see simpler, more sensible regulation come from those knowledgeable government social scientists who have put our current rules into place.

  3. RE: Walter and Chubby (or anyone else with an opinion,)

    Could you provide me with examples as to what sort of institutions you find appropriate to regulate, and what should be left alone by the government?


  4. Re: Walther

    There are a few distinctions that need to be drawn out from your comments.

    First of all, credit derivatives suffered from a lack of any substantive regulation. The problem is clear cut – mortgage backed securitizations did not properly price their risk when dealing with subprime lending and no one made them do otherwise. That is a problem of no regulation. Hedge and mutual funds all over the world bought into these “risk steals”, as Greenspan put it, and that is why they all collapsed when the housing bubble burst.

    Second, Fannie and Freddie were “highly regulated” in the sense that they were both subject to a lot of (quantitatively) regulation. They were not, however, properly regulated (qualitatively). Read anything about the CEO of Fannie – he wanted to give houses to everyone and Congress pressured him to do so. My argument is not that there is no such thing as “bad regulation” – there clearly is and both he and Congress engaged in it. Fannie and Freddie should have been “better regulated” to disallow Alt-A mortgages, as Greenspan noted in his comments to the House.

    Both are problems of a lack of any or good regulation. All regulations are not created equal.

    As you and I both know, there is nothing wrong with the “free-market” ideologically, because it is economic utopia. That, however, does not exist. There are only problems with the way the market functions, as you put it, because it exists in reality. My argument is that in order to move us closer to a perfectly free-market, we need to regulate well to prevent bubbles from bursting and collapsing our economy in the meantime. This is an important distinction – one that Ron Paul clearly grasped. I believe that our arguments are actually quite similar, if not identical. Greenspan failed to realize that regulation of credit derivatives was a necessary step in their nascent development, something he has now openly admitted. In other words, as usual, we are saying the same thing with different ideas.

    Re: Chubby Funster

    I am in no way commenting on libertarianism – I think there is a fundamental difference (I’m starting to sound like Obama) between the individual right to freedom and the duty of the government to regulate economic transactions that can be highly detrimental to the population without their knowing participation.

    My comments to Walther apply to your argument about Fannie/Freddie as well. I would like to add that hedge funds, which you are correct in pointing out, were almost entirely unregulated, but they are NOT doing well. Hedge funds are crashing all over the place. Over two hundred have gone under so far, according to the New York Times.

    You can find that article here:

    The only reason that more haven’t bitten the bullet is because they have accrued so much cash that they can weather the storm. That only demonstrates that they sucked enough liquidity out of the economy to allow them to survive, while others take the hit, at least in the short term.

    Like I said above, there is such a thing as bad regulation. There is also good regulation, as you duly note. Iceland clearly engaged in horrible regulation, letting their Treasury invest heavily in extremely high risk mortgage backed securitizations. I’m sorry if I made the issue appear too black and white, but I usually write to spark discussion.

  5. So if I can sum up this discussion: we should not have bad regulation we need to have good regulation. When there is too little regulation, banks take too much risk. When there’s too much regulation, government insitutions run wild.
    So we’re loooking for a mix–half black, half white–barack obama?

  6. If that’s all you took away from this, let me try again.

    Credit derivatives and other equity generating mechanisms like mortgage backed securitization that detach themselves from the actual assets they deal with need to be monitored by the federal government/SEC.

    Lending for housing also needs to be regulated, but in a way that does not significantly underprice risk or allow for subprime alt-A mortgages.

  7. right. that’s what I said with some more specific details. HOWEVER, if you want to get nitty-gritty, what does “monitor” mean? Does that mean have credit agencies assign risk values to them? because that doesn’t work. Mooty’s and S&P’s credit agencies have failed miserably, maybe because they are too closely linked to the companies and the assets they are rating?

    I think the premise behind CDS is absurd and needs to be eradicated. It’s a way to gain a lot of liability and is the root evil beyond this FIN crisis.
    Let me explain: Firs there is about 62 trillion dollars of “value” in CDS just so everyone understands the scope of CDS. With CDS, buyers pay premiums to sellers the same way you and I pay for health care insurnace. A small amount of money each period to help offset the cost in case of an emergency. So eseentially I will have a “co-pay” and entreprises will have a certain premium as well. But even non-stakeholders of the asset can buy into this program. That’s the same as health care companies telling my friend that they can pay a co-pay too and if something happens they’ll get a deductible too. So insurance companies essentially got greedy and believed their assets were so non-risky that they could just recieve premiums without any risk of having to dish out the cash if the asset defaults. So stooopid. When they did, they flopped. e.g. AIG.
    I think in any situation this is dangeruos, even if there is more monitoring by the SEC.

    I do agree that lending for houses need to be closely regulated. People who cannot afford a three bedroom for themselves and two children need to maange with a 2br. Stop giving out hosues to those that can’t afford it.

  8. Yeah – you’re probably right about the need to ban credit derivative swaps. Could that even happen?

    Regulate/tell people no – same difference with housing.

  9. Re: Anthony,

    Thanks for your response. To clarify the hedge fund point, I meant to say that hedge funds have not done demonstrably worse than the heavily regulated sectors of the financial, not that they haven’t done worse then their historical returns. The article you linked to notes that the average fund is down 17.6% this year. Given that the market as a whole is down something like 40%, this is a relatively good return.

    I wrote my first response in large part because the rhetoric your piece appeared similar to other articles in the blogosphere purporting that the current financial panic was caused by free market ideals or by libertarians. (For an example, see: Your response indicates you reject this monocausal view in favor of a more nuanced perspective. If that’s the case, than our respective positions may very well be closer than I first thought.

    That said, I still think you (and nobutta) have a unfounded belief that government and regulation will perform much better in the future than it has in the past in regards to the housing market. Regulation isn’t as straight forward as it seems (an excerpt from an interview with Warren Buffett demonstrates this nicely Government should get out of the housing sector.


    Re: Write Wing

    That is a broad question and I won’t be able to do it justice in a short response. I am okay with regulation if it can help correct a market failure, though that I also understand that regulations can be, and quite often are, more harmful than beneficial.

    One example I would point to is the drug approval process in the United States. I believe that the FDA has done more harm than good over the last 40 years, despite the good intentions behind it. Another would be the hugely inefficient CAFE standards put in place for cars and trucks (the same goals could have been advanced much more easily with a gas tax).

  10. Re: Chubby Funster

    I think that my position on government-economic regulation can be summed up fairly easily. The American/global economy is far too complex and vast for any individual or institution to have a legitimate grasp on all of the causal factors in play. Regulation can severely hurt the functioning of the economy when it functions too broadly without understanding the ramifications of its actions. Regulations must be highly contained and compartmentalized, like a ban on credit-derivative swaps. I don’t agree with liberals who think that the government should have any serious input into economic function, outside of preventing equity bubbles from blowing up and bursting. The market does work most of the time, when left to its own devices, but greed must constantly be checked by social science in order to make sure that the supervenient characteristics of the economy do not differ from some shared understanding of ethical action.

  11. re: chubby funster

    I never said anything about the future. All I believe is that we must learn from the past….and after this I believe there will not be a housing crisis of this magnitude so its impossible to really compare regulatory benefits and costs across time esp when you factor in two considerations.
    1) Fair Value Revolution, Federal Accounting Standard FAS 157 and IAS139 which helped clarify much of the banks illiquid assets by putting them in terms of mark-to market value and elucidating the real risk and value behind mortage backed securities and house values. This change in standards had a huge unappreciated esoteric contribution to the current crisis.
    2) Bill Clinton explained on the Daily Show that much of the surplus from his presdiency was funneled into housing which was part of the impetus behind the rise in value of houses. Hopefully we’ll learn not to do this again, so even if there is a drastic decrease in house value it will not be as substantial in the future. In fact one could argue that houses are more closely valued to what they are now (although they def. are underpriced under fair value at the moment) then what they were before with historial pricing methods…

  12. nobutta,

    I took your statement “I do agree that lending for houses need to be closely regulated” to mean that you are in favor of government regulation of housing finance going forward. Can you clarify?

    I have read little about Clinton’s theory that the surplus from his presidency helped create the run-up in housing prices. In fact, I’m not even sure what this means, or if it’s even true. Does he mean government surplus directly contributed to home prices? This seems like a blame-shifting maneuver to me (ie other people used my surplus unwisely, the CRA has nothing to do with what’s happened). If anyone could point me to a paper or article elucidating this theory I would appreciate it.

    Side note for admin(s): is there a way that comments can be numbered so as to make it easier for comments to respond directly to other comments. See for how this works.

  13. Re: Chubby Funster

    That’s a cool development they have at with the numbered commenting; I’ll try to see if we could code that. In the meantime, we’ll have to deal with some limited confusion.

  14. If you read the next sentence I was talking about people not affording the houses they were allowed to rent. Taking that one setp further, people should not be allowed to live in a 3 bedrrom house because predator lending strategies need to be kept in check.

    You know how everyone was talking about the housing bubble in like 2005 and 2006 bursting? Profits and surpluses from all over were directly funneled into house values and the housing markets. It seemed like the most lucrative less risky investments. I think this contributed to the same house today being worth abour 50% more two years ago–I mean its the same house there is no reason it should increase in value or decrease in value by such extradionary percentages.

  15. I have mentioned that the alleged Rand/Greenspan connection is nothing but a strawman argument several times before on this site, but it bears repeating again:

    Real Rand-ians do not consider Greenspan a true champion of free-markets. To say otherwise (that Greenspan is a Rand-ian) is at best shoddy research and at worst willful ignorance designed to try to control a public narrative. Don’t believe me? See here:{3CD42271-2D24-4D17-B136-8AB791D1F1C8}&dist=hppr

    Further, it’s also worth bearing in mind that the selected snippets used in this article and many others have not fully captured Greenspan’s sentiments on the subject. The final two paragraphs from an nyt article about Greenspan’s testimony:

    “Despite his chagrin over the mortgage mess, the former Fed chairman proposed only one specific regulation: that companies selling mortgage-backed securities be required to hold a significant number themselves.

    “’Whatever regulatory changes are made, they will pale in comparison to the change already evident in today’s markets,’ he said. ‘Those markets for an indefinite future will be far more restrained than would any currently contemplated new regulatory regime.’”

  16. The connection between Rand and Greenspan is not one of equivalence; that is not my contention. It doesn’t really matter if Objectivists think Greenspan is “really a capitalist” or not – they will always say that support of any regulation is non-Objectivist. They both, however, belong to the same school of ideology that suggests financial institutions can regulate themselves. Just because Greenspan is enough of a pragmatist to offer regulation on credit derivatives doesn’t take away from the fact that both he and Rand would contend self-interest can effectively govern the population. That is not a strawman – that is a dangerous economic philosophy that did a lot to get us to our current economic crisis. Self-interest is usually greed and greed destroys both economies and republics.

  17. To dismiss an argument without understanding it, or to lump to distinct arguments into the same bucket is poor intellectual work. Greenspan is saying the market had a flaw. Rand-ians say the market was never in place and that while the market doesn’t work perfect, it works better than when the government gets involved. In fact, they say that the credit bubble was in large part the fault of Greenspan!

    I am not defending Rand-ians, and it may very well be possible to prove their ideology to be full of holes, but lumping two separate ideologies, one of which thinks the other is entirely wrong, into the same bucket is lazy and factually incorrect. Greenspan and Rand-ians need to be analyzed separately.

    Self-interest and greed are not explanations for today’s current panic because they are pretty much constant. Institutions are a much better explanation.


    The link I posted last time didn’t go through, here it is

  18. Logically, here is my contention: Rand and Greenspan both argued that self-interest is enough to regulate the market economy and I disagree. That is it. I am not lumping them together for everything that they said, because that would be sloppy intellectual work. They are, however, two of the most well-known and outspoken advocates of self-interest and deregulation. As such, they SHOULD be lumped together when discussing the merits of self-interest as an economic theory.

    Regulation is sometimes good, like banning credit derivatives or forcing a percentage of those assets to be held by the speculator. Rand would have disagreed and Greenspan did disagree. Their joint-reasoning for this point (not commenting on anything else about Objectivism or Greenspanian economics) stems from an acceptance of self-interest as a guiding economic philosophy. Self-interest can be a lot of things, but it is mostly greed in this particular stage of human development. As such, people and banking institutions cannot regulate themselves perfectly or even satisfactorily.

    Greed, manifested through self-interest, is absolutely the cause of our financial meltdown. To say otherwise implies a fundamental misunderstanding of what occurred. Everyday people wanted houses, big and small, that they could not afford. They didn’t want to have their credit checked and they didn’t have enough income to pay back the loans. That is self-interest and in many cases greed. Self-interest for those people, many of which were simply trying to get a decent and pragmatic house, was not greed. They were just looking out for their families. That proves, however, that self-interest is not a good collective governance paradigm. The California McMansions WERE demonstrations of greed – they are examples of overconsumption at its worst. No one needs that much space; it’s all about telling other people that you are better than them. That is greed. Their collective demand for housing is the societal source of the self-interest problem in this housing bubble.

    Lending institutions, which make money for each loan they give, should have denied these loans. They did not, because the lack of regulation in the financial sector allowed them to trade off the debt they were owed until no one knew where the assets were actually coming from. That is a problem of greed and lack of regulation. If Alt-A mortgages were illegal, none of this would have happened.

    Fannie and Freddie Mac fall into this category as well. The fact that they were government institutions just proves there is bad regulation, but not that all regulation is bad. Congress-people and the CEOs of the Macs were greedy. The former wanted to maintain power through re-election to appease their constituency by making housing available. The latter wanted to make million of dollars by abiding with those demands, despite the poor bookkeeping that the practice required.

    Investment banks, foreign governments and hedge funds were greedy. They speculated, through mortgage-backed securitizations, on all of this real estate without pricing their risk effectively.

    Across the board, from consumers to lending institutions to Congress to state-owned enterprises to funds, greed was an essential cause of the financial collapse. Regulation, in many of those cases, would have solved those problems by preventing self-interest from resulting in poor business practice. Greenspan and Rand disagreed that this could happen and they were both wrong. That is why I “lump them together” – I am assaulting the ideology of self-interest and they are two of its largest proponents. As you say, Objectivists argue that the market was never in place. I agree, but that is the whole problem with their school of thought. The free market will never be perfectly in place, because that would denote perfect justice. In reality, regulation is necessary and that is why I hold them both accountable.

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