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.