What did Alan Greenspan concede?

by on October 25, 2008 at 7:54 am in Current Affairs | Permalink

From all the hullabaloo I thought he had granted the death of capitalism but no.  Here are his prepared remarks.  Here is part of the Q&A.

He did admit that risk models had failed by selectively overweighting periods of euphoria and that the credit default swaps market had exploded in our face.  He also knows that there are hundreds of trillions of dollars in open positions in other derivative markets and most of them have worked relatively well in this crisis; his words indicated as such.  He also stressed that capitalism has had a string of forty years of numerous successes and that recent experience is an outlier.  He is still not sure what to make of the current failure.

Greenspan also said: “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.”

His policy recommendation was the modest one of requiring banks to keep a share in any mortgage.

I don’t agree with all of his detailed points (e.g., too much emphasis on subprime securitization), but I thought the overall ideological "flavor" of his remarks was essentially correct.  For differing, and yet not totally different, point of view, here is John Quiggin on Greenspan.  Here is the Ayn Rand Center on Greenspan.

1 Eddiew21 October 25, 2008 at 8:16 am

Its pretty clear that with the Foreign Government Bailout of 1998, the super-low interest rates post 9/11 that the government would bail out banks.

Mr. Greenspan is surprised that banks would take such risks? Why? He created the environment that gave them a free option on risk-taking.

Mr. Greenspan never fails to blame others for failing his own principles. As we now enter, the Greenspan Recession.

2 Robert Bell October 25, 2008 at 9:49 am

One of the things that Greenspan seemed to suggest was a surprise to him is that investors did not exercise as much due diligence as he would have thought with respect to the value of the toxic assets they purchased. I.e. one would think that a rational economic actor would balance fear and greed rationally w.r.t an investment – trading off the increased yield against higher risk.

This might also apply to several large institutions that failed. The CEO’s of those institutions in many cases had large holdings in those firms, and hence should have been motivated to be more careful. I.e. contra Eddiew21, the option was not free for them, it was just an option, just like Capital Decimation Partners, that worked until it didn’t.

I wonder if part of the lesson here is that perhaps market self-regulate exactly and only to the extent that natural selection makes sub-optimal behavior irrelevant because firms that behave sub-optimally don’t stay around long enough to matter. If there are a large number of competitive firms responding in a diversified way over time to a large number of adverse events, then we can assume over time that the firms that are extant are rationally balancing trade-offs. At the other extreme would be oligopolies, where firms behave strategically, homogenously, and possibly suicidally (as the GSE’s did) to fend off competition from other firms behaving like CDP in the face of perverse incentives.

3 Bernard Yomtov October 25, 2008 at 10:02 am

Communism kills millions of dissidents to maintain control to run the show exactly how they want to and it’s failure is total collapse, starvation, and an aftermath of kleptocracy. Capitalism let’s people alone, puts more people into homes than it probably should have and it’s failure is a bunch of bankers get their panties in a knot. It would be nice if people had any sense of perspective, or any sense at all for that matter.

Andrew,

The choice is not between communism and totally unregulated markets.

The consequences of the current problem go very far beyond a bunch of ankers getting their panties in a knot.

As you suggest, a bit of perspective is in order here.

4 Bob Murphy October 25, 2008 at 10:25 am

Tyler,

The “hullabaloo” was that a bunch of people are blaming this on the free market–e.g. people at Slate and “raft” above this comment. So it seems like a done deal when Alan Greenspan also admits it was the fault of the market, just like its also a damning admissions when “free market economist Tyler Cowen” does the same thing on his blog (in this thread).

So those of us who don’t think this was the fault of the market now look even less credible, because we have to explain that Slate writers don’t know what they’re talking about (credible), but that Alan Greenspan and Tyler Cowen don’t know either (less credible).

But I appreciate the challenge you have given us…

5 Tyler Cowen October 25, 2008 at 10:56 am

Bob, what I am saying is that — rightly or wrongly — he didn’t concede that much.

6 Some Guy October 25, 2008 at 11:13 am

Does our monetary policy system depend upon our first finding a superstar Fed chief such as a Volker or a Greenspan to run the system? If so, then we actually don’t have a “system” at all.

7 David October 25, 2008 at 12:24 pm

It’s not what he conceded. It’s the way it was reported in the media. It will become a political soundbite (“even Greenspan admits deregulation failed”) that will be impossible to refute with any brevity. You’d be fumbling around like Jack Kemp trying to explain how the Mexican bailout stole the savings of the middle class–just as ours will to us–while Al Gore just shrugs.

8 Bob Murphy October 25, 2008 at 3:07 pm

Tyler et al.,

Well, obviously we all know what he said, and we’re just disagreeing on whether it was “a big deal.” But Greenspan literally said that he thought markets were self-policing, because they had worked like that for the previous 40 years, and now he realizes his model of how the world works was wrong. I’m not putting those words in his mouth, he literally said that. That’s a pretty big admission.

And if you still think not, OK that’s fine, but then Chuck Schumer isn’t really saying anything radical either. He’s not calling for central planning, he’s just saying that the “unregulated market of the Bush era” caused the current crisis, and that’s why we need more regulation because relying solely on the Invisible Hand will cause the world to fall apart.

I guess it would help if you said what Greenspan could have said that would qualify as a big concession. If he said, e.g., “Not only have markets failed us during the last 8 years, but now I realize they have always been unstable, and it was only wise government oversight in the past that prevented this catastrophe from striking earlier. We are fortunate that the worst extremes of the Reagan Revolution were not put into place because of political backlash”?

9 Superheater October 25, 2008 at 11:45 pm

The problem wth greenspan’s statement is a simple one. The key phrase is what follows:

“looked to the self-interest of lending institutions to protect shareholder’s equity”

He adds fuel to a fire lit fueled by dogmatic ignorance on the left, e.g., markets are “unregulated”.

There’s only one appropriate response: exactly what the hell is he talking about?

What “lending institutions” are unregulated? Banks sure aren’t, they are perhaps the MOST regulated enterprises going. Google provides 777,000 hits for the phrase “regulates banks”. There’s not only plenty of rules and regulations, there’s plenty of NEW ones. Hasn’t he heard of FDICIA passed in 1991? Among its major provisions:

Among its major provisions:

(1) raised the FDIC’s authority to borrow from the Treasury Department from $5 million to $30 million.

(2) revised deposit insurance coverage, linking the premiums banks pay for FDIC insurance to their financial strength.

(3) required banking regulators to intervene in restructuring banks and thrifts that fail to meet minimum capital requirements.

(4) required the FDIC to use the method least costly to the insurance fund when merging insolvent banks into healthy ones.

(5) required annual on-site examinations of banks and thrifts.

(6) required banks and thrifts to disclose fair market value of their assets. (Nice to see the accounting standard setter-FASB jump on that bandwagon, huh?)

(7) required audited financial statements in annual reports of banks and thrifts with assets of $150 million or more.

(8) introduced a new formula for computing capital adequacy.

(9) imposed new limits on executive compensation and lending to senior officers and bank directors. (Oh how this helps)

(10) extended U.S. Banking regulations and on-site examinations to branches of foreign banks.

(11) required disclosure of more information (Truth in Savings) on interest rates paid to depositors.

And then there’s Sarbanes-Oxley, which although not specifically a banking law, requires an that external auditors attest to the sufficiency of internal controls-the policies and procedures that ensure accurate financial reporting and adequate security of the auditee’s assets.

As for protecting shareholder equity, the greatest danger to that was having laws like the CRA, which assumes that banks irrationally & simplistically “redline” geographic areas to limit lending risk, so the government can require explanations and take actions against banks that

There’s regulation by the state regulators, if they are state chartered, the Fed, the OCC, The FDIC, even the very forms mortagages are recorded on have very specific instructions on how to complete a “HUD 1” settlement statement.

This concession speech may make Mr. Andrea Mitchell popular with the K street cognoscenti at dinner parties in the new Obamanation, but its verity is really, really lacking.

10 Barkley Rosser October 26, 2008 at 9:45 am

Of course the (near) failure that triggered the panic of Sept. 17 when T-bill rates went to 0.06% and led to Paulson announcing that there would be a “bailout,” was the near demise of AIG, which was insuring much of the high level global derivatives market. The unit doing this was its 277 person unit in a subsidiary in London. While AIG is an insurance company, and they are highly regulated, the only regulatory body dealing with this unit, where all of AIG’s troubles emerged from, was the Connecticut Thrift Supervision Board, whose reports are not public information. It would appear that they did not do much to warn this unit off its dangerous practices.

BTW, latest studies suggest that the safest banks in the world right now are those in Canada. They are highly regulated.

11 MHodak October 26, 2008 at 10:45 am

H. Waxman: I just want to know who’s responsible for this mess. Was it you? Huh? Was it?

A. Greenspan: Working within the probabilities of certain outcomes, good or bad, judgments had to be made by the individuals with the information at hand…

H. Waxman: So it was you? Were you to blame? Did you cause this mess?

A. Greenspan: The quandary in which we find ourselves has many contributory factors. My own judgment had some influence…

H. Waxman: So it was you. Right? You’re to blame. You caused this mess. You and your laissez-faire philosophy. Huh? This committee is very disappointed in you, sir.

12 Thorstein October 26, 2008 at 9:50 pm

Fortunately Greenspan did not kill capitalism in his speech to Congress, despite prodding by Con. Waxman. It turns out, we need capitalism because it is capitalism, and nothing else, that can save us from this mess. The truth is regulation must be done with extreme care and regulators can never become “enables” as they did for most of this decade.

Steve Forbes, devoted marketeer, has a great article on capitalism and its role in saving us from this crisis- http://www.forbes.com/hcome/forbes/2008/1110/018.html. As usual, he is right on target with some great analysis, timely insight, and rock shattering conclusions. Step away from the punch bowl and have a look at this.

13 Superheater October 26, 2008 at 11:59 pm

“I think he was referring to certain unregulated activities, like CDS and MBS; and that banks were allowed to take on a great deal of leverage. ”

On the matter of the MBS’s, its still a public offering and subject to the SEC.

When I worked on the audit of a bank (now swallowed up by a larger regional, likely to be itself swallowed up), it was rather fascinating to see how they regarded mortgages. The marketing was all about a long term relationship with your friends at “local bank”, but they kept relatively few mortgages in their portfolio.

Every morning, they got an offering sheet from Wells Fargo, Bank of America or Citi, each indicating the price they’d buy mortgages from “originators” thereof.

The purpose was to effectively hedge their interest rate locks. (When the bank “locks” an interest rate to a prospective borrower, they create a derivative-if there’s no effective hedge, its a giant FASB 133/149 issue and they have to mark to market. Small backs would rather hedge than go through all that Black-Scholes stuff.) Big banks were essentially the real lender, little banks were like insurance agents-they did the paperwork, but retained no financial interest in the contract.

It was very clear to me after being on this audit and engaging in inquiries with bank personnel as a part of my tasks that local/regional banks weren’t interested in being “lenders”. They knew they were being coerced into being “very accomodating” by the CRA and weren’t interested in having regulatory or civil action taken against them for redlining. Securitizations and default swaps were a way to turn junk into AAA stuff.

While there were other reasons to sell mortgages, such as obtaining immediate recognition of al those up-front “origination” fees (aka points) that would otherwise be required to deferred over the life of the loan by FASB 91, it seemed to me that these mortgages were really like kids abandoned by their parents.

After considering it a while, I think the securitizations, but especially the CDS market looks like a giant community garbage dump and the fallacy of composition is heavily at work. From the perspective of the individual bank, the default risk vanishes-BECAUSE SOME ONE ELSE ASSUMES IT, but the reality is that loan is still a risky instrument.

When people are able to get mortgages with fewer and fewer requirements and tax policy supports confusing a residence with an investment-we get where we are-prices rise and rise until a point where sales drop off, then a few people who were “sure” ever rising prices would allow a quick and easy sale, find they need to cover that balloon and the fun starts. I even saw a story on the boob-tube about a year ago about some 20 something would started an inventory of homes, using no income verification mortgages and operating over multiple states. He kept going until he wasn’t getting enough “inventory turns” to cover the mortgages. Al those foreclosures wouldn’t have happened if there were no “accomodating” mortgages that were merely created to allow Henry Cisneros to use the banking system as Habitat for Humanity.

All of these behaviors were reactions to government interference, no inadequate or nonexistent regulation.

14 yoyo October 29, 2008 at 2:21 am

LIBOR OIS & TED spreads ended the week down 21% and 27%CP Yields on 90day paper increased to 4.9% on Firday, posting a 14% decrease for the week

5 year spreads on A-rated corporate bond increasing 4.9% and B-rated bonds increased 3.7% for the week.

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