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What did Alan Greenspan concede?
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.
Posted by Tyler Cowen on October 25, 2008 at 07:54 AM in Current Affairs | Permalink
Comments
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.
Posted by: Eddiew21 at Oct 25, 2008 8:16:16 AM
All that Greenspan offered was a statement of the inclusion-exclusion principle of probability. As usual, the writers of The Simpsons nailed this before anyone else: http://www.youtube.com/watch?v=2Mr4aYcHUOY
Of course what I had forgotten about that clip is how Homer is also responsible for his failures by foolishly listening to the "experts" without giving the issue a second thought. Sound familiar?
Posted by: MJO at Oct 25, 2008 9:22:37 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.
Posted by: Robert Bell at Oct 25, 2008 9:49:04 AM
Is the real problem that certain people aren't capable of operating in unregulated markets?
Markets are kept honest for the free riders by the skeptical buyers. But, when all the buyers become free riders, the sellers can make a killing selling crap.
Should regulation focus more on the front door rather than the back door? Are bankers certified qualified to deal with complex securities?
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.
Posted by: Andrew at Oct 25, 2008 9:54:10 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.
Posted by: Bernard Yomtov at Oct 25, 2008 10:02:54 AM
the correct analogy to communism on the right is, of course, libertarianism. NOT capitalism, which most people understand to include appropriate regulation and intervention to smooth out boom-bust cycles.
i would say libertarianism has been completely discredited by the recent financial crisis, but the truth is that happened back in the 19th century.
Posted by: raft at Oct 25, 2008 10:14:19 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...
Posted by: Bob Murphy at Oct 25, 2008 10:25:36 AM
I found him straightforward, without deceit.
The best part of his remarks were those without flavor. He focused on monetary policy and left the non-sexy stuff, regulatory oversight, to a sub-committee. That was a mistake.
He talked sensibly about the propagation of sub-prime underwriting, with it exploding in 2005, alongside securitization.
While the run-up in sub-prime lending itself ($700 billion) was not desperately remarkable, it seems, he discounted the exponential growth in derivatives, many related to mortgage issuance, because the early 1990s warnings over derivatives expansion ... had proved false, to date. Sadly, making that generalization was a mistake.
His key ideological flavor, that loan officers know the risks better than any regulator ever could do, was ... interesting, but off the mark, for the current crisis. It's possible that the risks to the system, which no one party could judged themselves, arguably (knowing their part only), multiplied, rather than getting spread around.
For instance, Goldman was "into" AIG for a reported, eye-popping $20 billion (they deny that much). Did they know how much everyone else was into AIG? Only a regulator could know, or identify the weakest link in a chain, maybe. Whatever the case, by the time it came to shut down AIG, because of old-fahsioned mis-management, their counterparties appear not to have been ... fully apprised or reserved.
http://www.nytimes.com/2008/09/28/business/28melt.html?_r=2&pagewanted=print&oref=slogin&oref=slogin
Posted by: Amicus at Oct 25, 2008 10:47:24 AM
Bob, what I am saying is that -- rightly or wrongly -- he didn't concede that much.
Posted by: Tyler Cowen at Oct 25, 2008 10:56:43 AM
who is blaming the "free market"? that's like blaming the planes for causing 9/11. yeah, if you aim a Boeing 767 at a skyscraper, shit is gonna happen.
the fault here is with people--the false and failed ideology created by, promulgated by, and implemented by certain individuals and institutions. We reap what we sow.
Posted by: raft at Oct 25, 2008 11:08:59 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.
Posted by: Some Guy at Oct 25, 2008 11:13:08 AM
The main causes of the crisis, being poor investments, are:
1) The implicit system of government guarantees to intervene in a financial crisis.
2) Lack of transparency and collateralization in certain trades and transactions. In other words, more precision in the trades to determine the correct level of capitalization, and the guaranteeing that the collateral be there.
I understood him to be conceding 2. We need enough regulation, or better, supervision, to guarantee that these trade conditions are always met, especially in trades that involve the shifting of risk to a third party or the magnification of risk, where the correct amount of capital is difficult to determine.
I don't see either of these as having any large claim on the worthwhile nature of our capitalist system.
Posted by: Don the libertarian Democrat at Oct 25, 2008 11:53:42 AM
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.
Posted by: David at Oct 25, 2008 12:24:10 PM
Gtreenspan offers us no material insight. He played god and was found out to be just a man.
The major challenge we face is that regulatory models look at tail risk and the Fed manages a mean.
Posted by: martina at Oct 25, 2008 12:45:02 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"?
Posted by: Bob Murphy at Oct 25, 2008 3:07:31 PM
I really hate the idea that what we need is simply more regulation. Like regulation is a knob that you can turn higher or lower like a thermostat and if you turn it higher good things happen.
Regulations are rules that are enforced. Saying "more rules" is as useful as saying "better policy". What rules and regulations ought to have been there that aren't such that we don't get into messes like this one again? I've never heard a good answer to this question.
I don't think that regulations are bad as a rule, but I do think that of the set of regulations that are possible most of them will make things worse. I think that even of the set of regulations that sound sort of good most of them will still make things worse. There exist, I'm fairly confident, rules and regulations that would improve the state of affairs but divining the nature of these rules is likely very tricky.
But as of right now there seems to be this pretty childish back and forth of "rules are bad" v. "rules are good". That conversation is unlikely to be illuminating without evaluating specific rules.
Posted by: Michael Foody at Oct 25, 2008 3:44:39 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.
Posted by: Superheater at Oct 25, 2008 11:45:20 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.
Posted by: Superheater at Oct 25, 2008 11:46:47 PM
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.
Posted by: Barkley Rosser at Oct 26, 2008 9:45:55 AM
Well, I've been looking around a bit. Now, saying libertarianism is dead may be a bit premature, but at least the sentiment is correct, and in the right ballpark. But what have I seen? Not one single libertarian has conceded that their tenets have to be modified by so much as a scintilla! Nope, no matter what has played out over the last few years and months, it has not caused one libertarian to admit that maybe there are a few more things in heaven and Earth than are dreamt of in their philosophy.
Thanks for being so serious, guys.
Posted by: ScentOfViolets at Oct 26, 2008 10:33:42 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.
Posted by: MHodak at Oct 26, 2008 10:45:02 AM
ALAN Greenspan . . . he’s the man!
By l.t. Dravis
WASHINGTON, D.C. MSNBC NEWS – Thursday, October 23, 2008 – Former Federal Reserve Chairman Alan Greenspan did what George W. Bush, Dick Cheney, Donald Rumsfeld, Alberto Gonzalez, John Snow, Chris Cox, Josh Bolton, Mitch McConnell, John Boehner, and too many others to mention here haven’t got the guts to do: Admit a mistake!
As Dr. Phil (I still don’t get how fatman Phil could write a diet book with any credibility) says, ‘You can’t change what you won’t acknowledge”.
Greenspan admitted in front of the House Oversight Committee chaired by Congressman Henry Waxman (one of the toughest and best Representatives in America) and the entire world that he was wrong when he made decisions based on his belief that banks ‘operating in their self-interest’ would protect their shareholders, their equity, and, therefore, the backbone of the economy.
Hooya!
So, what do the losers . . . Bush, Cheney, Rumsfeld, Gonzalez, Snow, Cox, Bolton, McConnell, Boehner and others . . . who ‘led’ us down this disastrous path have in common?
One thing and one thing only: They’re gutless!
They don’t have guts enough to admit their mistakes and correct those mistakes in order to do what the taxpayers pay them to do: Protect the interests of the people . . . not their buddies, not the special interests, not the lobbyists!
Now, do I agree with everything Greenspan said today?
No.
Not that I’m an economist because I’m not.
I couldn’t even hope to stand in Alan Greenspan’s intellectual shadow.
But I am a people-onomist and I disagreed with Alan Greenspan when he said, “All those extraordinarily capable people were unable to foresee the development of this critical problem, uh, which, undoubtedly, was the cause of the world problem with respect to mortgage-backed securities. I have to think, I we have to ask ourselves, why is that? And, the answer is, that at, uh, we’re not smart enough.”
The reason, in my never to be humble opinion, is not that ‘we’re not smart enough’ but that we’re not honest enough . . . in other words, greed rules. Unrestrained greed, not lack of wisdom, motivated financial manipulators to create the current economic crisis we have to pay for.
Anyone surprised by that assertion?
If so, I don’t know why.
Every religion and every philosophy ever embraced by humanity teaches the simple, unchallenged fact that when human beings have access to riches without oversight or restraint; they will grab all they can for themselves without regard for anyone – or anything – else.
Ain’t that the truth!
Disagreements aside, I say thank you, Alan Greenspan, for your service.
Thank you for your wisdom.
But, most of all, thank you for your guts.
If only others in positions of power could take a cue from you.
You are, after all, the man!
P.S. Didn’t see one of my favorites on MSNBC today . . . Andrea Mitchell, where are you? Hope the suits didn’t take you off because Alan was under the lights on Capitol Hill. I’ll see you tomorrow . . . I hope.
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Posted by: l.t. Dravis at Oct 26, 2008 4:18:01 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.
Posted by: Thorstein at Oct 26, 2008 9:50:27 PM
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:
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.
To me the larger issue is that most companies and financial participants had *no idea* how much risk they were taking on, which could have been avoided with tighter control over leveraging and exotic financial instruments. (The issue wasn't that they weren't trying to protect shareholders' equity--I'm sure they were, but were unable to adequately assess the risk involved in certain activities.)
Posted by: pants at Oct 26, 2008 10:36:04 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.
Posted by: Superheater at Oct 26, 2008 11:59:08 PM
