August 30, 2008 by
Filed under: Uncategorized 


Gerald Greenspan: A true believer in free markets was betrayed by his convictions. The sub prime and the related financial crisis, an unlikely event but still possible, was allowed to occur due to leverage, greed and most of all the failure of the Federal Reserve under Chairman Greenspan to use its power to regulate the sub prime market in particular and the mortgage market in general.

Barney Frank(D)MA has said that Congress passed legislation allowing the Federal Reserve to regulate the mortgage industry in the Nineties. However, Fed Chairman Alan Greenspan, a diehard free market advocate, refused to use the regulatory powers of the Fed even to curb fraud in mortgage lending much less to set out guidelines for sub prime lending. The subsequent sub prime mortgage crisis and the spread of this crisis throughout the banking system has nearly brought down the system he was appointed to protect.

Greenspan has answered his critics by saying the role of regulation has been tried before and it doesn’t work. Further he has also stated that he was not fully cognizant on the extent of the bubble until 2007. These statements from a man of the sophistication of Greenspan don’t ring true.

Wikipedia discusses the controversy noting as follows:

“On March 17, 2008 Alan Greenspan wrote an article for the Financial Times Economists’ Forum entitled “We will never have a perfect model of risk“, in which he argued: “We will never be able to anticipate all discontinuities in financial markets.” He concluded: “It is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.” The article attracted a number of critical responses from forum contributors, which consists of some of the world’s leading economists (including two Nobel Memorial Prize in Economic Sciences winners, Edmund Phelps and Joseph Stiglitz), who, finding causation between Greenspan’s policies and the discontinuities in financial markets that followed, criticized Greenspan mainly for what many believed to be his unbalanced and immovable ideological suppositions about global capitalism and free competitive markets. For example, one forum contributor, Paul de Grauwe, wrote: “Greenspan’s article is a smokescreen to hide his own responsibility in making the financial crisis possible. Greenspan, who was at the helm of the most important monetary institution in the world, failed to take his responsibility to supervise the financial markets blinded as he, and his colleagues, were by a belief that markets and bankers know better than governments.” Other notable critics included J.Bradford Delong, Alice Rivlin, Richard Werner, Christopher Whalen, Michael Hudson, and Willem Buiter.”

On April 6, Greenspan responded to his critics in a follow-up article entitled, “A response to my critics,” in which he rigorously defended his ideology as applied to his conceptual and policy framework, which, among other things, prohibited him from exerting real pressure against the burgeoning housing bubble or, in his words, “leaning against the wind,” (which became a catchphrase used during the discussion). Greenspan argued, “My view of the range of dispersion of outcomes has been shaken, but not my judgment that free competitive markets are by far the unrivaled way to organize economies.” He concluded: “We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?”

The Pundits at Wikipedia further stated as follows follows:

“In the wake of the sub prime mortgage and credit crisis Greenspan admitted that there was a Bubble in the US housing market in 2007 and (forecast) “large double digit declines” in home values larger than most people expect.” However, Greenspan also noted, “I really didn’t get it until very late in 2005 and 2006.”

Again Greenspan hung himself with his own words:

“In a speech in February 2004, Greenspan suggested that more homeowners should consider taking out Adjustable Rate Mortgages (ARMS) where the interest rate adjusts itself to the current interest in the market. The Fed’s own funds rate was at an all-time-low of 1%. A few months after his recommendation, Greenspan began raising interest rates, in a series of rate hikes that would bring the funds rate to 5.25% about two years later. Hence, Greenspan’s recommendation came at a time when interest rates bottomed out making it a particularly bad time to take out an ARM. A triggering factor in the 2007 sub prime mortgage financial crisis (was the) many sub prime ARMS that reset at much higher interest rates than what the borrower paid during the first few years of the mortgage.”

And again Greenspan is quoted as saying in an April 2005 speech:

“Innovation has brought about a multitude of new products, such as sub prime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country … With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. … Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in sub prime mortgage lending; indeed, today sub prime mortgages account for roughly 10 percent of the number of all mortgages
outstanding, up from just 1 or 2 percent in the early 1990s.”

These positions were followed by the disastrous sub prime market collapse in March of 2007. Where was the invisible hand that moderates markets and prevents things from becoming outright disasters? Was the invisible hand a figment of Adam Smith’s and John Locke’s imaginations? It works under some conditions but the forces in play during the sub prime rise and collapse, namely low global interest rates, securitization of mortgages, investor and lender fraud and an insatiable demand by financial institutions, pension funds and others for these devices whose risk was wrongly assessed by the rating firms gave Wall Street the opening to manipulate and overwhelm the skeptics and opposing market forces.

This is a prime example and a refutation of Greenspan’s and others belief that a free market will always right itself. Now belatedly the Federal government is bailing out mortgage lenders, investment banks and even fraudulent borrowers and lenders with taxpayer’s money and lo and behold the Fed has begun to regulate the mortgage industry.

Free markets don’t always work as in the present instance where it was manipulated by Wall Street. Therefore and in some cases the government must step in and regulate for the good of all. The great question is when to regulate and how much to regulate not no regulation at all. That’s what we pay bureaucrats like Mr. Greenspan to know and his blind advocacy of free markets in this case only begot license and fraud in the market to the detriment of the American people.

The lesson Wall Street will take away from this catastrophe is: We Can Be as Profligate And In Many Cases Fraudulent As Possible And If It Threatens The Financial System the United States Government Will Bail Us Out.



Tell me what you're thinking...
and oh, if you want a pic to show with your comment, go get a gravatar!