'I made a mistake' admits Alan Greenspan
David Nason, New York correspondent | October 25, 2008
ALAN Greenspan,has finally conceded that the free market philosophy he championed for 40 years has fundamental flaws.
The former US central banker from 1987 to 2006, who was once regarded as omnipotent in all things financial, said they must be addressed by a new era of regulation.
He made his historic backflip before a Congressional hearing in Washington, the same kind of forum that for years acted as his personal free market cheer squad.
In doing so he effectively marked the end of the Age of Reagan, the 30 years beginning with the rise of former President Ronald Reagan in which business was given free rein to create wealth wherever and however it wanted, with the bare minimum of government intrusion.
But now, with the world's most advanced economies in the midst of the worst financial crisis since the Great Depression and hundreds of billions of taxpayers' dollars spent trying to prevent a full-scale global meltdown, Mr Greenspan said the free market ideology that had guided his life and dominated world capitalism for a generation did not work the way he thought it would.
Appearing before the House Committee on Oversight and Government Reform, the man once dubbed "The Maestro" said he had found a flaw in the "critical functioning structure that defines how the world works". "I don't know how significant or permanent it is but I have been very distressed by that fact," Mr Greenspan said.
"I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms."
Asked by committee chairman Henry Waxman if he was saying his world view was "not working", Mr Greenspan said: "Absolutely, precisely. You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."
The extraordinary testimony was not a total act of contrition and during the four hours of testimony there were sharp exchanges with some committee members. Mr Waxman accused Mr Greenspan of failing to use his authority as Fed chairman to prevent the reckless sub-prime lending that started the housing market collapse and of doing nothing to regulate the derivatives products now causing stress in the credit markets. Mr Greenspan responded by saying that many parts of the derivatives market were performing well.
He also insisted Fed officials were not well placed to assess national mortgage markets, of which sub-prime loans now comprise 10 per cent.
But in a 2004 speech, Mr Greenspan had no problem urging lenders to think outside the square of the traditional US 30-year fixed-rate mortgage and offer a greater variety of products to homebuyers.
"Innovation has brought about a multitude of new products, such as sub-prime loans and niche credit programs for immigrants," he said at the time.
"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." In his prepared remarks to the committee, Mr Greenspan said he was in "a state of shocked disbelief" about the breakdown in the ability of banks to regulate themselves and, without putting a number on it, predicted a significant rise in unemployment in the coming recession.
He also attempted to defend his record, saying that in 2005 he blew the whistle on the underpricing of risk and warned it could have dire consequences.
"This crisis, however, has turned out to be much broader than anything I could have imagined," he said.
"Fearful American households are attempting to adjust as best they can to a rapid contraction in credit availability, threats to retirement funds, and increased job insecurity."
Mr Greenspan said it was the failure to properly price risky mortgage-backed securities that precipitated the crisis.
"In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts, supported by major advances in computer and communications technology," he said.
"A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades.
"When in August 2007 markets eventually trashed the credit agencies' rosy ratings, doubt was indiscriminately cast on the pricing of securities that had any taint of sub-prime backlog -- backing.
"As much as I would prefer it otherwise, in this financial environment I see no choice but to require that all securitisers retain a meaningful part of the securities they issue."
Mr Greenspan admitted to being "partially" wrong in failing to regulate credit default swaps, but also appeared to warn against increased oversight that was too onerous when he said: "I think that it's interesting to observe that we find failures of regulation all the time." |
