Still Crazy After All These Years

According to a scathing assessment in the Huffington Post titled “Alan Greenspan Bravely Rushes To JPMorgan Chase’s Defense, With A Bucket Of Nonsense”  the former Federal Reserve Chairman still hasn’t learned his lesson about derivatives.  There is no ignorance quite like willful ignorance.

A New York Times article titled Taking Hard New Look at a Greenspan Legacy also discusses his infamous legacy:

Today, with the world caught in an economic tempest that Mr. Greenspan recently described as “the type of wrenching financial crisis that comes along only once in a century,” his faith in derivatives remains unshaken.

Let’s not forget that Mr. Greenspan’s errant views on derivatives dating as far back as 1994, which prevailed in debates about their regulation and use, contributed mightily to the current financial crisis. As use of derivatives increased fivefold Since 2002, Mr. Greenspan fiercely objected whenever derivatives came under scrutiny in Congress or on Wall Street. As he told the Senate Banking Committee in 2003:

“What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so. We think it would be a mistake [to more deeply regulate the contracts.]”

Oops! I Did It Again!

In 2008, almost three years after stepping down as chairman and humbled before  the House Committee on Oversight and Government Reform, Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,”

According to the New York Times:

Critics, including many economists, now blame the former Fed chairman for the financial crisis that is tipping the economy into a potentially deep recession. Mr. Greenspan’s critics say that he encouraged the bubble in housing prices by keeping interest rates too low for too long and that he failed to rein in the explosive growth of risky and often fraudulent mortgage lending.

Committee chairman Representative Henry A. Waxman wagged a finger at him and asked: “You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. Do you feel that your ideology pushed you to make decisions that you wish you had not made?” All Mr. Greenspan could say was:

“Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

Although Mr. Greenspan refused to accept blame for the crisis, he at least acknowledged then that his belief in deregulation had been shaken. He also noted that the largely unregulated business of spreading financial risk through the use of derivatives had gotten out of control and had added to the havoc of today’s crisis. He agreed that the multitrillion-dollar market for credit default swaps needed to be restrained.

“This modern risk-management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year.”

Talking to the Wall

However, when Mr. Waxman asked “Were you wrong?” he hedged: “Partially.”

During his 18 year tenure ending in January 2006, Mr. Greenspan, presided over one of the longest booms in history in a period of declining inflation. But by slashing interest rates to nearly record lows from 2001 until mid-2004, he helped housing prices climb far faster than inflation or household income, leading to a speculative bubble in home prices and home construction, paving the way for the housing bust,  which, by 2004, he was warned about by a growing number of economists.

But did he listen then? He brushed aside talk of a potential bubble, arguing that a bust was highly unlikely. Worse yet, Mr. Greenspan, along with most banking regulators in Washington, resisted tighter regulation of subprime mortgages that allowed people to borrow far more than they could afford.

Did he have the authority to prevent the situation? Yes, the Fed has broad authority to prohibit deceptive lending practices under the Home Owner Equity Protection Act of 1994.  But he chose not to enforce, and, during the long housing boom, fewer than 1% of all mortgages were subjected to restrictions under that law.

Excuses and Political Smokescreens

When the crisis hit, Greenspan could only disingenuously protest that he was blindsighted – as though he had not actually been warned:

“This crisis has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”

I guess that’s why we paid him the big bucks…

Many Republican lawmakers on the oversight committee who shared Mr. Greenspan’s ideological blindness, quickly tried to shift the blame for the mortgage meltdown to unchecked growth of Fannie Mae and Freddie Mac, after the government-sponsored mortgage-finance companies were placed in government conservatorship.

But Mr. Greenspan, while obtuse, was at least not as glaringly dishonest as the partisan politicians, properly faulting Wall Street companies that bundled subprime mortgages into pools and sold them as mortgage-backed securities. He acknowledged that Wall Street companies pressured lenders to lower their standards and produce more “paper” to meet high  global demand for the securities. In Greenspan speak:

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,” he said.

Irrational Exuberance: He Still Supports Market Insanity

Even while acknowledging the real source of the problem, he proposed only one relatively insignificant regulation: companies selling mortgage-backed securities should be required to hold a significant number themselves.

Now, Mr. Greenspan, instead of remaining silent and hanging his head in shame, has swept in to defend Jamie Dimon and JPMorgan following their huge derivative losses. According to the Huffington Post:

Yes, the Alan Greenspan, the same man who helped make it possible for banks like JPMorgan to get big enough to annihilate the financial system [by urging the disasterous repeal of Glass-Steagall], The same man who made it easier for those banks to shoot craps with their spare cash while also holding federally insured deposits. The same man who kept derivatives from being troubled by regulation, in the name of market efficiency.The very man, in other words, who is as responsible as any other human being alive or dead for the financial crisis that affects us all to this day. And he apparently wants to have another one, because he still sees absolutely nothing wrong with any of this, if a new interview with CNBC is any guide.

The truly remarkable thing about this story is that Greenspan, rather than being driven from society to live the rest of his days in the wilderness foraging for roots and berries, continues to find people to listen to what he has to say, despite his being utterly discredited.

Nonetheless: Greenspan was recently asked by CNBC for his opinion about JPMorgan’s loss in the credit-derivatives market, initially measured at about $2 billion but recently estimated to have crossed $4 billion. Greenspan responded that it was mere pocket change for JPMorgan, a pittance for a bank with almost $200 billion in equity.

Regrettably, as the article points out: “It’s still Alan Greenspan’s world, and we still live in it.”

Snap! principle of the insanity of financial deregulation:

Insanity means repeating the same failed strategies and expecting different results.