By James Kwak
Alan Greenspan is just as maddening in his retirement as he was during his nineteen-year reign over the global economy. Today in his appearance before the Financial Crisis Inquiry Commission (extensive coverage by Shahien Nasiripour and Ryan McCarthy here), Greenspan seems primarily concerned with passing the buck and preserving the remaining shreds of his legacy, a pathetic quest epitomized in his “I was right 70 percent of the time” remark. At the same time, however, he does make some very blunt statements about the financial industry and financial regulation that policymakers should ignore at their peril. (I’m not saying that because Greenspan was wrong before, he must be right now; I’m saying that when the most ardent defender of free financial markets reverses course, that should increase your skepticism toward free financial markets.)
Greenspan’s prepared testimony begins with a massive attempt to pass the buck. The first two pages of his account of the financial crisis have to do with rapid economic development overseas and the accumulation of the fabled global glut of savings. But he reaches even farther back to . . . the fall of the Berlin Wall and the discrediting of communism.
Greenspan also repeats the tired old argument that Fannie and Freddie were to blame (pages 3-4), focusing on their purchases of private mortgage-backed securities. This is something that, following Alyssa Katz, we also criticized Fannie and Freddie (and the government behind them) for. But tellingly, Greenspan’s data only go up to 2003-2004 — because from this point the GSEs’ share of the subprime market declined, as they were pushed out of the way by private sector players.
But the more interesting part of the testimony begins on page 7, where Greenspan discusses the challenges of regulating the modern financial system. The problems he points to include:
- systematic underestimation of risk
- “the virtually indecipherable complexity of a broad spectrum of financial products and markets”
- a failure of the regulatory system
With this in mind, Greenspan favors rules that “would kick in automatically, without relying on the ability of a fallible human regulator to predict a coming crisis,” including increases in capital and collateral requirements. This runs largely counter to the Obama administration’s preference for leaving specific limits to regulators.*
Here, though, I think Greenspan is still too optimistic. “I presume, for example,” he says, “that with 15% tangible equity capital, neither Bear Sterns nor Lehman Brothers would have been in trouble.” That is a huge increase over the current requirement of 4% (8% Tier 1 capital, but only half of that has to be tangible equity). But still, is it enough? As Steve Randy Waldman pointed out, Lehman turned out to be worth between $50 and $160 billion less than its books said it was worth just before its collapse. At about $640 billion in assets, that’s a “mistake” of 8 to 25 percentage points. If, as Greenspan acknowledges, the products themselves are extremely complex and we can’t count on anyone to evaluate them, how do we know that 15% capital is enough?
When it comes to “too big to fail,” Greenspan makes the same point, in similar terms, that we do in 13 Bankers: “The productive employment of the nation’s scarce saving is being threatened by financial firms at the edge of failure, supported with taxpayer funds, designated as systemically important institutions,” and “The existence of systemically threatening institutions is among the major regulatory problems for which there are no good solutions.” But then Greenspan proposes solutions: namely, contingent capital (an idea I’ve criticized here, citing Gillian Tett) and resolution authority. He proposes breaking up TBTF institutions . . . but only after they fail.
Nasiripour and McCarthy have additional statements by Greenspan from his responses to questions. One key point he was making was that regulators simply cannot keep up with the megabanks.
Regulators can’t keep up with today’s megabanks, he said. They’re too complex. Regulators, in short, don’t have a chance.
Greenspan, appearing before the panel convened to investigate the roots of the financial crisis, said that the “ideal way” to supervise banks would be to go through its individual loan documents — the way supervisors used to police banks and financial firms before they grew so large.
But unfortunately, he lamented, that’s no longer possible because firms are so complex.
“We are reaching far beyond our capacities,” Greenspan told the Financial Crisis Inquiry Commission. “It’s not a simple issue of ‘Let’s regulate better,'” he said. “It’s a different world.”
“The complexity is awesome,” he noted.
It’s nice that, in his retirement, Greenspan has finally become humble about the prospects for regulation. I wish the current batch of government officials would share the same humility. Not because I’m against regulation — I’m definitely in the more/stricter/better camp when it comes to regulation. But because I think you have to be prepared for it to fail. So either we need to change banking so that it is simple enough to regulate again (which isn’t going to happen). Or we need to reduce the size of banks so that when they do fail, they don’t take the financial system with them.
* In their defense, the administration might argue that those limits should be set by regulators but should then kick in automatically — although I’m not sure that’s what they are saying.