Greenspan Reconsiders: Free Market Faith Is Shaken (Valley News)
October 28, 2008
One of the most arresting spectacles yet produced by the world financial crisis was the appearance before a congressional committee last week of Alan Greenspan, the former chairman of the Federal Reserve, who pretty much conceded that his exuberant embrace of free market ideology was misplaced, if not downright irrational.
"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," Greenspan told the House Committee on Oversight and Government Reform. And, presumably, those who have not, are not.
Greenspan, who was chairman of the Fed for 18 years before stepping down in 2006, came to be widely — although not universally — regarded as the nation's economic oracle, a reputation that was perhaps enhanced by the sometimes Delphic quality of his utterances. Post meltdown, however, critics have assigned a large measure of blame to Greenspan for inflating the housing bubble by keeping interest rates too low for too long and for failing to restrain the rapid growth of high-risk, and sometimes fraudulent, mortgage lending practices.
On Thursday, Greenspan acknowledged that recent developments had shaken his faith that government regulators are no better than the markets themselves in imposing discipline. In particular, he agreed that the market for the exotic financial instruments called derivatives needed restraint, something he had vigorously and successfully opposed as far back as 1994. This epiphany is perhaps attributable to the fact that the unregulated multitrillion dollar market for one kind of derivatives, credit default swaps (which originally were supposed to insure bond investors against the risk of default), is heavily implicated in the implosion of the financial system. "This modern risk-management paradigm held sway for decades," Greenspan testified. "The whole intellectual edifice, however, collapsed in the summer of last year."
Not that Greenspan's conversion is complete. He went on to say that whatever regulatory changes are made, "they will pale in comparison to the change already evident in today's markets. Those markets for an indefinite future will be far more restrained than would any currently contemplated new regulatory regime." This assertion strikes us as embracing an unduly optimistic view of human nature, which, like the human body itself, seems to have a remarkable capacity for forgetting pain when the opportunity for pleasure presents itself anew. After all, the nation is only 20 years removed from the savings and loan crisis. We much prefer the protection that a strict program of government regulation affords to investors and to the public, rather than to rely on the object lesson provided by recent history.
Speaking of the economic future, we also note that Greenspan stressed the difficulty of predicting it. "The Federal Reserve had as good an economic organization as exists," he said. "If all those extraordinarily capable people were unable to foresee the development of this critical problem … we have to ask ourselves, why is that? And the answer is that we're not smart enough as people. We just cannot see events that far in advance." This is a good thing to remember when the nation is next tempted to consult an oracle.