Quelle Surprise! Greenspan warns about the dangers of regulation

Posted on by

(Apologies to Yves, but I believe she would have tagged it similarly)

Despite the mounting evidence that the worst financial crisis since the Great Depression was at least exacerbated by the lack of appropriate regulation and oversight in numerous markets ranging from the home mortgage lending to the securitization process to OTC derivatives markets to brokers and banks, Alan Greenspan, in a new commentary in the Financial Times warns against the dangers of too much regulation.

A commentary entitled “Repel the calls to contain competitive markets” contains such choice nuggets of advice to the world’s financial regulators as these:

The economic edifice – market capitalism – that has fostered this expansion is now being pilloried for the pause and partial retrenchment. The cause of our economic despair, however, is human nature’s propensity to sway from fear to euphoria and back, a condition that no economic paradigm has proved capable of suppressing without severe hardship. Regulation, the alleged effective solution to today’s crisis, has never been able to eliminate history’s crises.

This discounts the tremendous amount of regulation and oversight that is required for “market capitalism”, embodied in such institutions as the stock market and private corporations, to function and thrive. Stock markets are one of the most highly regulated and supervised markets in existence.

Furthermore, Mr. Greenspan conveniently ignores that the Great Depression was solved through the government’s fiscal and monetary policies (and of course the greatest government fiscal stimulus: war), rather than market forces. He also ignores that much of the regulatory apparatus in place is specifically designed to combat human nature’s so-called propensity to sway from fear to euphoria and back (including the circuit-breakers instituted in the markets under his watch after the 1987 crash).

Mr. Greenspan then goes on to assert that:

A financial crisis is heralded, in fact defined, by sharp discontinuities of asset prices. The crisis must thus be unanticipated. The fact that risk was heavily underpriced for much of this decade was broadly recognised in the financial community, but the timing of the sharp price correction was nonetheless a surprise.

While it may have been a surprise to Mr. Greenspan and other market boosters, the coming collapse in housing prices, and their long-term unsustainability at current levels was widely discussed. While it was not the majority opinion, it was nevertheless widely held by many respected economists. Mr. Greenspan can admit he was wrong, but here goes further to assert that no one can be right and this is clearly not true.

Despite Mr. Greenspan’s heavy blinders, it is heartening to see that he has finally accepted certain truths:

The credit crunch of the past year has not followed the path of recent economically debilitating episodes characterised by a temporary freezing up of liquidity – 1982, 1989, 1997-8 come to mind. This crisis is different – a once or twice a century event deeply rooted in fears of insolvency of major financial institutions.

In other words, even Mr. Greenspan is finally forced to admit that this is not a liquidity crisis but an insolvency crisis, something that others such as Mr. Roubini have been arguing for at least the past year.

The insolvency crisis will come to an end only as home prices in the US begin to stabilise and clarify the level of equity in homes, the ultimate collateral support for much of the financial world’s mortgage-backed securities.

Does this mean that Mr. Greenspan finally admits that while public and private interventions can ameliorate the declines and slow down the crisis, its ultimate resolution will only come when house prices return to sustainable levels?

So perhaps the cup is half full. Mr. Greenspan is still clearly wedded to his “free market” dogma despite the obvious truth that “free markets” can only exist and thrive within a framework of regulation and supervision. But even he is being forced to admit that the current crisis is fundamentally one of solvency which will only be solved when housing prices decline to sustainable levels.

Maybe after another year of unrelenting bad news and market failures, and another $500 billion in government intervention, Mr. Greenspan will finally be forced to admit the error of his past ways. One can only hope.

Print Friendly, PDF & Email


  1. doc holiday

    One of my favorite links:

    Alan Greenspan: ARMed and Dangerous

    (Feb. 27, 2004, at 4:47 PM ET)


    Calculations by market analysts of the “option-adjusted spread” on mortgages suggest that the cost of these benefits conferred by fixed-rate mortgages can range from 0.5 percent to 1.2 percent, raising homeowners’ annual after-tax mortgage payments by several thousand dollars. Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.

  2. Danny

    “Furthermore, Mr. Greenspan conveniently ignores that the Great Depression was solved through the government’s fiscal and monetary policies (and of course the greatest government fiscal stimulus: war), rather than market forces.”

    Greenspan conveniently ignores these ideas because they’re not true. Government intervention exacerbated the Great Depression in many many ways, including, but not limited to, most of the New Deal (which was actually started by Hoover, and given a clever moniker by FDR), the confiscation of gold as an alternative to holding the dollars that FDR would then debase, the Smoot Hawley Tariff, attempts to prop up prices of things such as dairy, which were confiscated and destroyed to ‘limit supply’, not even to mention the huge credit boom supplied by the Federal Reserve in the 20’s.


    And the common broken window fallacy that wars are good for the economy is propagated here. There are alternatives to the idea that the death of millions of men who might’ve otherwise been productive members of an economy somehow brought the US out of the Great Depression. Here is one paper:


  3. Tom Lindmark

    You wrote:
    the obvious truth that “free markets” can only exist and thrive within a framework of regulation and supervision.

    Could you please direct me to the source of this obvious truth and any other truths that are as obvious. Certitude like this will make my life much simpler.

    Thank you.

  4. Anonymous

    “Could you please direct me to the source of this obvious truth and any other truths that are as obvious.”

    Sure, Just for you!

    “People are evil at the core.”

    O.k now should we have regulations or not?

  5. Anonymous

    “People are evil at the core.”

    So. Regulators are not people?

    Ones who tend to be particularly susceptible to corruption, in fact?

  6. Anonymous

    There is no such thing as a free market. There will always be someone with the power to manipulate a market in their favor. Competition? Just bribe suppliers to delay shipments. That’s not a free market. That’s a monopoly or the mafia depending on how you look at it.

    As far as Alan Greenspan goes…why is anyone in their right mind paying attention to anything he says let alone quoting the creep?

  7. Lune

    I agree that many governmental policies during the Great Depression may have exacerbated the decline. I’m not claiming that every governmental initiative (or even most of them) works the way it was intended. But if it wasn’t governmental action, whether through legislation, fiscal stimuli, or monetary measures, what brought us out of the Great Depression? Surely you’re not arguing that free markets, completely independent of any government action, were the whole solution?

    My bone to pick with Greenspan is that he’s assuming “free markets” will get us out of this mess, when it’s becoming very clear that the lack of adequate supervision is what got us into this mess in the first place (or at least delayed the recognition of the problem until it became so big).

    Will Congress and the Fed botch this chance to clear things up and implement poor policy? Perhaps (indeed, I’ve been a critic of numerous Fed and Congressional policies over this past year). But I do know that leaving the market alone is not the answer.

  8. Lune

    I think it’s obvious because there is no free market in existence in this world that doesn’t exist within a framework of regulation created by a governmental body (usually national or international) that sets ground rules and standards for supervision. Whether that’s stock markets (can you name one that isn’t governed by some regulatory authority?) or “free trade” (only allowed within the framework of the numerous bilateral and multilateral treaties that countries have signed with each other to allow import/export of goods and services under specific terms).

    That in itself should be strong evidence that these markets can only exist within a regulatory and supervisory framework. But I’d go further and argue that such “free markets” cannot exist without such a framework? Why? Well, take the stock market, that paragon of freedom. If you were a joe blow investor in Iowa, how do you have the confidence to buy stock in IBM (for example), having never met the pit trader in the NYSE who will execute your order, nor the CEO of IBM to personally verify IBM’s books, not knowing whether the NYSE will actually execute your order or take your money and run, and never receiving a stock certificate verifying your ownership? The short answer: govt regulation:
    1) Regulations by the NYSE and SEC that assures the investor that the pit trader is qualified and executes orders according to very specific rules
    2) SEC and FASB rules that require IBM to report standardized, accurate, and audited financial data
    3) SEC rules that govern the NYSE and execution of orders
    4) Supervision by DTCC and other clearing agencies to make sure that you indeed now own the shares you thought you bought, even though you never knew who the seller was.

    Without those assurances, how many investors would engage in the type of arms-length trades that are the norm for public equities?

    Indeed, the breakdown of CDO and other OTC markets has been exacerbated by counterparty risk and opaque contracts precisely because the lack of regulation and supervision of these transactions has created an unknowable “black hole” of information from which the smart investor is staying away from.

    The purest example of a free market that exists right now is probably Darfur, Sudan. No government, no rules (that are enfored anyway). Do what you like, eat what you kill, and keep what you can defend. No dirty gubmint to get in the way. Last I checked, not many millionaires are being produced there, and there’s been no stampede of investors hoping to cash in on the ultimate free market.

    Let me know if you need to simplify your life further. I’ll be happy to help :-)

  9. Tom Lindmark

    You missed the point of my comment. The use of the phrase “obvious truth” by any writer implies that the writer has perfect knowledge and the reader should accept everything written at face value. Essentially, that what was written is not subject to discussion or rebuttal. It’s an old tired trick.

    As for your last comment, that was just petty. If you are going to blog and respond to comments keep it on a high level.

  10. Lune

    You’re right. My use of the word obvious might be overdone. But that said, I’d still argue that my original point is true, and easily proven so, if not necessarily obvious. I’d be interested in hearing your counter-argument (and I don’t mean that sarcastically).

  11. Anonymous

    Lune —

    Please don’t backtrack on your use of the word obvious. There are no ‘free markets’ in anarchy. Easily proven, yes. Obvious, yes as well, except to those who have a vested interest in disbelief. All commerce is enforced through actual violence or the ‘implied violence of the State’ that stands behind all regulation. In all but the most absurd circumstances, societies depend on regulation (including the most basic forms of selective contract enforcement) for any form of effective capitalism. The only way this is not obvious to anyone who has spent more than a minute debating it is by means of a desperate hope that the world is the way one wants it to be rather than the way that it is.

  12. Danny


    I linked to two articles, both of which give, one, a brief overview of Rothbard’s explanation of the depression, and two, a link to an essay as to what brought us out of the great depression.

    The whole misnomer of the term free market is one of the main problems. Free markets simply mean the cooperation of human beings in voluntary exchange.

    Anon @3:58: The whole idea that there can’t be a free market in anarchy and contracts are enforced only by the violence of the state is totally absurd. How do you explain black markets? Those operate away from the eye of the state, yet people exchange money for goods, and if the contract isn’t followed through, I will no longer conduct business with that person. I am often more pleased with my barter and black market deals than I am with your so called ‘only capable because of regulation purchases’. How do you explain that?

    And people call me dogmatic.

  13. Danny

    And I missed the main rebuttal!

    Lune, if most government policies make things worse, why would you want MORE government policies?

    Take most of what the Fed is doing, and the treasury, and the SEC. They are slowly turning us into Japan, step by step making the same mistakes. They messed up while the crisis was building up, what makes you think they’ll do a better job this time?

    They in fact were responsible for adding fuel to the fire! The ‘chief regulator’ Greenspan, proclaiming the wonders of ARMs when rates were at the their lowest ever, his infinite praise of derivatives and CDS’s as the great stabilizers, and of course his ever ready presence in bailing banks, thrifts, hedge funds, and the markets out on a consistent basis. Combine that with a total lack of persecution of fraud by the SEC, bogus ratings on toxic structured products due to an arcane government sponsored rating system, and the icing on the cake, the 100+ to 1 levered government sponsored hedge funds, excuse me, Fannie and Freddie, and it seems to me like government has it’s dirty paws all over the free market, and in fact, it’s interventions are the major cause of this disaster. All because some politicians in Washington thought an ‘ownership society’ was a good idea.

    Rant over.

  14. Danny

    And lemme say I agree with you, if the Fed is going to back stop the system, creating the systemic risk they claim they are mitigating, then yes, we do need heavy regulation. Hell, we should just socialize the system at that point.

    All I ask is that we try one or the other. Free markets, or government. The terrible hybrid leads both sides pointing at each other, and government always wins.

  15. Anonymous

    There is a reasonable case to be made that the ‘know your customer’ rule, (which basically leaves the onus of deciding what’s ‘fair’ in the hands of the people with superior knowledge)has served the stock markets well since it’s inception.

    The case (at least as I see it) is very strong that the HEART of this credit crisis is that it took place outside of those regulations, from the mortgage originators to the credit markets themselves.

    Just take one example: one of the stupidest gears that is broken right now is the paper trail of who actually owns the mortgage note, tying up courts and causing confusion. It wouldn’t have taken a strait jacket of regulation to create some oversight to the mortgage origination process.


  16. Anonymous

    He’s not “Mr Greenspan”.
    He’s actually Sir Alan Greenspan. He has sworn a formal oath to the British Sovereign, and is in possession of a British passport for Sir Alan Greenspan.

    And I cannot help but smile when I see how closely the “standard form” for the US Executive.

    I’ll use Iraq.

    First the “mistake” – Glass-Steagel, WMD.

    Next the delay, until the “mistake” cannot be denied credibly.

    Next the admission, but within the context that “everybody made the same mistake”.

    Next the refusal to reverse course, even though the “mistake” has been acknowledged.

    Finally, the dumping of the mess onto a new Administration.

    Never in his life has George W Bush cleared up his own messes. Why expect him to start now?


  17. S

    greenspan is a joke. As for what caused the GD1, seems there is an equal amount of certitude coming from 2 quoted papers. My sense is that is an as yet unsettled question in academia…

Comments are closed.