(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.