Alan Greenspan’s Disingenuous Financial Times Comment

Alan Greenspan had a brief moment when he seemed capable of being redeemed, when he admitted before Congress that he was wrong about his assumptions that firms could regulate themselves. I have yet to see another central figure in the banking meltdown admit error. But he has now gone back to trying to salvage burnish his reputation.

Irving Fisher, arguably the most famous economist of the 1920s and a big backer of that era’s new financial and economic paradigm, was virtually impoverished by the crash and spent the next few years trying to figure out what went wrong. Although his contemporaries (save Keynes) saw him as hopelessly tainted, posterity has been more kind. Fisher’s debt deflation theory is now seen as a useful, perhaps even fundamental framework for viewing financial crises.

But Greenspan when he was chairman of the Fed, and to this day, still wants to be liked. And that means he is still far too willing to enable those in power, no matter how destructive their pet plans may be. Yet the most effective counsellors I have seen are able to tell people when they think their ideas stink (admittedly, it takes a great deal of interpersonal skill to pull that off without offending often insecure people in high places) and in fact, are sought out for their candor.

From the Financial Times:

The extraordinary risk-management discipline that developed out of the writings of the University of Chicago’s Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators.

But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions….

Yves here. Dear God, Greenspan prostrates himself before the false icon of bankrupt methodologies. This is embarrassingly bad.

Has NO ONE clued him in that the Markowitz based constructs are close to rubbish? They assume Guassian (normal, bell curve) price distributions. Benoit Mandelbrot proved back in the 1960s that that just ain’t so. There have been, as John Dizard put it, terabytes written about this. Worse, these models work really well on a day to day basis, but they are terrible at accurately measuring the risk of a big blow up, and that was one of their important uses.

Did the FT edit this piece? Obviously not, The idea that the flaw of the models was…..that they rested on enlightened self interest? I’l admit to not having read any of the seminal papers, but modern portfolio theory pretty clearly endorses leverage (ie, you can use leverage to create portfolios superior to ones on the efficient investment frontier) and does not appear so imply any limits on leverage. Plus it has a ton of assumptions that do not correspond with reality (continuous pricing is a biggie, which means markets are ever and always liquid, and it rejects the notion that diversification can break down, that it, that formerly weakly correlated assets can move strongly together at times of stress). Back to the article:

Even with the breakdown of self-regulation, the financial system would have held together had the second bulwark against crisis – our regulatory system – functioned effectively. But, under crisis pressure, it too failed. Only a year earlier, the Federal Deposit Insurance Corporation had noted that “more than 99 per cent of all insured institutions met or exceeded the requirements of the highest regulatory capital standards”

Yves again, I see, it’s all the FDIC’s fault. Notice no mention of the Fed or SEC? Or more important, that the belief in the virtues of “free markets” which for many meant unregulated, meant that the watchdogs had been neutered. It was the Fed that actively promoted the notion of securities firms and banks coming up with their own risk management and valuation models, and was affirmatively opposed to the idea of regulators having an independent point of view. All they were supposed to do was (at most) look over banks’ shoulders.

And he also conveniently fails to mention that credit default swaps were unregulated, or that financial institutions were exempted from Sarbanex-Oxley rules barring the use of off balance sheet entities. Oh, and that the FDIC approved of Goldman, Morgan Stanley, Merrill, Bear, and Lehman gearing themselves much more than had been previously allowed. Back to the article:

US banks are extensively regulated and, even though our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still took on toxic assets that brought them to their knees….

Yves here. Again, misleading. The Fed was taking the line at the time that banks were handing out credit like Santa Claus that there was no reason to worry about consumers’ levered balance sheets, since their net worth was growing. As Tim Duy has pointed out, they seemed to forget that debt is serviced out of cash flow, meaning income. The authorities also refused to consider that housing prices could ever fall nation-wide, even though quite a few countries (Japan, the UK, the Nordic nations, to name a few) have seen 25%+ falls in modern times. The Fed also acknowledged that housing price would have to moderate, but merely argued that they’d flatten, rather than contemplate that they might actually fall. Back to the article:

The important lesson is that bank regulators cannot fully or accurately forecast whether, for example, subprime mortgages will turn toxic, or a particular tranche of a collateralised debt obligation will default, or even if the financial system will seize up. A large fraction of such difficult forecasts will invariably be proved wrong.

Yves here. Again, misleading. The “let a thousand flowers bloom” attitude meant it was OK to let banks acquire paper (remember, banks did buy paper in the secondary market) that they and the regulators did not fully understand. That is an absolute no no that became acceptable behavior. Again to the story:

What, in my experience, supervision and examination can do is set and enforce capital and collateral requirements and other rules that are preventative and do not require anticipating an uncertain future. It can, and has, put limits or prohibitions on certain types of bank lending, for example, in commercial real estate. But it is incumbent on advocates of new regulations that they improve the ability of financial institutions to direct a nation’s savings into the most productive capital investments – those that enhance living standards. Much regulation fails that test and is often costly and counterproductive. Regulation should enhance the effectiveness of competitive markets, not impede them. Competition, not protectionism, is the source of capitalism’s great success over the generations.

Yves here. Huh? Since when were banks EVER in the business of making productive investments (save in their PE or VC entities, for those that have them)? They extend credit! A loan is about finding borrowers that can make principal and interest payments on time, and charging enough to earn a decent return on capital, cover origination and loan servicing expenses, and reasonable loss expectations. On a portfolio basis, you want good diversification among loans.

And what about “enhance the effectiveness of competitive markets”? The problem with competition in banking is banks are horribly imitative and all rush off the cliff together every 10 or 15 years. I have serious doubt about competition being a great measure of success in banking, particularly since the losses generated by undue zeal get fobbed off on taxpayers. Back again to Greenspan:

New regulatory challenges arise because of the recently proven fact that some financial institutions have become too big to fail as their failure would raise systemic concerns. This status gives them a highly market-distorting special competitive advantage in pricing their debt and equities. The solution is to have graduated regulatory capital requirements to discourage them from becoming too big and to offset their competitive advantage. In any event, we need not rush to reform. Private markets are now imposing far greater restraint than would any of the current sets of regulatory proposals.

Yves here. This gets worse. The pricing advantage the big players had was NOT due to their too-big-to-fail status. No one assumed anyone (save Citi) had that until they got in trouble. The big firms were de facto funded cheaply because they geared themselves like crazy. And the not rushing to reform argument is rubbish. The time to impose reform is when the problem is acute. If we wait and conditions start improving, the industry will argue changes are no longer necessary, the crisis passed without them. Greenspan knows full well delay works to the advantage of the incumbents. Back to the article:

Free-market capitalism has emerged from the battle of ideas as the most effective means to maximise material wellbeing, but it has also been periodically derailed by asset-price bubbles and rare but devastating economic collapse that engenders widespread misery. Bubbles seem to require prolonged periods of prosperity, damped inflation and low long-term interest rates. Euphoria-driven bubbles do not arise in inflation-racked or unsuccessful economies. I do not recall bubbles emerging in the former Soviet Union.

Yves again. This is truly scary. Not only is the ideology so thick you can cut it with a knife, but we have ignorance on top of it. The French economy was a mess when John Law created the Mississippi Company in 1717, whose bubble and collapse created an economic crisis. And there certainly weren’t any banking regulators back then to meddle with “free market capitalism.”

Believe it or not, there is more tripe of this sort, but I’ll leave it for your delectation.

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  1. jbmoore

    I hope when you negotiate your book contract, you do something like Taleb did. For a book sold in the U.S., he gets paid in dollars. In Europe, I believe he gets paid in euros. One would hope he would offer advice to a fellow dissenter and economics heretic. Your book will be a great read if your writing is as good as your ability to dissect financial essays.

    Greenspan is done for. Writing such tripe only endears him to those bankers and their legislators who wish for the financial system to remain “intact” for them to pillage and loot (as if they aren’t doing it now). If we “Anglo-Saxons” can’t see through the delusion and lies being promoted, then we deserve what we get from our supposed corporate and political leaders who are likely quite cynical about the intelligence of the great unwashed masses. If not for Roubini, Krugman, Jon Stewart, you, and several others speaking truth to power, the layman reader would be horribly out of luck because our news media doesn’t ply their trade for the most part any more. There is a terrible absence of critical thinking in this supposedly modern world.

  2. selise

    from the nyt, 1987:

    Top officials at the Treasury Department have concluded that the Government should encourage creation of very large banks that could better compete with financial institutions in Japan and Europe.

    The Treasury plan, which would permit the acquisition of banks by large industrial companies, was also endorsed by Alan Greenspan, in an interview before President Reagan nominated him this week to be chairman of the Federal Reserve Board.

    Mr. Greenspan said the plan would provide multibillion-dollar pools of investment capital for a banking industry that was ”severely undercapitalized.”

    the whole article is pretty interesting. here is another bit:

    In the interview, Mr. Greenspan said ”the separation of commerce and banking at this stage is simply not helpful” because it cuts off one important source of new capital. He added that the declining profits of the leading American banks had hampered their ability to raise capital in stock offerings. That leaves them only one practical source for large injections of funds: the industrial sector of the economy.

    Given the current banking environment, Mr. Greenspan said, ”I do not have a fear of undue concentration of banking powers.”

    if i’m not misreading this:

    1) reagan wanted big banks (american banks must be the biggest!)
    2) volcker was not going along
    3) reagan’s treasury advocates for big banks
    4) greenspan says what reagan wants to hear and one week later is nominated to replace volcker

  3. fresno dan

    Greenspan is much like a rooster crowing – the sun rises, therefore the rooster caused the sun to rise.
    There was a great boom. Greenspan happened to be there. He should have taken away the punch bowl – but he didn’t – he poured more. Everybody loved the pourer of punch, till the hangover. Now they hate him.
    But what of the hangover? More punch!!!

  4. cojock

    Greenspan was a genius.

    He brought forward the collapse of a mathematically unsustainable system by maybe 10 years.

    He deserves a Nobel prize for that.

  5. M.G.

    I definitely agree with you Yves! It could be a chapter of your book…
    It’s just a matter of behavioral rules: social norms against market norms. If the latter prevail they mess your mind up. If then they prevail also in rulers’ minds, you simply screw the economy up and destroy wealth.

  6. Bourning Markets

    Okay to most criticism about Greenspan.

    But I would ask not to throw the baby with the water.

    The solution is to have graduated regulatory capital requirements to discourage them from becoming too big and to offset their competitive advantage.

    This is systemic provisioning and it is a good deal indeed. As far as I know, the first ones who put it forward were Pedersen & Roubini.

    Implement that combined with some form of dynamic anticyclical provisioning (Quinn, Westpac, Banco de Espanha). Then and only then you can count on banking firms doing "espontaneously" some of that famous "self-regulation" Greenspan had so much faith on.

    Despite any other criticism we could make about the man, the idea itself merits wide support, whoever writes about it; better if quoting also Pedersen & Roubini on the same proposal.

  7. cojock

    It does not appear to have sunk in that the problem is not shortage of credit but a shortage of the creditworthy.

    Wealth has become too concentrated in too few hands, and the solution can only be systemic fiscal reform.

  8. Kurt Osis


    Greenspan is “correct” in saying “The idea that the flaw of the models was…..that they rested on enlightened self interest?”

    The assumption of “rational” self interest is not testable and can always be asserted as an explanation for any behavior post hoc. It is from this poisonous tree that fruit of asset price appreciation is harvested. It is on the back of Bernoulli’s theory of marginal utility that all economics bases its assumption for rational behavior. However, the implicit assumption is that individuals can predict their own utility function with certainty or with known maximum and minimum bounds (or that this utility function is stable though unknown to the actor). While this assumption holds when making decisions with respect to a discrete selection of alternatives on a finite time interval in reality there are an infinite combinations and permutations of alternatives. The binomial to normal approximation of the rational expectational decision tree does not work.

    What George Soros calls reflexivity and Mandelbrot recursive self affinity is the process by which people make assumptions and as those assumptions hold people increase the size of their investment in those assumptions. Using normally distributed prices as their presumption people decrease their expectation of variance as observations of prices within an interval increase. They begin to borrow money to increase the rate of their return. The problem comes when variance exceeds the maximum expectation. Lenders lose confidence in their ability to collect their principal and raise the cost of capital accordingly sellers are forced to reduce leverage to meet this cost and are forced into sell assets in the process, the fall in prices created by delevering triggers lenders to become more concerned still; and they raise their cost of capital further and the cycle repeats itself. This is what is commonly known as the credit cycle. The net effect is that prices of assets are not, never were and never will be normally distributed they overact to the upside in good times and overact to the down side in bad times. Further, this process is scale invariant as well as recursive. It is precisely when one has made a consistent rate of return in an investment that they are often most at risk, because they begin reduce their expectation of the rate of the rate of change in prices, or the acceleration of price changes if you will. For this reason, because people usually make steady amounts of money over medium length time periods and then go broke very quickly, that one cannot asses the performance of an investor based on how much money they have made in the past. While they may be a “competent investor” They may also be exposed to instantaneous volatility and be bankrupt in two weeks, it is impossible to tell.

  9. MarcoPolo

    “Huh? Since when were banks EVER in the business of making productive investments (save in their PE or VC entities, for those that have them)? They extend credit! A loan is about finding borrowers that can make principal and interest payments on time, and charging enough to earn a decent return on capital, cover origination and loan servicing expenses, and reasonable loss expectations.” – Yves

    Yes, yes, YES! BUT WHO NEEDS THAT?

    Our financial system is over-reliant on bright young men with good educations and no practical experience who find it easier to look up someone’s credit score or consult the ratings agency oracle (staffed by their friends from the same schools) and make those investments in non-productive sectors (or extend credit to those sectors, if you prefer that terminology) in a process which can be automated rather than analyze the prospects of a business proposal. Therefore productive investment is not made and innovation not funded. These people have the wrong backgrounds, the wrong training, and the wrong analytical ability and it needs to go away in substantial measure.

    I’m looking forward to your book.

  10. But What do I Know?

    This is great stuff, Yves, although I don’t suppose Mr. Greenspan, even if he read it would have a come-to-Jesus moment and admit his culpability. I, for one, greatly appreciate you taking his half-truths and evasive self-justifications apart, but the sad truth is that the MSM will continue to report his claptrap since he now has nothing else to do but say it wasn’t his fault (BTW, do you think he ever rereads Atlas Shrugged and recognizes himself?–not that rereading Atlas Shrugged is a wonderful way to spend retirement, but Ayn Rand was much more accurate writing about her villians than her heros/heroines.)

    I’m really going to miss your insightful comments, but good luck with the book and try not to worry too much about the blog in your semi-absence–some of us appreciate all that you do and will be right here when you get back.

  11. Anonymous

    Greenspan writes: “The important lesson is that bank regulators cannot fully or accurately forecast whether, for example, subprime mortgages will turn toxic, or a particular tranche of a collateralised debt obligation will default, or even if the financial system will seize up.”

    I think Greenspan’s point is a sound one and Yves is being glib in dismissing it. Regulators will fall under the influence of accepted opinion in the future. The dream of the perfectly objective, competent public servant is a fantasy and not grounded in reality – just like Greenspan’s dream of enlightened self-interest on the part of bank executives.


  12. Anonymous

    Right out of “Atlas Shrugged”.

    The SEC is a failed institution that needs to be shaken out. Talk about a bunch of no class government workers.

    The Fed has been allowed to over reach, assigning itself the power to indebt the citizens of the US with failed gambles of their shareholders, the banking trusts. The Fed is a political arm of the financial services business and was never meant to have the power it has accumulated.

  13. Anonymous

    Great post!

    fresno dan said – “There was a great boom. Greenspan happened to be there. He should have taken away the punch bowl – but he didn’t – he poured more. Everybody loved the pourer of punch, till the hangover. Now they hate him.”

    Puppet Greenspan’s crime was not taking away the punch bowl. His crime was being a willing and knowing party to the cabal that set the punch bowl out.

    Less attention should be paid to puppet Greenspan and more attention paid to his strings and the broader political context that pulls them. These are not bumbling idiots as they would have you believe, they are deceptive gangster state actors playing in a well planned and well orchestrated multifaceted finance based global/domestic coup. The FT rag is just another of their propagandistic promoters. They are working their asses off to deflect from the ruse and give ‘legitimacy’ to the scam.

    Deception is the strongest political force on the planet.

    i on the ball patriot

  14. ruetheday

    Imagine if we applied the principles of “enlightened self-interest” and “free market capitalism” to nuclear power generation. Everyone is free to build mini nuclear power plants in their backyards in residential neighborhoods and then sell electricity to the grid. No regulation is necessary. No one would do business with an unsafe plant so the market would simply regulate itself. Utopia! Not.

  15. joebhed

    First I agree with Cojock that Greenspan exactly accelerated the mathematically-driven downfall of the banking system by a decade.

    Second, I agree with Anon that future regulators WILL fall under the spell($$) of the day.

    Unless – and I implore Yves to take a listen, we do away with fractional reserve banking – PERIOD.

    She mentions Irving Fisher, who really did become enlightened after his financial downfall.

    Both HE and Milton Friedman advocated a money system based on the 100 percent reserve plan.

    It’s very simple Yves.
    The way to do away with moral hazard is to do away with moral hazard.
    Remove the leveraging function of banking.
    Separate the banking function from the money-creating function, that properly belongs with the federal government.
    When banks are only lending their depositors’ money, the depositors will be the self-regulators of the industry.
    We’re getting close to breaktime here.
    People better be thinking about alternatives.

    The Chicago Plan,
    “A Financial and Monetary Framework for Economic Stability”.


  16. garrisongold

    Can one of you financial/economic experts help me here?

    What the rationale was for exempting financial institutions from the requirements of SOX? Now how do we get to the truth?

    Learning that kind of crap just serves to make me more cynical. It angers me even more!

  17. Stebillan

    Greenspan also has a frighteningly ignorant view of what brought the Soviet Union and its satellites to its knees. Though prices in those countries were held low by the system, there were few goods, so people had to accumulate tons of worthless paper money in their accounts (hence crooks hardly bothered to rob banks; hence the devaluations of their currencies when the commie world imploded.) THAT’S A BUBBLE, ALAN!!!! Grade in economic history: F!

  18. Anonymous

    Excellent article. But the sad thing abut Greenspan is how many bankers were uncritical and followed him slavishly for so many years. I read his book “Age of Turbulence”, and was not the only one. Just after it came out there were many fellow banker gym-goers reading Ayn Rand while on the treadmills. Like lemmings we were…

  19. OSR

    The man is no dolt, so I question his “Who knew trees wouldn’t grow to the sky?” foolishness. It looks like the standard “ignorant not corrupt” argument that seems to be in vogue amongst those who were in power during the last 8 years.

    I do not question that central banks can defuse any bubble. But it has been my experience that unless monetary policy crushes economic activity and, for example, breaks the back of rising profits or rents, policy actions to abort bubbles will fail. I know of no instance where incremental monetary policy has defused a bubble.

    The above section is all you need to read, although I’m not convinced it’s his reputation that he’s trying to save. The entire article reads as if he’d recently realized that there is a distinct possibility that he may end his career at the end of a rope.

  20. Anonymous

    You can’t compare Greenspan’s predicament to Fisher’s. We’re in a golden age of looting, where the Fed is literally printing money and giving it to the malefactors of the past decade, thereby cheapening the hard earned assets of those who actually produce things for a living. Why wouldn’t Greenspan try to endear himself to the looters? It makes sense for all of us to get as close to the looters as possible. They should be in control for a very long time.

  21. Anonymous

    In autumn 2003, CNNFN website posted an article. Alan Greenspan was quoted stating that offshoring would be a disaster for Americans.

    I have never again see that quote.

  22. Sandi Rubinspan

    “I do not question that central banks can defuse any bubble. But it has been my experience that unless monetary policy crushes economic activity and, for example, breaks the back of rising profits or rents, policy actions to abort bubbles will fail. I know of no instance where incremental monetary policy has defused a bubble.”

    A very poignant statement when considering that Greenspans’ success, and the 30 year stock market rally, was an artifact Volker popping the 70’s inflation bubble.

  23. Anonymous

    OT’ sort of: Sometimes your best friend is your worst enemy, Mark Thoma version on the rating agencies (his trade policy is worse): Can’t everyone just get along ?

    Cherry picked Mark Thoma:

    “Thus, even if the mean rating does not change, the variance of the ratings make it worthwhile to pay for more than one rating and cherry pick the best of the lot, i.e. to shop around.

    Second, it is easier for the issuer to capture the rating agency, i.e. for the agency to produce the ratings the company is looking for,

    The benefit is the chance that the new, incremental rating will be higher than the ratings already in hand,

    Uh, yeah. It’s covered in econ 050.

  24. Anonymous

    Sounds as though the Maestro was really the master illusionist.
    How I wish for some real intelligence and integrity from those in authority.
    Thank you, Yves, cutting through the crap.

  25. Anonymous

    Greenspan was a tool, first and foremost. He did his job well for the oligarchy.

    One hopes that history will properly vilify him.

    If not then it means that we lost the battle to maintain some semblance of moral & humanistic social order.

    Write fast Yves……


  26. MyLessThanPrimeBeef

    Greedspan babbled gibberish when he ran the Fed and he still babbles gibberish when he is not running the Fed now.

    Did anyone really understand what he said? Can anyone really understand what he’s saying now?

    He’s best ignored.

  27. jeremy

    Thank you Yves!

    I have no idea what a Markowitz curve is but when I read this article this morning in the FT I couldn’t believe the amount of nonsensical bullshit Greenspan was attempting to foist upon the reader. There was nothing in the piece that hinted at a great intellect, either past or present. To think this man was called the Maestro. His op-ed read like a right wing rant in USA today or worse.

    My favorite part was his bit about the USSR. “Euphoria-driven bubbles do not arise in inflation-racked or unsuccessful economies. I do not recall bubbles emerging in the former Soviet Union.” What the hell does that even mean? Should we be grateful for the privilege of our bubbles here in the US of A? Greenspan the economic genius has figured out inflation and “unsuccessful” economies are unconducive for bubbles? Do you think the totalitarian communist state which prevented the ownership of private property may have helped tap down a few bubbles maestro? Furthermore hyperinflation in Russia only occured AFTER the demise of the communist system when Greenspan’s neo liberal ideas were forced upon the Russian economy via “shock therapy”.

    Greenspan, please die already.


  28. K Ackermann

    Economic shock, indeed.

    The villiage-saving tactics that have come from the Chicago school is something the world would do good to forget.

    The fire department is to be feared above the fire, and Chicago fronts like the IMF are always looking for smoke.

    Free market capitalism is now a threat you use to frighten children with.

    Colin Powell has sullied the laser pointer and satellite photo.

    George Bush has sullied liberty and democracy.

    Milton Friedman… (sorry, I wretched), Milton Friedman has sullied free market capitalism.

    Saying a thriving economy is a requirement for bubbles is like saying that living is a requirement for starvation.

  29. Anonymous

    Greenspan is becoming a dangerous man. Despite the fact that he is totally

    discredited by his (& his social classes) total failure he has enough of a "Name" to get on camera or into big time print. It's time he was put in his place publicly & permanently so that we have a real chance at reform. What the elites want is a

    return to the good old days & they will seize on this burned out fool to lead the

    charge. Be very afraid. If the elites manage to get thru this with their money &

    power intact they will not allow any further challenges to their rule. This means

    any challenges by the people of this country. As an abject example we might look

    to Russia. They have the same constitution as they always had. From the beginning

    thru the Stalinist horror to their collapse. Where are they now? That constitution

    is a typical modern new democracy constitution. Who really rules Russia today? Is

    it the people?

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