As soon as I heard on Thursday what former Fed Chairman Alan Greenspan had said during his grilling from house lawmakers, it struck me as an odd statement.
“I’ve found a flaw,” he said.
It came across as an attempt by the man many blame for the current financial crisis to assert or maintain some sort of control over his destiny. Remember Greenspan has been significantly influenced by Ayn Rand.
But the problem was that only after the economy nearly melted down did he find this flaw.
I’ve pasted the transcript of the entire exchange between Greenspan and House Oversight and Government Reform Committee Chairman Henry Waxman, California Democrat. What do you think of Greenspan’s use of that phrase?
REP. WAXMAN: We’ll now proceed to questioning by the members. And without objection, the questioning of witnesses will proceed as follows. Questioning will begin with a 12-minute block of time for each side, with the chairman and ranking member each having the right to reserve time for later use. I will start the questioning.
Dr. Greenspan, I want to start with you. You were the longest- serving chairman of the Federal Reserve in history, and during this period of time you were perhaps the leading proponent of deregulation of our financial markets.
Certainly you were the most influential voice for deregulation. You have been a staunch advocate for letting markets regulate themselves.
Let me give you a few of your past statements. In 1994, you testified at a congressional hearing on regulation of financial derivatives. You said there is nothing involved in federal regulation which makes it superior to market regulation. In 1997, you said there appears to be no need for government regulation of off-exchange derivative transactions. In 2002, when the collapse of Enron led to renewed congressional efforts to regulate derivatives, you wrote the Senate: We do not believe a public policy case exists to justify this government intervention. And earlier this year, you wrote in the Financial Times: Bank loan officers in my experience know far more about the risks and workings of their counterparties than do bank regulators.
And my question for you is simple, were you wrong? Would you be sure the mike is turned on?
MR. GREENSPAN: Well, partially. But let’s separate this problem into its component parts. I took a very strong position on the issue of derivatives and the efficacy of what they were doing for the economy as a whole, which in effect is essentially to transfer risk from those who have very difficulty — have great difficulty in absorbing it to those who have the capital to absorb losses if and when they occur.
These derivatives are working well. Let me put it to you very specifically.
REP. WAXMAN: So you don’t think you were wrong in not wanting to regulate the derivatives.
MR. GREENSPAN: Well, it depends which derivatives we’re talking about. Credit default swaps, I think, have serious problems associated with them. But the bulk of derivatives — and indeed the only derivatives that existed when the major discussion started in 1999 — were those for interest rate risk and foreign exchange risk.
REP. WAXMAN: Let me interrupt you, because we do have a limited amount of time. But you said in your statement that you delivered, the whole intellectual edifice of modern risk management collapsed. You also said, “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shock and disbelief,” end quote.
Now, that sounds to me like you’re saying that those who trusted the market to regulate itself, yourself included, made a serious mistake.
MR. GREENSPAN: Well, I think that’s true of some products, but not all. I think that’s the reason why it’s important to distinguish the size of this problem and its nature. And what I wanted to point out was that the — excluding credit default swaps, derivatives markets are working well.
REP. WAXMAN: Well, where do you think you made a mistake, then?
MR. GREENSPAN: I made a mistake in presuming that the self- interest of organizations, specifically banks and others, were such (as that ?) they were best capable of protecting their own shareholders and their equity in the firms. And it’s been my experience, having worked both as a regulator for 18 years and similar quantities in the private sector, especially 10 years at a major international bank, that the loan officers of those institutions knew far more about the risks involved in the people to whom they lent money than I saw even our best regulators at the Fed capable of doing.
So the problem here is, something which looked to be a very solid edifice, and indeed a critical pillar to market competition and free markets, did break down. And I think that, as I said, shocked me.
I still do not fully understand why it happened. And obviously, to the extent that I figure out where it happened and why, I will change my views. And if the facts change, I will change.
REP. WAXMAN: Dr. Greenspan, Paul Krugman, the Princeton professor of economics who just won a Nobel Prize, wrote a column in 2006, as the subprime mortgage crisis started to emerge. He said, “If anyone is to blame for the current situation, it is Mr. Greenspan, who pooh-poohed warnings about an emerging bubble and did nothing to crack down on irresponsible lending,” end quote.
He obviously believes you deserve some of the blame for our current conditions. I’d like your perspective. Do you have any personal responsibility for the financial crisis?
MR. GREENSPAN: Let me give you a little history, Mr. Chairman. There’s been a considerable amount of discussion about my views on subprime markets in the year 2000. And indeed one of our most distinguished governors at the time, Governor Gramlich, who frankly is regrettably deceased but was unquestionably one of the best governors I ever had to deal with, came to my office and said that he was having difficulties with the problem of what really turned out to be fairly major problems in predatory lending.
REP. WAXMAN: Well, he urged you to move, with the power that you had as the chairman of the Fed, as both the Treasury Department and HUD suggested, that you put in place regulations that it would curb these emerging abuses in subprime lending, but you didn’t listen to the Treasury Department or Mr. Gramlich. Do you think that was a mistake on your part?
MR. GREENSPAN: Well, I question the facts of that. He and I had a conversation. I said to him I have my doubts as to whether it would be successful.
But to understand the process by which decisions are made at the Fed, it’s important to recognize what our lines of responsibility and lines of authority are within the structure of the system. The Fed has an incredibly professional large division that covers consumer and community affairs. It’s got probably the best banking lawyers in the business in the legal department and an outside council of expert professionals to advise on regulatory matters. And what the system actually did was to try to corral all of this ongoing information and to eventually filter it into a subcommittee of the Federal Reserve Board —
REP. WAXMAN: Dr. Greenspan, I’m going to interrupt you just — the question I have for you is, you had an ideology, you had a belief that free, competitive — and this is your statement — “I do have an ideology. My judgment is that free, competitive markets are by far the unrivaled way to organize economies. We’ve tried regulation. None meaningfully worked.” That was your quote.
You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying its price.
Do you feel that your ideology pushed you to make decisions that you wish you had not made?
MR. GREENSPAN: Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to — to exist, you need an ideology.
The question is whether it is accurate or not.
And what I’m saying to you is, yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.
But if I may, may I just answer the question —
REP. WAXMAN: You found a flaw in the reality —
MR. GREENSPAN: Flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak.
REP. WAXMAN: In other words, you found that your view of the world, your ideology was not right. It was not working.
MR. GREENSPAN: Precisely. That’s precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.
But just let me, if I may —
REP. WAXMAN: Well, the problem is that the time has already expired and there are, as you can see, many members.
MR. GREENSPAN: The reason basically is this, that Governor Gramlich said to me that he had problems. Indeed I agreed that I had heard very much the same thing. I frankly thought that when our meeting ended that the subcommittee of the board, which supervises all of the various aspects of consumer and community affairs, within the Board of Governors and the Federal Reserve System, would move forward and present to the board, as a whole, recommendations to be made. That was not made. And I presumed at the time that essentially the subcommittee didn’t think it rose to the higher level.
But just quickly to say that the overall view that I take, of regulation, is that I took a pledge when — I took an oath of office when I became Federal Reserve Chairman. And I recognized that you do with that — what I did is I said that I’m here to uphold the laws of the land, passed by the Congress, not my own predilections.
And I think you will find that my history is that I voted for virtually every regulatory action that the Federal Reserve Board moved forward on. Indeed I voted with the majority at all times. And I was doing so because I perceived that that was the will of the Congress. And in fact if you go back and look at the record, I felt required by my oath of office to adhere to what I’m supposed to do, not what I’d like to do. And that is my history. And I think the evidence very strongly supports that.
REP. WAXMAN: I appreciate that.
On the other hand, you didn’t get to vote on regulations that you didn’t put before the Federal Reserve Board, even though you had the legal authority for those regulations. That’s more not a question but a comment.