Greenspan Says Mortgages Should Have Been More Regulated

[Pangloss]

Alan "Ayn Rand is Rolling in Her Grave" Greenspan said today that he made a mistake in trusting the real estate mortgage market to police itself, and that it should have been more tightly regulated.

 

http://www.nytimes.com/2008/10/24/business/economy/24panel.html?bl&ex=1224993600&en=da694ed4921c5e8b&ei=5087%0A

 

He noted that the immense and largely unregulated business of spreading financial risk widely, through the use of exotic financial instruments called derivatives, had gotten out of control and had added to the havoc of today’s crisis. As far back as 1994, Mr. Greenspan staunchly and successfully opposed tougher regulation on derivatives.

 

But on Thursday, he agreed that the multitrillion-dollar market for credit default swaps, instruments originally created to insure bond investors against the risk of default, needed to be restrained.

 

“This modern risk-management paradigm held sway for decades,” he said. “The whole intellectual edifice, however, collapsed in the summer of last year.”

 

IMO this is a staggering blow for the Austrian/Libertarian crowd. I'd love to find out what my Austrian economist-professor cousin thinks of this, but he's not on speaking terms with me since I told him I'm voting for Obama, whom he thinks is an actual communist. (lol)

[bascule]

Zombie Milton Friedman says: "Who'da thunk it?"

[Pangloss]

Just caught a little more of this on the TV, and there's actually a point at which Waxman asks Greenspan if he's basically saying that his ideology had failed him, and Greenspan confirms this to be the case, saying that it had worked for him for more than 40 years, but failed him when it came to trusting these banks.

 

Wow. You really don't see public figures getting their entire ideologies shot down in flames on camera very often!

[gcol]

Being wise after the event is a great political attribute. Do I smell a Mea Culpa or repentant sinner theme to an embryo retirement fund book? Should sell well in the bible belt, they just love a repentant sinner. For myself, it becomes just another entry in my list of never-ending reasons to never trust politicians/bankers/experts and anyone else who makes a living from telling me what is best for me. They are all just humans, like you and me, and just as deeply flawed. Trust only in the great God Mammon. Unpleasnt maybe, but predictable always.

[ParanoiA]

IMO this is a staggering blow for the Austrian/Libertarian crowd. I'd love to find out what my Austrian economist-professor cousin thinks of this, but he's not on speaking terms with me since I told him I'm voting for Obama, whom he thinks is an actual communist. (lol)

 

Me too, as I consider myself "in study" on the whole Austrian economic theory. I'm going to see if Paul has written anything up in reply to Greenspan's take on this.

 

Regardless, it's pretty cool to see him just come clean like that. I wish our politicians had the capacity for that.

 

Edit: Well, that was easy. http://www.ronpaul.com/ - front page, Youtube clip of Paul's response to Greenspans testimony.

Edited October 24, 2008 by ParanoiA

[bascule]

Waxman asks Greenspan if he's basically saying that his ideology had failed him, and Greenspan confirms this to be the case

 

Yeah, that's pretty awesome of him to admit

[Realitycheck]

He didn't really have to say that. Playing around with the interest rates to try and tweak sales is one thing, but I place all of the responsibility on relaxed lending criteria, whether it was prompted by Clinton, the CRA, or the actual banks themselves. Isn't Fannie/Freddie meant to guarantee loans? So this means that any loans that they acquire have already defaulted once already, meaning that they are innately high risk from the onset. Why do people not make their mortgage payments? High gas prices, high food prices, higher energy prices, I'm sure there has got to be some more good reasons, such as Republican-led income gap issues, but I have not researched enough into that. Reserve activations suddenly having their incomes halved probably might be a bit of an issue, but most of them are probably reasonably responsible.

[Mr Skeptic]

Yeah, that's pretty awesome of him to admit

 

I agree, but the cynical bit in me wonders how much money he could have been offered to take the blame

[bascule]

 

There was flaw in the model that I perceived is the critical functioning structure that defines how the world works.

 

[...]

 

I made a mistake in presuming that the self-interest of organizations' date=' specifically banks and others, was such as they were best capable of protecting their own shareholders.[/quote']

 

Yowza. That's coming from perhaps the principal disciple of Milton Friedman.

 

Is it safe to say free market economics don't work yet? Or do free market people actually think this sort of thing is natural and healthy for an economy?

[Realitycheck]

His job was not to predict banks' abilities to do their jobs. Irrational exuberance in the stock market is one thing, while irrational lending practices are something else altogether, not nearly as easily monitored.

Edited October 30, 2008 by agentchange

[iNow]

His job was not to predict banks' abilities to do their jobs.

 

Oh, but it was. He was tasked with understanding these things so well, operationally... tactically... conceptually... strategically... inside and out... frontwards and backwards... even diagonally... so as to keep everything running as smoothly as possible... to keep money flowing and economies growing.

 

I posit that if you truly think that Greenspan (and any other Fed chairman, for that matter) is not inherently mandated to predict banks' abilities to do their jobs, then either you are not seeing the reality around you as it truly is, or you have no idea what the Federal Reserve is in place to do.

 

 

 

 

http://en.wikipedia.org/wiki/Federal_Reserve_System

Current functions of the Federal Reserve System include:

 

1. To address the problem of banking panics
   
   
2. To serve as the central bank for the United States
   
   
3. To strike a balance between private interests of banks and the centralized responsibility of government
   
   
   • To supervise and regulate banking institutions
     
     
   • To protect the credit rights of consumers
     
     

[*]To manage the nation's money supply through monetary policy to achieve the sometimes conflicting goals of

• maximum employment
  
  
• stable prices
  
  
• moderate long-term interest rates

[*]To maintain the stability of the financial system and contain systemic risk in financial markets

[*]To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system

• To facilitate the exchange of payments among regions
  
  
• To respond to local liquidity needs
  
  

[*]To strengthen U.S. standing in the world economy

Edited October 30, 2008 by iNow

[Pangloss]

Is it safe to say free market economics don't work yet? Or do free market people actually think this sort of thing is natural and healthy for an economy?

 

We've never had free market economics. It's fair to say that regulation has to be carefully measured -- THAT we know from experience.

[iNow]

We've never had free market economics. It's fair to say that regulation has to be carefully measured -- THAT we know from experience.

 

I couldn't have said it better. You took the words right out of my mouth... (or, right out of my fingers/keyboard?)

[Realitycheck]

Duh. The Fed = Banks. My father was a banker. For some reason, I equated bank regulations with some other entity.

[ecoli]

*groan* von Mises is rolling in his grave.

 

He didn't really have to say that. Playing around with the interest rates to try and tweak sales is one thing, but I place all of the responsibility on relaxed lending criteria, whether it was prompted by Clinton, the CRA, or the actual banks themselves. Isn't Fannie/Freddie meant to guarantee loans? So this means that any loans that they acquire have already defaulted once already, meaning that they are innately high risk from the onset. Why do people not make their mortgage payments? High gas prices, high food prices, higher energy prices, I'm sure there has got to be some more good reasons, such as Republican-led income gap issues, but I have not researched enough into that. Reserve activations suddenly having their incomes halved probably might be a bit of an issue, but most of them are probably reasonably responsible.

keeping interest rates low does more than tweak sales. It promoted [mal]investment in the housing market. When you keep interest rates below market value, people don't ascertain risk well.

 

It's hypocritical to keep interest rates low to promote risky investment, and than pass regulation to determine how those investments should be carried out.

 

Let the free market determine interest rates, and the widespread mal-investments will stop. People will still take risks, but not so much that it will cause business cycles.

 

I can't believe Greenspan doesn't see that.

[bascule]

We've never had free market economics. It's fair to say that regulation has to be carefully measured -- THAT we know from experience.

 

This assumption:

 

I made a mistake in presuming that the self-interest of organizations, specifically banks and others, was such as they were best capable of protecting their own shareholders.

 

...is the basis of free market economics.

[ecoli]

So Greenspan is now saying that it's the government's job to ensure that organizations protect their shareholders? Isn't that the inherent risk of being a shareholder, though? Is the government going to start insuring all investments on wall street now?

 

Yeah, there's a role in government regulation from dealing with fraud and other illegal activities, but making risky investments isn't illegal, and it isn't the government's job to protect investments and the economy.

[Realitycheck]

Let the free market determine interest rates, and the widespread mal-investments will stop.

 

What a brilliant idea.

 

Looks like banks may have had some free reign in the form of taking risks with low rated debtors. I believe that they have to keep a certain percentage of deposits in order to maintain dealings with that type of market, but when things turn sour in the overall market ... EVERYBODY CRY WOLF!!!

 

The U.S also has one of the most highly regulated banking environments in the world; however, many of the regulations are not safety and soundness related, but are instead focused on privacy, disclosure, fraud prevention, anti-money laundering, anti-terrorism, anti-usury lending, and promoting lending to lower-income segments. Even individual cities enact their own financial regulation laws (for example, for usury lending).

http://en.wikipedia.org/wiki/Bank_regulation_in_the_United_States Edited October 30, 2008 by agentchange
multiple post merged

[Pangloss]

This assumption:

 

I made a mistake in presuming that the self-interest of organizations, specifically banks and others, was such as they were best capable of protecting their own shareholders.

 

...is the basis of free market economics.

 

And that assumption hasn't been disproved. But I suppose it's possible that we have reached a point of diminishing returns in the quest to find that answer -- you may have a point there. Just as we reached a point of such diminishing returns in the similar question about socialism in 1989.

 

I certainly hope we can move past the question. But good luck convincing my cousin, a tenured professor of economics at a major American university, who considers any kind of government economic regulation to be anathema. (And Barack Obama to be a communist.)

 

(There's also a Socialist Party candidate for President this year. Go figure.)

[ecoli]

What a brilliant idea.

 

Looks like banks may have had some free reign in the form of taking risks with low rated debtors. I believe that they have to keep a certain percentage of deposits in order to maintain dealings with that type of market, but when things turn sour in the overall market ... EVERYBODY CRY WOLF!!!

 

You're missing my point. We don't need regulation to make sure that companies don't take these sorts of risks (like handing out subprime mortgages). The problem is that government policy (community reinvestment act, low interest rates, et. al) led to companies taking unnecessary risks, that they wouldn't have in a free market environment.

 

Fractional reserve banking is indeed a problem, but banks won't generally take the risk of not having loans match cash reserves in a free market. Government agencies which promise to ensure a bank's reserve (at least in part) leads to this dangerous fractional reserve banking.

 

Government policy affects how companies assess risk and invest accordingly. That's the underlying problem here.

 

The government now wants to promote investment by obscuring how the market assesses risk (market based interest rates, etc.) and then wants to increase regulation to control what risks the companies should take.

 

Its hypocritical, and its NOT the government's job to stop normal risk taking practices which occur in the free market. OF course, the problem is, as pangloss points out, we don't have a free market.

 

Here's a good article on the matter: http://mises.org/story/3165

 

I certainly hope we can move past the question. But good luck convincing my cousin, a tenured professor of economics at a major American university, who considers any kind of government economic regulation to be anathema. (And Barack Obama to be a communist.)

I'd like to meet that cousin of yours. I've been studying Austrian economics on my own time, between classes. No arguments I've come across have been better able to explain the economic crises better than the Austrian notion of how business cycles are created. Yet, these free market principles are being abandoned by our politicians when they see a chance to increase spending and their personal influence and control over the economy. Why isn't this worrying everybody else?

[bascule]

The problem is that government policy (community reinvestment act [...] led to companies taking unnecessary risks)

 

I see one group being rather vocal on CRA (the Ron Paulites) however FactCheck.org didn't include it on their list of causes leading to the financial crisis. I think such accusations are overblown. Moreover, the CRA was worded so that banks didn't need to take unnecessary risks. It did not encourage risky lending.

 

Fractional reserve banking is indeed a problem, but banks won't generally take the risk of not having loans match cash reserves in a free market. Government agencies which promise to ensure a bank's reserve (at least in part) leads to this dangerous fractional reserve banking.

 

Fractional reserve banking also leads to the volume of credit needed to drive modern day American society. Imagine if there were a multi-year waiting list before you could take out a loan.

 

Moreover, we have it from the horse's mouth here. If any one single person is responsible for the financial crisis, it's Greenspan, and he now has the opportunity to look in 20/20 hindsight and see what he did wrong. And he blames the assumption that the self-interest of financial institutions was sufficient that they would always act in their shareholders' best interest.

Edited October 30, 2008 by bascule
multiple post merged

[Pangloss]

I'd like to meet that cousin of yours. I've been studying Austrian economics on my own time, between classes. No arguments I've come across have been better able to explain the economic crises better than the Austrian notion of how business cycles are created. Yet, these free market principles are being abandoned by our politicians when they see a chance to increase spending and their personal influence and control over the economy. Why isn't this worrying everybody else?

 

The answer to your question is that it's not worrying everybody else because we're not abandoning the basic two-directional balance and throwing our lot in with the socialists. Just look at bascule above talking about the importance of fractional banking and earlier about the benefits of the credit-driven society -- hardly socialistic principles!

 

I understand your concern and it's not an entirely unreasonable one -- we do have to remember that too much regulation is a bad thing. But that's exactly what Obama has been talking about, for example -- the importance of balance in regulation, finding the right amount of it. If the left takes that to mean "socialism, yay!" and the right takes that to mean "socialism, oh no!", is that really our problem? Let's take the man at his word.

 

My two bits on it, anyway.

[ParanoiA]

I see one group being rather vocal on CRA (the Ron Paulites) however FactCheck.org didn't include it on their list of causes leading to the financial crisis. I think such accusations are overblown. Moreover, the CRA was worded so that banks didn't need to take unnecessary risks. It did not encourage risky lending.

 

Granted FactCheck.org is a great thing, it's hardly the be-all end-all of analytical deduction. Further, the cause of the financial crisis is not "fact", so I hardly see why they qualify for anything more than yet another collective opinion, albeit a valuable one.

 

However, all that aside, they did indict the Clinton administration "which pushed for less stringent credit and downpayment requirements for working- and middle-class families."

 

So, what was the tool Clinton used to do that? I believe that was CRA. CRA did play a role.

Edited October 30, 2008 by ParanoiA

[Mr Skeptic]

*groan* von Mises is rolling in his grave.

 

 

keeping interest rates low does more than tweak sales. It promoted [mal]investment in the housing market. When you keep interest rates below market value, people don't ascertain risk well.

 

It's hypocritical to keep interest rates low to promote risky investment, and than pass regulation to determine how those investments should be carried out.

 

That's true, but lower interest rates also promote all investment, not just risky ones. Some investments are very low risk but also wouldn't be viable with higher interest rates. So with care, it would be possible to increase investment without too great an increase in risky investment. That shouldn't be a business as usual policy, but it could be used to raise employment or fiddle with the economy.

 

Let the free market determine interest rates, and the widespread mal-investments will stop.

 

Possibly, but another reason for malinvestments is that people are allowed to go bankrupt. This skews the balance in favor of risky investments regardless of interest rates.

 

People will still take risks, but not so much that it will cause business cycles.

 

Weren't there business cycles before there was a Fed?

[npts2020]

Isn't business cycle just a kind term for when the latest business ponzi scheme gets out of control? Before the depression of the 1930's banks were so highly leveraged they couldn't even cover their depositors money, much less any investors. This led to the creation of the Federal Reserve to oversee the banks and insure small depositors. Now we have a similar situation where there is something like $500 trillion in leveraged debt, known as derivatives. Where has all of this money gone? Wellllll, it wasn't ever really there to begin with (only financial instrument to guarantee debt,etc).............the only real question is how far the lever can be extended before breaking? My impression is that the economy is more highly leveraged than it was in the 1920's before the crash. My biggest hope for avoiding a repeat is that todays economy is much more diversified and flexible. My biggest pessimism is that politicians will still find a way to screw it up, the recent Emergency Economic Stabilization Act of 2008 looking like a positive sign of it.