[Corp. Watch] Blind adherence to economic dogma led to real-world crisis

[Corporation Watch]

Alan Greenspan: The Oracle -- or the Master of Disaster?

  By Thomas B. Edsall

(Huffington Post, Feb. 19) -- On June 10, 1999, at the height of his  
power, Alan Greenspan told members of Harvard's graduating class how  
they should assess their lives in the future: "The true measure of a  
career is to be able to be content, even proud, that you succeeded  
through your own endeavors without leaving a trail of casualties in  
your wake."

	At the time, Greenspan, 73, clearly thought he had lived up to his  
own standard. Four months earlier, on February 15, Time magazine had  
honored him with a cover story, presenting Greenspan as the de facto  
chair of the three-member "Committee to Save the World."

	The American economy Greenspan had overseen for 12 years from his  
perch as chairman of the Federal Reserve was, by his description, "in  
the grip of what ... Joseph Schumpeter, many years ago called  
'creative destruction'. ... This is the process by which wealth is  
created, incremental step by incremental step. It pre-supposes a  
continuous churning of an economy, as the new displaces the old."

	The free market, Greenspan told the graduating seniors, is a pillar  
of civilization which "pre-supposes the productive interaction of  
people engaged in the division of labor, driven -- I cannot resist the  
jargon -- by economic comparative advantage. This implies mutual  
exchange to mutual advantage among free people."

	Greenspan's years of running the Federal Reserve, from August 1987 to  
January 2006, were a time of economic glory. On July 16, 2003, for  
example, when economic figures such as Warren Buffett and George Soros  
were warning of the dangers of derivatives, Greenspan told the Senate  
Banking Committee, according to a transcript of the session:


> "What we have found over the years in the marketplace is that  

> derivatives have been an extraordinarily useful vehicle to transfer  

> risk from those who shouldn't be taking it to those who are willing  

> to and are capable of doing so. Prior to the advent of derivatives  

> on a large scale, we did not have that capability. And we often had,  

> for example, financial institutions, like banks, taking on undue  

> risk and running into real, serious problems. ...

>

> "The vast increase in the size of the over-the-counter derivatives  

> markets is the result of the market finding them a very useful  

> vehicle. And the question is, should these be regulated? Well,  

> indeed, for the United States, they are obviously regulated to the  

> extent that banks, being the crucial creators of these derivatives,  

> are regulated by the banking agencies, but not beyond that.

>

> And the reason why we think it would be a mistake to go beyond that  

> degree of regulation is that these derivative transactions are  

> transactions amongst professionals. And the institutions which are  

> involved have very considerable what we call 'counterparty  

> surveillance', where, for example, one major bank will know far more  

> about its customer, whether it's a bank or something else, than we  

> could conceivably know as regulators. In a sense, this counterparty  

> surveillance has become the crucial element which has created  

> stability in that particular system."


	Greenspan's tenure coincided with a period during which total wealth  
increased dramatically, although much of the growth was concentrated  
among the richest of the rich -- not just the top one percent of the  
income distribution, but the top 0.1 percent.

	The gross national product, in inflation-adjusted 2000 dollars, rose  
from $6.47 trillion in 1987 to $11.32 trillion in 2006, while  
unemployment fell by a substantial 1.6 percentage points, from 6.2  
percent in 1987 to 4.6 percent in 2006. Corporate profits rose from  
$368.8 billion to $1.59 trillion, without adjusting for inflation.

	The Dow Jones Industrial Average, which was just above 2,700 when  
Greenspan took office in 1987, rose to over 11,000 in January 2006,  
when he retired.

	In one of his more controversial decisions, the Fed under Greenspan  
flooded the market with cash in the immediate aftermath of the 9/11  
terrorist attacks, and sharply cut interest rates as part of a world- 
wide effort on the part of central bankers to reinvigorate the global  
economy.

	Now, three years after he left the Fed, Greenspan confronts a  
catastrophic legacy. All around him is the evidence of an  
extraordinary "trail of casualties" left in his wake -- men and women  
losing their jobs at a rate of half a million a month, foreclosures  
forcing Americans out of their homes, and the Dow plunging by 46.7  
percent from its high of 14,164.53 on October 9, 2007.

	The gross domestic product began to fall at an annual rate of 0.5  
percent in the third quarter of 2008 and then accelerated to a 3.8  
percent rate of decline in the fourth quarter; corporate profits fell  
by $160 billion from $1.67 trillion in the third quarter of 2007 to  
$1.51 trillion in the fourth quarter of 2008.

	The unemployment rate has risen from 4.7 percent in January 2006,  
when Greenspan retired, to 7.6 percent last month. The Dow Jones,  
which reached a high of 1,4164.53 on October 9, 2007, has collapsed to  
7,555.63 at the close of business Wednesday -- a drop of nearly 47  
percent.

	Much of the blame has been aimed at Greenspan: "Because the Federal  
Reserve under Alan Greenspan pushed interest rates too low and kept  
them low for too long, and because regulation of financial  
intermediaries had dwindled over the years, and became especially lax  
during the Bush administration, the bankers were allowed -- and  
competition forced them -- to take risks that could have and have had  
disastrous results," wrote Richard A. Posner, Seventh Circuit Court of  
Appeals Judge.

	Nobel Laureate Joseph Stiglitz adds other culprits as crucial to the  
making of the current economic crisis. Among them:

1) The April 1998 decision of President Clinton's Working Group on  
Financial Markets to quash a proposal by Brooksley Born, head of the  
Commodity Futures Trading Commission (CFTC), to regulate derivatives

2) Enactment of the Gramm-Leach-Bliley Act on November 12, 1999,  
allowing consolidation of commercial and investment banks

3) Passage of the Commodity Futures Modernization Act of 2000,  
removing derivatives from federal oversight

4) The Bush tax cuts of 2001 and 2003

5) The failure of the Federal Reserve to take responsibility for  
regulating derivatives [in the absence of the executive branch doing so]

6) The Securities and Exchange Commission (SEC) decision in April,  
2004, to allow large investment banks to increase their debt-to- 
capital ratio from 12 to 1 to 30 to 1, or higher

	What each of these actions (and inactions) has in common is that  
Greenspan either initiated or endorsed them.

	The rejection of CFTC chief Born's proposal to regulate derivatives  
was backed by Treasury Secretary Robert Rubin and SEC Chairman Arthur  
Levitt, both members of the Working Group on Financial Markets, but,  
according to most accounts, Greenspan led the charge.

	Some argue that Greenspan was less an independent power in his own  
right than a reflection of the forces that have generally dominated  
the setting of banking regulation over the years. Columbia economist  
Massimo Morelli, for example, contends that:


> "[A]llowing banks to become much more than banks, and allowing  

> investment banks to operate in an almost lawless environment were  

> huge mistakes, and with large unfair distribution consequences. ...  

> [T]he strong financial lobbies have certainly had an impact on such  

> mistakes, and so part of the responsibility goes certainly to the  

> Fed and Treasury secretaries, but it would be hard for me to take  

> sides on who or what institution was primarily responsible.

>

> "The unfortunate point I would make today is that the same lobbies  

> seem to be still very powerful, given the unfair distributional  

> consequences of the TARP and the unwillingness of the decisionmakers  

> in Washington to resolve the lending problems of this economy by a  

> simple resort to swapping debt into equity, [thereby] making the  

> bank debt-holders suffer to a greater extent than taxpayers."


	Greenspan has struggled to come to terms with the economic collapse  
and his role in it. Last autumn, with the economy in a tailspin, he  
remained remarkably sanguine, voicing little or no self-reproach for  
the possible consequences of his hands-off, free-market approach to  
the regulation of derivatives.

	In an October 2, 2008, speech at the Sandra Day O'Connor Conference  
at Georgetown University, Greenspan blamed a lack of trust -- not  
regulation -- for the financial melt-down, and predicted a quick  
turnaround:


> "In a market system based on trust, reputation has a significant  

> economic value. I am therefore distressed at how far we have let  

> concerns for reputation slip in recent years. Reputation and the  

> trust it fosters have always appeared to me to be the core  

> attributes required of competitive markets. Laws at best can  

> prescribe only a small fraction of the day-by-day activities in the  

> marketplace. When trust is lost, a nation's ability to transact  

> business is palpably undermined. In the marketplace, uncertainties  

> created by not always truthful counterparties raise credit risk, and  

> thereby increase real interest rates and weaker economies.

>

> "During the past year, lack of trust in the validity of accounting  

> records of banks and other financial institutions in the context of  

> inadequate capital led to a massive hesitancy in lending to them.  

> The result has been a freezing up of credit. As I noted in my  

> opening remarks, trust will eventually re-emerge as investors dip  

> hesitantly back into the marketplace. From that point, history tells  

> us, financial and economic revival sets in. I suspect it will be  

> sooner rather than later. In either event, human nature being what  

> it is, revival will come. It always has in this society governed by  

> that remarkable document we call the constitution of the United  

> States."


	Just 21 days later, however, testifying before the House Oversight  
and Reform Committee on October 23, 2008, a suddenly chastened  
Greenspan appeared repentant and certainly no longer the defender of  
untrammeled laissez-faire. In his prepared testimony, Greenspan told  
the committee:


> "[T]hose of us who have looked to the self-interest of lending  

> institutions to protect shareholders' equity -- myself especially --  

> are in a state of shocked disbelief. Such counterparty surveillance  

> is a central pillar of our financial markets' state of balance."



	Under questioning by committee chair Henry Waxman, Greenspan was more  
explicit:


> Waxman: "[T]his 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.' ... Do you feel that your ideology pushed you to make  

> decisions that you wish you had not made?"

>

> Greenspan: "Well, remember what an ideology is. It's 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 have  

> found a flaw.' I don't know how significant or permanent it is. But  

> I have been very distressed by that fact. ... A flaw in the model  

> that I perceived is the critical functioning structure that defines  

> how the world works, so to speak."


	More recently, Greenspan had adopted a different tack. Once proud of  
his nickname, "The Oracle," and of his de facto chairmanship of the  
Committee to Save the World, Greenspan told CNBC on February 12 that  
during the critical years leading up to the 2008 collapse, he was both  
ignorant of the scope of the problem and powerless to deal with it.

	"I remember my initial response [in 2005] when a staff member came up  
to me and he says, 'I don't know if you have seen something like  
this'," while showing the then-Fed chairman data that sub-prime  
mortgages represented 20 percent of all new mortgages. "I said, 'I  
don't believe that number'."

	Asked if the Fed could have prevented the housing bubble, Greenspan  
pleaded powerlessness:


> "If we tried to suppress the expansion of the sub-prime market, do  

> you think that would have gone over very well with the Congress? ...  

> When it looked as though we were dealing with a major increase in  

> home ownership, which is of unquestioned value to this society --  

> would we have been able to do that? I doubt it."



	Not only that, Greenspan contended on CNBC, but if the Fed had taken  
action, the results would have been disastrous:


> "We could have basically clamped down on the American economy,  

> generated a 10 percent unemployment rate. And I will guarantee we  

> would not have had a housing boom, stock market boom, or indeed a  

> particularly good economy either."



	Most recently, Greenspan's ideological journey has taken an abrupt  
left turn. On February 18, the Financial Times reported that the one- 
time libertarian devotee of Ayn Rand now thinks the government might  
be best advised to take over 'lemon' banks.

	"It may be necessary to temporarily nationalize some banks in order  
to facilitate a swift and orderly restructuring," he said in an  
interview. There is no way to predict what the former Chairman will  
say in his next commencement address.