The questions Greenspan didn't ask
The former Fed chief's media offensive glosses over the apparent shortcomings of his laissez-faire stance.
(Fortune) -- Alan Greenspan was once known for his inscrutable pronouncements, but his penchant for self-justification is now plain for all to see.
Bristling at charges he fueled the housing bubble by being loose with interest rates and lax with bank regulation, Greenspan has launched a media crusade of sorts. This week alone he has penned an opinion piece in the Financial Times, participated in a front-page profile in The Wall Street Journal and conducted a live interview with CNBC.
Greenspan once was the master of obfuscatory "Greenspeak," the man who in 1995 counseled senators that "if I say something which you understand fully ... I probably made a mistake." But shorn of that ambiguity, his message - that the Fed's role in fostering an unprecedented run-up of house prices has been vastly overstated, and that regulators aren't up to the task of preventing financial crises anyway - sounds almost willfully obtuse.
"The U.S. bubble was close to median world experience, and the evidence that monetary policy added to the bubble is statistically very fragile," Greenspan wrote in the FT. He told CNBC that "I have no regrets on any of the Federal Reserve policies that we initiated back then, because I think they were very professionally done."
Greenspan may well be correct on those counts. The problem is that Americans generally aren't interested in comparing worldwide house-price trends or considering how the Fed arrives at its decisions. What they expect from the Fed is policy that fosters stable economic growth and cushions ordinary people from the booms and busts associated with the free markets Greenspan so ardently defends. And on those scores, it's clear, something has gone awry.
The past nine months have found the U.S. paying for a leverage-fueled property binge that began toward the end of Greenspan's tenure. Since last summer, we have seen the collapse of the market for subprime-related securities, the disclosure of hundreds of billions of dollars in writedowns at major financial institutions and the related CEO shakeups at Citi (C, Fortune 500), Merrill Lynch (MER, Fortune 500) and UBS (UBS), and a government-brokered rescue of Bear Stearns (BSC, Fortune 500). Unemployment is ticking up, and the tightfisted lending by cash-short banks threatens to stifle economic growth.
Greenspan is aware of these problems, but he doesn't seem to believe there was any way he could have done anything - such as raising interest rates earlier in the economic recovery earlier this decade, or cracking down on loose lending practices - to restrain them. Instead, he prefers to hide behind the limitations of the statistics he famously devours. Greenspan contended in a piece in the Financial Times last month that "the essential problem is that our models - both risk models and econometric models - as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality."
But all the modeling in the world can't change the fact that the financial market meltdowns of the past year share roots in the housing mess - a debacle that some observers have been warning about for years. Northern Trust economist Paul Kasriel, for instance, said flatly in a June 2004 interview with Investment News that "housing is a bubble." He predicted "a real shakeout in the housing sector because today's real estate prices won't be justified by higher interest rates."
In fact, U.S. house prices didn't start peaking till 2006, after Greenspan gave way atop the Fed to Ben Bernanke. But the end of house-price appreciation fueled a rise in mortgage defaults and delinquencies, which left investors everywhere holding bonds that didn't turn out to be as safe as Wall Street had claimed.
There is no shortage of blame to go around in this mess - everyone from investors to bankers to regulators acted imprudently - and no one claims there is an easy answer. "Better regulation doesn't mean better outcomes," says Howard Simons, a strategist at Bianco Research in Chicago. Still, Greenspan's suggestion that the ramifications of the housing bubble were unforeseeable beggars the imagination.
"Greenspan is right, of course, that we will never have a perfect model of risk in a complex economy," Alice Rivlin, a senior fellow at the Brookings Institution, wrote in a response to Greenspan's March column at ft.com. "But the culprit was not imperfect models," Rivlin added. "It was failure to ask common sense questions."
Rivlin, who previously was director of the Congressional Budget Office and a Fed governor, wrote that Greenspan should have been asking whether house prices could rise forever (not likely, she answered) and what would happen to the value of mortgage-related securities when house prices stalled (they would decline). Ironically, one result of Greenspan's failure to pose those questions is Washington's march toward re-regulation of the financial sector - an outcome, as columinst Caroline Baum recently pointed out on Bloomberg, that Greenspan has spent his career opposing.
The Bear Stearns episode in particular seems to have crystallized sentiment that the pendulum has swung too far in the direction of self-regulation. Asked earlier this month by Congress to explain why the Fed was using taxpayer dollars to finance Bear's sale to JPMorgan Chase (JPM, Fortune 500), Treasury Undersecretary Robert Steel responded, "The failure of a firm that was connected to so many corners of our markets would have caused financial disruptions beyond Wall Street." In effect, he was saying the mighty U.S. economy couldn't withstand the failure of a second-rate brokerage firm - a notion that fairly calls out for substantial changes aimed at reducing so-called systemic risk.
Yet Greenspan retains his faith in modest, market-based solutions. "Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators," Greenspan wrote in his most recent FT piece. "Regulators, to be effective, have to be forward-looking to anticipate the next financial malfunction. This has not proved feasible."