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Dumping On Alan Greenspan

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March 22, 2010

On Friday, March 19, former Federal Reserve chair, Alan Greenspan appeared before the Brookings Institution to present his 48-page paper entitled, “The Crisis”.  The obvious subject of the paper concerned the causes of the 2008 financial crisis.  With this document, Greenspan attempted to add his own spin to history, for the sake of restoring his tattered public image.  The man once known as “The Maestro” had fallen into the orchestra pit and was struggling to preserve his prestige.  After the release of his paper on Friday, there has been no shortage of criticism, despite Greenspan’s “enlightened” change of attitude concerning bank regulation.  Greenspan’s refusal to admit the Federal Reserve’s monetary policy had anything to do with causing the crisis has placed him directly in the crosshairs of more than a few critics.

Sewell Chan of The New York Times provided this summary of Greenspan’s paper:

Mr. Greenspan, who has long argued that the market is often a more effective regulator than the government, has now adopted a more expansive view of the proper role of the state.

He argues that regulators should enforce collateral and capital requirements, limit or ban certain kinds of concentrated bank lending, and even compel financial companies to develop “living wills” that specify how they are to be liquidated in an orderly way.

*   *   *

. . . Mr. Greenspan warned that “megabanks” formed through mergers created the potential for “unusually large systemic risks” should they fail.

Mr. Greenspan added:  “Regrettably, we did little to address the problem.”

That is as close as Greenspan came to admitting that the Federal Reserve had a role in helping to cause the financial crisis.  Nevertheless, these magic words from page 39 of “The Crisis” are what got everybody jumping:

To my knowledge, that lowering of the federal funds rate nearly a decade ago was not considered a key factor in the housing bubble.

The best retort to this denial of reality came from Barry Ritholtz, author of Bailout Nation.  His essay entitled, “Explaining the Impact of Ultra-Low Rates to Greenspan” is a must read.  Here’s how Ritholtz concluded the piece:

The lack of regulatory enforcement was a huge factor in allowing the credit bubble to inflate, and set the stage for the entire credit crisis.  But it was intricately interwoven with the ultra low rates Alan Greenspan set as Fed Chair.

So while he is correct in pointing out that his own failures as a bank regulator are in part to blame, he needs to also recognize that his failures in setting monetary policy was also a major factor.

In other words, his incompetence as a regulator made his incompetence as a central banker even worse.

Paul La Monica wrote an interesting post for CNN Money’s The Buzz blog entitled, “Greenspan and Bernanke still don’t get it”.  He was similarly unimpressed with Greenspan’s denial that Fed monetary policy helped cause the crisis:

This argument is getting tiresome.  Keeping rates so low helped inflate the bubble.

*   *   *

“The Fed wasn’t the sole culprit.  But if not for an artificially steep yield curve, we probably would not have had a global financial crisis,” said John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala.

“Greenspan and Bernanke are missing the point.  It all stems from monetary policy,” Norris added.  “If you give bankers an inducement to lend more than they ordinarily would they are going to do so.”

From across the pond, Stephen Foley wrote a great article for The Independent entitled, “For the wrong answers, turn to Greenspan”.  He began the piece this way:

The former US Federal Reserve chairman, the wizened wiseman of laissez-faire economics, shocked us all — and probably himself — when he told a congressional panel in 2008 that he had found “a flaw in the model I perceived is the critical functioning structure that defines how the world works, so to speak”.  He meant that he had realised banks cannot be trusted to manage their own risks, and that markets do not smoothly self-correct.

But instead of taking that revelation and helping to point the way to a new, post-crisis financial world, he has shuddered to an intellectual halt.  It is the same intellectual stop sign that Wall Street’s bankers are at.  The failure to move forward is regrettable, dangerous and more than a little self-serving.

These reactions to Greenspan’s paper are surely just the beginning of an overwhelming backlash.  The Economist has already weighed in and before too long, we might even see a movie documenting the Fed’s responsibility for helping to cause The Great Recession.



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More Heat For The Federal Reserve

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October 5, 2009

On Thursday, October 1, Federal Reserve chairman Ben Bernanke testified before the House Financial Services Committee.  That event demonstrated how the Fed has fallen into the crosshairs of critics from both ends of the political spectrum.  A report in Friday’s Los Angeles Times by Jim Puzzanghera began with the point that the Obama administration has proposed controversial legislation that would expand the Fed’s authority, despite bipartisan opposition in a Congress that is more interested in restricting the Fed’s influence:

Worried about the increased power of the complex and mysterious Fed, and upset it did not do more to prevent the deep recession, Capitol Hill has focused its anger over the financial crisis and its aftermath on the central bank.  The Fed finds itself at the center of a collision of traditional political concerns – conservatives’ fears of heavy-handed government intervention in free markets, and liberals’ complaints of regulators who favor corporate executives over average Americans.

More than two-thirds of the House of Representatives has signed on to a bill that would subject the central bank to increased congressional oversight through expanded audits.  A key senator wants to strip the Fed of its authority to regulate banks.  And the chairman of the House Financial Services Committee wants to rein in the Fed’s emergency lending power, which it used to help engineer the sale of Bear Stearns Cos. and bailout American International Group Inc.

The article noted the observation of Jaret Seiberg, a financial policy analyst with Concept Capital’s Washington Research Group:

“The Fed is running into unprecedented opposition on Capitol Hill,” he said.

“In the Senate, there’s open hostility toward any expansion of the Federal Reserve’s authority.  And in the House, you certainly have Republicans looking to focus the Fed solely on monetary policy and strip it of any larger role in financial regulation.”

Mr. Puzzanghera’s report underscored how the Fed’s interventions in the economy during the past year, which involved making loans (of unspecified amounts) and backing commercial transactions, have drawn criticism from both sides of the aisle.  The idea of expanding the Fed’s authority to the extent that it would become a “systemic risk regulator” has been criticized both in Congress and by a former member of the Federal Reserve Board of Governors:

House Republicans want to scale back the Fed’s power so the bank focuses on monetary policy.  And many have opposed the administration’s proposal to give the Fed the new role of supervising large financial institutions, such as AIG, that are not traditional banks but pose a risk to the economy if they fail.

“I’m not alone with my concerns about the Fed as a systemic regulator,” said Rep. Scott Garrett (R-N.J.).  Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) has similar concerns, as do others on his panel.  In fact, Dodd has proposed stripping the Fed of all of its bank oversight functions as part of his plan for creating a single banking regulatory agency.

Former Fed Gov. Alice M. Rivlin also said it would be a mistake to increase the Fed’s regulatory powers because it would distract from the central bank’s monetary policy role.

“Do we want to augment the regulatory authority of the Fed?      . . .  My answer is no,” said Rivlin, a senior fellow at the Brookings Institution.  “My sense is many people would be nervous about that augmentation.”

The colorful Democratic chairman of the House Financial Services Committee, Barney Frank, recently published a report card on the committee’s website, criticizing the Fed’s poor record on consumer protection.  The report card contrasted what Congressional Democrats had done to address various issues (categorized under the heading:  “Democrats Act”) with what the Fed has or has or has not done in dealing with those same problems.

Meanwhile, Republican Congressman Ron Paul of Texas, is making the rounds, promoting his new book:  End The Fed.  A recent posting at The Daily Bail website includes a YouTube video of Ron Paul at a book signing in New York, which resulted in a small parade over to the New York Fed.  Although the Daily Bail piece reported that Paul’s book had broken into the top ten on Amazon’s list of bestsellers — as I write this, End The Fed is number 15.  I would like to see that book continue to gain popularity.  Perhaps next time Chairman Bernanke testifies before a committee, he will know that something more than his own job is on the line.  It would be nice to see him make history as the last Chairman of the Federal Reserve.



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The Window Of Opportunity Is Closing

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September 17, 2009

In my last posting, I predicted that President Obama’s speech on financial reform would be “fine-sounding, yet empty”.  As it turned out, many commentators have described the speech as just that.  There weren’t many particulars discussed at all.  As Caroline Baum reported for Bloomberg News:

At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.

“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City.  (“You will not stay out until 2 a.m. again.”)

*   *   *

Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill.  But his words rang hollow.

*   *   *

But you can’t, with words alone, alter the perception — now more entrenched than ever — that the government won’t allow large institutions to fail.

How do you convince bankers they will pay for their risk-taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?

They learn by example.  The system of privatized profits and socialized losses has suited them fine until now.

Although the President had originally voiced support for expanding the authority of the Federal Reserve to include the role of “systemic risk regulator”, Ms. Baum noted that Allan Meltzer, professor of political economy at Carnegie Mellon University, believes that Mr. Obama has backed away from that ill-conceived notion:

“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said.   “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”

Ms. Baum took that criticism a step further with her observation that the mission undertaken by any systemic risk regulator would not likely fare well:

Bankers Outfox Regulators

It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size.  Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit.  When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.

What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.

At this point in the economic crisis, with Federal Reserve chairman Ben Bernanke’s recent declaration that the recession is “very likely over”, there is concern that President Obama’s incipient attempt at enacting financial reform may already be too late.  A number of commentators have elaborated on this theme.  At Credit Writedowns, Edward Harrison made this observation:

If you are looking for reform in the financial sector, the moment has passed.  And only to the degree that the underlying weaknesses in the global financial system are made manifest and threaten the economy will we see any appetite for reform amongst politicians.  So, as I see it, the Obama administration has missed the opportunity for reform.

More important, the following point by Mr. Harrison has been expressed in several recent essays:

Irrespective, I believe the need for reform is clear.  Those gloom & doom economists were right because the economic model which brought us to the brink of disaster in 2008 is the same one we have at present and that necessarily means another crisis will come.

At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:

Some observers say it’s OK that a year has gone by without reform; we don’t want to get it wrong.  But the political reality is that as the urgency passes, it’s harder to pass reforms.

“We have lulled ourselves into the mind-set that we are out of the woods, when we aren’t,” says Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University School of Law.  “I don’t think time is our friend here. We risk losing the sense of urgency so that nothing happens.”

*   *   *

Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, thinks the unofficial deadline for financial-sector reform is now October 2010 — right before the next congressional elections.

That leaves lawmakers a full year to get the job done.

But given all the details they have to work out — and the declining sense of urgency as stocks keep ticking higher — you have to wonder how much progress they’ll make.

On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:

You are kidding yourself if you think real reform is coming to the financial sector before the mid-term elections, especially with healthcare, two wars and the need to ensure recovery still on politicians’ plates. Obama could go for real reform in 2011 — or in a second term in 2013.  But, unless economic crisis is at our door, there isn’t a convincing argument which says reform is necessary.

At The Washington Post, Brady Dennis discussed the Pecora Commission of the early 1930s, which investigated the causes of the Great Depression, and ultimately provided a basis for reforms of Wall Street and the banking industry.  Mr. Dennis pointed out how the success of the Pecora Commission was rooted in the fact that populist outrage provided the fuel to help mobilize reform efforts, and he contrasted that situation with where we are now:

“Pecora’s success was his ability to crystallize the anger that a lot of Americans were feeling toward Wall Street,” said Michael Perino, a law professor at St. John’s University and author of an upcoming book about the hearings. “He was able to create a clamor for reform.”

But Pecora also realized that such clamor was fleeting

*   *   *

“We’ve passed the moment when there’s this palpable anger directed at the financial community,” Perino said of the current crisis.  “When you leave the immediate vicinity of the crisis, as you get farther and farther away in time, the urgency fades.”

Unfortunately, we appear to be at a point where it is too late to develop regulations against many of the excesses that led to last year’s financial crisis.  Beyond that, many people who allowed the breakdown to occur (Bernanke, Geithner, et al.) are still in charge and the players who gamed the system with complex financial instruments are back at it again, with new derivatives — even some based on life insurance policies.  Perhaps another harbinger of doom can be seen in this recent Bloomberg article:  “Credit Swaps Lose Crisis Stigma as Confidence Returns”.  Nevertheless, from our current perspective, some of us don’t have that much confidence in our financial system or our leadership.



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