Greenspan: “I Was Wrong”

I have been surprised in recent years to still encounter folks who have no idea what caused the financial collapse and who continue to proffer talking points about the virtues of the “free market” [1]. When I point out that even free-market ideology guru Alan Greenspan admitted that his ideology had a major flaw, I receive–shockingly–only blank stares in return.

This is major feat of indoctrination: despite the utter collapse of the financial system because of insufficient state intervention to stabilize it, and despite the admission by the preeminent guru of free market ideology that the ideology was wrong, the political class on the right remains ignorant of these basic facts.

For reference, here is the record on Greenspan.

“…in shocked disbelief…”

NY Times, Oct. 2008

For years, a Congressional hearing with Alan Greenspan was a marquee event. Lawmakers doted on him as an economic sage. Markets jumped up or down depending on what he said. Politicians in both parties wanted the maestro on their side.
But on Thursday, almost three years after stepping down as chairman of the Federal Reserve, a humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform…. “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,” said Representative Henry A. Waxman of California, chairman of the committee. “Do you feel that your ideology pushed you to make decisions that you wish you had not made?”Mr. Greenspan conceded: “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.”

Washington Post, columnist, 2006 [prior to US financial collapse], “Laissez-Fairest of Them All”:

A determination to substitute the wisdom of markets for the heavy hand of government runs through the Greenspan story.

… [P]erhaps Greenspan‘s most important contribution has been as the policymaker who, through the power of his office, the force of his intellect and the cunning of his behind-the-scenes maneuvering, engineered the wholesale deregulation of the U.S. banking and financial system. In this respect, his most enduring legacy is an American economy that is not only more prone to assets bubbles, corporate scandal and financial crises, but robust enough to absorb such shocks while continuing to deliver long-term economic growth.

The Washington Post in 2008:

The former chairman of the Federal Reserve said the crisis had shaken his very understanding of how markets work, and agreed that certain financial derivatives should be regulated — an idea he had long resisted.

… Yesterday, many members of the House Oversight and Government Reform Committee treated him as a hostile witness.“You found that your view of the world, your ideology was not right, it was not working?” said Rep. Henry A. Waxman (D-Calif.), the committee chairman.

… With the global financial system unraveling, economists and political leaders are coming to doubt some of Greenspan‘s most closely held views: that markets can exact self-discipline, that central bankers should generally not try to prick bubbles in the price of houses or tech stocks, that a policymaker’s most powerful tool to encourage growth is to stay out of the way. Even Greenspan seemed genuinely perplexed yesterday by all that had happened, hard-pressed to explain how formerly fundamental truths about how markets work could have proved so wrong.“Absolutely, precisely,” Greenspan said.

The Guardian, 2008:

The former Federal Reserve chairman, Alan Greenspan, has conceded that the global financial crisis has exposed a “mistake” in the free market ideology which guided his 18-year stewardship of US monetary policy.

A long-time cheerleader for deregulation, Greenspan admitted to a congressional committee yesterday that he had been “partially wrong“ in his hands-off approach towards the banking industry and that the credit crunch had left him in a state of shocked disbelief. “I have found a flaw,” said Greenspan, referring to his economic philosophy. “I don’t know how significant or permanent it is. But I have been very distressed by that fact.”

… he told the House oversight committee that he regretted his opposition to regulatory curbs on certain types of financial derivatives which have left banks on Wall Street and in the Square Mile facing billions of dollars worth of liabilities.

“I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms,” said Greenspan.

… He suggested his trust in the responsibility of banks had been misplaced: “Those 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.”

The congressional committee’s Democratic chairman, Henry Waxman, pressed him: “You found that your view of the world, your ideology, was not right, it was not working?” Greenspan agreed: “That’s precisely the reason I was shocked because I’d been going for 40 years or so with considerable evidence that it was working exceptionally well.”

Here is an excerpt from a recent book by Nobel Laureate in economics Joseph Stiglitz, providing context for the housing bubble and ensuing financial collapse:

Strikingly, the Fed and its chairman at the time, Alan Greenspan, didn’t learn the lessons of the tech bubble.  But this was in part because of the politics of “inequality,” which didn’t allow alternative strategies that could have resuscitated the economy without creating another bubble, such as a tax cut to the poor or increased spending on badly needed infrastructure.  This alternative to the reckless path the country took was anathema to those who wanted to see a smaller government—one too weak to engage in progressive taxation or redistributive policies.  Franklin Delano Roosevelt had tried these policies in his New Deal, and the establishment pilloried him for it.  Instead, low interest rates, lax regulations, and a distorted and dysfunctional financial sector came to the rescue of the economy—for a moment.

The Fed engineered, unintentionally, another bubble, this one temporarily more effective than the last but in the long run more destructive.  The Fed’s leaders didn’t see it as a bubble, because their ideology, their belief that markets were always efficient, meant that there couldn’t be a bubble.  The housing bubble was more effective because it induced spending not just by a few technology companies but by tens of millions of households that thought that they were richer than they were.  In one year alone, close to a trillion dollars were taken out in home equity loans and mortgages, much of it spent on consumption.  But the bubble was more destructive partly for the same reasons: it left in its wake tens of millions of families on the brink of financial ruin.  Before the debacle is over, millions of Americans will lose their homes, and millions more will face a lifetime of financial struggle.

Overleveraged households and excess real estate have already weighed down the economy for years and are likely to do so for more years, contributing to unemployment and a massive waste of resources.  At least the tech bubble left something useful in its wake—fiber optics networks and new technology that would provide sources of strength for the economy.  The housing bubble left shoddily built houses, located in the wrong places and inappropriate to the needs of a country where most people’s economic position was in decline.  It’s the culmination of a three-decade stretch spent careening from one crisis to another without learning some very obvious lessons along the way.

In a democracy where there are high levels of inequality, politics can be unbalanced, too, and the combination of an unbalanced politics managing an unbalanced economy can be lethal.

Notes

[1] Never mind that the free market is a term that is virtually without meaning outside of the world of economic theory, since there is no existing market system that does function with enormous state intervention and regulation, ranging from tariffs to patent law to immigration quotas to industry targets, subsidies, and tax exemptions (used as incentives or penalties for market practices). It has long been recognized by the business community that state intervention is a crucial factor in managing a stable economic system (this realization became policy with the business-driven New Deal policies, designed to stabilize the business system as well as satisfy some of the basic demands for a more human labor system). For further explanation and references on this point, see Columbia economist Ha-Joon Chang’s books Kicking Away the Ladder and Bad Samaritans. His points are excerpted here as well. A different approach to the same concept, using Polanyi, is developed here.