Greenspan’s Mea Culpa

By David Leonhardt

Updated at 4 p.m.

Here’s a fascinating exchange between Alan Greenspan and Representative Henry A. Waxman from today’s hearing on Capitol Hill (as reported by Michael Grynbaum):

Referring to his free-market ideology, Mr. Greenspan added: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”

Mr. Waxman pressed the former Fed chair to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.

“Absolutely, precisely,” Mr. Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

Over the last 30 years or so years, the world has been deeply influenced by a laissez-faire economic philosophy, which has shifted the world toward an embrace of markets. And markets certainly do many things very well. (Can you name a country that has prospered without relying to a great extent on an open, market-based economy? Or at least moving toward one?)

But it certainly seems as if this country, at least, went too far toward laissez-faire economics. I wonder whether we might now be at the beginning of a period in which we move back somewhat in the other direction. And I wonder if historians will someday look back at that exchange between Mr. Greenspan and Mr. Waxman as a sign that the change was coming.

My earlier post on the testimony appears below:

Alan Greenspan is up on Capitol Hill today, apparently issuing a bit of a mea culpa. (Our colleagues at DealBook are live blogging the hearing.) Mr. Greenspan said he had believed that banks would do a good job of protecting their own financial interests, which was largely why he didn’t try to put a stop to the explosion of risky mortgage lending. He is now in a “state of shocked disbelief” that banks failed to do so.

This is an honorable thing for him to do. Mr. Greenspan was wrong about several important things, and I’m not sure whether he will acknowledge all of them. But it’s also worth saying that standing up in front of Congress and admitting error cannot be easy.

Here is a big question for the future: Will the Federal Reserve be willing to attack the next bubble? Maybe so.

We have now established that companies do not always act in their own best interests and that bubbles can happen. Identifying them isn’t easy. But it is sometimes possible. By 2005, there should not have been any doubt that the real-estate and mortgage markets were in a bubble — and that tougher regulation was needed.

Next time, I hope regulators pay more attention to economic fundamentals (like the ratio of house prices to incomes). In both the housing and dot-com bubble, the fundamentals were flashing bright red.

Comments are no longer being accepted.

andrew October 23, 2008 · 1:37 pm

“I have found a flaw”! Hilarious.

Norm Bleistein October 23, 2008 · 1:45 pm

We have all been victimized by Alan Greenspan’s unwavering adherence to the Ayn Rand’s objectivist credo that business people act ethically because it will be good for business. The problem is that Ayn Rand never knew about the quarterly report and the severance package. Thus, this ideology is nonsense in the modern business world. She could be forgiven for her ignorance, but Alan Greenspan cannot. He had to be totally oblivious to the reality of the new reality around him to pontificate and make policy decisions based on this false premise in or modern financial world

jay October 23, 2008 · 1:51 pm

Indeed! Wonderful news that free-market ideologues are “waking up”! Gives me hope for the election, and the future of this country!

Bill U. October 23, 2008 · 1:51 pm

Money was coming in so fast for top bankers that they fell into a different kind of moral hazard — a willingness to disregard risks–even the certainty of a coming crash–because they would still be unbelievably rich for generations after those risks materialized. And they are. They may have people mad at them, but they now need never work again, nor their children nor their children’s children. What a system!

Late in life for A.G. to be learning about human nature, but better late than never, I suppose.

Dr K October 23, 2008 · 1:52 pm

Corporate Predators! Corporate heads are money-making, hungry and unstoppable machines. Our government, such as it is, is too weak to regulate or stop these CEO’s. Sad to say, they will continue in their ways until they sink the ship of state.

Tacho October 23, 2008 · 1:52 pm

Dr. Greenspan reminds me of that famous line in the movie Casablanca when the French Police Commander
Captain Renaud says to Rick (Humphrey Bogart),

“I’m Shocked…Shocked…to hear that there is gambling going on in this establishement !”

That was after he received his winnings !

Guy October 23, 2008 · 1:53 pm

Well its good to see Greenspan take some responsibility. I am sure he will make up by donating some of his very substantial wealth to help the victims of his terrible error in judgment. Put his money where his words were so to speak. Or maybe (ha) I am being naive here???

Miffed October 23, 2008 · 1:58 pm

Unbelievable — apparently Greenspan didn’t notice that whole Savings and Loan collapse thing, as well as the slow but downward trajectory of the real economy over the “last 40 years,” which might have been wonderful for him and his ilk, while for the rest of us poverty rose steadily and the middle class began to show signs of disappearing.

It’s taken the present calamity to help him grow up and maybe even stop believing that the “market fairy” will always be there to sprinkle her magic dust over us, and make everything all better…

John McGlynn October 23, 2008 · 1:58 pm

OK, so we have that established.

But why weren’t insurance laws applied to derivatives contracts?

In essence, as I understand it, derivatives contracts say “In the event of your lack of receipt of funds from your investment in X, I will pay you Y”. So – I insure you in the event of your loss, the same way car and house insurance works.

Insurance laws require that insurance companies maintain reserves to cover the risk of their policies. The problem with the derivatives contracts was that there were no reserves, the Treasury department having eliminated the requirement for them.

How were derivatives contracts not construed under the law as insurance, and who was responsible for that lack of oversight – or should I say, the nerve to enforce existing law?

It’s all a mystery to me.

John McGlynn
San Francisco

Scott October 23, 2008 · 2:00 pm

The flaw that remains is we are still privatizing profits and socializing debt. Where there are no risks there will never be self regulations.

mambokid October 23, 2008 · 2:03 pm

Honorable? No! Honorable is when you agree to commit
Hari-Kiri. I see very little honor amongst bankers taking questionable mortgages and the wealthy bad-tranch merchants of Wall Street. To them, I’d add the SEC, the Treasury, and other Washington beneficiaries of this financial mob.

Harvey October 23, 2008 · 2:10 pm

I think that the insurance aspect of this tragedy of errors was the reason for the fall from grace of AIG.

Lou October 23, 2008 · 2:10 pm

Want to know what the next “bubble” is, ENERGY. Right now, the trillions of dollars of bad mortgages are overshadowing the pending energy crisis. It is unfortunate that our professional politicians will wait until the energy crisis criples our country before they take serious action to make us energy independent.

hoho October 23, 2008 · 2:11 pm

there is only one way that you may never see the bubble again — the one advocated by Karl Marx.
anyone ?

the true delusion is that there could be no recession ever again in capitalism, or that rate cuts could do anything to prevent downturns of any size, small, medium, large.

according to those “professionals” , Fed Funds rate should be zero forever. 14 months ago, these guys even wanted you to believe that the Fed Funs rate WERE the LIBOR. now all the Fed has is 150 basis points.

Hazel Meade October 23, 2008 · 2:12 pm

Actually, many people did identify the bubble and tried to do something about it back in 2004-2005. Not to mention Ron Paul’s warnings way before that.

It was the congressional Democrats who stopped proposals that would have popped the bubble by reining in Fannie Mae and Freddie Mac – because they wanted to keep up the supply of low-income home loans.

That history reveals the folly of believing that politicians will ever be willing to pop a bubble. It’s way too unpopular to tell people that what appears to be a boom is really an illusion.

Miffed October 23, 2008 · 2:12 pm

To John McGlynn:

Who was responsible? How about Alan Greenspan for starters, whose job for decades was to regulate the financial industry? The whole idea of the “credit default swap” was to provide a type of insurance — by simply giving it a new name the vultures were able to bypass the rules and regulations that are required for the real insurance industry.

Greenspan called that “financial innovation” — others, who saw this crisis coming years ago, came to call it “the shadow banking industry.”

Lester October 23, 2008 · 2:12 pm

It may turn out that the real villain in the financial crisis is the federal deficit. In the past eight years, the Fed has monetarized the deficit for over $2 trillion. This is a likely cause of the huge inflation in real estate and commodities which in turn has lead to this crisis. Of course, it was also abetted by incredible stupidity of Wall Street bankers and fraud committed by their rating agency dependents.

Amit Gupta October 23, 2008 · 2:14 pm

The question here is, “Did Mr. Greenspan have a choice?” Would he be able to defend the pointed and concerted questioning that he would be subject to? His admittance may be out of sheer necessity and self preservation – admittedly he is not an arrogant fool, but someone who is willing to bend his ego when he has no wiggle room. It is ridiculous that any professional can get away from liability by simply saying that to the best of their knowledge the problem did not exist. Unless there is a punishing cost like seizure of personal assets involved for executives amongst the lenders and makers, why will any executive NOT REPEAT what we have just witnessed??? There is no incentive to not engage in responsible behavior if getting away is so easy!

Sheri Dennis/Rockland County, NY October 23, 2008 · 2:18 pm

I disagree with the author’s statement, “This is an honorable thing for him to do. … standing up in front of Congress and admitting error cannot be easy.”

No, it was not an honorable thing to do. It’s too late to be honorable from such an ostensibly intelligent man. His mea culpa is meaningless to me and he made a mockery out of the Federal Reserve and our government. He allowed the lowest common denominator – greed – to come out of every nook and cranny. Surely he knew what was going on and what was going to happen. He assisted in bringing us down to levels we haven’t even begun to see.

blacklight October 23, 2008 · 2:19 pm

Greenspan is the personification of the right-wing, conservative Republicans’ brand of see no evil, hear no evil and speak no evil oversight . The results speak for themselves.

Considering how often greed has been the underlying motivation for incredibly stupid and self-destructive behavior, Greenspan’s attitude toward oversight and regulation is based on hopelessly naive assumptions about human nature. Enlightened self-interest requires objective analysis, introspection and self-discipline. The foundation of greed is immediate self-gratification,which is why greed will overwhelm enlightened self-interest every time.

Ron Davis October 23, 2008 · 2:20 pm

The public needs to receive better and more responsible advice in financial matters. I find it highly questionable that the general populace should be make to suffer as a result of financial transactions which are not only unregulated but incomprehensible to nearly everyone.

Ron Davis
La Paz, Bolivia

Tom October 23, 2008 · 2:25 pm

Coming up: Bush apologizes for the Iraq debacle, saying “my fundamental philosophy that all Arabs are terrorists was wrong”.

A. V. October 23, 2008 · 2:27 pm

This man has no sense of shame, neither does Congress, Cox, Snow or the other apparatchiks. But they all still have their COLA pensions and govt. health plans. Taxpayers are truly suckers.

Credit default swaps distorted the real interest rate pricing for loans given the credit risk. Greenspan’s policies of low interest rates accentuated it.

Leave your money in a bank so they can pay you nothing on it while your Fed works against the electorate. What a joke.

digshy October 23, 2008 · 2:28 pm

He and others followed to the letter , flawed theory that put forwarded by a semi crazy, recluse -Adam Smith, in his so called master piece ” wealth of the nation” preached self-interest ( greed), free trade and no regulations.
Mr. Greenspan who has a nerve to tell the world and to the American congress that he was wrong in respect to regulations. Hard working Americans are scrambling to survive, saw their life saving hit the bottom. in weeks.
He is the same Joker who not too long ago proposed the bail out of the hedge funds.
It would be nice on his part and other culprit to share their wealth with the poor , victimised citizens by donating to charity.. Some one should look into filing a law-suit to humiliate them.

Web Smith October 23, 2008 · 2:34 pm

Regulations, like the tax code, just present businesses with an opportunity to make money if they can only figure out a way to get around them.

Laws that imprison and strip the wealth from those who practice predatory business practices and cause harm to the population’s property and wealth don’t.

//ewebsmith.com/Finance/therealproblem.html