2008 October 26 Sunday
Shocked That Alan Greenspan Is Shocked

I am shocked that Alan "irrational exuberance" Greenspan is shocked by this credit crisis. He ought to know better. Surely he knew that housing became overpriced compared to various historical ratios of housing prices versus income and rents. Surely he knew that personal indebtedness was reaching dangerous levels. Yet look at former Federal Reserve Chairman Alan Greenspan's recent Congressional testimony about his shock at the financial crisis.

"As I wrote last March, 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... Such counter-party surveillance is a central pillar of our financial markets' state of balance. If it fails, as occurred this year, market stability is undermined."

He demonstrates a hubris in the power of elites reacting to markets to make correct decisions. Greenspan ignores the agency problems with CEOs and other top executives. They get bigger incentives for success than rewards for avoiding failure. Their bonuses aren't based on multi-year achievements. They find too many ways to boost earnings in the short run at the expense of the long run. They have captive boards that can't control them. Corporate governance has serious flaws.

Mr. Greenspan's thinking contains some serious contradictions. First off, his long-running claim to economic understanding does not come as a result of an impressive history of competing in the private sector. His power and influence came chiefly as a result of an appointment in government. Government is what he professes to trust less than the private sector. But he's Mr. Government himself. So why should he trust his own judgments?

Second, most of the economic growth that happened while he was chairman of the Fed came as a result of large numbers of decisions in the private sector. He doesn't deserve veneration for being Fed Chairman for this period of economic growth - at least if he takes seriously his own view of the relative importance of the private sector and government.

Third, he is now shown to have been incredibly wrong. In a speech in 2005 what Greenspan hailed as innovations by the private sector were in fact a disaster waiting to happen.

A brief look back at the evolution of the consumer finance market reveals that the financial services industry has long been competitive, innovative, and resilient. Especially in the past decade, technological advances have resulted in increased efficiency and scale within the financial services industry. Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. ...

... For example, information processing technology has enabled creditors to achieve significant efficiencies in collecting and assimilating the data necessary to evaluate risk and make corresponding decisions about credit pricing.

But now Greenspan sees a huge flaw in how those financial innovations were priced by the market.

"It was the failure to properly price such risky assets that precipitated the crisis," Greenspan said, by encouraging investors worldwide to look at U.S. subprime loans as a "steal" rather than an uncertain bet that relied on escalating home values. "The whole intellectual edifice . . . collapsed in the summer of last year."

Fannie Mae and Freddie Mac are creatures created by the US government and are continually pressured by the US government. They intervened in the subprime market and distorted that market. At the same time federal regulators, politicians, newspapers, and political activists pressured banks and other financial institutions to issue risky debt to help non-Asian minorities (NAMs) buy houses and other things they couldn't afford to buy. These were big distortions in the market that a supposed free marketeer like Greenspan ought to have recognized and factored into his thinking. But he obviously didn't.

Other important market distortions emanated from East Asian governments buying up debt in the US. The Chinese government maintains a currency peg against the US dollar. The Chinese government enforces rules on Chinese banks and Chinese businesses so that US dollars flowing into China to buy goods get converted into local currency in a way that builds up foreign reserves. The resulting (unsustainable and damaging) trade deficit distorts US capital markets. The Chinese purchase of US bonds distorts the US money supply and US credit markets. That too distorted the market and caused a big mispricing of debt and risk. Why didn't Greenspan recognize the importance of huge market distortions caused by governments? Because he's become too much the government insider.

A fractional reserve banking system requires government regulation by its nature. Objectivists therefore oppose fractional reserve banking. The Objectivists do not see Greenspan as a free marketeer.

Yaron Brook, executive director of the Ayn Rand Center for Individual Rights, today issued the following commentary:

Opponents of the free market are giddy at Alan Greenspan's declaration that the financial crisis has exposed a "flaw" in his "free market ideology." Greenspan says he is "in a state of shocked disbelief" because he "looked to the self-interest of lending institutions to protect shareholder's equity"--and it didn't.

But according to Dr. Yaron Brook, executive director of the Ayn Rand Center for Individual Rights, "any belief Greenspan ever had in truly free markets was abandoned long ago. While Greenspan long ago wrote in favor of a truly free market in banking, including the gold standard that such markets always adopt, he then proceeded to work for two decades as leader and chief advocate of the Federal Reserve, which continually inflates the money supply and manipulates interest rates. Advocates of free banking understand that when the government inflates the currency, it artificially increases prices and causes booms in certain sectors of the economy, followed by inevitable busts. But not only did Greenspan lead the inflation behind the .com bubble and the real estate boom, he blamed the market for their treacherous collapses. Greenspan should have recognized that what he wrote in 1966 of the boom preceding the 1929 crash applied here: 'The excess credit which the Fed pumped into the economy spilled over into the stock market--triggering a fantastic speculative boom.' Instead, he superficially blamed 'infectious greed.'

"Should it be any shock that Greenspan now blames the free market for today's meltdown--rather than the Fed's policies, which fueled an inflationary housing boom, which rewarded reckless lenders and borrowers from Wall Street to Main Street? Greenspan didn't mention the word 'inflation' once in his testimony.

"Whatever Greenspan's economic philosophy is, it is not anything resembling a free market."

Whether a gold-based banking system is practical I have my doubts. But I think the Objectivists are right to see serious flaws in Greenspan's idea of a free market. Though, I must add, I see serious flaws in Objectivism.

Update: I would like to know when the leaders of either political party will come right out in public and say that our 5% of GDP trade deficit is another unsustainable problem that needs to be dealt with. When are they going to admit we are living beyond our means and that foreign governments are helping to cause the trade deficit?

Share |      By Randall Parker at 2008 October 26 10:53 AM  Economics Financial Regulation

jes said at October 26, 2008 11:57 AM:

It's easy to become lazy or blinded by what you presume to be the answer, even when it's your position and obligation not based on your job. Look at the Challenger disaster. It was all foreseeable but the obvious was seen.

See the "The User Illusion"


gcochran said at October 26, 2008 2:12 PM:

Actually, Objectivism shows Greenspan's foolishness in a direct way. Once upon a time, Ayn Rand had a young devotee named Nathanial Branden. For a number of years, Branden porked her, even though both he and she were already married to otehr people, even though she was an crazy old hag. During this period, Branden was considered the leading figure in the inner circle of Objectivism, second only to Rand. When the relationship ended - particularly when Branden began a sexual relationship with actress Patrecia Scott - without Rand's knowledge or consent. Rand cast him out of inner darkness. She repudiated him and severed all relations and demanded that the core members do the same. They did so: the members of NBI (Nathaniel Branden Institute) issued a statement denouncing the Brandens. Alan Greenspan was one of those members.

In other words, at the age of 44, Greenspan was a committed member of a ridiculous cult - committed enough to publicly denounce a fellow cultist for refusing to fuck the guru.

And three administrations chose him to shepherd this nation's money supply. Is this a great country or what?

Some wordy bastard said at October 26, 2008 5:48 PM:

Oh Greg, if it be you, you have a way with words.

realist gun nut said at October 26, 2008 6:19 PM:

I would not be surprised to see a white coup in South Africa in the coming year or so ... the blacks have proven that they cannot run the country and I think that certain other countries will be very preoccupied at home for quite a while to come. Of course, Team Obama could send a carrier group that way ...

Stephen said at October 26, 2008 7:11 PM:

Randall said: "When are they going to admit we are living beyond our means and that foreign governments are helping to cause the trade deficit?

Blaming foreigners is classic head in the sand thinking. There would be no sellers without buyers.

Randall Parker said at October 26, 2008 7:16 PM:

Stephen, You are wrong. China really does cause a large part of our trade deficit via currency manipulation. There are more buyers for Chinese manufacturers and fewer buyers for US manufacturers as a result of currency manipulation.

Matt@occidentalism.org said at October 27, 2008 2:10 AM:

I wonder, what if a country does not have gold, or cannot afford it? In that case it does not make sense to have a gold standard at all, at least in the sense of backing a government issued paper currency.

Why can't we have a constitutionally set limit on the amount of money in circulation? For example, set the amount of money to $100 000 per person for each person currently a citizen of the US, and not allow any increases in the money supply except by constitutional amendment. Surely that would ensure the value of the currency, and avoid the inflationary effects of increases in the fiat money supply.

Is this feasible?

Stephen said at October 27, 2008 3:35 AM:

The global economy is too big for a gold standard. There's too much 'stuff' in the world and not enough gold to back it.

Kenelm Digby said at October 27, 2008 5:21 AM:

Of course Greenspan is an old man - and therefore he must have at least 60 years of experience in his chosen profession - 60 years totally absorbed in economics, nothing else but economics, day and night, year in year out, god he must know the subject inside out and back to front.
The analogy I like to think of - What would you say of an 82 year old Carpenter who worked in the trade his entire life, who couldn't hang a door - any door - properly?
I don't think the analogy is too harsh.

Roger Melly said at October 28, 2008 4:00 AM:

English, as spoken in England at least, is well known for its prolix vocabulary that allows an infinite variety of meanings and subtlties to be attached to words and phrases.
Case in point is the word 'cunt' nt generally used in its original ancient meaning, but in modern English usage having usurped previous profanity in signifying an individual or object deserving of the uttmost contempt.In this sense 'cunt' has replaced 'bastard' in the vernacular in retaining a hard cutting edge, the power of wounding insult, and signifier of extreme distaste. ('bastard' as applied to richard Nixon, at least, is now almost an affectionate term).
A fuller discourse on the subject may be found in the excellent 'Roger's Profanisaurus' - the modern lexicon of English insuting usage and profanity, published by the incomparable publishers of the 'Viz' journal.
Now to the real point of this post.The use of the word 'cunt' to denote an extremely objectionable and perhaps evil man is gradually being blurred in England to denote another objectionable character, not evil as commonly understood, but a man who is downright incompetent and useless in his chosen profession - the signifier of ultimate professional contempt.
In this context "calling Alan Greenspan a cunt" (another fine English stock phrase), is eminently justifiable.

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