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.
"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|