Alan Greenspan, a man described as a “bigger threat to the US economy than Osama bin Laden”* in his latter years at the Federal Reserve (1986-2006) is now increasingly regarded as the architect of the subprime crisis that could tip us into global recession.
In an article published in the Financial Times (“We will never have a perfect model of risk“) Greenspan cheekily shows no remorse for the mayhem he helped unleash during his period at the Fed. Nor did he offer any viable olutions to get us out of the deepening financial crisis that has engulfed financial markets.
The critical issue here is whether self-regulation, also known as “light touch, limited touch regulation, can survive at a time of unlimited state hand-outs to the failures of Wall Street. First, you have to remember that the US bank JP Morgan Chase is not buying its collapsed rival, Bear Sterns, out of altruism or a noble desire to preserve the capitalist system.
No.
- The bank founded by John Pierpont Morgan is buying Bear Sterns because it can — it is snapping up a bank whose market capitalisation reached $25bn in January 2007 for a mere $236m and;
- It only agreed to take on the Bear because the Federal Reserve offered to guarantee $30 billion of the failed bank’s riskiest assets.
Despite these facts, Greenspan seems oblivious to the “moral hazard” (the notion that implicit government guarantees and the expectation of bail-outs in the event of failure might distort bankers’ behaviour, promoting recklessness) involved in this and related deals. In his Financial Times article, “We will never have a perfect model of risk,” Wall Street’s erstwhile oracle wrote: “I hope that one of the casualties will not be reliance on counterparty surveillance, and more generally financial self-regulation, as the fundamental balance mechanism for global finance.”
To me, it is a wild hope. Unlimited state hand-outs to failed banks and other enterprises can never — never — go hand in hand with continuing self-regulation or even reliance on the vigilance of counterparties (a counterparty is the other party in a financial transaction). Just think about it.
The Financial Times’s Washington columnist, Clive Crook, put it rather succinctly in his blog yesterday: “The real lesson of this crisis is that the authorities will do anything — at any cost to taxpayers — to shore up a financial system on the point of being wrecked by greed and incompetence. For the sake of minimising the harm to innocent bystanders, they may very well be right to take that view. But the quid pro quo is stricter regulation. Implicit uncapped guarantees plus “self-regulation” is a formula for the very disaster that is now unfolding.
*It was Edinburgh-based investor Robin Angus who called Greenspan a “bigger threat to the US economy than Osama bin Laden,” and he did so back in January 2005
This blog post was published on 18 March 2008