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Greenspan’s hands-off regulation has failed

Greenspan’s hands-off regulation has failed
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First Published: Sat, Oct 25 2008. 12 08 AM IST

Updated: Sat, Oct 25 2008. 12 08 AM IST
Alan Greenspan has found a flaw in his model. Too bad that he didn’t recognize it a decade ago. The US Federal Reserve’s former chairman says he’s in a state of “shocked disbelief” that self-regulation didn’t work in the banking sector. He now admits regulatory changes must be made in the areas of fraud, settlement and securitization, “as much as (he) would prefer it otherwise”.
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While this tepid mea culpa from the “maestro” was unexpected, he’s hardly the first to recognize the shortcomings of his hands-off approach.
The criticisms of Greenspan’s Fed are widespread and have merit. It was lax on monetary policy, argued against oversight of new financial instruments and took an extremely relaxed view of its regulatory responsibilities over banks.
His overarching flaw, however, was his inability to entertain the idea that individual financial actors’ hubris and greed could hurt the system — and themselves.?This can be readily seen in the housing bust. Greenspan now admits that mortgage salesmen didn’t have incentives to evaluate the credit quality of the loans they originated and securitized. The risk management systems established by banks were flawed in their use of housing data from cheerful economic times. And investors didn’t want to face the risks they took.
It was hardly the first time Greenspan ignored the danger of base motivations. Take his claim in 2001 that high-grade collateralized debt obligations (CDOs) could replace government treasuries as riskless investments. In their purveyors’ wildest dreams, yes.
In reality, the structure of a CDO encourages its managers to hold schlocky, high-yielding assets. They were designed to enrich their designers, not their investors.
And when Greenspan told consumers to take out adjustable rate mortgages at the height of the housing boom, while opposing limits on predatory lending, he turned a wilfully blind eye to the potential for disaster.
There is an irony in this. Hands-off regulation has failed catastrophically, establishing a climate in which hysterical and poorly conceived regulation may fester.
Had Greenspan accepted the idea that an outside party is needed to administer a few firm rules, the John Galts of the world have been better able to flourish.
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First Published: Sat, Oct 25 2008. 12 08 AM IST