Greenspan Concedes to `Flaw' in His Market Ideology

By Steve Matthews and Scott Lanman

Oct. 23 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said a ``once-in-a-century credit tsunami'' has engulfed financial markets and conceded his free-market ideology shunning regulation was flawed.

``Yes, I found a flaw,'' Greenspan said in response to grilling from the House Committee on Oversight and Government Reform. ``I was shocked because I'd been going for 40 years or more with very considerable evidence that it was working exceptionally well.'' Greenspan added he was ``partially'' wrong for opposing the regulation of derivatives.

Greenspan's contrition came after lawmakers and Fed watchers increasingly blamed the former Fed chairman for helping cause the crisis with lax oversight of the housing boom and derivatives markets. Normally afforded deference by Congress, he endured almost four hours of questions from lawmakers less than two weeks before a national election.

``Greenspan is finally taking some responsibility for his actions,'' said Paul Kasriel, director of economic research at Northern Trust Co. in Chicago and a former Fed official. ``The damage has been done. His reputation has definitely been tarnished.''

Greenspan, responding to questions, said only ``onerous'' regulation would have prevented the financial crisis. Stifling rules would have suppressed growth and hurt Americans' standards of living, he said.

Not Infallible

``We have to do our best but not expect infallibility or omniscience,' he said.

Part of the problem was that the Fed's ability to forecast the economy's trajectory is an inexact science, he said.

``If we are right 60 percent of the time in forecasting, we are doing exceptionally well; that means we are wrong 40 percent of the time,'' Greenspan said. ``Forecasting never gets to the point where it is 100 percent accurate.''

The admission that free markets have their faults was a shift for the former Fed chairman who declared in a May 2005 speech that ``private regulation generally has proved far better at constraining excessive risk-taking than has government regulation.''

Committee Chairman Henry Waxman, a California Democrat, said today that Greenspan had ``the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis.''

`Paying the Price'

``You were advised to do so by many others,'' he told the man hailed in the 1990s as the ``Maestro'' of the global financial system and awarded a knighthood in 2002. ``And now our whole economy is paying the price.''

Greenspan's devotion to free markets was nurtured in part by his association with Ayn Rand, the libertarian novelist and philosopher who espoused laissez-faire capitalism. He met Rand in the 1950s, becoming part of her inner circle of followers meeting regularly in her Manhattan apartment.

``Greenspan in a very, very kind of unwise, left-brain way, imputed pure rationality to markets,'' James Grant, editor of Grant's Interest Rate Observer, said in an interview on ``Night Talk'' with Mike Schneider to be broadcast later today on Bloomberg Television. ``They are just as rational and just as efficient as the people that operated in them.''

Waxman echoed that sentiment to Greenspan: ``The mantra became government regulation is wrong. The market is infallible.''

Gramlich's Warnings

Former Fed Governor Edward Gramlich, who died in 2007, had urged Greenspan to strengthen oversight of banks during the record U.S. mortgage boom from 2004 to 2006.

Questioned about those warnings, Greenspan said ``Governor Gramlich said to me that he had problems'' and that he left the meeting expecting a Fed subcommittee dealing with consumer and community affairs to present recommendations, which didn't occur. ``I presumed at the time that essentially the subcommittee didn't think it rose to the higher level'' requiring action, Greenspan said.

Responding to criticism that he was too ideological, Greenspan said he sought as chairman to abide by laws passed by Congress, ``not my own predilections.''

He later added that he couldn't respond to every warning. ``There are always a lot of people raising issues, and half the time they're wrong.''

Regulatory Actions

Greenspan pointed out that he voted for every regulatory action the Fed moved on, drawing a rebuke from Waxman. ``On the other hand, you didn't get to vote on regulations that you didn't put before the Federal Reserve board, even though you had the legal authority for those regulations.''

Firms that bundle loans into securities for sale should be required to keep part of those securities, Greenspan said in prepared testimony. Other rules should address fraud and settlement of trades, he said.

Greenspan opposed increasing financial supervision as Fed chairman from August 1987 to January 2006. Policy makers are now struggling to contain a financial crisis marked by record foreclosures, falling asset prices and almost $660 billion in writedowns and losses tied to U.S. subprime mortgages.

Greenspan, 82, reiterated his ``shocked disbelief'' that financial companies failed to execute sufficient ``surveillance'' on their trading counterparties to prevent surging losses. The ``breakdown'' was clearest in the market where securities firms packaged home mortgages into debt sold on to other investors, he said.

Pricing Risk

``In this financial environment, I see no choice but to require that all securitizers retain a meaningful part of the securities they issue,'' Greenspan said. That would give the companies an incentive to ensure the assets are properly priced for their risk, advocates say.

Greenspan said the Fed didn't know the size of the subprime mortgage market until late 2005.

Securities and Exchange Commission Chairman Christopher Cox and former Treasury Secretary John Snow also appeared at the House committee hearing.

Snow said the economy is headed down a ``bad, bad path'' and he endorsed consideration of more fiscal stimulus. For the longer term, Snow said the global financial system should be reorganized by focusing on increasing transparency of ``excessive'' leverage to prevent institutions from creating too much risk.

The U.S. needs ``one strong national regulator'' to oversee firms and fix what Snow called ``a fragmented approach'' to regulation.

Addressing the trio that oversaw the U.S. financial markets as the housing bubble developed, Representative John Yarmuth, a Democrat from Kentucky, characterized them as ``three Bill Buckners,'' referring to the Boston Red Sox first baseman whose fielding error some fans blame for the team's loss in the 1986 World Series.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Steve Matthews in Atlanta at smatthews@bloomberg.net.