Greenspan Urges Tighter Regulation After `Breakdown'

By Scott Lanman and Steve Matthews

Oct. 23 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan called for tighter regulation of financial companies, distancing himself from the free-market culture that he helped to create.

Firms that bundle loans into securities for sale should be required to keep part of those securities, Greenspan said in prepared testimony to the House Committee on Oversight and Government Reform. Other rules should address fraud and settlement of trades, he said. Greenspan's office released the text ahead of the hearing scheduled for 10 a.m. in Washington.

The comments contrast with Greenspan's aversion to increasing financial supervision as Fed chairman from August 1987 to January 2006. He said in a May 2005 speech that ``private regulation generally has proved far better at constraining excessive risk-taking than has government regulation.''

Today, the former chairman asked: ``What went wrong with global economic policies that had worked so effectively for nearly four decades?'' During his term at the Fed's helm, Greenspan repeatedly warned lawmakers against inhibiting markets, such as by tightening oversight of certain types of derivatives.

Greenspan, 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.

`No Choice'

``As much as I would prefer it otherwise, 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.

The rout sparked by the collapse of the U.S. subprime mortgage market has cost financial institutions worldwide $659 billion in writedowns and losses since the start of last year. Firms have raised $642 billion of capital in response.

``We are really going to have to rebuild this system from the ground up,'' Paul Volcker, who was Greenspan's predecessor, said at a conference late yesterday in New York. The creation of complex financial products, ``instead of spreading the risk and creating transparency'' wound up concentrating risk and ``opaqueness,'' Volcker told the Columbia University's Women's Economic Round Table.

Magnitude of Crisis

Volcker, 81, said the current crisis is more complex than any other in U.S. history. Greenspan, 82, called it a ``once-in-a century credit tsunami.''

House Financial Services Committee Chairman Barney Frank called this week for a freeze on executive bonuses and other stronger regulation of Wall Street, following passage of a $700 billion rescue plan for financial institutions.

Frank said in a hearing in February that Greenspan ``erred'' in ``his view that regulation was almost never required.'' Greenspan ``often told us'' that there were two options: ``I can either deflate the entire economy or I can let the problems continue,'' Frank said.

Securities and Exchange Commission Chairman Christopher Cox and former Treasury Secretary John Snow are also scheduled to appear at the House committee hearing today.

Root Cause

The credit crisis was rooted in a ``surge in global demand'' for U.S. subprime-mortgage debt, fed by ``unrealistically positive rating designations by credit agencies,'' Greenspan said. ``Whatever regulatory changes are made, they will pale in comparison to the change already evident in today's markets.''

Before the crisis intensified last month with the bankruptcy of Lehman Brothers Holdings Inc., Greenspan said markets should still be allowed to police themselves.

``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,'' Greenspan wrote in the Financial Times in March.

His successor, Ben S. Bernanke, has tried to revive credit during the past 15 months with an expansion of lending unprecedented since the Great Depression.

Bernanke has cut interest rates to 1.5 percent from 5.25 percent, made loans available to investment firms for the first time since the 1930s and arranged rescues of Bear Stearns Cos. and American International Group Inc.

Economic Impact

``Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment,'' Greenspan said today. There will probably be a ``marked retrenchment of consumer spending,'' he said, and a stabilization of home prices ``is still many months in the future.''

``To avoid severe retrenchment, banks and other financial intermediaries will need the support that only the substitution of sovereign credit for private credit can bestow,'' Greenspan said. The $700 billion rescue program, under which Treasury will inject capital into banks and buy distressed assets, is ``adequate to serve that need,'' he said.

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.

Greenspan said in a Bloomberg News interview in January that criticism of his record ignores the limits on what regulation and monetary policy can achieve.

Since retiring, Greenspan has returned to his role as a private economic forecaster, speaking at conferences and to groups of bankers and investors, while consulting for clients such as Deutsche Bank AG.

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