Greenspan is 'shocked'

WASHINGTON (Reuters) – Former U.S. Federal Reserve Chairman Alan Greenspan told Congress on Thursday he is "shocked" at the breakdown in U.S. credit markets and said he was "partially" wrong to resist regulation of some securities.

Despite concerns he had in 2005 that risks were being underestimated by investors, "this crisis, however, has turned out to be much broader than anything I could have imagined," Greenspan said in remarks prepared for delivery to the House of Representatives Committee on Oversight and Government Reform.

"Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief," said Greenspan, who stepped down from the Fed in 2006.

Banks and other financial institutions need public support, such as the recently approved $700 billion bailout package, to avoid a serious reduction in credit, he said.

This deserves a few comments.

1. Greenspan is 'shocked' about the wrong thing. It is certainly not a lack of regulation that brought about the crisis. If you think about it, the credit market segment that actually blew up first - the mortgage credit market - has been, and remains, one of the most heavily regulated segments of the credit markets. Does anyone actually believe that if otc derivatives markets had been subject to more regulation, then the crisis would not have occurred?

We have seen credit boom heaped upon credit boom, with the attendant malinvestment of capital on a grand scale. It appears likely that capital has been consumed to such an extent that a very severe economic bust will be required to repair the discoordination of the capital structure and liquidate/redirect all this malinvested capital. Indeed, the cartelized banking system played a major role in bringing this state of affairs about, and finds itself at the center of the storm. However, no amount of additional regulation could have possibly averted this outcome.

It's funny, but probably not too surprising, that Greenspan is so eager to throw overboard what little he had in terms of credentials in support of the free market, by 'admitting' that even more regulation would perhaps have helped avert the calamity.
In a free market, the banks would indeed have acted more cautiously, and their self-interest to protect their shareholders equity would have been far more pronounced.

The root of the problem is not with this assumption turning out not to be true - the root of the problem is something else. The banks and broker dealers were subjected to the wrong incentives - by an agency that has nothing to do with the free market. The root of the problem is the monetary system itself - the one that Greenspan helmed - the fractionally reserved fiat money system, at the center of which we find a central economic planning agency - the Federal Reserve.
Greenspan's greatest error was to believe that modern day central banks had somehow managed to 'emulate a gold standard', as he once averred in a q&a with Congressman Ron Paul.

This is manifestly not the case, as the sheer unlimited credit creation during Greenspan's reign (inter alia) attests to.
It is of course obvious by dint of economic theory as well that letting a gaggle of bureaucrats fix interest rates can only lead to economic outcomes that are worse than those a free market set interest rate would lead to.

The bureaucrats manning the Federal Reserve are in exactly the same position that the Soviet GOSPLAN agency found itself in: they can not possibly know what the correct interest rate should be at a given point in time. , just as GOSPLAN never knew how many tractors, how many chickens and how many shoes should be produced.
This is the problem Greenspan should have acknowledged, but that is of course 'impossible' for a former central bank chief, even though i personally suspect that he actually knows better.

2. 'Banks and other financial institutions need public support, such as the recently approved $700 billion bailout package, to avoid a serious reduction in credit, he said'

He would say that, wouldn't he? It wouldn't do to for instance tell the congregation of honorables 'you idiots have just thrown 700 billion of good money after bad and in all likelihood helped to transform a sharp recession into a long-lasting depression', even if it's true.

If the economy's pool of real funding is stagnating or shrinking - and there are good reasons to believe that that is the case - then it won't matter how much money is thrown at the banks - they still won't lend. The propping up of failed enterprises is pretty much the worst thing one can do as it were, as the necessary adjustment process that the economy must go through is hampered and delayed with such interventions. Not only that, but the already problematic situation of the pool of real funding becomes even worse. After all, the government has to take this money from someone else. Who can it take the money from? Obviously, the only providers of capital at this stage must be those in the economy who still produce wealth. Their situation is made worse in other words, while entities that are de facto bankrupt are being put on artificial life support concurrently. Hank Paulson tried to sell these socialistic policies as some kind of 'lesser evil', but they are not - they are both evil and grossly mistaken, period.

In fact, one shouldn't be too surprised that the stock market greeted the bail-out package with a crash. Even though the above facts are seldom spelled out (recommended reading matter in this context can be found at www.mises.org - look specifically for the very lucid explanations provided by Frank Shostak), the market mind is aware of them, on a subconscious level.
Naturally, forced selling via margin calls, redemptions from hedge and mutual funds and so forth, conspired to make a bad situation in the market even worse, but first and foremost the market finally discounted what all the government interventions in the economy will likely produce: a long lasting, and far more severe economic downturn than the one that would have occurred had the government adopted a hands-off policy.

No-one in a position of power has yet stopped to ask why similar interventions by Japan's government resulted in a now 2 decades long slow-motion depression. The common refrain is though that 'they have not intervened enough'.
Well, the way things have been going of late (with e.g. the closet communist Sarkozy from France demanding the 'renationalization of certain important industries'), we may soon end up with everything nationalized. After all, there are e.g. not many corners of the credit markets left that have not been 'backstopped' by some or other central bank or government.
As sad as that would be, there is one bright side to this: no-one would be able to claim anymore that 'they have not intervened enough'. This nonsense would finally lose its cachet once capitalism has been saved by means of utterly destroying it.