Former Federal Reserve Chairman Alan Greenspan said the central bank and other US regulators “failed” during the financial crisis because they became too complacent about risks.
“Even with the breakdown of private risk management, the financial system would have held together had the second bulwark against crisis -- our regulatory system — functioned effectively,” Greenspan said in the text of a speech at a Brookings Institution conference on Friday. “But, under crisis pressure, it too failed.”
Greenspan echoed comments he made in a paper released yesterday citing the central bank’s failures to rein in the housing bubble and growth of the largest US banks. Greenspan, 84, who ran the central bank from 1987 to 2006, said low interest rates weren’t to blame for inflating the bubble, placing the blame instead on regulators.
“Even though for years our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still were able to take on toxic assets that brought them to their knees,” Greenspan said.
The former central bank chief said he and others at the Fed didn’t fully understand the extent of the housing bubble and its ramifications for the economy. In October 2008 testimony before Congress, he said free market ideology might be flawed in the wake of a “once-in-a-century credit tsunami.”
Capital requirements
Increased capital and liquidity requirements would help to blunt, though not eliminate, future crises, Greenspan said. Yesterday, he proposed that regulators boost capital levels as much as 40 per cent to ensure they have a cushion to protect banks from risks.
Regulators and financial managers, who had seen only moderate recessions in recent decades, didn’t anticipate the severity of a crisis that might occur only once in a century, he said.
“In the growing state of euphoria, managers at financial institutions, the Federal Reserve, and other regulators failed to fully comprehend the underlying size, length, and impact of the negative tail of the distribution of risk outcomes that was about to be revealed as the post-Lehman crisis played out,” Greenspan said.
“That led to significantly and chronically undercapitalised financial intermediaries, and was arguably the major failure of the private risk management system,” he said.
Lehman Brothers
Lehman Brothers Holdings Inc, which went bankrupt, and Bear Stearns Cos, acquired by JPMorgan Chase & Co with help from the Fed, both could have survived on their own if they had adequate capital, Greenspan said.
Neither “would have been in trouble” with tangible capital equal to 15 per cent of their assets, Greenspan said. His paper proposed that banks may need to hold capital equal to 14 per cent of their assets, compared with about 10 per cent in mid- 2007 before the financial crisis.
Lawmakers are considering an overhaul of banking regulation, including the biggest revamp of the central bank’s powers since its creation in 1913. Such changes may include creating a systemic risk regulator and giving the government the ability to dismantle failed firms.
Greenspan reiterated that Fed policy under his chairmanship didn’t lead to the housing bubble by keeping interest rates too low for too long. Instead, a global savings glut led to low mortgage rates and housing booms across nations, he said.
Mortgage rates
“The house price bubble, the most prominent global bubble in generations, was engendered by lower interest rates, but it was long-term mortgage rates that galvanised prices, not the overnight rates of central banks, as has become the seeming conventional wisdom,” Greenspan said.
Pricking an asset-price bubble wasn’t possible without damaging the economy, he said.
“Regulators cannot successfully use the bully pulpit to manage asset prices, and they cannot calibrate regulation and supervision in response to movements in asset prices,” he said. “Nor can they fully eliminate the possibility of future crises.”
Greenspan’s view differs with economists including John Taylor of Stanford University, a former Treasury undersecretary, who say that low rates helped bring about the housing boom and bust that led to the recession.
Under Greenspan, the Fed lowered its benchmark rate to 1.75 per cent from 6.5 per cent in 2001 and cut it to 1 per cent in June 2003. The central bank left the federal funds rate for overnight interbank lending at 1 per cent for a year before raising it in quarter-point increments from 2004 to 2006.
