By Neil Irwin and Amit R. Paley
Washington Post Staff Writers
Friday, October 24, 2008
Alan Greenspan, once viewed as the infallible architect of U.S. prosperity, was called on the carpet yesterday, pilloried by a congressional committee for decisions that contributed to the financial crisis devastating world markets.
The former chairman of the Federal Reserve said the crisis had shaken his very understanding of how markets work, and agreed that certain financial derivatives should be regulated -- an idea he had long resisted.
When he stepped down as Fed chairman less than three years ago, Congress treated Greenspan as an oracle, one of the great economic statesmen of all time. Yesterday, many members of the House Oversight and Government Reform Committee treated him as a hostile witness.
"You found that your view of the world, your ideology was not right, it was not working?" said Rep. Henry A. Waxman (D-Calif.), the committee chairman.
"Absolutely, precisely," Greenspan said. "You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."
Greenspan alternately defended his legacy and acknowledged mistakes. Waxman asked whether the former chairman was wrong to consistently oppose regulating the multitrillion dollar derivative market that has contributed to the financial crisis.
"Well, partially," said Greenspan, before stressing the difference between credit-default swaps and other types of derivatives.
With the global financial system unraveling, economists and political leaders are coming to doubt some of Greenspan's most closely held views: that markets can exact self-discipline, that central bankers should generally not try to prick bubbles in the price of houses or tech stocks, that a policymaker's most powerful tool to encourage growth is to stay out of the way.
Even Greenspan seemed genuinely perplexed yesterday by all that had happened, hard-pressed to explain how formerly fundamental truths about how markets work could have proved so wrong.
Members of Congress who not long ago would seek Greenspan's blessing for their preferred public policies were at turns combative and disdainful. Rep. John Yarmuth (D-Ky.) called him a "Bill Buckner," referring to the Boston Red Sox first baseman who missed an easy ground ball against the Mets in the 1986 World Series, costing the team the game.
The tough talk reflected a widening sense that some of Greenspan's apparent successes in managing the economy from 1987 to 2006 were in fact illusory, that they came at the cost of building the biggest credit bubble in world history.
"Markets and societies move on belief systems," said James Grant, editor of Grant's Interest Rate Observer and a longtime critic of Greenspan. "The belief system of finance featured the notion that someone with unusual power to see around corners and through walls and into the future was running things, and that someone was Alan Greenspan."
"His reputation was as inflated as were house prices in the early 2000s and tech stocks in the late 1990s," Grant said.
Greenspan repeatedly used his control over the levers of the economy -- especially cutting interest rates -- to deal with problems. When the financial system in many emerging countries imploded in 1998, he cut rates to protect the U.S. economy. When the dot-com bubble burst, he used the same tack, even more aggressively.
Indeed, the housing bubble, which was fueled by low interest rates, helped keep the 2001 recession relatively mild, as construction and other real estate-related activity soared in the first several years of this decade.
But Greenspan's actions to keep the economy on an even keel may have made lenders complacent about risk, one of the factors that led them to expand lending in irresponsible ways. He acknowledged in testimony yesterday that the crisis is also a result of the fact that lenders base their models of credit risk on a 20-year period in which home prices were rising and the economy was strong.
Economists are increasingly rethinking their views on whether central bankers should try to combat bubbles in the prices of assets, though not necessarily by using their power to set interest rates.
"When bubbles cause huge problems is when they cause the financial sector to seize up," said Frederic S. Mishkin, a Columbia University economist and, until recently, Fed governor. "The right way to deal with that kind of bubble is not with monetary policy," but with bank supervision and other regulatory powers.
Greenspan himself stressed the challenge of predicting the evolution of economic conditions.
"The Federal Reserve had as good an economic organization as exists," Greenspan said. "If all those extraordinarily capable people were unable to foresee the development of this critical problem . . . we have to ask ourselves: Why is that? And the answer is that we're not smart enough as people. We just cannot see events that far in advance."
But he deflected criticism, too.
Responding to charges that the Fed did not regulate subprime lending aggressively enough, Greenspan said: "I took an oath of office when I became Federal Reserve chairman. . . . I said that I am here to uphold the laws of the land passed by the Congress, not my own predilections. . . . I think you will find that my history is that I voted for virtually every regulatory action that the Federal Reserve Board moved forward on. . . . And I was doing so because I perceived that that was the will of the Congress."
In fact, it is almost unheard of for the Fed to move forward on regulatory policy if the chairman disagrees, and Congress at the time was often deferential toward Greenspan on financial regulation. In his time in office, Greenspan wielded both official and unofficial powers with an effectiveness that few other central bankers have matched.
While endorsing some expanded regulation yesterday, such as requiring the companies that combine large numbers of loans into securities to hold on to significant numbers of those securities, he also repeatedly retreated to his libertarian-leaning roots, and warned of the dangers of overreacting.
"We have to recognize that this is almost surely a once-in-a-century phenomenon," Greenspan said, "and in that regard, to realize the types of regulation that would prevent this from happening in the future are so onerous as to basically suppress the growth rate in the economy and . . . the standards of living of the American people."
Greenspan used the word "mistake" once during the five-hour hearing, which also included former Treasury secretary John Snow and current Securities and Exchange Commission Chairman Christopher Cox.
"I made a mistake," Greenspan said, "in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms."