For a man noted for the complexity of his speech and writing, Alan Greenspan’s perscription for helping prevent the sort of devastating crisis just experienced is alarmingly straightforward: more capital.
“The primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades,” Greenspan wrote in a paper running 48 pages of text and 18 charts. This retrospective is elegantly titled “The Crisis.”
The paper, for presentation today at the Brookings Institution, will be best remembered for the former Fed chairman’s continued and more complex defense of the low short-term interest rate regime the central bank maintained during the middle years of the prior decade.
Greenspan maintains those low short rates weren’t the cause of the housing bubble, the eventual bursting of which led to all our troubles. He cites various factors, including declining mortgage rates, but sees different causes from Fed monetary policy for that.
And while he’s willing to concede some regulatory and judgment lapses in a world where many now have changed their assessment of him from the near universal view as the iconic central banker, Greenspan won’t give on the Fed’s ability to diffuse an asset price bubble as its inflating.
Given the post-housing bubble damage in the global economy, that hands-off, we’ll help clean up afterwards policy is certainly due for a rethink.
“But why not incremental tightening?” Greenspan writes of a possible bubble-busting strategy. “There are no examples, to my knowledge, of a successful incremental defusing of a bubble that left prosperity intact.”
He also references his 1996 “irrational exuberance” speech that slowed the dot-com stock boom for a day. It then continued to inflate for four more years, he said, even though the Fed raised the federal funds rate 350 points from 1994 to 2000.
Hindsight is just that, of course, meaning its easy, and Greenspan is understandably fighting for his legacy. But he certainly could have done more in the mid-1990s than make one speech about the dot.com bubble. Perhaps regular and increasingly vigorous warnings about the dot.com irrationality combined with surprise and somewhat steeper rate increases could have achieved the necessary “risk aversion” needed without killing economic growth. We just don’t know.
As for increased capital requirements for banks and other financial entities, it’s hard to argue with that.