Blowing Bubbles

Blowing Bubbles

by digb

Greenspan emerges from his lair to defend capitalism, the Enlightenment, Ayn Rand and group think, all in one morning:

TAPPER: You'll be testifying about the financial crisis on Wednesday before the Financial Crisis Inquiry Commission. When you testified before Congress in October, you said that you finally saw a flaw in -- in the way that you looked at markets, that markets cannot necessarily be trusted to completely police themselves.

But isn't it -- isn't it more than a flaw? Isn't it an indictment of Ayn Rand and the view that laissez-faire capitalism can be expected to function properly, that markets can be trusted to police themselves?

GREENSPAN: Not at all. I think that there is no alternative, if you want to have economic growth and higher standards of living, in a democratic society, to have competitive markets. And, indeed, if you merely look at the history since the Enlightenment of the 18th century, when all of those ideas surfaced and became applicable in public policy,we've had an explosion of economic growth, and especially in the developing countries, where hundreds of millions of people have been pulled out of poverty, of extreme poverty and starvation, basically because we have competitive markets.

So it's not the principle of competitive markets which really has no alternative which works. It is a strict application -- as I presented in a Brookings paper fairly recently on a somewhat technical area, the major mistake was assuming what the nature of risk would be. And the reason it was missed is we have had no experience of the type of risks that arose following the default of Lehman Brothers in September 2008.

That's the critical mistake. And I made it. Everybody that I know who works in this business made it. And it means that basically we have to work our way back to understanding what went on. And as I argue, what we need is far more required capital for financial institutions than we've had.

You'll notice that Greenspan talks about "competitive markets," not Rand and laissez-faire as Tapper asked him. But that's to be expected. The man is now pretending to be shocked, simply shocked at all the gambling that went on and literally has no answers other than raising capital requirements to prevent it from happening in the future. But that's because he still doesn't really believe that what happened was a result of greedy gamblers willingly blowing up the entire system as long as they get theirs. (Why, that doesn't seem like the John Galt he knows at all...)

Tapper then brings up this op-ed in today's NY Times by an investor who very well knew what was going on and made a bundle selling short. This fellow argues that it was obvious, he tried to tell people but that he finally just had to put his investors' money into what he knew was coming: a reckoning.
Observing these trends in April 2005, Mr. Greenspan trumpeted the expansion of the subprime mortgage market. “Where once more-marginal applicants would simply have been denied credit,” he said, “lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.”

Yet the tide was about to turn. By December 2005, subprime mortgages that had been issued just six months earlier were already showing atypically high delinquency rates. (It’s worth noting that even though most of these mortgages had a low two-year teaser rate, the borrowers still had early difficulty making payments.)

The market for subprime mortgages and the derivatives thereof would not begin its spectacular collapse until roughly two years after Mr. Greenspan’s speech. But the signs were all there in 2005, when a bursting of the bubble would have had far less dire consequences, and when the government could have acted to minimize the fallout.

Instead, our leaders in Washington either willfully or ignorantly aided and abetted the bubble. And even when the full extent of the financial crisis became painfully clear early in 2007, the Federal Reserve chairman, the Treasury secretary, the president and senior members of Congress repeatedly underestimated the severity of the problem, ultimately leaving themselves with only one policy tool — the epic and unfair taxpayer-financed bailouts. Now, in exchange for that extra year or two of consumer bliss we all enjoyed, our children and our children’s children will suffer terrible financial consequences.

Greenspan responded to Tapper's question about the above by implying that there were only a very, very few people who knew more than he did as well as a few lucky duckies who simply made the right bet. He implies that this fellow was one of the latter or perhaps some sort of idiot savant and that he should be thrilled because he made a bunch of cash from the misfortune of others --- and isn't capitalism grand? It's quite a little dance he does, but it reveals more about him than about anything else. In his mind, if "most people" think something, it's perfectly reasonable to believe that it must be true. In other words market psychology trumps reality. And if that's the case we just have to expect bubbles and when these bubbles pop, the country (and the world) will have to deal with it. Shame about the carnage.

*One other thing: nobody ever wants to address the political dimension but it pays to remember that Greenspan had been excoriated for raining on the parade back in 1991 and allegedly costing Bush senior the election. I think there was plenty of pressure (consensus?) to keep that bubble going through 2004 --- and by that point they were all in.

Also, keep in mind that in the spring of 2005 when Greenspan made those comments they were in the middle of their failed push to privatize social security. There were a lot of reasons to keep that bubble going as long as possible. As it worked out it popped just before Bush and Greenspan left office leaving the Democrats holding the shreds of the exploded balloon. Funny how that works.

Update: Krugman notes that Greenspan is still not a mensch --- meaning that he won't take responsibility for what he helped cause. Yet another example of conservatism rotting from the head.