Wednesday, February 18, 2009

Greenspan on the Free Market

It’s gotten to the point that whenever I read about any of Alan Greenspan’s new commentary on the economy, I’m sure to be unable to finish the article without disgust. I’ve been working on a small op-ed for my OAC class regarding the mortgage crisis and as a result I’ve had to read some of Greenspan’s commentary over the last few years. What I’ve come to understand is that in any given context, it’s not what he says that is so crucial it’s what he fails to say. Take his commentary last night at a New York Economic Club dinner regarding the recent crisis, from a WSJ blog entry. [bold mine]

In comments at a New York Economic Club dinner late Tuesday, the retired Fed chairman steered clear of much self-reflection on his role in the credit boom. But he did take a new swipe at the market’s self-correcting tendencies and bowed his head to a new period of increased regulation.

All of the sophisticated mathematics and computer wizardry essentially rested on one central premise: that enlightened self interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring and managing their firms’ capital and risk positions,” the Fed chairman said. The premise failed in the summer of 2007, he said, leaving him “deeply dismayed.”

Self-regulation is still a first-line of defense, Mr. Greenspan said. But after the financial collapse of 2007 and 2008, “I see no alternative to a set of heightened federal regulatory rules of behavior for banks and other financial institutions.” He said hoped hoped it would come in the form of tougher capital requirements for banks.

The glaring omission of course is that if sophisticated mathematics and wizardry did not allow bankers to see [past the distorted economic policy he himself was implementing – but I digress] the future then by what method will a regulator be able to a priori prevent the same thing from happening? This is the key omission when anyone clamors for central planning or regulation. Anyone can apply regulations in hind sight, which only guarantees that the next financial crisis will occur somewhere else that was also unforeseen.

Controls will not prevent financial crises. They will only breed more controls.

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