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Thursday, October 23, 2008 1:23 PM

Greenspan Admits 'Flaw' in His Market Ideology

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Speaking before Congress Greenspan Concedes to 'Flaw' in His Market Ideology.

Former Federal Reserve Chairman Alan Greenspan said a "once-in-a-century credit tsunami" has engulfed financial markets and conceded that his free-market ideology shunning regulation was flawed.

"Yes, I found a flaw," Greenspan said in response to a grilling from the House Committee on Oversight and Government Reform. "That is precisely the reason I was shocked because I'd been going for 40 years or more with very considerable evidence that it was working exceptionally well."

Greenspan said he was "partially" wrong in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected.

In May 2005 speech, Greenspan said that "private regulation generally has proved far better at constraining excessive risk-taking than has government regulation."

Committee Chairman Henry Waxman, a California Democrat, said Greenspan had "the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others," he told Greenspan. "And now our whole economy is paying the price."

Waxman and other lawmakers repeatedly interrupted Greenspan as he answered their questions, in contrast to deference to his testimony while he was Fed chairman.

Firms that bundle loans into securities for sale should be required to keep part of those securities, Greenspan said in prepared testimony. Other rules should address fraud and settlement of trades, he said.

Greenspan opposed increasing financial supervision as Fed chairman from August 1987 to January 2006. Today, the former chairman asked: "What went wrong with global economic policies that had worked so effectively for nearly four decades?"

Greenspan reiterated his "shocked disbelief" that financial companies failed to execute sufficient "surveillance" on their trading counterparties to prevent surging losses.

Securities and Exchange Commission Chairman Christopher Cox and former Treasury Secretary John Snow also appeared at the House committee hearing today.

Snow said the global "financial architecture" should be reorganized by focusing on increasing transparency of "excessive" leverage to prevent institutions from creating too much risk.

The U.S. needs "one strong national regulator" to oversee firms and fix what Snow called "a fragmented approach" to regulation.
Sad Twist Of Irony

It is fitting that the "Maestro" is humbled before Congress. Unfortunately it is for the wrong thing. And it is hugely ironic that Geeenspan admitted an error for the only thing he has been correct on for his entire career as Fed chairman!

"Private regulation generally has proved far better at constraining excessive risk-taking than has government regulation."

Strong National Regulator Is Lunacy

And Cox's idea of "one strong national regulator" is lunacy.

Note the irony of the very position Cox wants. How could any regulator possibly allow the increased lending exposure of Fannie Mae and Freddie Mac that is happening now during this bailout?

A national regulator's first responsibility would be to stop all such nonsense. What is the likelihood of that?

Only The Free Market Can Judge Risks

Only the free market can judge risks. The failures are not of the free market, the failures happened because we did not have a free market.

Instead we had governments sponsorship of the GSEs, government sponsorship of the ratings agencies, micro management of interest rates by the Fed, fractional reserve lending compounded by Greenspan himself authorizing sweeps of checking accounts.

Sweeps permitted nearly every penny of money that is supposed to be available on demand to be lent out. Money that you think is in your checking account is simply not there. It has been lent out.

Solution To The Mess

The solution is not more regulation. The solution to this financial crisis is a return to free market principles, abandonment of GSEs, rating agencies that get paid by buyers of bonds rather than sellers of bonds, the phasing out of fractional reserve lending, and a return to a strong currency backed by gold.

The biggest irony of all in this mess is that gold is the only regulator we have ever needed, a position once held by Greenspan himself, before he became Fed chairman, decades ago.

Mike "Mish" Shedlock
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