Alan Greenspan changes his mind about regulation

Seems a shame we had a top regulator for so long who didn't believe in regulation. Do you think he believed in his salary?

Well--and I probably should have mentioned this in the post--Greenspan didn't ever seem to have a problem with regulation of the money supply. Neither did the Chicagoans, for the most part.

I think he had to say something like that because he's been taking a lot of heat for this crisis,(along with 3 people named Gramm, Leach and Bliley). It's clear that large institutions had (have?) the political power, and for a long time, the happy circumstance of having a Fed chairman who agreed with them, to largely avoid any meaningful regulation while small institutions experienced more rigorous regulation. Given the continued market tumult, regulatory changes should not wait for the next administration (as I know Paulson has said), although the calendar is such now that will be the case.

I agree that Greenspan didn't mind the regulation of the money supply, and I think he viewed that as the Fed's only true role.

A few years ago, I did a study on Greenspan's interest rate moves. I forget the exact numbers, but something like 90% of the rate changes Greenspan made followed changes that had already occurred in the bond market. If it looked like his hand was on the tiller, that was just because he was resting it there!

Personally, I don't think we need much more regulation. We just need regulators who have the will to shut down the party (or at least turn down the music) before the cops arrive.

The Fed has plenty of examiners who have the "will" to shut down the party, but the problem is lack of support from their higher ups, especially when times are good and the activities appear to be earning money. That makes the bankers tone-deaf to risk management.

It is nice to hear someone as powerful and influential as Mr. Greenspan to admit mistakes. However, I think his comment on regulation is being way over-blown. I am sure that Mr. Greenspan would advocate for a reasoned approach to fixing our economy and not some reactionary regulations that would severely hamper the recovery of our economy (and could actually hurt it more). I think Mr. Greenspan would agree with Steve Forbes, who just came out with a thoughtful piece on the need for capitalism in our effort to fix our economies. Mr. Forbes also gives a strong warning to those considering increased regulation in order to fix our current problems. Forbes references U.S. history, our recessions and periods of economic growth. (If you're reading this blog you're probably well-aware of how over-regulation and taxation under Hoover that preceded the Depression).

Forbes approaches our current problems pragmatically and instead of advocating reactionary regulation, he argues in favor of creation of "clearinghouses for exotic instruments such as credit swaps." Credit swaps are areas of the economy partially responsible for our current state, and over-regulation will not solve these problems without hurting our economy. I'm sure that Mr. Greenspan would agree.

Forbes makes the argument much better than I recount, read it for yourself:

http://www.forbes.com/hcome/forbes/2008/1110/018.html

You make an interesting point. I believe that regulation should be minimal, and work.

"It is important to remember, however, that whatever regulatory changes are made, they will pale in comparison to the change already evident in today's markets. Those markets for an indefinite future will be far more restrained than would any currently contemplated new regulatory regime."

That's what I've always believed. If you allow a crisis, it's much worse than minimal regulation.

By minimal, to the extent that I understand them, I would include CDO's and CDS's. Anything meant to shift risk, in other words, needs to be looked at. I'm not saying always regulated, but looked at to make sure the system is transparent and collaterlaized.

As to the Fed, I think that Greenspan willfully ignored problems, but I'm not a fan of the spigot theory, which says that if interest rates are too low or there's too much capital around, you'll end up with a bubble. Politically, if people are making money and feeling secure, however foolish they are in feeling that way, raising interest rates to spoil the party on a theory will be hard.

The sad thing is that, I know I could be wrong, the things that we needed to do, like a clearinghouse for swaps and Greenspan slowing the economy a bit to get us to check the engine, would not have been that hard or onerous to the market.

Is it not the province of government to create a level playing field? A playing field applied fairly to all concerned?

Two examples from the auto industry: seat belts and CAFE standards. Both are required of every manufacturer. Similarly, drug safety, and food inspection, and impact fees, and a myriad of other legitimate governmental functions. All of these add cost to the product, a cost borne by the buyer and indeed demanded by the willing buyer as the price of civilized society.

With no company having unfair advantage, I support– no, encourage– governmental regulation. After all, it is about the only way to promote the interests of society as a whole without unfair burdens from anyone doing business. It's not perfectly implemented, but the notion is perfectly fair and reasonable.

While some claim that social benefit and free market exist in exclusive spheres, an exclusivity not understood, at least by me.

Others admit the role of business in the general weal, thinking that the 'free market' will ultimately provide social benefit similar to regulation, and in fact posit any free market achievement as de facto desirable.

I have seen no rational explanation for why a free market is an ultimate touchstone, or why the phrase 'let the market decide' has any relevance at all.

What Don said.

I think he is hitting on the right theme here. We should also note that Greenspan was particularly saddened by the failure of the concept that business would act within the self-interest of its shareholders and not do anything really crazy.

I think that fundamentally there is a very real problem with this rationale. I read this somewhere (don't remember who wrote it) but comparing business/economics to nature is particularly distressing when you recognize that business has none of nature's inherent checks and balances.

For instance, if you fed a shark a constant load of fish, they don't have the sense to know or recognize that their stomach can only process so much food. At some point, there stomach and guts bust open. Left to its own devices, the shark may even consume some of its own internals. Not a pretty picture, but why doesn't this occur often in nature. Because simply put, scarcity of resources acts as check on the shark's natural tendency to consume whatever is in front of it. While sharks consuming fish is necessary for its survival, overconsumption can be fatal.

The same is true of economic markets and businesses left to their own devices. The glaring difference is that nature provides no such natural check on man. We have long since figured out ways to produce more than enough food to feed the globe [if we so chose], get man to the moon, etc. It is precisely this dearth of limitation for which regulation is a necessity. As with anything else in nature, over-regulation, just like under-regulation, may prove similarly harmful.

The trick is to figure out what regulations are needed and how much is needed to make them effective but not life-threatening. Some tylenol for a head-ache is good, but a whole bottle can destroy the liver and kill you. In any event, I think the point has been conveyed.