[ExI] Greenspan: rhetoric vs. reality/was Re: More on US Health Care Costs

[dan_ust at yahoo.com]

--- On Fri, 5/22/09, BillK <pharos at gmail.com> wrote:
> On 5/22/09, Dan  wrote:
> <snip>
>> Where was this "regulation free system" with regard to
>> Wall Street?
>> How is the US financial system -- one that is heavily
>> regulated from the
>> Federal Reserve System, the SEC, etc. on the federal
>> level to a host of
>> state and local laws -- "regulation free system" in
>> your view?
>> (And was it ever so?)  What of the Sarbanes-Oxley
>> Act of 2002, the
>> Community Reinvestment Act, Freddie Mac, Fannie Mae,
>> and the myriad
>> other interventions in the financial markets?  I
>> might agree that there are
>> times of more or less regulation -- often just times
>> where one or more
>> regulations is less enforced but the whole system of
>> regulations remains
>> in place -- but none in US history where it was
>> regulation free.
>> (Maybe the closest to the time was during the so
>> called "free banking"
>> period -- roughly 1837 to 1860 -- but even then the
>> banks were still
>> regulated at the state and local level.)
> 
> If you don't accept that lack of regulation was one of the
> main causes
> of the financial crisis, then I think you need to do more
> investigation.
> (Note: not lack of regulations. Lack of implementation of
> most of the regulations).

On the parenthetic comment, which regulations are ever fully implemented?  Certainly in the case of many of things I've mentioned -- Sarbanes-Oxley, and the CRA -- these were implemented.  If you're going to blame them on not being implemented well enough, that's debatable, though I fear that's just a way court intellectuals will justify the failures of regulation -- "We didn't do enough." "Our hands were tied." etc.
 
> See the Wall Street Journal, February 17, 2009, (as one
> example of many):
> <http://blogs.wsj.com/economics/2009/02/17/greenspan-vs-the-greenspan-doctrine/>
> 
> Quote:
> The Greenspan Doctrine – a view that modern,
> technologically advanced
> financial markets are best left to police themselves –
> has an
> increasingly vocal detractor. His name is Alan Greenspan.

This was mostly Greenspan's rhetoric.*  The reality is that market players expected and knew that Greenspan would act whenever they needed more liquidity, bailouts, and the like.  So, even to the degree he rhetorically championed de-regulation, he was ever there to provide support -- short-circuiting healthy negative feedback loops.  (Providing liquidity and bailouts (in many cases, Greenspan lent support to such rather than actually provided them) means big players who make mistakes don't have to pay for them -- much less learn from them.  This should be the lesson of the Greenspan years, right from his first crisis in 1987.)

Also, there's a point to be made about markets.  They are self-regulating, BUT NOT because the big players -- like, e.g., the big banks -- "police themselves" but because all participants have an exit option is most of their relationships.  This means, e.g., if one bank, no matter how big, is messing with its clients or investors, they can choose to bank somewhere else or not to bank at all.  (Also, there's the related feature that markets allow other entrants to participate -- as when, e.g., people on a free market might turn to gold and away from paper money.  This is currently mostly illegal due to legal tender laws -- which are, by the way, strictly enforced as those involved with the Liberty Dollar have found out.)
 
> As Fed chairman, Mr. Greenspan was a frequent opponent of
> market
> regulation. Sophisticated markets, he argued, had become
> increasingly
> adept at carving up risk themselves and dispersing it
> widely to
> investors and financial institutions best suited to manage
> it.

Yet, despite this rhetoric, at no time did Greenspan give up his power to control rates.  Nor did his abhor or counsel against FMOC operations.

> The retired chairman has had to revise his views. 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.”

The problem for this view -- aside from it likely being Greenspan covering his tracks** -- why would "owners and managers of [major] financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring and managing their firms’ capital and risk positions"?  After all, they knew of the "Greenspan put" -- that Greenspan, time and again, would come to the rescue of just about any firm "too big to fail."

In effect, this is merely the same problem that happened to Fannie Mae and Freddie Mac: when someone covers someone else's risks, this leads to more risks being taken -- NOT to people better managing risk.  Why would anyone but a fool expect otherwise?  Think of how anyone would gamble in Vegas if someone gave you endless credit.  Would this likely lead to less, more, or the same number of risky bets being placed?  (This, of course, applies to both private and public covering of risk.  The difference, though, with private covering is that the effects are usually localized and highly self-limiting.  E.g., if you suddenly decided to fund my spree in Vegas, eventually you'd run out of money -- unless I got very lucky.  It's also more likely that, as it's your money, you'd place limits on what I could do, how much I could spend, and the like.  Chances are, you'd notice quickly if I were a compulsive gambler.  If not, again, you'd go broke and my money would
 then be cut off -- ending my career as a gambler.  This isn't the same when the Fed and the federal government subsidize risk.  The costs are bourne by other parties, so it's not self-limiting.  Also, the Fed and the federal government are systemic big players.  They tend to set the tone for the whole financial sector -- of the nation if not the planet.  While you might make the mistake of backing me, this is unlikely to bring down the whole gaming sector.  With the Fed and federal government, this is exactly what's happened time and again.)

Regards,

Dan

*  See, e.g., this 2005 piece on the Greenspan mess:

http://mises.org/story/1985

**  I bet he's aware of the Austro-libertarian critique of his policies and his time at the helm of the Fed.