And then came 2008.
An excerpt from The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby
On October 23, 2008, Greenspan appeared before a House committee. His face was etched with lines and his white shirt collar was rumpled. It was the first time he had submitted to an open-ended grilling on Capitol Hill about his role in the mortgage meltdown.
“I would like to provide my views on the sources of the crisis,” Greenspan began. “I would also like to discuss how my thinking has evolved and what I have learned this past year.”
At the root of the crisis, Greenspan explained, lay a failure of Wall Street’s risk models. In assessing mortgage securities, investors had placed their faith in “a vast risk management and pricing system . . . combining the best insights of mathematicians and finance experts.” But as Greenspan had known since his days a young consultant, no mathematical model was worth anything if the data that went into it were flawed, and Wall Street had made the fatal mistake of basing expectations of the future on a few scant years of good performance. Having thus convinced themselves of the safety of mortgage securities, investors had rushed in to buy; and lenders had responded by creating mortgages of all kinds, with no regard to quality. Here, in a nutshell, lay the cause of the troubles. The “whole intellectual edifice . . . collapsed . . . because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.”
The chairman of the committee, Henry Waxman, listened to Greenspan’s confession. With a bald head and a precisely clipped mustache, he had the air of a joyless functionary, not a glad-handing politician.
Waxman was not satisfied with Greenspan’s story. The former Fed chairman was apologizing for Wall Street’s mistakes, not for his own ones. “You were, perhaps, the leading proponent of deregulation of our financial markets,” Waxman said accusingly. “You have been a staunch advocate for letting markets regulate themselves.”
“Let me give you a few of your past statements,” the congressman continued menacingly.
“In 1994, you testified at a congressional hearing on regulation of financial derivatives. You said, ‘There’s nothing involved in Federal regulation which makes it superior to market regulation.’
“In 1997, you said, ‘there appears to be no need for government regulation of off-exchange derivative transactions.’
“In 2002, when the collapse of Enron led to renewed congressional efforts to regulate derivatives, you wrote the Senate, ‘We do not believe a public policy case exists to justify this government intervention.’
“Earlier this year, you wrote in the Financial Times, ‘Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators.’ ”
Waxman looked up from his script and fixed his gaze on Greenspan.
“My question for you is simple,” he announced.
“Were you wrong?”
Greenspan could have hit back directly. He was not simply an ideologue who believed in deregulation as a matter of faith. He was a pragmatist who had surveyed the evidence and concluded that private risk managers, however fallible, might be better than regulators. One conspicuous failure albeit a huge one — did not necessarily prove that his judgment had been wrong. Private risk management had worked for many years. Perhaps it would work again in the future.
But instead of confronting Waxman, Greenspan tried to evade him.
“Let’s separate this problem into its component parts,” he parried professorially. He was willing to concede that credit derivatives — the sort that AIG had sold to customers seeking to protect themselves against a counterparty’s default — had “serious problems.” But derivatives on currencies and interest rates were fine; and at the time of the debate with Brooksley Born, those were the ones that had existed. Greenspan had green-lighted virtuous swaps, in other words. On evil swaps, not guilty.
Waxman realized that Greenspan could hide in the details of derivatives for a long time, running out the clock on him. So he interrupted.
“You said in your statement that you delivered, the whole intellectual edifice of modern risk management collapsed. You also said, ‘those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shock, disbelief.’
“Now that sounds to me like you are saying that those who trusted the market to regulate itself, yourself included, made a serious mistake?”
Greenspan tried to dive back into the long grass of the swaps market. But Waxman was not having it.
“Where did you make a mistake?” he insisted.
“I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms,” Greenspan offered.
Now Waxman was closing in. But Greenspan was already running on to safer ground, explaining why for forty years he had doubted the efficacy of regulation.
“It’s been my experience, having worked both as a regulator for eighteen years and . . . in the private sector, especially ten years at a major international bank, that the loan officers of those institutions knew far more about the risks involved and the people to whom they lent money than I saw even our best regulators at the Fed capable of doing,” Greenspan pleaded.
“So the problem here is something which looked to be a very solid edifice . . . did break down. And I think that, as I said, shocked me.”
“Do you have any personal responsibility for the financial crisis?” Waxman asked. He was not interested in the subtleties.
Greenspan set off on a new tack, seeking to put the record straight about his dealings with Edward Gramlich. He still spoke in the same mesmerizing way: he was dense, circuitous, and difficult to follow; yet somehow his listeners were encouraged to believe that the difficulty was their fault. Five, ten, or fifteen years earlier, the magic of his manner might have worked — Waxman himself had fallen under Greenspan’s spell occasionally. But now the maestro effect was gone. Waxman was not going to defer to him.
“Dr. Greenspan, I am going to interrupt you,” the congressman broke in. “You had an ideology. You had a belief.” Then he quoted Greenspan’s own admission on this score. “I do have an ideology,” Greenspan had once said. “My judgment is that free, competitive markets are by far the unrivaled way to organize economies. We have tried regulation, none meaningfully worked.”
“That was your quote,” Waxman declared fiercely. “You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?”
Waxman’s windup had combined an exaggeration of the Fed’s power to enforce lending standards at nonbanks; an exaggeration of the force with which Edward Gramlich had spoken; and an exaggeration of the link between reckless mortgage lending and the collapse of leveraged finance. But his question was a master stroke. The hunter had pushed his quarry out of the long grass: rather than going after him on regulatory detail, he was gunning for nothing less than his entire ideology.
Now Greenspan made a fatal error. Rather than unpicking Waxman’s exaggerations, he urged him to refine his thoughts on the nature of ideology.
Ideology, Greenspan explained earnestly, was “a conceptual framework . . . [governing] . . . the way people deal with reality.
“Everyone has one,” Greenspan continued. “You have to. To exist, you need an ideology.
“The question is, whether it is accurate or not. What I am saying to you is, yes, I found a flaw, I don’t know how significant or permanent it is, but I have been very distressed by that fact.”
It was an unremarkable observation. Of course, all ideologies had flaws; the fact that Greenspan had acknowledged his went only to show his pragmatism. By the same token, the opposite ideology had flaws. How often had regulation failed? Would proregulation ideologues match Greenspan’s honesty in acknowledging the fissures in their framework? In Greenspan’s understanding, the statement that his ideology was flawed was almost a statement of the obvious.
Having offered his token philosophic concession, Greenspan wanted to return to the matter of Edward Gramlich. He seemed oblivious to the fact that Waxman had wounded him.
“But if I may, may I just finish an answer to the question — ” Greenspan began.
“You found a flaw?” Waxman interrupted.
“A flaw, a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak,” Greenspan confirmed. He was impatient to move on to his next argument.
“In other words, you found that your view of the world, your ideology, was not right, it was not working?” Waxman asked. He was intent on wounding his target as many times as possible.
“Precisely,” Greenspan acknowledged. “That’s precisely the reason I was shocked, because I had been going for forty years or more with very considerable evidence that it was working exceptionally well.”
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