In a 60 Minutes interview, Leslie Stahl asked former Fed chairman Alan Greenspan
whether he knew what was going on in the sub-prime lending market. His answer?
While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late. I didn't really get it until very late in 2005 and 2006.
Huh? An economist with his experience didn't understand that lenders will be happy to take outrageous risks if they think they can sell off the loans and not have to deal with the defaults? It's not as though no one brought it up. According to the CBS story, former Fed governor Ed Gramlich said that he had proposed examining the lending practices, but that Greenspan rejected the idea. Apparently that is the case:
"I thought that…we would not be capable of doing what he was suggesting," Greenspan says.
"But if sitting on them, taking some regula-what…" Stahl asks.
"Well, I think not," Greenspan replies.
"Even looking into it?" Stahl asks.
"It's nothing to look in to particularly because we knew there was a number of such practices going on, but it's very difficult for banking regulators to deal with that," Greenspan says.
So, he knew they were going on. I cannot - simply cannot - believe that Greenspan couldn't see the writing on the Wall Street, not after warning about irrational exuberance. No way to check on this? Not even with all the intellectual power and computing systems that the Fed has? Couldn't find a way to do some random checking on credit scores that were probably part of the lending record versus the size of loan and verified income? No way to see how many of the loans depended on lenders not verifying income, maybe? I don't believe it. This wouldn't be rocket science. and then there was this interchange:
"Just remember we raised interest rates at every meeting from June of 2004 till I got out of office," he says.
"You raised rates in 2004. But only after you held interest rates at historically low level for three years, while the bubble, the housing bubble was forming," Stahl points out. "And that you had 13 rate cuts in that period of time."
"It was our job to unfreeze the American banking system if we wanted the economy to function. This required that we keep rates modestly low," Greenspan explains.
Unfreeze the banking system? This sounds dubious. American companies had clearly over-invested in the 1990s and it would take them years to digest all that spending. Low interest rates weren't needed for investment - they were needed to get consumers to spend.
Perhaps Greenspan truly believed in the market the way I see many treat it, almost as a form of religion. Free everything up and it will all work out. I somehow don't think he's try to rig the system to let certain people take advantage. When asked about the major American car companies, he replied, "I would suggest they focus on selling, creating better cars for their customers," rather than depend on lowered interest rates. Perfectly sound advice. They aren't selling because they aren't producing products that consumers want most.
But there's a problem with the market-cures-all vision of unfettered capitalism. Depending on a market isn't relying on some invisible, rational, impartial mechanism that evens out the bumps. It means trusting to human greed, fear, and emotional goads that cause people to do the most unbelievably stupid things. Lending large sums at high interest rates, which will only go up, to people who will be unlikely to maintain payments is stupid business. It's hoping that enough of the money will come in to cover the losses. This isn't business; it's gambling.
As happens with most such decisions, what people do is rationalize why what they want to do really makes sense. Maybe that's what Greenspan was doing - hoping that things would work out as they were "supposed to."
Labels: economy, Fed, Greenspan, sub-prime