Twice Burned, Greenspan Not Shy About Nationalizing Banks
The blogosphere reacted with a sense of amusement Wednesday to news that former Federal Reserve Chairman and free market stalwart Alan Greenspan was urging the nationalization of American banks. While Paul Krugman laughed that "Comrade Greenspan" had called for the government to "seize the economy's commanding heights," Atrios snickered "I guess he's capable of being right." Of course, given that Greenspan missed both the 1980's savings and loans crisis and the risk of an imploding housing market 20 years later, the joking is well founded.
Greenspan in an interview with the Financial Times Wednesday added his voice to the growing chorus of those calling for the Obama administration to nationalize the teetering U.S. banking system:
"It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring. I understand that once in a hundred years this is what you do."
Sadly, about once every twenty years, what Alan Greenspan did was to miss economic calamity emerging just over the horizon.
The first time, as I noted last fall, was the devastating S&L crisis. Back in 1984 (before his tenure at the Fed), Greenspan and his economic forecasting firm, Townsend-Greenspan & Company were retained by the law firm representing Charles Keating's Lincoln Savings and Loan. As the archives of the New York Times detail, Greenspan was hired not only to "conduct a study on real estate investment, known in the savings industry as direct investments, by savings and loan associations."
He was also to study Lincoln's financial condition, and if he considered the institution stable, to write officials of the Federal Home Loan Bank of San Francisco supporting an application by Mr. Keating for an exemption for Lincoln to a bank board rule forbidding substantial amounts of such investments. Mr. Greenspan sent such a letter in February 1985. Lincoln did not receive the exemption.
What triggered Greenspan's hiring in late 1984 was growing concerns on the part of the Federal Home Loan Bank Board with risky direct investments by savings and loans, worries which prompted it to adopt a regulation capping such activities at 10% of an institution's business. For his part, Greenspan in his report gave a glowing assessment of Keating's Lincoln Financial, a firm whose later implosion would cost U.S. taxpayers $3.4 billion:
He submitted his study on direct investment to the bank board, but it adopted the regulation limiting such real estate investments anyway. Then Mr. Greenspan wrote the regulators, asking that Lincoln be given an exemption from the new rule.
Mr. Greenspan described Lincoln's management as ''seasoned and expert in selecting and making direct investments,'' as having a ''long and continuous track record of outstanding success in making sound and profitable direct investments,'' as succeeding ''in a relatively short period of time in reviving an association that had become badly burdened by a large portfolio of long-term fixed-rate mortgages'' and that it had ''restored the association to a vibrant and healthy state, with a strong net worth position.''
Like John McCain, Greenspan was later forced to admit his cataclysmically poor judgment about Charles Keating and Lincoln Financial. While the episode proved no barrier to Greenspan succeeding Paul Volcker at the Fed, Greenspan acknowledged his mistake to the New York Times in 1989:
"When I first met the people from Lincoln, they struck me as reasonable, sensible people who knew what they were doing, I don't want to say I am distressed, but the truth is I really am. I am thoroughly surprised by what has happened to Lincoln.
Of course I'm embarrassed by my failure to foresee what eventually transpired. I was wrong about Lincoln. I was wrong about what they would ultimately do and the problems they would ultimately create."
Two decades after his bit part in the S&L disaster, Greenspan repeated his myopia in the meltdown of the U.S. housing market and Wall Street.
While the New York Times and Time in recent weeks each highlighted Alan Greenspan's critical role in the build up to the subprime mortgage crisis, others warned of the looming disaster years ago.
In a stunningly prescient April 2004 article ("There Goes the Neighborhood") in the Washington Monthly, Benjamin Wallace-Wells argued that home prices were about to plummet and take the economy down with them.
During the last week in February , when Greenspan recommended that the home-owning public take a good hard look at switching from fixed-rate mortgages, under whose terms payments stay the same no matter what interest rates do, to adjustable rate mortgages (ARMs), where payments fluctuate along with interest rates--which, right now, makes close to zero sense. Interest rates are lower than they've been in 30 years, and, with all economists predicting a general economic upturn, and Bush's budget deficit and the weak dollar sucking up capital, little doubt exists that interest rates must rise, in which case, switching from a fixed-rate to adjustable-rate mortgage would be pretty costly for any family naive enough to take Greenspan at his word. The episode did not pass completely without critical notice. It was "the strangest bit of advice ever to be proffered by an American central banker," Jim Grant, publisher of Grant's Interest Rate Observer, told the San Francisco Chronicle. Then the press moved on: "Oh, it's just Greenspan"...
...Greenspan's rather ham-handed effort to get them to go for ARMs, is a sign not of the chairman's own eccentricity or advanced age, but, instead, of the economy's current unsteadiness. Greenspan knows, perhaps better than anyone, that this economy is perched nervously on top of a wobbly, Dr. Seuss-like tower. Our recovery is propped up by consumer spending, which is in turn propped up by mortgage refinancing, and if that refinancing dries up before more props can be put in, the whole edifice could fall. "Since long-term interest rates cannot fall low enough to facilitate another wave of fixed-rate refinancings, he is trying to encourage homeowners to refinance one last time: fixed to ARM," Peter Schiff, president of Euro Pacific Capital in Los Angeles told the San Francisco Chronicle.
Over the previous five years, Americans had extracted almost $1.6 trillion in cash from refinancing and spent virtually all of it on consumer goods purchases. As Wallace-Wells noted four years ago, "Greenspan has played enabler to this boom," and concluded:
"To get out of the recession, he had to rely on, stay mum about, and even encourage a housing bubble. Now, that very bubble may be the thing that destroys the recovery he has sought to create."
For his part, Greenspan admitted as much last week in a CNBC interview featured in its special investigation of the financial crisis, House of Cards. Among other jaw-dropping statements, CNBC noted, "Greenspan also admits that he was puzzled by the more complex mortgage-backed securities on the market." And in language that echoed his Lincoln Financial mea culpa twenty years prior, Greenspan last fall concurred with Rep. Henry Waxman's question, "You found that your view of the world, your ideology was not right, it was not working?"
"Absolutely, precisely. You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well...
...I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms."
Which may be why Greenspan today told the FT that nationalization may be the only answer left. "In some cases," he said, "the least bad solution is for the government to take temporary control."
UPDATE: Tom Edsall adds his own perspective on Greenspan's record and legacy over at the Huffington Post.