Jeremy Warner: Greenspan admits to 'flaw' in his free market thinking


Outlook Alan Greenspan, quoting Keynes, insists that when the facts change, he changes his mind. It wasn't exactly a mea culpa we had from the former Federal Reserve chairman in Congressional testimony yesterday, but it was about as close as we are likely to get to it.

Mr Greenspan has spent much of the last two years trying to justify what, with the benefit of hindsight, were plainly a series of mistakes, both in the exercise of interest rate policy and in the regulation of banks, for which the Fed is partly responsible in the US. Central banks shouldn't attempt to deflate asset bubbles, he has argued, but only deal with their aftermath, while banks are best left alone to regulate themselves in their own self interest.

Yesterday, he admitted for the first time that at least some of this thinking was flawed. Rather in the manner of religious disillusionment, his realisation that the market isn't always right has come as a terrible shock to the former monetary wizard. Yet Mr Greenspan is not entirely repentant. As far back as 2005, he insists, he raised concerns that the protracted period of underpricing of risk, if history was any guide, would have dire consequences.

Unfortunately, it may already have been too late by that stage, and in any case, he failed to act on his own wake-up call, despite ample authority and opportunity to do so. He also admits to having failed to act on the concerns of Ed Gramlich, a former member of the Federal Reserve's board of governors, who had warned him in terms as far back as 2000 of the perils of predatory pricing in sub-prime mortgage lending.

It is always easy to be wise after the event, and I'm not sure we should be too hard on Mr Greenspan for failing to recognise the significance of the boom in sub-prime lending. Hardly anyone else did either until it was too late. On the other hand, it is the job of a central banker to take away the punch bowl just as the party gets interesting, to quote another former chairman of the Fed, William McChesney Martin, and this Mr Greenspan notably failed to do.

Yet it was not for failings in monetary policy that Mr Greenspan was apologising, but rather for flaws in his whole world view. As he has said before, those who look to the self-interest of lending institutions to protect shareholders' equity are in a state of "shocked disbelief". For him at least, 40 years of faith in the ability of the free market system to protect and heal itself has gone up in smoke.

Personally, I cannot see why an economist as ancient and accomplished as Mr Greenspan, brought up in the crucible of the Great Depression, should find this shocking at all. Down the ages, banks have repeatedly proved careless both with their shareholders' capital and their depositors' money. As the good times roll, they invariably drop their lending standards and eventually find themselves crucified by bad debt. In that respect, there is nothing unique about the present banking crisis at all.

As Mr Greenspan points out in yesterday's testimony, the crisis is at root about failure properly to price risky assets. Again, all banking crises share this characteristic. What made this one a bit different was the extent of global demand for dodgy, mispriced US assets.

Yet it is not so much the present state of market failure Mr Greenspan is in shocked disbelief over, as the fact that self-surveillance and correction by banks should have broken down on such a scale. Again, it is hard to see why he should find this remarkable. As the boom times roll, banks always end up allowing risk controls to become eroded and thereby lending too much. The longer the boom, the more extreme the process becomes.

What Mr Greenspan should really be kicking himself about is not his naive belief in the idea that markets are self regulating in their own interests, but his own failure to spot the extent of the mispricing, and then act on it. He's hardly alone in this failing, but then it was his job to keep the children under control. In any case, Mr Greenspan has now joined the greater regulation bandwagon. Yet it is endearing to see that he has not entirely lost his free market faith. Whatever regulatory changes are made, he says, will pale in comparison with the change already evident in markets. "Those markets for an indefinite future will be far more restrained than would any currently contemplated regulatory regime". Quite so. When markets get it wrong, they really know how to punish themselves. Unfortunately, it is the little guy, and not the responsible bankers, who takes the brunt of it.

Start your day with The Independent, sign up for daily news emails
News
people
Arts and Entertainment
Attenborough with the primates
tvWhy BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter
Sport
The RBS Six Nations trophy at the Aviva Stadium ahead of Ireland vs England
rugby
News
Campbell: ‘Sometimes you have to be economical with the truth’
newsFormer spin doctor says MPs should study tactics of leading sports figures like José Mourinho
ebooks
ebooksA special investigation by Andy McSmith
Arts and Entertainment
Kanye West found himself at the centre of a critical storm over the weekend after he apparently claimed to be “the next Mandela” during a radio interview
music
Sport
Wes Brown is sent-off
football
Voices
Lance Corporal Joshua Leakey VC
voicesBeware of imitations, but the words of the soldier awarded the Victoria Cross were the real thing, says DJ Taylor
Life and Style
Alexander McQueen's AW 2009/10 collection during Paris Fashion Week
fashionMeet the collaborators who helped create the late designer’s notorious spectacles
News
i100
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: HR Benefits Manager

£40000 - £50000 per annum + pro rata: SThree: SThree Group have been well esta...

Recruitment Genius: Office Manager / Financial Services

£30000 - £37000 per annum: Recruitment Genius: Established in 1999, a highly r...

Jemma Gent: Year End Accountant

£250-£300 Day Rate: Jemma Gent: Are you a qualified accountant with strong exp...

Jemma Gent: Management Accountant

£230 - £260 Day Rate: Jemma Gent: Do you want to stamp your footprint in histo...

Day In a Page

War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn
Yvette Cooper: We can't lose the election. There's too much on the line

Yvette Cooper: We can't lose the election. There's too much on the line

The shadow Home Secretary on fighting radical Islam, protecting children, and why anyone in Labour who's thinking beyond May must 'sort themselves out'
A bad week for the Greens: Leader Natalie Bennett's 'car crash' radio interview is followed by Brighton council's failure to set a budget due to infighting

It's not easy being Green

After a bad week in which its leader had a public meltdown and its only city council couldn't agree on a budget vote, what next for the alternative party? It's over to Caroline Lucas to find out
Gorillas nearly missed: BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter

Gorillas nearly missed

BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter
Downton Abbey effect sees impoverished Italian nobles inspired to open their doors to paying guests for up to €650 a night

The Downton Abbey effect

Impoverished Italian nobles are opening their doors to paying guests, inspired by the TV drama
China's wild panda numbers have increased by 17% since 2003, new census reveals

China's wild panda numbers on the up

New census reveals 17% since 2003
Barbara Woodward: Britain's first female ambassador to China intends to forge strong links with the growing economic superpower

Our woman in Beijing builds a new relationship

Britain's first female ambassador to China intends to forge strong links with growing economic power
Courage is rare. True humility is even rarer. But the only British soldier to be awarded the Victoria Cross in Afghanistan has both

Courage is rare. True humility is even rarer

Beware of imitations, but the words of the soldier awarded the Victoria Cross were the real thing, says DJ Taylor
Alexander McQueen: The catwalk was a stage for the designer's astonishing and troubling vision

Alexander McQueen's astonishing vision

Ahead of a major retrospective, Alexander Fury talks to the collaborators who helped create the late designer's notorious spectacle
New BBC series savours half a century of food in Britain, from Vesta curries to nouvelle cuisine

Dinner through the decades

A new BBC series challenged Brandon Robshaw and his family to eat their way from the 1950s to the 1990s
Philippa Perry interview: The psychotherapist on McDonald's, fancy specs and meeting Grayson Perry on an evening course

Philippa Perry interview

The psychotherapist on McDonald's, fancy specs and meeting Grayson Perry on an evening course
Bill Granger recipes: Our chef recreates the exoticism of the Indonesian stir-fry

Bill Granger's Indonesian stir-fry recipes

Our chef was inspired by the south-east Asian cuisine he encountered as a teenager
Chelsea vs Tottenham: Harry Kane was at Wembley to see Spurs beat the Blues and win the Capital One Cup - now he's their great hope

Harry Kane interview

The striker was at Wembley to see Spurs beat the Blues and win the Capital One Cup - now he's their great hope
The Last Word: For the good of the game: why on earth don’t we leave Fifa?

Michael Calvin's Last Word

For the good of the game: why on earth don’t we leave Fifa?
HIV pill: Scientists hail discovery of 'game-changer' that cuts the risk of infection among gay men by 86%

Scientists hail daily pill that protects against HIV infection

Breakthrough in battle against global scourge – but will the NHS pay for it?