Greenspan Defends His Legacy As Housing Crisis Widens

He can spin all he likes, but many are not buying former Federal Reserve Chairman Alan Greenspan's attempts to distance himself from the housing crisis -- and to make sure the Fed's laissez-faire economic practices don't take any blame either.

Greenspan, both his critics and his political allies note, is a political survivor who does what it takes to stay on top. So he's forcefully and publicly defending himself and his staunch anti-regulatory views, even as fingers point to his tenure at the Fed as the source for the housing mess.

"The Fed is Blameless on the Property Bubble," declared the headline of Greenspan's piece in Monday's Financial Times. He offered no apologies, and instead wrote, "Free competitive markets are the unrivalled way to organise (cq) economies." In a defensive interview in The Wall Street Journal Tuesday, Greenspan said he was speaking out to set the record straight and to make sure the wrong lesson - tighter regulation - wouldn't be the end result of the foreclosure crisis.

Ayn Rand, his early mentor, would have been proud. The novelist was a fervent advocate of laissez-faire capitalism and she continually asserted that government's highest purpose was the protection of individual rights. Ask anyone who's read "The Fountainhead."

But beyond Greenspan's Beltway admirers, attitudes are different. Greenspan can defend his legacy all the day long, but it won't change the fact that, on his watch, the Fed failed to rein in abusive and predatory practices by banks and lenders that have resulted in millions of people losing their homes. He can't do anything to stop a growing movement to put some brakes on the financial markets, and to reverse his efforts of the past three decades to push for less and less oversight.

On Monday, for example, Federal Deposit Insurance Corp. Chairwoman Sheila Bair called for more federal activism and spending to combat foreclosures.

"I think history is going to be very unkind to Chairman Greenspan," said Tom Schlesinger, founder of the Financial Markets Center, a research group that follows the Fed. "A lot of the blame is due to Greenspan's extremely doctrinaire and permissive views on financial regulation generally. The guy was fundamentally allergic to controls on the financial sector, and he ran his institution according to that financial inclination."

"You can look at speech after speech that Greenspan delivered on regulation, over 18 years," Schlesinger continued, "and they're very consistent. The consistency is that government should have a light hand -- if it has any hand whatsoever -- and it's not the role of the Federal Reserve to get in the way of financial innovation."

That innovation was applauded when the economy was growing and homeownership levels were hitting record highs. But it's looked at quite differently in the wake of the housing mess -- blamed in part on lax underwriting standards, predatory loans and the rapid defaults of newer mortgage products like Option ARMS, or adjustable rate mortgages.

Greenspan said last year that he had "no notion" of how significant subprime lending practices had become until late 2005 and 2006. He also said in his 2007 memoir that while he was aware of risks concerning subprime loans, he believed that broadened home ownership outweighed them.

The Fed's role in slashing or hiking interest rates and in managing monetary policy often overshadows the fact that is has strong consumer protection authority it can wield - if it chooses to.

Those arguments might fly among "the circle of fawning Beltway journalists and acolytes who treated him as some sort of God-like figure during his years at the Fed," Schlesinger said. But they don't pass the common sense test. "He'll be judged particularly harshly for willfully ignoring what was plain for anyone to see, the abuses in the mortgage market." Schlesinger said, "Not only did he willfully ignore it, but under his leadership, the Fed failed to use its existing authority to deal with the abuses."

The Fed's role in slashing or hiking interest rates and in managing monetary policy often overshadows the fact that is has strong consumer protection authority it can wield - if it chooses to. Congress in 1994 passed the Home Ownership and Equity Protection Act, aimed at defining and curbing high-cost and predatory subprime loans. Consumer advocates considered the law as so narrow in scope as to exclude most lenders -- but it gave the Fed authority to monitor abuses and step in, if necessary, to restrict or stop an lenders and their practices. The Fed held hearings and made a few minor changes to the law, but did nothing beyond that.

Greenspan's comments that he was unaware of the extent of problems in the subprime market boggles the mind...

"If the Fed had stepped up, it could have averted a good deal of this crisis," said Eric Halperin, director of the Washington office of the Center for Responsible Lending, a nonprofit research group that analyzes predatory lending. "What we're really seeing here is the serious negative consequences that no regulations can have."

Greenspan's comments that he was unaware of the extent of problems in the subprime market "boggles the mind," Halperin said, noting that consumer advocates had been besieged with complaints from subprime borrowers for years before the housing market collapse.

"From my narrow perspective," Halperin said, "Greenspan's legacy will be the failure to see predatory and abusive practices in the subprime market and to make any attempts to regulate them."

Whatever Greenspan's legacy, it clearly matters far more to him and to his followers than it does to the average person underwater on their mortgage or facing foreclosure. Greenspan is fighting to preserve his reputation and to push his economic ideology, but the many victims of predatory lending practices have ruined credit and may be about to lose the homes they once dreamed of.

The lessons learned will be those going forward. Neither Greenspan nor the Fed will enjoy their once-invincible reputations -- probably a good thing for the economy, said Mark Thoma, a University of Oregon economics professor and blogger. Investors will take fewer risks, knowing that the Fed can't solve everything by tweaking the money supply. Separate from Greenspan, the Fed tends to learn from its mistakes and adjust accordingly -- which is why the U.S. is facing high oil prices now but not runaway inflation, as in the 1970s, he said.

Thoma and some others tend to give Greenspan a pass for failing to recognize the housing bubble, and for making cheap money available after 9-11 to boost the economy.

But Greenspan's attempts to defend his anti-regulatory stance are inciting ridicule in the blogosphere, where followers of Ayn Rand and the unfettered free market seem to be in short supply. Her following came to be criticized as cultish, and it has been waning in the decades since "Atlas Shrugged" was published in 1957.

It may be a sign of the fall of the cult of Greenspan that the response to his arguments has not been greeted with the reverence that once accompanied his every utterance.

In the Financial Times, Greenspan argued that unrealistic expectations of what regulators can do, rather than regulations themselves, are the barrier to imposing new rules. It prompted this retort from Naked Capitalism:

But the biggest problem with Greenspan's posture is that he fails to accept the rationale for regulation. Banking is an industry that can create enormous externalities, namely, financial panics, asset bubbles (which suck investment out of more productive uses) and busts. Even a mere nasty credit contraction exacts a toll on the real economy. We accept the rationale of regulating polluters, food producers, and drug makers because the costs to society when they get it wrong can be large.

Greenspan is basically saying we shouldn't regulate banks because it's hard to be smart enough about their business. That's a pathetic excuse.

Rather than squabbling over Greenspan's legacy, it might be useful to hold a congressional hearing to find out what Greenspan knew about the subprime crisis and when he knew it. And why he didn't do anything about it, said James Galbraith, an economics and government professor at the Lyndon B. Johnson School of Public Affairs at the University of Texas. That gets around the problem of having a former Fed chairman declare that the U.S. is facing the worst economic crisis in 50 years, but he didn't have anything to do with it, despite his 18 years at the helm of the agency that oversees monetary policy.

"Only once in a generation do you get a guy like (Former Defense Secretary) Bob McNamara, who takes responsibility and says he was wrong," Galbraith said. "For the kinds of things that happened on his watch, Greenspan isn't going to do it."

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