Alan Greenspan has learned nothing

By Felix Salmon
October 2, 2009
Atlantic event in Washington this morning, and it was quite shocking how little Greenspan seems to have learned from the crisis. Yes, he has decided that banks need more capital: "You cannot function with a financial system with capital as low as it was," he said, adding that "in retrospect, Basel II was clearly suboptimal. You can't have capital at 10% or less, because human nature changes too quickly."

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David Leonhardt interviewed Alan Greenspan at the Atlantic event in Washington this morning, and it was quite shocking how little Greenspan seems to have learned from the crisis. Yes, he has decided that banks need more capital: “You cannot function with a financial system with capital as low as it was,” he said, adding that “in retrospect, Basel II was clearly suboptimal. You can’t have capital at 10% or less, because human nature changes too quickly.”

But on other matters — especially when it came to systemically-important things which didn’t fail in this particular crisis, Greenspan was alarmingly sanguine.

When Leonhardt brought up the subject of derivatives, Greenspan was at pains to differentiate interest-rate and foreign-exchange derviatives, on the one hand, from credit default swaps, on the other. He explained, quite rightly, that the percentage of the notional amount which players stand to lose is much higher in the CDS market that it is in say the rates market, but he never mentioned that notional amounts outstanding in the rates market are orders of magnitude greater than the CDS market ever was.

The degree to which Greenspan claimed not to be worried about the vast bulk of the derivatives business was highly alarming:

Nobody hears about problems in interest-rate or fx derivatives. We’ve had the most extraordinary stress test, and they came up clean. I’m saddened by the fact that the problems in CDS have been generalized to all financial derivatives.

For one thing, we do hear about problems in interest-rate derivatives: a man appearing at the conference later this afternoon, Larry Summers, contrived to lose $1 billion of Harvard’s money in just that market. Given the extreme measures which have been taken by the world’s central banks, and given the fact that global capital imbalances remain enormous, there’s clearly a lot of tail risk in the interest-rate and fx markets. If volatility there spikes in some unprecedented way — which is entirely possible — then no one knows who could end up becoming spectacularly unstuck in those markets.

Greenspan defended the CDS market, too, in familiar terms:

We have to make adjustments in the way that market is working, but fundamentally the concept of CDS is a very desirable one. You are distributing risk to those who are more interested in holding it or more capable of holding it, and that’s desirable.

Haven’t we learned that this isn’t true? Haven’t we learned that the people who end up holding the risk, once the banks have done their derivatives-based, structured-product thing, are precisely people who are not interested in holding it but who don’t realize what risk they’re holding? After all, those buyers will always be much more attractive, to risk sellers, than the kind of risk-hungry hedge funds who demand high returns for taking on that risk. The derivatives market turns out to have been one the best mechanisms ever designed for hiding risk, and I don’t see that as desirable in the least.

Greenspan, in other words, seems to have learned almost nothing from the crisis. When Northern Rock failed, he said, “the UK authorities were the best set of regulators in the world” — er no, they weren’t, as a glance at the leverage ratios at UK banks would tell anybody. So when Greenspan talks about inflation not being a problem until 2012, as he did at the end of his session, it’s not obvious why anybody should listen to him. He simply isn’t reliable or useful any more.

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Comments
10 comments so far

Couple of things. First, somehow I don’t think Summers contrived to lose a billion in the rates market. Maybe the Harvard endowment did, but I doubt he had much to do with it. I may not be a fan of his, but you’re painting with a very broad brush. Second, you seem to be doing some mixing here when you go from CDS to structured product. That does not establish that CDS are inherently dangerous or even that structured product is. The issue is much more complex than that and you should know it.

Posted by Dean | Report as abusive

Felix is order of magnitude younger than Greenspan, reached a career height similarly compared to the ex Fed chair.

And he dared to say the old man has learned nothing in economics.

Felix Salmon is right. Congratulations!

BYW the best report I read on the Summers-Harvard fiasco is that, while he did buy those fancy interest rate swaps when he was president, the security was left to the endowment CFO in good shape when Summers left Harvard. It is for the CFO to manage it properly, meaning to take certain critical timely decisions, which did not happen.

Posted by The Real Deal | Report as abusive

Hey Felix:

I used to like your work. But I have to agree with some of your other recent critics. You’re focusing way to much on the the things others are doing wrong — and you’ve lost that creativity of what could be done right!

I don’t really care much about problems, unless you can also propose a solution. Listening to complaining is a waste of my time. I want to hear from the folks proposing solutions so we can get working on it.

Cheers!

Posted by NoName | Report as abusive

Asking what a once powerful Alan Greenspan thinks of global capital markets is somewhat irrelevant. I am always more interested in what current administration or Fed. personalities say.

If Norman Rothschild or Cosmo de Medici were alive they might have some interesting analysis and perspective, but the utility of Alan Greenspan has long been exhausted…

Posted by Dave Brown | Report as abusive

Just thought I will chime with some feedback about your recent blogs. I have been a long time reader since your time in RGE Monitor, so please consider this friendly banter rather than criticism. I see a big deterioration in the quality of your posts since your move to Reuters, especially in the last few months. You are way too focused on sensationalistic finger-pointing rather than contributing anything meaningful or of substance. Your spat with Zero hedge, your incessant griping about Greenspan or Ben Stein is just making me question why I still follow you on the blogosphere. Most people are busy with their lives, and many of your financially-educated types know there is a huge difference between interest-rate swaps and CDS. Perhaps you can reduce the quantity of your posts but focus more on quality and intelligent commentary. The picking of characters across media to gripe about will only serve to reduce your base. The switching cost in blogs is nothing, as you most definitely know.

Posted by someone | Report as abusive

> For one thing, we do hear about problems in interest-rate derivatives: a man appearing at the conference later this afternoon, Larry Summers, contrived to lose $1 billion of Harvard’s money in just that market.

this is a problem for harvard but not for the market.
and their counterparties profited from these trades.
harvard could have and did lose $1B on investments not involving derivatives.

Posted by q | Report as abusive

Felix, two excellent sentences sum up a sword that overhangs the market.

“Given the extreme measures which have been taken by the world’s central banks, and given the fact that global capital imbalances remain enormous, there’s clearly a lot of tail risk in the interest-rate and fx markets. If volatility there spikes in some unprecedented way — which is entirely possible — then no one knows who could end up becoming spectacularly unstuck in those markets.”

Interest rates and forex markets have been very smooth by historical standards, especially given the circumstances. I suspect much of this is due to derivatives which push choppiness into the future by smoothing things over for years until the rubber band snaps.

Posted by Dan | Report as abusive

Greenspan should hang it up. He says that he thinks unemployment will go about 10% when it is already at 9.8 and has been rising. What insight!!!

He testified to Congress on the Bush tax cuts that he was concerned that with the then budget surpluses, we would pay off the national debt, which would have occurred by about now. Instead Bush left office with a budget deficit of over $11 trillion. Now Greenspan is worried about budget deficits. He is a menace.

Posted by Will | Report as abusive

Greenspan abandoned free market economics years ago.
He was at his best when he was under Ayn Rand’s umbrella.

Posted by Paul Williams | Report as abusive

Alan Greenspan is a feeble minded fool who has done enough damage to the U.S.A. His stupidity fringes on treason. His mouth should stay retired. Jack

Posted by John Koch | Report as abusive
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