Securities regulation: Atlas shrugged

Alan Greenspan and the downside of self-interest.

It’s Oct. 23, 2008, a small committee room on Capitol Hill. The atmosphere resembles a trial, and in one sense, it is one. In the hot seat: unfettered free market capitalism.

The committee in question is the House Committee on Oversight and Government Reform, chaired by Democratic Rep. Henry Waxman. Testifying today is former chairman of the Federal Reserve Alan Greenspan; current chair of the Securities and Exchange Commission Christopher Cox; and former Treasury Secretary John Snow.

Greenspan’s testimony is first. He reads from a short prepared statement, in an attempt to explain why the financial system is melting down. “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially,” he says, “are in a state of shocked disbelief.”

After the other two speak, Waxman zeroes in on Greenspan, a disciple of free marketeer Ayn Rand. “You were the longest-serving chair of the Federal Reserve—and perhaps the leading proponent of deregulation of financial markets,” he says. (Yet as everyone in the room with a pulse knows, financial markets are now in free fall, aided and abetted by unregulated markets in mortgage securities and credit default swaps.) “Were you wrong?”

Greenspan takes the mic. “Partially,” he intones. He starts to explain why, but Waxman interrupts.

“You had an ideology. You had a belief that free competitive markets were the best way to organize an economy,” Waxman says. “You also had the authority to prevent irresponsible lending practices. You were advised to do so. Now, the whole economy is paying the price. Did your ideology push you to make these decisions?”

“To exist, you need an ideology,” Greenspan shoots back. “The question is, whether it is accurate or not. But I have found a flaw. And I have been very distressed by that fact.”

What follows is four hours of testimony in which the man once heralded as the saviour of global capitalism was interrupted, harangued, grilled, even called a butterfingers by Democratic Rep. John Yarmuth of Kentucky, for dropping the ball on financial regulation. After 18½ years at the helm of the Fed, steering the U.S. economy to ever-greater heights of growth, Greenspan came in for harsh criticism for everything from championing unregulated derivatives markets to promoting low interest rates, which some argue generated the easy money that stoked the housing bubble.

Mark Gertler, a New York University economist, says the criticism of Greenspan’s interest rate policies is unfair. “Housing policy is tied to long-term rates, which were also low due to a massive influx of capital coming into this country from fast-growing emerging-market economies,” explains Gertler. “The only way you can say the Fed overdid it on interest rates was to look at inflation rates and, well, there was no inflation at that time.” Gertler, however, acknowledges that the criticism of Greenspan’s regulatory policies is fair.

Meanwhile, Greenspan’s admission of a “flaw” in his thinking has set off tidal waves of punditry. “It’s an incredible U-turn,” says Wharton School professor Susan Wachter. “What was the flaw? He’s finally admitted that markets don’t self-correct. Markets occasionally fail. That’s why we need regulation.”

Back in the committee room, Democratic Rep. Stephen Lynch of Massachusetts is asking the panel about the many billions of dollars’ worth of complex derivatives without buyers that continue to gum up the global financial system. Shouldn’t something be done about them? he asks.

“I have no objection to regulating those instruments,” says Greenspan. “My puzzlement is: who is buying those things? There are a lot of instruments out there that make no sense”—and 72% of them are held by hedge funds.

Continues Greenspan: “That is what I find most disturbing. We are not dealing with people who are dumb. We are dealing with thoughtful, sophisticated people who created the major problems.”

In other words, genius failed. Atlas shrugged, and the results aren’t pretty. Now it’s left to the rest of us to pick up the pieces. Here’s hoping we’re up to the job.