WASHINGTON - Badgered by lawmakers, former Federal
Reserve Chairman Alan Greenspan denied the nation's economic crisis
was his fault on Thursday but conceded the meltdown had revealed a
flaw in a lifetime of economic thinking and left him in a "state of
shocked disbelief."
Greenspan, who stepped down in 2006, called the banking and
housing chaos a "once-in-a-century credit tsunami" that led to a
breakdown in how the free market system functions. And he warned
that things would get worse before they get better, with rising
unemployment and no stabilization in housing prices for "many
months."
Gloomy economic reports backed him up. New jobless claims soared
to just under 500,000 for last week, and Goldman Sachs, Chrysler
and Xerox all said they were cutting thousands more workers. On
Wall Street, the Dow Jones industrials bounced erratically all day
before finishing up 172 points _ after a two-day drop of nearly
750.
The financial crisis even prompted the Republican Greenspan, a
staunch believer in free markets, to propose that government
consider tougher regulations, including requiring financial firms
that package mortgages into securities to keep a portion as a check
on quality.
He said other regulatory changes should be considered, too, in
such areas as fraud.
Also looking for solutions, another banking regulator told
Congress the government was working on a loan-guarantee plan that
could help many homeowners escape foreclosure as part of the $700
billion bailout legislation. That plan is being discussed by the
Treasury Department and the Federal Deposit Insurance Corp., said
FDIC Chairman Sheila Bair, who is pushing the idea.
Greenspan's interrogation by the House Oversight Committee was a
far cry from his 18 1/2 years as Fed chairman, when he presided
over the longest economic boom in the country's history. He was
viewed as a free-market icon on Wall Street and held in respect
bordering on awe by most members of Congress.
Not now. At an often contentious four-hour hearing, Greenspan,
former Treasury Secretary John Snow and Securities and Exchange
Commission Chairman Christopher Cox were repeatedly accused by
Democrats on the committee of pursuing an anti-regulation agenda
that set the stage for the biggest financial crisis in 70
years.
"The list of regulatory mistakes and misjudgments is long,"
panel chairman Henry Waxman declared.
Greenspan, 82, acknowledged under questioning that he had made a
"mistake" in believing that banks, operating in their own
self-interest, would do what was necessary to protect their
shareholders and institutions. Greenspan called that "a flaw in the
model ... that defines how the world works."
He acknowledged that he had also been wrong in rejecting fears
that the five-year housing boom was turning into an unsustainable
speculative bubble that could harm the economy when it burst.
Greenspan maintained during that period that home prices were
unlikely to post a significant decline nationally because housing
was a local market.
He said Thursday that he held to that belief because until the
current housing slump there had never been such a significant
decline in prices nationwide. He said the current financial crisis
had "turned out to be much broader than anything that I could have
imagined."
Greenspan's much-anticipated appearance before the House panel
came as the Senate Banking Committee held its own hearing on what
the government is doing now to get out of the mess.
Assistant Treasury Secretary Neel Kashkari, who is overseeing
the $700 billion financial rescue effort that passed Congress on
Oct. 3, said the administration was not only working to get federal
purchases of bank stock started quickly but also the program to mop
up troubled mortgage-related assets. He also said the government
was working to make sure that directives in the legislation to help
struggling homeowners avoid foreclosure were being addressed.
Kashkari said the plan could include setting standards that
banks should follow for reworking mortgages to make them more
affordable. He said the administration was considering a
recommendation to provide government loan guarantees to cover the
reworked mortgages to make the program more attractive to
banks.
"We are passionate about doing everything we can to avoid
preventable foreclosures," Kashkari told the committee.
The FDIC's Bair told the same Senate panel that the government
needs to do more to help tens of thousands of people avoid
foreclosure.
She said the FDIC was working "closely and creatively" with the
Treasury Department to come up with a plan.
Greenspan was asked to defend a variety of actions he took as
Federal Reserve chairman _ resisting recommendations to use the
Fed's powers to crack down on subprime mortgages, for one. And
opposing efforts to impose regulations on derivatives, the complex
financial instruments that include credit default swaps, which have
also figured prominently in the current crisis.
He said that outside of credit default swaps, the bulk of
financial derivatives had not caused major problems. He said the
boom in subprime lending occurred because of the huge demand for
investment opportunities in a global economy, and he blamed the
crash on a failure by investors to properly assess the risks from
such mortgages, which went to borrowers with weak credit.
As for firms that package mortgages into securities, he said,
"As much as I would prefer it otherwise, in this financial
environment I see no choice but to require that all securitizers
retain a meaningful part of the securities they issue."
On the billions of dollars of losses suffered by financial
institutions because of their investments in subprime mortgages,
Greenspan said he had been shocked by the failure of banking
officials to protect their shareholders from their bad loan
decisions.
"A critical pillar to market competition and free markets did
break down," Greenspan said. "I still do not fully understand why
it happened."
SEC Chairman Cox told the House panel that "somewhere in this
terrible mess, laws were broken." And Snow said that lawmakers
should have responded more quickly to his pleas for stronger
regulation for mortgage giants Fannie Mae and Freddie Mac, which
were taken over by the government last month.
In the meantime, Kashkari, the Treasury official overseeing the
bailout program, said there has been much progress, resulting in
"numerous signs of improvement in our markets and in the confidence
in our financial institutions." Still, he cautioned, "the markets
remain fragile."