Greenspan, interventionist

by Russ Roberts on November 19, 2011

in Uncategorized

In 1991, Alan Greenspan testified before Congress on three bills related to banking:

I am pleased to appear before this Committee to
discuss three important banking reform bills: H.R. 6, the
Deposit Insurance and Regulatory Reform Act of 1991,
introduced by Chairman Gonzalez; H.R. 15, the Depositor
Protection Act of 1991, introduced by Congressman Wylie; and
H.R. 1505, the Treasury's proposed Financial Institutions
Safety and Consumer Choice Act of 1991. These three bills
all would modify our deposit insurance system in order to
place limits on an expansive safety net that has created
incentives for our banks to take excessive risk with
insufficient capital.

It was a very good idea to get rid of that “expansive safety net” that encouraged “banks to take excessive risks with insufficient capital.” But did Greenspan really think it was a good idea?

The standard narrative is that Greenspan was the free-market ideologue who opposed all regulation of the financial sector. But did he favor intervention of other kinds? He did orchestrate the rescue of LTCM (though without government money). He testified in favor of the government rescue of Mexico, which made sure that all of Mexico’s creditors, many of which were American financial institutions. And he often lowered interest rates to protect asset values. Not exactly a free-marketer (unless it benefits American banks and their bottom line. And later in the testimony Greenspan testified that it was a good idea to keep in place the power to bail out creditors. His bottom line is in the last paragraph below.

Greenspan was not a free-marketer. A simpler explanation is that he and the rest of the Fed and the rest of the policymakers responded to incentives and those incentives were to protect large American banks.

The Wylie bill is silent on the failure resolution
procedure of the FDIC, while the Treasury and the Gonzalez
bills would require the FDIC to resolve failed banks in the
least costly manner, which generally means that uninsured
depositors would receive only pro rata shares of residual-12-
value, if any. The Gonzalez bill, however, has no provision
permitting conaideration of systemic risks, and, after 1994,
prohibits outright any financial assistance by the FDIC to
an insured bank that would have the effect of preventing
loss to uninsured depositors or creditors. The Gonzales
bill also contains a provision intended to limit Federal
Reserve discount window lending to undercapitalized
institutions, where lending to such institutions is not just
for very short-term liquidity purposes. The Federal Reserve
is sympathetic to concerns about failing bank use of the
discount window to fund the flight of uninsured creditors,
potentially raising the cost of resolution to the FDIC. The
Federal Reserve would prefer not to lend to insolvent
institutions unless the failure to do so might have systemic
implications. However, we are concerned that the Gonzales
bill would seriously handicap the Board's ability to ensure
the stability of the banking system and might prematurely
close off liquidity support to viable institutions.
The Treasury bill calls for an exception to the
least costly resolution of failed banks when the Treasury
and the Federal Reserve Board, on a case-by-case basis,
jointly determine that there would be bona fide systemic
risk. No one — including the Federal Reserve Board — is
comfortable with the exception procedures for addressing
systemic risk, even though the Treasury proposal would
tighten up the way such cases are handled. While, in-13-
principle, systemic risk could develop if a number of
smaller or regional banks were to fail, systemic risks are
more likely to derive from the failure of one or more large
institutions. Thus, the need to handle systemic risk has
come to be associated with the too-big-to-fail doctrine.
The disproportionate degree of systemic risk at larger banks
highlights the tension between one of the main purposes of
deposit insurance — protecting smaller-balance depositors
-- and the concern that the rapid withdrawals by uninsured
depositors and other short-term creditors from larger banks
perceived to be in a weakened condition could cause and
spread significant disruptions that could, in turn, affect
credit availability and macroeconomic stability. Whatever
its macro benefits might be, too-big-to-fail has
increasingly offended observers and policymakers alike
because of its inequitable treatment of depositors, other
short-term creditors, and borrowers at banks of different
sizes, and its tendency both to broaden the safety net and
to undermine depositor and creditor discipline on bank risk-taking.
Despite the substantial concerns, the Board, like
the Treasury, has reluctantly concluded that there may be
circumstances in which all of the depositors and short-term
creditors of failing institutions will have to be protected
in the interests of macroeconomic stability. In evaluating
our conclusion, it is important to underline that we
anticipate that there will also be circumstances in which
large banks can fail with losses to uninsured depositors and
creditors but without undue disruption to financial markets.

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{ 31 comments }

Invisible Backhand November 19, 2011 at 8:12 pm

Remember your challenge from about two weeks ago? Whatever happened to that?

Matt November 19, 2011 at 8:51 pm

Your ability to constantly troll amazes me.

Jon Murphy November 19, 2011 at 8:54 pm

He’s so cute when he thinks he’s people.

Invisible Backhand November 19, 2011 at 9:34 pm

“So my challenge to Paul Krugman and Brad DeLong and Matt Yglesias and Daniel Kuehn and others who didn’t like my claims about ideology and truth-seeking is this: what evidence could you imagine that would dissuade you from supporting massive government spending?”

http://cafehayek.com/2011/10/my-challenge-to-paul-krugman.html

Funny enough, he engaged a few people, including Daniel, then just stopped answering. C’est le Russ.

Andrew_M_Garland November 19, 2011 at 11:14 pm

Yes, that is a link to Boudreaux’s question.

It seems that you have been tracking this issue. Would you have the link to Krugman’s reply or the other replies?

Jon Murphy November 19, 2011 at 11:17 pm

Actually, I was just reading an article about this. The human brain is wired so that once we form an opinion, it is extremely difficult to change that opinion. It would require some life-changing massive fact for the brain to change it’s opinion.

So, from the scientific POV, I’d say the answer to the question is “No.”

Invisible Backhand November 19, 2011 at 11:21 pm

Russ, not Don.

No I don’t have a link to anything, AFAIK the issue died. It might have been carried on via email perhaps, but I’ve never heard. Krugman is out of Russ’s weight class. He had a chance at Krugman (see K’s “I am not your mirror image” post) but he blew it. The champ can’t fight every drunk in every bar because there are thousands of drunks and only one champ.

Jon Murphy November 19, 2011 at 11:29 pm

Um…isn’t “concerned” spelled with a “C” not a “K”?

Andrew_M_Garland November 20, 2011 at 12:41 pm

To Invisible Backhand,

You wrote “he [Russ] engaged a few people”. If they didn’t respond, what did that mean, and what did “he [Russ] just stopped answering” mean?

You proposed that Russ issued a public question, then he refused to engage in the debate. That seems not to be true.

Jon Murphy November 19, 2011 at 8:38 pm

Can we really say any central banker is a free-market ideologue?

Invisible Backhand November 19, 2011 at 8:50 pm

True story: After I asked Russ about the challenge, I immediately went to google news to see if Greenspan had had a stroke or something, because Russ’s post seems like such a transparent attempt to make Greenspan an unperson.

For anyone wondering about Greenspan’s free market bona fides, look him up on wikipedia. Their editing process makes sure BS doesn’t last long about any controversial public figure, like Greenspan.

Globalization: Where money flows from the poor in rich countries to the rich in poor countries and the poor in poor countries to the rich in rich countries.

Matt November 19, 2011 at 8:53 pm

Amazed once again. You never dissapoint.

Shared Prosperity November 19, 2011 at 10:23 pm

I think you should go ask China’s middle class how they feel about it. Or India’s rapid rise in GDP/capita and standard of living.

If you want equal misery and equal advancement for all, then you just need to come out and say it instead of hiding behind a false sense of self-righteousness. If you want people to not have things until those things can be manufactured entirely in the United States, I want you to admit it. Because we’ve had that before. It’s called poverty.

Invisible Backhand November 19, 2011 at 10:42 pm

I think you should go ask China’s middle class how they feel about it. Or India’s rapid rise in GDP/capita and standard of living.

I bet a lot of people in India and China think a guided economy has worked very well for them. I think we should try that in the USA instead of the current neoliberal ‘washington consensus’ shock doctrine.

Jon Murphy November 19, 2011 at 10:51 pm

The problem with a directed government is you cannot grow at 8% into perpetuity. For nominal growth targets (like China has), it is extremely expensive to maintain and, if it should fall below the states level, you risk unrest. Likewise, you get self-determined bubbles (like China’s real estate bubble or their inflation).

Also, look when China has grown. Pre-1970′s, they had a very centrally planned economy (a smelter in every yard, as Mao said). China was the poorest country in the world and millions died from hunger. When China took steps towards liberalizing trade, allowed (some) private property and backed off (somewhat) from the planning processes of companies, the country really began to grow and millions moved out of poverty and into the middle class. The issue now is China is attempting to keep that growth rate by artificially creating products just to meet their GDP target (part of the reason we see so many ghost cities).

Darren November 21, 2011 at 12:25 pm

Central planning can work fairly well when you are a poor country and have the examples of other more developed nations to learn from when deciding what to do and what not to do. China has the advantage now of being able to bypass many of the errors other economies have already muddled through (having to figure out things from scratch). There will come a point when China’s development catches up. At this point, China will have shift modes from ‘development’, where it can be pretty obvious what the ‘big’ things are that need to be done, to ‘maintenance’ of what they have, where it will be much more problematic what central planners can really accomplish compared to the private sector. They’ve been doing pretty good so far in shifting toward a more free market economy (compared to what they had), again learning by what works in other economies. It will certainly be interesting to see how things develop.

Jon Murphy November 19, 2011 at 10:33 pm

It’s amazing to me how people can look at the world we live in now compared to the one we lived in in, say, the 70′s and claim the poor countries are poorer and the rich countries are richer. Especially when you look at China and India.

Invisible Backhand November 19, 2011 at 11:26 pm

The ideological rationale for this system is unequivocal. We recall the words of Hayek in Chapter 3: ‘A free society needs morality that is ultimately reduced to the maintenance of life – not the maintenance of all life, as it could be necessary to sacrifice individual life in order to save a greater number of other lives. That is why the only rules of morality are those leading to a “calculation of life”: property and contract.’

In other words: only those who own private property and/or are capable of contract (for example, workers) have a right to life in a pure market economy. Private property and contract are the two mainstays of the market. Very few people own private property as a means of production and more and more people are being deprived of the opportunity to contract their labour in order to make a living, given the increasing role of technology. Moreover, in a neo-liberal system the state is unable to subject property to a policy of social concern in the interests of losers. For all these reasons, the system as such means more suffering, exclusion and death for more people.

Property for People, Duchrow

Psst Jon – you really need to watch a movie called ‘Good Will Hunting’

Jon Murphy November 19, 2011 at 11:30 pm

I have seen Good Will Hunting. Good movie.

Shared Prosperity November 19, 2011 at 11:39 pm

Please tell me where you find this additional suffering, death, and exclusion. China and India haven’t benefited from additional central planning of their economies; they have clearly benefited from liberalization. Hopefully the economic liberalization will eventually lead to full political liberation. They go hand in hand, as history as clearly shown time and time again.

Everyone has private property (individual body/labor) and should have the ability to contract. You also assume that the state has the interest of “losers” and that it is able to help them. Previous policy outcomes suggest that despite all claims of righteous objectives, those objectives have failed the poor. The most depressing and sad of these are public education and regulation/enforcement surrounding the consumption of xenobiotics.

The most shocking thing about working in Congress was understanding how almost no outcomes were tracked and policies were assumed to operate almost exactly as intended. With the slow feedback mechanisms (voting) as compared to the market, politicians have little incentive to actually improve outcomes. This allows them to claim they are helping the poor all the while not having to show that they have done a single thing to actually help the cohort. It is despicable.

Invisible Backhand November 19, 2011 at 11:59 pm

I have seen Good Will Hunting. Good movie.

You’re the guy that believes whatever his last textbook said.

Andrew_M_Garland November 19, 2011 at 11:23 pm

Greenspan says: “Despite the substantial concerns, the Board, like
the Treasury, has reluctantly concluded . . . will have to be protected
in the interests of macroeconomic stability.”

After much bloviating in erudite terms, Greenspan eventually says that he and his buddies retain the right to bail out whomever they wish.

It doesn’t matter what Wikipedia says, that is not a free-market position. Fed interference has not produced macro-economic stability. It is exactly the power of the government to bail out its friends which reduces market discipline and dereases stability.

Chucklehead November 19, 2011 at 9:27 pm

The General Consul of LTCM, who negotiated the rescue, lost his shirt in the process. Incensed he was not on the risk management committee to prevent this, he spent the subsequent years studying risk management. The result was a new vision in systemic risk which he has been lecturing on at SAIS and Kellog, which oddly enough led to national security work. His new book “Currency Wars” was just released and is now #1 in International Economics at Amazon, & #5 in Business on WSJ books. It is a compelling read, and would make for a great Econtalk episode. Just a thought.

Invisible Backhand November 19, 2011 at 10:01 pm

Wow, 14 reviews at amazon, all 5 star.

This one looks good too:

Synopsis
According to the book, the western countries in general and the US in particular are controlled by a clique of international bankers, which use currency manipulation (hence the title) to gain wealth by first loaning money in USD to developing nations and then shorting their currency. The Japanese Lost decade, the 1997 Asian Financial Crisis, the Latin American financial crisis and others are attributed to this cause. It also claims that the Rothschild Family has the wealth of 5 trillion dollars whereas Bill Gates only has 40 billion dollars.

Mr Song also makes the sensational claim that the famous U.S. central bank – the Federal Reserve, is not a department of state functions, but several private banks operated by the private sector, and that theses private banks are loyal to the ubiquitous Rothschild family.

On June 4, 1963 President Kennedy signed a virtually unknown Presidential decree, which, as an amendment to Executive Order 10289, delegated the authority to issue silver certificates (notes convertible to silver on demand) to the Secretary of the Treasury. The direct consequence was that the Federal Reserve lost its monopoly to control money.

The book looks back at history and argues that fiat currency itself is a conspiracy; it sees in the abolishing of representative currency and the installment of fiat currency a struggle between the “banking clique” and the governments of the western nations, ending in the victory of the former. It advises the Chinese government to keep a vigilant eye on China’s currency and instate a representative currency. The book, published in 2007, also correctly described and warned of the various forms of derivative speculation used by Wall Street which eventually became the causes of massive margin call sell offs and stock market crash in late 2008.

Reception

The book has achieved bestseller status in China. The Financial Times described the book’s thesis are far-fetched, and described it as only passably entertaining, though they acknowledged the book’s huge popularity in China.

http://en.wikipedia.org/wiki/Currency_Wars

kyle8 November 19, 2011 at 10:11 pm

Oh noes! the Rothschildes! Dem sum big jooos! I’ll bet the Bilderburgers and trilateralists are behind it too!

Jon Murphy November 19, 2011 at 10:23 pm

You know, you could try forming your own opinions on things rather than relying on what other people tell you. I know it’s scary to think for yourself, but it will be rewarding.

Invisible Backhand November 19, 2011 at 10:46 pm

You said you were ignoring me.

Chucklehead November 19, 2011 at 10:28 pm

Wrong book. It’s the new one
Currency Wars: The Making of the Next Global Crisis (Portfolio) [Hardcover]
James Rickards
http://www.amazon.com/Currency-Wars-Making-Global-Portfolio/dp/1591844495/ref=cm_cr_pr_product_top

Invisible Backhand November 19, 2011 at 10:47 pm

I know, I found the other by accident because it had the same name. But it does look good.

Nikolai Luzhin, Eastern Promises November 20, 2011 at 9:08 am

mindlessness

reading all the mindless drivel above, the blah blah blah is just such bs

when the Fed lends to assure liquidity (which requires collateral) it doesn’t know the future (whether a bank wil fail or not, or why or how)

this simple concept is beyond the ability of anyone here to understand.

you will note that in 1990, no one was willing to reduce the size of banks to assure none continued to be TBTF

kyle8 November 20, 2011 at 1:59 pm

Well if we are all mindless, then what does that make you? Why waste your time with us Neanderthals? Glutton for punishment?

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