Wednesday, February 18, 2009

Greenspan II (from Dollars and Sense magazine)

Greenspan (!): Nationalize the Banks
by Dollars and Sense

We weren't so surprised when Noriel Roubini called for (temporary) bank nationalization in a Washington Post op-ed co-authored with Matthew Richardson this past Sunday. But now this bombshell from the Financial Times, via Naked Capitalism, with Yves Smith's excellent-as-usual commentary:

Greenspan Predicts TARP Will Prove Insufficient, Supports Bank Nationalization

Before readers start throwing brickbats at the mention of the name of Alan Greenspan, it's important to remember that he has become the poster boy of the policy errors that lead to our financial mess. And that isn't an accurate picture. This crisis had many parents, and even though Greenspan was one of the key actors, he was far from alone. Treasury Secretaries Robert Rubin and Larry Summers were also backers of the financialization of the economy, the permissive regulatory posture, and the strong dollar policy.

Greenspan, to his credit, at least appears chastened by the mess helped create. As far as I can tell, very few of the other perps have questioned their decisions.

Greenspan spoke this evening at the Economic Club of New York. Some of his comments show that he has made some considerable shifts from his libertarian, anti-regulation stance. But he hasn't had a Damascene moment; he seems to be changing his views incrementally.

Nevertheless, it's remarkable that Greenspan has come out saying that nationalizing banks is the "least bad" policy option, as he did in a Financial Times interview. Now we are seeing role reversal: the loyal libertarian reluctantly admitting the need for regulation and the advantages of taking over dud banks, even big dud banks, while the Democrats tip toe around the idea of doing anything that might ruffle bankers feathers too much.

Note that he stresses, as we have, the need to clean up the financial system for fiscal stimulus to be effective (as in kick the economy into a higher gear, rather than provide a temporary amphetamine hit that quickly wears off). He also sounded a warning similar to Willem Buiter's, that the US is fiscally constrained and cannot run deficits as large as we might otherwise like without incurring serious sdverse consequences. Buiter has warned of the danger of a collapse in dollar assets. Greenspan seems more concerned about immediate effects, namely, rising long term bond rates (the Fed in theory can suppress a rate rise by buying long-dated Treasuries, but I suspect in practice this policy would lead to private investors and other central banks abandoning the long end of the yield curve, knowing the Fed could not continue this strategy on an unlimited basis, and the Fed having qualms about ballooning its balance sheet to grotesque size. Even at this level, the Fed seems cautious about further balance sheet growth, even though some have argued the Fed would need to expand its balance sheet far more aggressively to combat deleveraging).

From the Financial Times:
The US administration will have to go back to Congress for additional funds to recapitalise the banking system to restore the normal flow of credit in the economy, Alan Greenspan, former chairman of the Federal Reserve, said yesterday....

Mr Greenspan warned that, without a proper banking sector fix, the $787bn fiscal stimulus would provide only short-term relief.

"Given the Japanese experience of the 1990s, we need to assure that the repair of our financial system precedes the onset of major fiscal stimulus," he said. "Unless we are successful at that, in my judgment, the positive impact of a fiscal stimulus will peter out after its scheduled completion."

Mr Greenspan said foreign investor appetite for US government debt was not unlimited. "There is obviously a limit to the expansion of US federal debt," he said. He said the recent rise in long-term interest rates "may be signalling market concerns".

The former Fed chairman—a champion of laisser-faire principles—said he now acknowledged there was "no alternative to a set of heightened federal regulatory rules for banks and other financial institutions".

However, he suggested that rather than rely heavily on regulators to prevent the next crisis, the authorities should simply increase the amount of capital banks were required to hold against risks of all kinds...

But at a time when the US Congress is racing to begin legislation on a new regulatory framework for the financial system, Mr Greenspan urged less haste, saying the market was currently imposing strict discipline.

As for the idea of increasing capital levels, it's a poor second best to rethinking what the financial system ought to look like. And it is truly sobering how little serious thought has been done on that front.

As for Greenspan depicting Congress champing at the bit to reform the industry, that couldn't be further from the truth. Enacting strict limits on pay to TARP recipients is a far cry from meaningful regulatory reform.

From the Financial Times interview:

In an interview with the FT Mr Greenspan, who for decades was regarded as the high priest of laissez-faire capitalism, said nationalisation could be the least bad option left for policymakers.

"It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring," he said. “I understand that once in a hundred years this is what you do."...

The former Fed chairman said temporary government ownership would "allow the government to transfer toxic assets to a bad bank without the problem of how to price them."

However, he wimped out on cramming down bondholders (note Martin Wolf and Nouriel Roubini, among others, have advocated that step, although Wolf did warn that it would need to be done with ample preparation for temporary disruption):

"You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks," he said. “This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt."

Greenspan is a consultant to Pimco, and Pimco has consistently bet that the Feds would be nice to banks (I am told by someone in a position to know that they own a lot of junior bank debt). So this statement may be de facto an admission by Greenspan that he sees nationalization as inevitable and is trying to shape what form it takes.

No comments: