Greenspan: The Costs of Government Activism

When Alan Greenspan was nearing the end of his time as Chairman of the Federal Reserve System, there was a celebration of his career at the Fed meeting held annually at Jackson Hole, Wyoming. At this meeting he was ordained, for all intents and purposes, as the greatest central bank ever. He must have been on top of the world.

However, since the housing market crash and subsequent deep recession, an event that can be linked to regulatory failures under his watch and to other policies he supported, his reputation has taken a big hit. In response, Greenspan has been doing everything he can to restore his reputation, including writing a book, writing op-eds, and giving interviews laying out his case.

Greenspan would not agree with the charge above that failure to regulate banks adequately caused the crisis. In fact, he argues just the opposite -- that government activism was responsible for the crisis. His latest defense of his anti-regulatory stance continues this argument, and in a new article he blames the severity of the economic recession on "regulatory and financial environments faced by businesses since the collapse of Lehman Brothers, deriving from the surge in government activism." This activism, in his view, is "crippling our chances of a full long-term recovery":

The costs of government activism, EurekAlert: In an article to be published in the forthcoming issue of International Finance, Dr. Alan Greenspan, former chairman of the Federal Reserve, issues a major analysis of the U.S. government's economic recovery and reform efforts since the collapse of Lehman Brothers in September 2008. ...

Applying a range of analytical and historical lenses, and data-sifting techniques, Greenspan concludes that the primary cause of the malaise is the exceptional level of government activism during the past two years. "Although the actions the government took in the immediate aftermath of the Lehman Brothers shutdown were necessary and appropriate responses to the crisis," he writes, "these actions are not necessary any longer, and could in fact be crippling our chances of a full long-term recovery."

Greenspan argues that the real problems with government activism began with the stimulus package of early 2009 and the failure to phase out the "temporary" actions taken during the last quarter of 2008. He argues that this fostered a degree of risk aversion to investment in illiquid fixed capital, on the part of both corporations and individuals, that was most evident in our longest-lived assets – real estate, both nonresidential and residential. "Without the abnormal weakness in long-lived assets," he writes, "the current unemployment rate would be well below 9%."

Here's the abstract from his article:

The US recovery from the 2008 financial and economic crisis has been disappointingly tepid. What is most notable in sifting through the variables that might conceivably account for the lacklustre rebound in GDP growth and the persistence of high unemployment is the unusually low level of corporate illiquid long-term fixed asset investment. As a share of corporate liquid cash flow, it is at its lowest level since 1940. This contrasts starkly with the robust recovery in the markets for liquid corporate securities. What, then, accounts for this exceptionally elevated level of illiquidity aversion? I break down the broad potential sources, and analyse them with standard regression techniques. I infer that a minimum of half and possibly as much as three-fourths of the effect can be explained by the shock of vastly greater uncertainties embedded in the competitive, regulatory and financial environments faced by businesses since the collapse of Lehman Brothers, deriving from the surge in government activism. This explanation is buttressed by comparison with similar conundrums experienced during the 1930s. I conclude that the current government activism is hampering what should be a broad-based robust economic recovery, driven in significant part by the positive wealth effect of a buoyant U.S. and global stock market.

He also warns that new regulation will destabilize financial markets:

The degree of complexity and interconnectedness of the global 21st century financial system, even in its current partially disabled form, is doubtless far greater than the implied model of financial cause and effect suggested by the current wave of re-regulation. There will, as a consequence, be many unforeseen market disruptions engendered by the new rules.

I hope it's clear by now that I do not support Greenspan's view of regulation. I think the failure to bring the shadow banking system under the regulatory umbrella that covered traditional banks -- something Greenspan opposed vigorously -- was a big mistake. Thus, the non-activism he supported was a big part of the problem. And, contrary to Greenspan who thinks recent regulation has gone too far, in my view it does not go far enough.