Greenspan says Mea Culpa, but Paulson pleads Not Guilty

The former chairman of the Federal Reserve Board Allan Greenspan was once considered an “infallible maestro”, according to the NYT in its report dated October 23, 2008. To his credit, during a hearing before members of the House Committee of Government Oversight and Reform, he admitted that he “made a mistake” in believing that free markets could run safely without government oversight.

Initially, in his prepared statement Allan Greenspan admitted that he was only partially wrong in not regulating the market for credit default swaps, whose excesses contributed to the current financial crisis.

But in follow-up questions at the meeting chaired by Representative Henry Waxman, Greenspan conceded a more serious flaw in his long held belief in the superiority of an economic system based on 100 percent free markets.

“I made a mistake in presuming that the self-interests of organizations, specifically banks and others were such as that they were best capable of protecting their own shareholders and their equity in the firms,” Mr. Greenspan said.

Referring to his free-market ideology, Alan Greenspan added: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”

Congressman Waxman pressed the former Fed chair to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working.”

“Absolutely, precisely,” was Greenspan’s response. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

In contrast, Treasury Secretary Henry Paulson Jr. denies being in any way responsible for the financial crisis. In an interview with the NYT he refutes what many executives on Wall Street and officials in European financial capitals believe, that Mr. Paulson and Mr. Bernanke, by allowing Lehman Brothers to fail, exposed the banking system to shock waves, “turning a financial tremor into a tsunami”.

“We didn’t have the powers,” Mr. Paulson insists. By law, he says, the Federal Reserve could bail out Lehman with a loan only if the bank had enough good assets to serve as collateral, which it did not.

Bankers involved in negotiations with Secretary Paulson say they do not recall Mr. Paulson talking about Lehman’s impaired collateral. According to them, potential buyers walked away from Lehman Brothers because they could not get the same kind of government backing that facilitated the Bear Stearns deal.

The day after Lehman collapsed, the Fed rescued A.I.G. with an emergency $85 billion loan, but the credit markets around the world began freezing up anyway. It was at this point that Henry PaulsonHenry Paulson decided to find a systemic solution and to stop the piecemeal approach. He and the Federal Reserve chairman, Ben Bernanke decided to go to Congress and request a $700 bailout.

History will be the final judge of the current financial crisis. The administration's rescue efforts have been called chaotic. “Questions have been raised about the government’s — and Mr. Paulson’s — decisions.” Apart from the Lehman Brothers debacle, Paulson and Bernanke have been criticized for their original $700 billion bailout plan, based on the government’s purchase of toxic mortgage-backed securities from banks and others.

As may be seen from previous reports on this website, (Financial Crisis threatens to become the Perfect Storm; Global Economy Withers as Bush Administration Dithers), even after Congress passed the bill on Oct. 3, financial and stock markets remained in turmoil. Only after Britain and other European countries injected capital directly into the banks, and the United States followed suit, was some confidence restored.

The worst of the turmoil might have been avoided, say critics, if Henry Paulson had not stuck to his original "unworkable" bailout plan.

On his part Henry Paulson is worried that some of the government’s moves could spell trouble in future, particularly the decision to guarantee all bank deposits and interbank loans, something the United States did in response to similar decisions in Europe. Otherwise, says Paulson, “Our banks would not have been able to compete.”