Regulators Failed During The Financial Crisis Due To Complacency; Alan Greenspan (JPM)

Bloomberg reports that Alan Greenspan, former chairman of the Federal Reserve, said the central bank and regulators in the U.S. “failed” during the financial crisis. Greenspan believes that complacency about risks was the main reason for the failure of the central bank and regulators.

In a speech at a conference in Washington, Greenspan said, “Even with the breakdown of private risk-management, the financial system would have held together had the second bulwark against crisis -- our regulatory system -- functioned effectively. But, under crisis pressure, it too failed.” Greenspan, who was the Fed chairman from 1987 to 2006, made the same comments in a paper released on Thursday. He said, “Even though for years our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still were able to take on toxic assets that brought them to their knees.”

Greenspan defended himself by saying that the Fed could not gauge the extent of the housing bubble and its effect on the economy. He also said that the era of low interest rates during the time he was chairman of the Fed could not be blamed for the creation of the housing bubble. He believes that future crises can be averted if increased capital and liquidity requirements are placed on banks. He said, “In the growing state of euphoria, managers at financial institutions, the Federal Reserve, and other regulators failed to fully comprehend the underlying size, length, and impact of the negative tail of the distribution of risk outcomes that was about to be revealed as the post-Lehman crisis played out. That led to significantly and chronically undercapitalized financial intermediaries, and was arguably the major failure of the private risk management system.”

Greenspan believes that Lehman Brothers (OTC: LEHMQ) and Bear Sterns, two of the five biggest Wall Street firms prior to their collapse, could have survived the crisis if they had adequate capital. Bear Sterns was taken over by JP Morgan Chase & Co. (NYSE: JPM) in March 2008, while Lehman Brothers filed for bankruptcy in September 2008.

Greenspan defended his monetary policy during most of his speech saying it is difficult to deflate an asset bubble without affecting the economy. “Regulators cannot successfully use the bully pulpit to manage asset prices, and they cannot calibrate regulation and supervision in response to movements in asset prices,” he said, adding that it was difficult to completely eliminate the possibility of any future crisis.