Former Federal Reserve Chairman Alan Greenspan, whose legacy has been tarnished by the global financial crisis, on Thursday laid out a scholarly defense of why Fed policy did not fuel the housing bubble.
Greenspan did offer somewhat of a mea culpa, though, noting that the regulatory system failed by not demanding financial firms hold much larger capital buffers.
Greenspan, who led the U.S. central bank from 1987 to 2006, has been criticized by some analysts who argue he kept short-term, benchmark interest rates too low for too long in the early 2000s.
The former Fed chief defended the central bank's actions, saying that the seeds of the housing boom were sown by geopolitical events that were out of the Fed's control, an argument he has presented a number of times in the past.
The fall of the Soviet Union led to hundreds of millions of workers entering the global marketplace, he said in a paper to be presented to a Brookings Institution conference.
This new market-based workforce, Greenspan said, helped push up growth in the developing world. This in turn fueled a global savings glut that drove down long-term interest rates, leading to an "unsustainable boom" in house prices, he said.
That housing boom, Greenspan stressed, was not a phenomenon in the United States alone with 20 other countries also witnessing huge run-ups in home values.
While he acknowledged that markets and regulators misread the risk embedded in the complex financial products that triggered the crisis, he said no regulator can be expected to consistently forecast if a specific product will turn toxic.
A better approach, he said, would be higher capital buffers.
"Capital and liquidity, in my experience, address almost all of the financial regulatory structure short-comings exposed by the onset of crisis," Greenspan said.
"Adequate capital eliminates the need for an unachievable specificity in regulatory fine-tuning."
Greenspan also endorsed the idea of contingent capital, or debt that converts to equity in times of distress. He said this could reverse moral hazard, the expectation of bankers and traders that the government will bail them out if their bets go awry.
Lawmakers are currently working on the most sweeping overhaul of bank and capital market oversight since the 1930s. The reform will likely involve the Fed being tasked with regulating large, interconnected firms whose failure would pose a risk to the entire financial system.
Greenspan, who was known for his light-touch approach to regulation during his tenure as Fed chairman, said that the idea that a systemic risk regulator can spot risks in a timely manner is likely untenable.
"The notion of an effective systemic regulator as part of the regulatory reform package is ill-advised," Greenspan said.
"Forecasters as a group will almost certainly miss the onset of the next financial crisis, as they have so often in the past and I presume any newly designated systemic risk regulator will also."
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