Greenspan: Crisis Prompted Re-examination of Economic Beliefs

Wednesday, 23 Oct 2013 10:03 AM

By Michael Kling

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The 2008 financial crisis caused former Federal Reserve Chairman Alan Greenspan to question his long-held beliefs about economics, the former chairman told CNBC.

"I said to myself when I saw what happened on Sept. 15 [2008] that there's something fundamentally wrong with the way I and a lot of my colleagues look at the economy," Greenspan told CNBC, referring to the date Lehman Brothers collapsed and sparked the financial crisis.

According to traditional economic beliefs that he subscribes to, markets will act rationally and in their long-term interests, despite some short-term irrationality. But Greenspan said he was "shocked, surprised and delighted" when he realized the importance of fear and euphoria.

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Some experts have stressed the importance of behavioral economics, or how fear and greed drive markets. But Greenspan said behavioral economics cannot provide a model.

When it comes to emotions, fear is far more important than euphoria or greed are, said Greenspan, who analyzes recent economic history in his new book "The Map and the Territory."

"You can see this by the way business cycles function," he told CNBC. "They go up. Bubbles go up slowly and then go bang. It happens all the time."

A collapse in stock prices doesn't necessarily cause a financial crisis or a recession, he pointed out. The Dow dropped 22 percent in a single day, Oct. 19, 1987, the most ever in one day, yet the economy avoided a recession.

And the implosion of dot-com stocks barely hit GDP. Bubbles combined with excessive leverage cause financial meltdowns, he said.

"I thought we were going to run into all sorts of problems. Nothing happened. Now to be sure it was touch and go for a while. The Fed opened up to spigots," he told CNBC, referring to the 1987 crash.

"All of us knew there was a bubble. But a bubble in and of itself doesn't give you a crisis," he explained. "It's turning out to be bubbles with leverage."

Although lauded during his tenure as Fed chairman, Greenspan has been criticized for failing to halt the subprime mortgage bubble or predict the financial crisis and for promoting deregulation, which many believed led to the crisis.

If you are looking for him to accept any responsibility for the crisis, you'll be sorely disappointed, said Washington Post columnist Steven Pearlstein in a review of the book.

The book is supposed to include Greenspan's self-examination of his role in the financial crisis, a re-examination of his economic beliefs and an explanation of why markets failed.

"What we find, however," Pearlstein wrote, "is that Greenspan’s journey of discovery brings him right back to where he began — to an unshakable faith in free markets, an antipathy toward market regulation and a conviction that progressive taxes and social spending are to blame for slow growth, stagnant wages and exploding deficits."

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