Greenspan’s Sticky History

GREENSPAN SAYS HE KNEW ABOUT ABUSES IN SUBPRIME LENDING BUT FAILED TO FORSEE THEIR PARALYZING MARKET EFFECTS UNTIL LATE 2005
Thu Sept 13 2007 12:30:11 ET

Was Greenspan really as clueless as he claims he was? Let’s look at some recent history to find out…

The clues lie in an article written by a young Greenspan in 1966 for the Ayn Rand journal “The Objectivist”. ‘Gold and Economic Freedom’ gives a simple synopsis of banking practices and the need for a Gold standard. These days precious metal standards to limit lending/inflation of currencies are generally considered an antiquated concept, but back in 1966 the U.S. was still on a pseudo-Gold standard. The objectivist/libertarian nature of Greenspan’s article may raise some hackles, but, please just focus on the overall economic implications of what he says. Keep in mind that Greenspan continues to be a follower of Rand and has never repudiated his previous assertions. So here are some of the things Greenspan has to say about credit practices and interest rates…

Here Greenspan gives an interesting, simple explanation of how banks create money by loaning out more than their deposits and the importance of limiting these loans…
-”But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits…But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.”-

Greenspan describes banking ventures with low profit leading to higher interest rates…hmmm could that include the subprime mortgage market Mr. Greenspan?
-”when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves and they begin to curtail new lending, usually by charging higher interest rates.”-

this one is interesting…he’s basically describing why the Fed would have recently wanted to keep interest rates high…
-”if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher interest paying
banks in other countries. This will immediately cause a shortage of bank
reserves in the «easy money» country, inducing tighter credit standards
and a return to competitively higher interest rates again.”-

This is one of his descriptions of the economic situation during the interwar period…
-”the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable).”-
So Mr. Greenspan is this the real reason you advocated low interest rates, or did you really have no idea what was happening?

Obviously Greenspan seems to have a fair handle on the situation and a clear suspicion of reckless lending. Claiming cluelessness with this article floating around is kind of difficult to do, but maybe I’m being to hard on ol’ Al. I suppose that in his plea of stupidity he is just trying to defend himself. After all, he wasn’t really ‘in charge’ of the Federal Reserve but he gets to take the blame when things go bad. I would say the trick is in this quote from the Drudge article “Greenspan says there was little he could do.” In reality anything but low interest rates and allowance of ‘reckless’ lending at that time period would have resulted in a politically un-expedient environment. Really, I would say Greenspan had no choice but to tow the line. Does that make him a sell out, especially to his fellow Objectivist? Most definitely, but he certainly can’t claim that he didn’t have a clue.