There's a lot of hubbub about a paper former Fed Chairman Alan Greenspan is presenting today. In it, he (once again) comes to his own defense and says the Fed's low-interest rate policies had very little to do with the housing bubble and that the financial crisis was inevitable. No need to rehash that, but he's right about one thing.
At the end of Greenspan's 48-page paper, "The Crisis" he writes (emphasis mine):
The major failure of both private risk management and official regulation was to significantly misjudge the size of tail risks that were exposed in the aftermath of the Lehman default. Had capital and liquidity provisions to absorb losses been significantly higher going into the crisis, contagious defaults surely would have been far less.
This paper argues accordingly that the primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades.
In other words, Greenspan is arguing that banks should be required to maintain a capital reserve cushion that can absorb unexpected blows. And trades should be backed with actual collateral -- a novel concept that might have prevented AIG from being torn apart.
But in testimony last month, current Fed Chairman Ben Bernanke suggested the Fed might eliminate reserve requirements.
The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.
If there were no minimum reserve requirements, what kind of chaos would that lead to in our financial system? Not that we are operating with sound money now, but is the solution to have no restrictions at all? Of course not.
What in the world is Bernanke thinking?
The truth is that Bernanke is making a mess of the U.S. financial system.
There was a time when Greenspan was like EF Hutton. People stopped and listened. He's pretty much lost that status by constant revising his theories to deflect criticism. But that doesn't mean he's always wrong.
Greenspan also thinks a "systemic regulator" is a bad idea, and there again, many people agree that such a regulator will find it difficult to prevent a future crisis. Greenspan says -- "The current sad state of economic forecasting should give governments pause on the issue."
It's hard to argue with that.