Alan Greenspan's Latest Epiphany

Mr. Big Stuff himself, as he used to be called on CNBC during his heyday, has spoken once again. But this time, Alan Greenspan has uttered an inconvenient truth. So, will Washington and Wall Street listen?

The former Federal Reserve chairman's statement Thursday before the Council of Foreign Relations in New York about today's megabanks—"if they’re too big to fail, they’re too big"—is so self-evident a fifth-grader would get it. But the adults who are formulating economic policy at the Treasury Department and on Capitol Hill have treated that simple statement as heresy. There has been no serious move on either side of Pennsylvania Avenue to address the increased concentration of the banking sector that has been the consequence of the Wall Street bailout actions of the past year.

Neither has there been much of a ripple in the financial press over Greenspan's comments. (CNBC, which used to slavishly pore over every Greenspan utterance for hours on end when he was Fed chairman, did not mention the Greenspan speech on its website.) They were reported by Bloomberg News [1]:

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

... The former Fed chairman said while “just really arbitrarily breaking down organizations into various different sizes” goes against his philosophical leanings, something must be done to solve the too-big-to-fail issue.

“If you don’t neutralize that, you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said.

“Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”

The earnings reports from the financial sector that have come out this week help underscore how the too-big-to-fail problem has been worsened by the policy decisions that have been made by both the Bush and Obama administrations. As the Christian Science Monitor noted this week [2] in reporting on JPMorgan Chase's blockbuster third-quarter earnings of $3.6 billion:

Before the financial crisis, in May 2007, these firms accounted for about 55 percent of the market value of financial firms within the S&P 500. Smaller banks and insurance firms accounted for the other 45 percent, according to numbers crunched earlier this year by Bespoke Investment Group.

Today, those 18 firms account for nearly two-thirds of the financial-sector market value in the index, according to numbers from S&P and the Yahoo! Finance website.

The Washington Post reported in August: [3]

J.P. Morgan Chase, an amalgam of some of Wall Street's most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show.

You may recall that this is not Greenspan's first come-to-Jesus moment. It was about a year ago when Greenspan, testifying before the House Committee on Oversight and Government Reform, admitted that he got the whole unbridled-capitalism-is-always-good thing wrong. "Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief," he said. Back then, our Robert Borosage wrote [4]:

Greenspan spurned the Republican acolytes trying desperately to defend the faith and blame the crisis on the Community Reinvestment Act and the powerful lobby of poor people who forced powerless banks to do reckless things. Greenspan dismissed that goofiness in response to a question from one of its right-wing purveyors, Rep. Todd Platts, R-Pa., noting that subprime loans grew to a crisis only as the unregulated shadow financial system securitized mortgages, marketed them across the world, and pressured brokers to lower standards to generate a larger supply to meet the demand. Private greed, not public good, caused this catastrophe.

But to look at what came out of the House Financial Reform Committee Thursday is to question whether anyone seriously considered Greenspan's change of heart. That committee approved legislation that exempts virtually every bank in the country from policing by a new Consumer Financial Protection Agency. While the argument is that the agency would still have the authority to oversee about 150 of the nation's largest banks, the fact that the remaining 8,000 can escape the scrutiny of an agency charged with safeguarding consumer interests is another jaw-dropping example of the extent to which the banking industry, and not the people, "own" Congress. That 8,000, by the way, includes banks that have assets of as much as $10 billion.

Further, that same legislation creates regulations for derivatives—the shadowy financial transactions that set the stage for the Wall Street financial collapse—that are so full of holes that even Gary G. Gensler, chairman of the Commodity Futures Trading Commission, told The New York Times [5] that he hoped a second congressional committee would rework the legislation to make it stronger.

The anonymous creator of iStockAnalyst, a stock tip site, captured the import [6] of Greenspan's Thursday comments when he wrote on his blog, "You know we've reached code red 'Outrageous' when even 'hands off' Alan Greenspan believes the banks have become too large. As many sensible people have said, anything that is 'too big to fail' is TOO big period."

He goes on to write: "Will it change? No - but now you even have the Chief Provider of Narcotics to the financial industry for two decades worried about the Frankenstein he has helped birth."

That should give everyone pause. We should make sure it does.