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Saturday, June 11, 2011

Goldman Sachs' Excesses Enabled Greek Debt

He who has the gold makes the rules.  I suspect this is the operating mantra at Goldman Sachs even after the bank’s near-death experience (when Solomon Bros stock was taking a hit, Blankfein knew his bank could be next).  As it turns out, the bank was involved in enabling Greece to stealthily spend beyond its means. According to The New York Times, in 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means. Additionally, in late November, 2009— three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

Lest it be forgotten, half of Goldman Sachs’ 2009 revenues came from trades on its own books—even as the bank had become a bank holding company and thus supposedly more not less risk averse.  In general terms, my concern is that the bankers at Goldman might be overly in love with leverage and thus be blind to the risks.  Were this contagion limited to Goldman Sachs, it would be a question of whether the bank is too big to fail; that the bank has actively enabled one of the EU’s states to secretly take on more debt suggests that the systemic risk that is involved is political as well as economic.

According to The New York Times, “bankers enabled Greece and other governments to borrow beyond their means, in deals that were perfectly legal. Few rules govern how nations can borrow the money they need for expenses like the military and health care. The market for sovereign debt — the Wall Street term for loans to governments — is as unfettered as it is vast.”  This is a condition that American and European citizens have allowed to happen; the market for sovereign debt (and the enabling banks) could be better regulated. Indeed, the government of Iceland floundered economically and politically due to its holdings in valueless subprime mortgage derivative securities; its perilous fiscal condition prompted it to apply to the EU to become a state. Enlargement itself was flagged in the EU as entailing risks for the union. So Wall Street banks whose managers believe in debt and minimizing or avoiding market regulation present the world with not just economic systemic risk, but added political risk as well. That is to say, Wall Street can reach across the Atlantic, with European governments hanging in the balance. To push for banking deregulation in the U.S. can entail political risks abroad. In other words, banking regulation can be viewed as a social responsibility and a matter of good foreign policy.

Even though they had contributed to political instability in Europe, Goldman Sachs managers received near record bonuses in 2010. The payouts were more than a sufficient incentive for the economic alcoholism to carry on in abject denial.  "We're not at fault! We're just market makers." The problem here is that the alcoholic has the gold, and thus can make (or at the very least dance around) the rules.  As Richard Durbin of the U.S. Senate said in 2010 after he tried to allow bankruptcy judges to be able to modify home mortgages, the banking lobby owns Congress. The amazing point here is: the lobby could still call the shots in Congress even in the wake of the industry's sordid role in the financial crisis of 2008. This ought to be a red flag for anyone who values the republic as a form of government in the U.S.

Ultimately, it is the American people who are to blame—that's right, you and me—because too many of us are sufficiently credulous to elect and re-elect representatives who cave in to the banking lobby’s pressure.  There are too many “professional” pols seeking to perpetuate themselves; there is hardly a citizen statesman left serving as a matter of duty rather than power and vocation.  We have stood by and let the banks too big to fail get even bigger (and thus more powerful over our governments). We have not put sufficient pressure on our representatives in Congress to remove the too big to fail problem.  It is all too easy to point our fingers at the managers of Goldman Sachs, especially on the bank’s role in the Greek debt problem, but it is ultimately ourselves who are responsible for enabling the elephant in our living room.  Now that that elephant is breaking furnature in other houses, perhaps we might find the time to get our own house in order.  We continue to think and act otherwise. Crucially, this is to our own peril.  In other words, denial is not a viable survival mechanism, even if it is more comfortable.

Click to add a question or comment on the role of Goldman Sachs on the Greek indebtedness.


Louise Story, Landon Thomas, Jr., and Nelson D. Schartz, “Wall St. Helped to Mask Debt Fueling Europe’s Crisis,” The New York Times, February 13, 2010.

Stakeholder Management: Part III (Fiduciary Duty)

“A growing number of business experts advocate adjusting the conventional view of a company’s purpose—to generate wealth for its stockholders—to a more holistic view that recognizes that business doesn’t operate in a vacuum. Everything a business does affects someone somewhere—not just the stockholders—and those other someones deserve consideration from every business that affects them” (Bowie, p. 14).

Stakeholder Management: Part II (Nietzsche)

Nietzsche contends that modern ethicists seek to impose their Thou Shalt Not in order to dominate the strong out of weakness. The normative subterfuge used by these new birds of prey masks their hypertropic (exaggerated) instinct to dominate. Whereas the strong naturally dominate, the weak who feel compelled to do so must resort to subterranean means in order to beguile the strong into renouncing their native strength. Imagine, for example, a wan-looking business ethicist in a small academic office trying to dominate Donald Trump, Bill Gates, or Warren Buffet, for instance. Nietzsche wonders how in the hell the strong ever got roped into being ashamed of their strength by the sordid moralists whose instinct to dominate is somehow immune from such shame.

The full essay is at "Stakeholder Socialism."

Stakeholder Management: Part I (Profit-Seeking)

The Johnson & Johnson Credo says in part, “We believe our first responsibility is to the doctors, nurses, and patients. . . . Our final responsibility is to our stockholders. Business must make a sound profit” (Bowie, p. 18). Final here does not mean last but not least; nor does it mean first among equals. Instead, this credo, which I contend is tailored for marketing purposes, denies the residual profits feature of commercial property rights. To place a cap on profit such that the residual can go to stakeholders without the majority and minority owners’ approval is to violate property rights in favor of redistribution.

The full essay is at "Stakeholder Socialism."

Friday, June 10, 2011

Word-Games Obfuscating Scottish Secession

Following the Scottish National Party’s victory in the Scottish regional elections in Britain (typically used as synonymous with United Kingdom), the question of whether the E.U. state of Britain would or should be partitioned received a lot of press. Plenty of word-games were in the mix. “Scottish National Party” alone is problematic, as Scotland is not recognized as a nation or a nation-state, as it is in Britain. If a specific cultural identity alone is sufficient to connote national, then the word should not be used to refer to a polity being a sovereign country. Incidentally, referring to Scotland as a country is misleading, as the region is not sovereign. Even Britain, being a semi-sovereign state in the E.U., is only a country (and nation) if Virginia and California are so as well, as they are also semi-sovereign states in a union. 

The full essay is at "Is the E.U. a Federal State?"

Wednesday, June 8, 2011

Prerequisite to the Financial Crisis of 2008: Federalism Deconstructed & Deregulation

Weakening federalism in the name of preemptive deregulation played a major role in enabling the financial crisis of 2008. Specifically, Carter’s Depository Institutions Deregulation and Monetary Control Act of 1980 abolished Regulation Q (over time), which had limited thrifts’ deposit interest rates, and preempted “the many state usury laws that placed a ceiling on mortgage and credit card rates” (Madrick, p. 360). Mortgage originators could thus charge much higher rates, “making it possible to write subprime mortgages” (Ibid.). Pressing on, Wall Street got Congress to pass the Secondary Mortgage Market Enhancement Act in 1984, “that largely ended key state restrictions on the sale of mortgage-backed securities as long as the private ratings agencies gave the securities a high rating” (Ibid.). Solomon Brothers and FirstBoston, which began the private-sector collateralized mortgage-based bond arrangements (rather than simply selling those arranged by Fannie), persuaded Congress that the additional money for mortgage-originations brought in by selling CMOs would mean lower mortgage rates and that “the rating agencies were competent enough to provide a trustworthy assessment of risk” (Madrick, p. 361). Congress in turn supported securitization as a means to expand home ownership—a goal befitting a democracy.

Of course, Wall Street took its cut, so mortgage rates did not come down with the increase in funds available; instead, cuts in the federal funds rate by the Federal Reserve (under Alan Greenspan) were responsible for lower rates—including the initial teasers in the sub-prime mortgages (even as the deregulation enabled much higher rates in the outlying years). I am still not convinced, by the way, that such steep resets were necessary for the banks; I suspect that lesser increases would have reduced the number of defaults and thus foreclosure costs (averaging $44,000 per house in 2008).

Also, competence did not keep the rating agencies from taking advantage of the institutional conflict of interest in the issuer-pays system. The agencies made out quite well financially from giving the triple-A rating to the top tranche of CMOs. Wall Street had evidently oversold Congress.

More generally speaking, taking out the states’ respective firewalls on mortgage rates and on securitization meant a one-size-fits-all financial crisis could manifest across the United States as a whole. Deregulation, combined with an eclipse of the checks and balances in federalism, enabled Wall Street to profit but at huge systemic risk, which in turn was an externality to the financial houses unless any of them happened to get caught in the rip-tide (e.g. Bear Stearns, Merrill Lynch, and Lehman). Even as a patch-work of fifty state regulations is not convenient for big business, turning regulating interstate commerce into a prohibition on regulation within the United States or instituting a sole regulation throughout the Union introduces tremendous systemic risk into the entire consolidated system. In other words, if the containment devices are rendered impotent, a fire had better not break out. This is akin to forbidding quarantine such that so if a new highly contagious fatal illness gets going, an entire society can be decimated. Human beings tend to discount such a low-probability outcome in spite of its degree of severity, so we focus instead on convenience.

Knowing our innate tendency to discount systemic risk, we can counter this drawback of human nature by bringing back (admittedly inconvenient) institutional checks and balances that do not involve structural conflicts of interest (and we can disassemble such existing conflicts, such as the issuer-pays arrangement). Rather than relying exclusively on the Dodd-Frank Wall Street Reform and Consumer Protection Act, which passed Congress in 2010, state regulations ought to be reconsidered rather than relegated or dismissed. If state regulations can be resurrected as part of our fortifications even though they are not necessarily in the interest of the Wall Street financial houses, the next fire (and there will be fires) may not reach as far (or as deep) as the conflagration of 2008.


Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Alfred Knopf, 2011).

The Fiat 500: American Tastes Revealed

One means of doing cross-cultural comparison is by contrasting consumer tastes; such proclivities tend to evince societal mores by which societies can be perceived to be distinctive. In the case of the E.U. and U.S., Fiat, a European auto company that controls Chrysler, an American company, is discovering some societal differences as it refashions the Fiat 500 for American customers.

For example, the pod of drink holders had to be enlarged to hold American-size “supersize” drinks. According to Fabio DiMuro, chief engineer of the 500, the in-car beverage concept is so foreign to Europeans that the workers didn’t understand his exhortations for more and bigger holders. The American taste for larger portions is known to restaurant owners and managers in the United States, but what does the preference say about the society and its people? Is it as simple as greed—a desire for more and to excess? Or is it simply a preference for convenience—filling up more so the next meal can be pushed back to make room for other activities? 

In terms of convenience, “Americans consider all-season tires a must,” whereas Europeans keep two sets (which must be changed with the advent of the snow season). Of course, this comparison over-generalizes, for we are talking about the Northern states in the E.U. and U.S. Even so, the northerners in America tend to be willing to sacrifice some traction in the snow for the convenience of not having to take the car to the garage to have the tires changed.

Furthermore, the fuel tank of the 500 was enlarged from 10.6 to 14.5 gallons “for longer distances typical in the U.S.”  The larger tank also enables American in-town drivers to drive more before having to fill up. The interstate highway system sports enough gas stations that the longer-distances rationale is perhaps specious; it probably comes from the European misconception of the U.S. being like one of the E.U.’s countries but with a larger territory. The U.S., an empire-level union of republics, is qualitatively as well as quantitatively distinct from a large state like Texas or France.

Returning to the matter of convenience, the comfort-factor may be a relevant difference. The U.S., having excelled in terms of material goods in the decades after World War II, may in the twenty-first century be more accustomed to comfort. Hence, the American 500 is to have an armrest added to the driver’s seat.

A stress on comfort may also explain why “lots more” insulation is needed in the American 500, “to keep it quiet enough for Americans.” This is a rather odd phrase, considering the growth of the car stereo industry in the 1970s and 1980s. Nevertheless, the notion of one’s car as a personal cocoon of sorts resonates. Might this be a manifestation of the individualism for which Americans are so well known? 

If one’s home is one’s castle, one’s car might be one’s bubble through which one passes through public space. Considering the “road rage” phenomenon and general impoliteness, the greater insulation might suggest that Americans are in general rather unfriendly when we are out and about. Hence there are “screening” devices such as fraternities and sororities, as well as country clubs and other private associations. The general American public may contain too many loud, pushing or boorish people to be palatable to the elite.

In general, James Healey’s article on the American Fiat 500 is not flattering to Americans, but perhaps Healey is pointing to indications of undesirable traits that we (for I am an American) should face about ourselves and our society. I for one have noticed that where strangers communicate without any purpose, such as in a store, politeness is the norm. However, as soon as a purpose is added, such as buying and selling a car, renting an apartment or room, or resolving a bill at a restaurant, presumptuous tends to raise its ugly head.

I don’t know if it is arrogance or a presumption that the worst is apt to be in others, but I would not disagree with a European assessment of American society in general as anti-social or antagonistic. It is perhaps no wonder that houses are castles and cars are insulated bubbles. Of course, I am over-generalizing, as the U.S. is composed of various cultures. Once flying from New York to Seattle, I was struck by the difference in how strangers treated each other; then I realized (aided by a few anti-New Yorker comments from Seattle airport employees) I had just flown over a continent! To render a continent as akin to a European state writ large is to miss the vital distinction between an empire and a kingdom politically and geographically.

Another possible source of my over-generalizing may be that modern society itself could be too much inclined to the road of most convenience.  Europeans may have their rankles as well, even as they differ from those of Americans. For example, the whole “peers/commoners” thing can be read as a matter of convenience by some at the expense of others. Such a matter of convenience is not apt to show up in an analysis of the Fiat 500. In general, we moderns may be too spoiled and too presumptuous when it comes to dealing with strangers. Humility, it seems, is out of fashion in modernity, at least in the public square. If so, my cultural critique goes well beyond the American shores. Although war and poverty are not to be wished for, it would be nice if greater human solidarity could be realized amid our lattes and 500s.


James Healey, “Fiat 500: Little Car Shoulders Huge Responsibility in U.S.,” USA Today, June 1, 2011, p. 5B.

On the Myopic Hyperbole of Wall Street

I suppose that after looking at something closely for a long period of time, virtually anyone would perceive a small change in it as huge. This is reflected in how people formulate graphs. In particular, typically only a small interval is shown, the perceptual impact of which is that small changes look big. For example, msnbc.com reported on June 8, 2011 that the price of oil “soared” on that day “almost $2 to near $101 a barrel.” My reaction in reading the report was that the word “soared” indicates a lack of perspective on Wall Street and the media.

To be sure, a graph showing the price of oil with the y-axis running from $98 to $102 would show what looks like a huge increase, while a y-axis extending from $0 to $150 would show a barely noticeable change on June 8th.  The second graph would be more accurate in terms of the significance of the change.

The modest increase in price was momentary, caused by investors who had shorted oil and wanted to get out because of a bearish expectation. On June 8th, the Organization of Petroleum Exporting Countries (OPEC) talks broke down without an agreement to raise output after Saudi Arabia failed to convince the cartel to lift production. Iran, Libya, Iraq and other oil-producing states wanted to hold production targets while Saudi Arabia sought to raise them so the price of oil would stabilize at between $70 and $80 a barrel. Wise, long-term-oriented Saudi government officials understood that stability rather than short-term windfalls is in the long-term best economic interest of oil exporters—especially if oil is the sole export. According to The Wall Street Journal, "In the wake of the failure to reach agreement, people familiar with the matter said the Saudis are now likely to unilaterally increase their own production by up to one million barrels a day, which would put them well above their stated quota of eight million barrels a day." The Saudi assurance that it would supply the needs of the oil market regardless of OPEC left investors bearish after the meeting, and short-sellers were simply unloading. To report that the price of oil “soared” by $2 after the meeting is utterly misleading. By the end of trading for the day, oil was up just $1.65 (at $100.74).

Even by Wall Street’s own mantra wherein investors tend to do well in the stock market by holding a well-diversified position for a long time, over-dramatic renderings of short-term changes are counter-productive because they can seduce long-term investors to react. If newscasters on CNBC are announcing that the sky is falling today because oil went up $2, the temptation is to do something.  Anything.  Acting at all would be at odds with taking a long-term position in the market, tweeking it only to maintain a diversified portfolio.

I suspect that cause of the hyperbole is tunnel-vision, which is caused by zeroing in on something too closely and for too long. At the very least, it might be a bad idea for Wall Streeters to develop some hobbies that have nothing to do with work. Also, analysts might avoid the temptation to pay so much attention to the talking heads on CNBC. Furthermore, analysts might resist orienting graphs to overplay small changes by artificially restricting the interval on the y-axis. Lastly, Wall Streeters might resist the fun in using overly-dramatic jargon or loose-fitting (at best) analogies.

If the stock market is “crashing,” for example, we had better be talking about thousands rather than hundreds of points lost on the Dow. A plane going from 12,000 to 11,500 feet is not crashing; it is probably just making way for another plane. If a company is getting “killed,” it better be in liquidation without anything going to equity or bond holders. Better still, analysts would gain credibility if they stayed away from the military jargon completely; at the very least, using the vocabulary is an insult to the brave men and women who really have put their lives on the line.

In short, Wall Street could do with a dose of perspective. Such a change would be in line not only with credibility and reputational capital, but also how Wall Streeters fare in the market. As one person might say to another who has been dumped romantically, don’t over-analyze it!


Summer Said, Hassan Hafidh, and Benoit Faucon, "New Cracks in Oil Cartel," The Wall Street Journal, June 9, 2011, p. A1.

Democracy and the Courts: Alternative Checks on Austerity

In May 2011, “Athens agreed to impose a new $9 billion round of tax increases and spending cuts and speed up nearly $75 billion in promised privatizations.” In early June, a new round of tightening was being planned by the Greek government. It was feared that those cuts would deepen the recession and thus further shrink the tax base, making it even harder for the government to cut its deficit. Meanwhile, Reuters reported, “Greeks are showing signs of reaching the limits of their endurance as budget cuts imposed under Greece's first bailout a year ago have helped to push unemployment close to 16 percent.” The news service cited police reports of more than 80,000 people packing the main Syntagma square outside parliament on June 6th—the 12th consecutive day of protesting there.


Reuters reports that George Papandreou, the Prime Minister of the parliamentary state government, “used his parliamentary majority to ram through successive rounds of austerity including cuts to pensions and civil servants' salaries. But faced with the popular anger, some PASOK lawmakers [were] becoming uneasy.” The extent of protests suggests that the cuts may have been hitting up against bone. Short of a coup, however, protests do not in themselves arrest a government.

Interestingly, pressure from the E.U. on the Greek state to get its public finances in order has not been countered by intervention by the ECJ or a state court to protect constitutional obligations of the state toward civil servants, the unemployed, and the poor. In the case of some of the American states that have been instituting rather severe austerity programs, the governments have been reminded of their respective constitutional obligations in ways that have forced the governments to back off on some of their cuts. Specifically, the republics’ respective constitutional courts have been stepping in on behalf of the people (and the constitutions). North Carolina, Kansas, and New Jersey illustrate this dynamic, which is curiously lacking in the case of Greece.

The New York Times reports that in June 2011, “A judge in North Carolina has scheduled a hearing . . . to examine whether education cuts there violate previous court orders. ‘The current financial difficulties of the state do not relieve, justify or excuse the State of North Carolina from its constitutional obligation to provide each and every child in North Carolina an equal opportunity to obtain a sound basic education,’ the judge, Howard E. Manning Jr. of Wake County Superior Court, wrote in announcing the hearing.” How is Greece doing on its constitutional obligation?

The newspaper adds, “School districts in Kansas have filed a lawsuit arguing that with recent cuts in education spending, the state has effectively reneged on the promises it made to abide by old court rulings — a charge the state denies. ‘Just because the checkbook is empty doesn’t mean that the constitutional standard is swept away,’ said John S. Robb, a lawyer for the school districts, adding that Kansas had cut taxes as it cut education spending. ‘Especially if you are cutting taxes and claiming poverty,’ he added.” In the case of Greece, part of the problem may be tax evasion rather than a tax cut “solution” to deficits. Both Kansas and Greece should raise as much revenue as possible without sparking a recession; a tax cut or looking the other way in tax collecting is a luxury that neither state can afford.

Finally, “’Like anyone else,’ the New Jersey Supreme Court ruled, ‘the state is not free to walk away from judicial orders enforcing constitutional obligations.’ The court ordered the state to spend another $500 million in those districts. . . . Governor Christie of New Jersey, a Republican, complained after the schools ruling that ‘as a fundamental principle, I do not believe that it is the role of [New Jersey’s] Supreme Court to determine what programs the state should and should not be funding, and to what amount.’” At the same time, Christie could blame the high court for having to institute tax increases as he thanks the justices for relieving him of the political fallout from the cuts that he would have had to make. As of early June 2011, Papandreou could not avail himself of such a cover, and he had the other European states breathing down his back through the E.U. (and the world through the I.M.F.). Consequently, he was facing mass protests, whose utility in pushing back on the cuts does not have the force of a judicial ruling. It is ironic that the least democratic of the governmental branches may be the ultimate protector that a people can call on to counter lapses by their own government.


Michael Cooper, “Courts Upend Budgets as States Look for Savings,” The New York Times, June 7, 2011.

George Georgiopoulos, “Greek Austerity Plan Draws 80,000 to Athens Square,” Reuters, June 5, 2011.

Kicking the Can,” The New York Times, June 6, 2011.

Tuesday, June 7, 2011

Industry Undoing European Federalism: The Case of Cookies

In 2010, the EU Parliament passed a law to protect internet users from invasive “cookies,” which track computer usage at the expense of privacy. The 27 E.U. states had to implement the directive, but as this involved discretion, the business sector feared at the time that the states “might interpret the law differently, creating a nightmare of conflicting standards.” In other words, business can be intolerant toward federalism.

According to John Vassallo, Microsoft’s legal counsel in Brussels, “In the end, what matters is harmonized rules across Europe.” Ironically, it was the lobbying by Europe’s Internet-advertising industry group that led to the wiggle-room in the EU law that opened up the possibility of different state interpretations at the expense of European integration. Britain, for example, was expected to go along with the industry’s interpretation in which a browser’s settings that allow cookies would count as consent by the user. The French state Assembly, on the other hand, was leaning toward requiring that a browser ask the user upfront whether to accept future cookies. The French legislature was more resistant to the influence of the industry with the vested interest. 

In terms of European federalism, the business sector can have a financial incentive to push for  political consolidation at the expense of the inherent diversity that exists throughout Europe. As the case of cookies demonstrates, the consolidation desired by business involves pulling some state governments away from a strict interpretation of the E.U. directive so the convergence is more favorable to the industry. The push for a one-size-fits-all internet regulatory mechanism or standard may be most efficient from the standpoint of industries wanting to take advantage of the single market in the E.U., but settling on one solution up front is risky where uncertainty is significant in knowing how to best protect the privacy of internet users.

In general terms, a general law allowing a material extent of diversity in application is particularly well-suited for cases in which no single solution is definitive. Such cases can be expected in terms of regulation in an environment of shift technological change, such as in the first decade of twenty-first century. In other words, the sort of federalism that has taken root in the E.U. may be well-suited to the technological environment of the twenty-first century. The directive/implementation arrangement in particular can allow for unity without uniformity, which in turn can effect a balance between political and economic integration as well as technological and regulatory experimentation.

Click to add a question or comment on European federalism and the regulation of internet cookies.


Paul Sonne and John W. Miller, “EU Chews on Web Cookies,” Wall Street Journal, November 22, 2010, pp. B1-2.

See related essay: "Online Privacy and Advertising Databanks: Kant, Societal Norms, and Regulation"

Scotland as a New E.U. State

In early May 2011, “the Scottish National Party (SNP) won 69 out of 129 seats in the Scottish Parliament, with about 45 percent of the vote, up by more than 12 percentage points. Their three main rival parties — Labour, the Conservatives and Liberal Democrats  — all lost ground,” according to msnbc.com.

                         David Cheskin (AP)
The full essay is at "Is the E.U. a Federal System?"

Monday, June 6, 2011

On the Arrogance of Power: Greenspan, Rubin, and Summers

Over two years after the financial crisis of 2008, a commentator on Fox News said that the banks should not stop the foreclosure process because that would not be good for the free market. He said that people who cannot afford their houses should lose them. Another commentator remarked that there was still too much government in the financial sector. This, according to the commentator, is “the problem.” It is particularly striking that Alan Greenspan’s stark admission to a U.S. House committee in 2008 that the deregulated laissez faire market paradigm contains a fundamental flaw was lost on the two commentators. In May 2011, House Speaker Boehner charged that business is over-regulated. This comment too is remarkable given Greenspan’s realization. In general, if we as a society disown our own lessons, history is destined to repeat itself.
According to Jeff Madrick, one of the causes of the Asian financial crisis of 1997 was the Clinton administration’s urging of South Korea to deregulate its capital controls. Another cause was the low U.S. interest rate, which prompted capital to flow into markets such as South Korea, which had a higher interest rate. The result was a bubble in Asia.[1]
Madrick adds that in 1999, “when arguing against the proposal of the head of the Commodities Futures Trading Commission [Brooksley Born] to regulate financial derivatives, Greenspan claimed that unrestricted derivatives trading would stabilize finance, not disrupt it. He had no idea how dangerous the new mortgage-based collateralized debt obligations were.”[2] In other words, the chairman of the Federal Reserve was flying blind even as he had great power.
Additionally, Greenspan, along with Robert Rubin and Larry Summers, lobbied Congress to remove the CFTC’s authority to regulate financial derivatives. According to Rubin, “Larry thought I was overly concerned with the risks of derivatives.”[3] Both Summers and Greenspan believed that most derivative securities are a way of spreading out risk so it is not toxic to any one party.[4] Greenspan even supported subprime ARM mortgages; he claimed that they were saving home-owners money—which is an incredible claim considering the steep resets (i.e., higher interest rates after the initial one).
Therefore, Greenspan sought to stimulate the housing market in 2003 by lowering the federal funds rate to 1 percent. In general terms, the low rates between 2000 and 2004 stimulated the housing boom. When Greenspan raised rates in 2004, the mortgage factories continued at full speed and the higher rates made the resets beginning in 2006 even steeper (hence increasing defaults and lowering housing market values).
As if Time magazine putting Greenspan, Rubin and Summers on its February 1, 1999 cover and calling them the committee to save the world is not ironic enough, President Obama would select Larry Summers to be his chief economic adviser in the wake of the financial crisis of 2008. In retrospect, Obama’s choice may have been akin to hiring an alcoholic to run a bar. Perhaps the president would have done better in hiring a recovering alcoholic. In 2008, Greenspan said the following to a U.S. House committee: “[I] made a mistake in presuming that the self-interest of organizations, specifically banks and others, were [sic] such that they were best capable of protecting their own shareholders and their equity in the firms.” Furthermore, he added, “[I found a] flaw in the model that I perceived is the critical functioning structure that defines how the world works.”[5] It takes guts to admit that there is a fatal flaw in one’s long-standing paradigm. His admission implied a need for government regulation.
In fact, whereas in the late 1990s Greenspan worried that the U.S. debt might be paid off by years of budget surpluses such that the Fed would not be able to conduct monetary policy without Treasury securities, in May 2011 he urged that taxes should be raised to reduce the budget deficits. The man had learned to set his ideology aside to deal with rather obvious problems. Even so, his years as chairman of the Federal Reserve as a deregulating, low interest rate advocate present us with the troubling problem of the arrogance of power that can’t be wrong. Moreover, the continued calls for deregulation even after Greenspan’s confession presents us with the troubling question of whether we are capable of learning from our mistakes.

[1] Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Alfred Knopf, 2011), p. 238.
[2] Ibid., p. 225.
[3] Ibid., p. 240.
[4] Ibid., p. 245.
[5] Ibid., p. 246.