After the financial crisis in September 2008 in the U.S.,
the former chairman of the Federal Reserve, Alan Greenspan, admitted to a
Congressional committee that his free-market notion that a market will automatically
self-correct itself had a major flaw. He had come to this realization because
the financial market for mortgage-backed bonds had failed to correct in terms
of price for the dramatic increase in risk. Instead, that market, and that of
overnight commercial paper, had seized up rather than simply adjust price to
the decreased demand. Fear had paralyzed what had hitherto been thought to be a
self-correcting market. The failures of Bear Stearns and Lehman Brothers
introduced us to the concept of systemic risk, wherein the failure of a bank
(or company) causes a market to collapse. Such a bank is thus too big to fail.
If actualized, such risk interferes with even the basic operation of a market,
not to mention its self-correcting feature. One question is whether banks that
are too big to fail should merely be more adequately regulated or broken up, as
the U.S. Supreme Court broke up Standard Oil in 1911.
Alan Greenspan, former chairman of the U.S. Federal Reserve Bank
The full essay is at "Addressing Systemic Risk: Alan Greenspan."
