Greenspan shrugs at the "too big to fail" problem.

Gossip, speculation, and scuttlebutt about politics.
June 4 2009 6:40 PM

Greenspan Shrugged

The former Fed chairman preaches fatalism about the "too big to fail" problem.

Alan Greenspan.
Alan Greenspan

It wasn't very long ago that the world would hang on every word uttered by Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006. But when the economist whom Bob Woodward dubbed "Maestro" gave a major speech on June 3 at the American Enterprise Institute, it attracted comparatively little attention. One likely reason is that the financial press was preoccupied by the current Fed chairman's newsworthy warning that same day that a growing deficit might impede economic recovery. A second likely reason is that the current very deep recession has brought about a steep decline in Greenspan's reputation as economic wise man. But I like to think that a third reason also played a role: Greenspan gave a lousy speech.

The essence of its lousiness was its fatalism. On the one hand, Greenspan said,

For years I have been concerned about the ever-larger size of our financial institutions. A decade ago, I noted that "megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail." Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. I often wondered: had bankers discovered economies of scale that Fed research had missed? It is clear, in retrospect, that they had not.

One highly disturbing consequence of the ["too-big-to-fail"]-bailout problem is that I can see no way to convince markets henceforth that every large financial institution, should the occasion arise, would be subject to being bailed out with taxpayer funds. The implicit subsidy that such notions spawn insidiously impairs the efficiency of finance and the allocation of capital. ...

Government guarantees of the liabilities of institutions viewed as too big to fail thwarts the competitive process that produces capital efficiency. It results in protected businesses having market and cost-of-capital advantages, but not efficiency advantages over firms not thought to be too big to fail. TBTF freezes obsolescent capital in place and impairs creative destruction—the primary means by which output per hour and standards of living are raised. Of all the regulatory challenges that have emerged out of this crisis, I view the TBTF problem and the TBTF precedents, now fresh in everyone's mind, as the most threatening to market efficiency and our economic future. [Italics mine.]

Advertisement

In essence, Greenspan was saying that when banks become too big to fail, they are corrupted by the knowledge that the government won't let them fail. This presumed guarantee distorts the market and rewards risky behavior.

On the other hand, Greenspan said,

There are certain regulatory problems for which there are no good solutions. And TBTF is one of them.

Greenspan's main target was an option under consideration by the Obama administration to make the Fed a "systemic risk regulator," a plan whose details have yet to be sketched out. Nowhere did Greenspan utter the word antitrust, a much more obvious method to prevent corporations from becoming too big to fail. This is odd, because reinvigorating antitrust prosecution is not, like creating a "systemic risk regulator," a hypothetical policy but, rather, a stated goal of the Obama Justice Department under its new antitrust chief, Christine Varney. In a May 12 speech Varney said,

[W]e cannot develop sound antitrust policy merely on a case-by-case basis. Instead, as I have charged the Division's staff, we must consider the overall state of competition in the industries in which we are reviewing potentially anticompetitive conduct or mergers, or providing guidance to regulatory agencies charged with industry oversight. We thus must consider market trends and dynamics, and not lose sight of the broader impacts of antitrust enforcement.

To drive this point home, Varney has tossed out antitrust guidelines worked up in 2008 by the Bush administration on the grounds that they "raised too many hurdles" and "favored extreme caution." This decision has created mild hysteria on the right. But if the proliferation of economic entities too big to fail really is "the most threatening" regulatory problem to emerge from the current economic mess, it might not be a bad idea to, you know, address it.

TODAY IN SLATE

Sports Nut

Grandmaster Clash

One of the most amazing feats in chess history just happened, and no one noticed.

The Extraordinary Amicus Brief That Attempts to Explain the Wu-Tang Clan to the Supreme Court Justices

Amazon Is Officially a Gadget Company. Here Are Its Six New Devices.

Do the Celebrities Whose Nude Photos Were Stolen Have a Case Against Apple?

The NFL Explains How It Sees “the Role of the Female”

Future Tense

Amazon Is Now a Gadget Company

Food

How to Order Chinese Food

First, stop thinking of it as “Chinese food.”

Scotland Is Inspiring Secessionists Across America

The Country Where Women Aren’t Allowed to Work Once They’re 36 Weeks’ Pregnant

The XX Factor
Sept. 18 2014 11:40 AM The Country Where Women Aren’t Allowed to Work Once They’re 36 Weeks’ Pregnant
Moneybox
Sept. 17 2014 5:10 PM The Most Awkward Scenario in Which a Man Can Hold a Door for a Woman
  News & Politics
Weigel
Sept. 18 2014 3:19 PM In Defense of Congress Leaving Town Without a New War Vote
  Business
Business Insider
Sept. 18 2014 3:31 PM What Europe Would Look Like If All the Separatist Movements Got Their Way
  Life
Outward
Sept. 18 2014 4:15 PM Reactions to a Sketch of Chelsea Manning Reveal Transmisogyny
  Double X
The XX Factor
Sept. 18 2014 3:30 PM How Crisis Pregnancy Centers Trick Women
  Slate Plus
Behind the Scenes
Sept. 18 2014 1:23 PM “It’s Not Every Day That You Can Beat the World Champion” An exclusive interview with chess grandmaster Fabiano Caruana.
  Arts
Brow Beat
Sept. 18 2014 4:33 PM The Top 5 Dadsplaining Moments From The Cosby Show
  Technology
Future Tense
Sept. 18 2014 4:26 PM Global Oceans Break All-Time Heat Record; World on Pace for Warmest Year Ever
  Health & Science
Science
Sept. 18 2014 3:35 PM Do People Still Die of Rabies? And how do you know if an animal is rabid?
  Sports
Sports Nut
Sept. 18 2014 11:42 AM Grandmaster Clash One of the most amazing feats in chess history just happened, and no one noticed.