Greenspan, Summers, and Why the Economy Is So Out of Whack

Robert Reich is Professor of Public Policy at the University of California at Berkeley. He has served in three national administrations; written 12 books, including, most recently, Supercapitalism; and has regular commentaries on American Public Media's Marketplace. The following article was originally published on April 4, 2010, on his personal blog.

I'm in the green room at ABC News, waiting to join a roundtable panel discussion on ABC's weekly Sunday news program, This Week.

Alan Greenspan is now being interviewed. He says he bore no responsibility for the housing bubble that catapulted the nation into a financial crisis in 2008 because no one could have known about the bubble when he chaired the Fed in the years before it burst. Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?
If any single person is most responsible for the financial crisis, it's Alan Greenspan. He presided over a Fed that lowered interest rates to zero (adjusted for inflation) but failed to prevent banks from using essentially free money to speculate wildly. You do not have to be a brain surgeon to understand that if money is free, banks will take it and lend it out. And if oversight is inadequate, the banks will lend the money to anyone who can stand up straight, and to many who cannot. The result will be a giant subprime lending bubble that will burst. 

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin. In 1999, they advised Congress to repeal the Glass-Steagall Act, which since 1933 had separated commercial from investment banking. By 1999, Wall Street was salivating over such a repeal because it wanted to create financial supermarkets that could use commercial deposits to place bets in the financial casino. That would yield the Street trillions. 

At the same time, Greenspan, Summers, and Rubin also quashed the efforts of the Commodity Futures Trading Corporation to regulate derivatives when its director began to worry that derivative trading already was getting out of control.

Yet Greenspan continues to take no responsibility for what occurred. In the interview he just completed, he avoiding saying anything about the failure of the Fed under his watch to adequately oversee the banks, or the absence of sufficient financial regulation to begin with. 

Misguided direction
I dislike singling out individuals for blame or praise in a political system as complex as that of the United States, but I worry that the nation is not on the right economic road, and that these individuals -- one of whom advises the president directly and the others who continue to exert substantial influence among policy makers -- still don't get it. 

The direction financial reform is taking is not encouraging. Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives. Neither bill adequately prevents banks from becoming insolvent because of their reckless trades. Neither limits the size of banks or busts up the big ones. Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds. 

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism. It was just reported, for example, that America's top 25 hedge fund managers last year earned an average of [$1 billion each]. They continue to pay a federal income tax of 15% on most of that, by the way, because their lobbying efforts have been so successful. 

Seriously out-of-whack
Meanwhile, the so-called jobs bills emerging from Congress and the White House are puny relative to the challenge of restoring jobs in America. The most recent jobs report, read most positively, showed 112,000 private-sector jobs added to the economy in March. But that's below the number needed simply to keep up with an expanding population. In other words, we're actually worse off now than we were a month ago. At the same time, the median wage of Americans with jobs keeps dropping. 

The American economy is seriously out of whack. The two people interviewed this morning don't seem to understand how far. 

Those are Robert Reich's thoughts on Greenspan, Summers, and why the economy is so out of whack. Tell us yours in the comments section below. The Fool has a disclosure policy.


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  • Report this Comment On April 23, 2010, at 7:05 PM, fadler1 wrote:

    It sounds like Robert Reich is interviewing for a new job. Just like health care "reform" never addressed the "root cause" of the real helath care problem "high cost health care" (most with hospitals and doctors and lawyers), Dr. Reich's comment, "If any single person is most responsible for the financial crisis" ignores the "root" cause of the crisis which is lending money to people who could never pay it back ala Community Reinvestment Act on steroids. Reduce health care costs DIRECTLY. Stop making home loans to people who don't even have the down payment or the means to make reasonable payments.

  • Report this Comment On April 23, 2010, at 7:18 PM, fadler1 wrote:

    add on:

    The Wonderful Thing about America is that every individual has the potential to move up the personal wealth ladder. They are all equal under the law. That does not mean they all should own the same stuff by right. They have the right to work for it. I know Dr. Reich feels differently, but that is easy when you sit in the university world and not the real one making payroll every day for your workers.

  • Report this Comment On April 23, 2010, at 7:38 PM, AdamGaglio wrote:

    It seems fairly obvious from his own article that the root of the problem is the Fed.

  • Report this Comment On April 23, 2010, at 7:57 PM, BeachPHool wrote:

    fadler1, the one sentence you seem to fixate on is followed by the reason he made that statement: "[Greenspan] presided over a Fed that lowered interest rates to zero (adjusted for inflation) but failed to prevent banks from using essentially free money to speculate wildly."

    Dr. Reich's premise is that if interest rates weren't at zero, bankers would have not done the things you list as the "root" cause.

    Dr. Greenspan kept rates at zero (A), which encouraged the "lending of money to people who could never pay it back" (B), which resulted in the financial crisis (C). A caused B, resulting in C. Without A, B doesn't happen and neither does C. Your argument ignores A and only has B causing C .

  • Report this Comment On April 24, 2010, at 3:26 AM, bohlmanch wrote:

    If zero rates were made higher than effectively zero and the Community Reinvestment Act still made it "uncomfortable" for a bank not to lend to people who were substantial risks, the loans would have still been made. High subprime loan rates did not stop subprime buyers.

    Hence, the effective zero rate was at best only a compounding factor and the CRA was more of a contributing factor forcing institutional lending to subprimes.

    The bundles of subprime loan files were bundled by the originators. The bundles were then boxed up with bundles from other originators. At that point it began getting complicated and nobody ever opened the box again to see what was in it.

    Even the risk rating agencies never opened the boxes.

    Financial institutions began buying and selling the boxes. They did not open them.

    The same institutions began insuring the value of the contents of the boxes. They didn't open them either.

    Then the financial houses began buying and selling the insurance contracts on the unopened boxes (default swaps) and the great game of liar's poker was on.

    Presumably, someone made a whole bunch of money at this because in order for all of the wealth invested in these boxes to disappear while the real assets (the mortgaged house) remained, the money had to go somewhere.

    No, I cannot lay all of that on Alan Greenspan's doorstep. Government regulation and interference by creating artificial incentives to lend toward very high risk situations was the cause. I believe the expression goes that the road to hell is paved with good intentions. Unfortunately the bricklayers are people with grand ideas who get to use other people's money to fund their failed experiments. You are along for the ride whether or not you want to be.

  • Report this Comment On April 24, 2010, at 5:35 AM, plange01 wrote:

    how can greenspan possible be still out of jail for his role in causing the biggest financial collapse in history?had he been in china he would have been executed a year ago..

  • Report this Comment On April 24, 2010, at 7:15 AM, saunafool wrote:

    fadler,

    Your fixation on the CRA is totally misplaced. Nearly every country in the world experienced a housing bubble. Both countries which promote home ownership (Spain) and those which don't (France) experienced bubbles. Furthermore, the bubble occurred across all income levels in the U.S.

    Blaming the bubble on loans to poor people does not explain all of the places where bad loans occurred where there was not CRA and where there were no poor people.

    More importantly, the CRA says nothing about ignoring ability to pay. Up until 2003, the payment rates on sub-prime loans were actually very high. It was only when the mortgage brokers stopped checking incomes and prices escalated beyond any reasonable metric that the poison pills were planted.

    These poison pills were the direct result of excessively loose monetary policy combined with lack of regulation.

    But, you can be delusional and try to figure out how your theory explains how Dubai had a massive bubble and subsequent collapse in an environment with no regulation and no CRA and almost all of the loans going to wealthy expats.

  • Report this Comment On April 24, 2010, at 8:00 AM, TMFJebbo wrote:

    I see two problems.

    # 1 - the banks are indemnified against losses.

    # 2 - the allowance of excessive leverage.

  • Report this Comment On April 24, 2010, at 8:42 AM, alpowers wrote:

    There was a reason that the Glass-Steagall Act of '33 was passed back then and for very good reason. When Congress repealed the Act in '99, this bust was engraved on the wall. Commercial and Investment Banking need to be separated as was under the Glass-Steagall Act, the profit motive is just to great for banks to behave in a rational manner.

    And to blame all this on one person or a group of people is just simply wrong. Let's face it as a country we got greedy, the government was willing to look the other way aorund which made the banks willing to lend the money to anyone and we had people buying homes and other large capital goods that were way out of their means, no matter what their personal income was, and they knew it. There's enough blame to go around for everybody on this bust.

  • Report this Comment On April 24, 2010, at 11:01 AM, withoutlimits wrote:

    I rarely agree with Mr. Reich, but he has a good point here!

    Davidsmith10, Jeez, what a shameless plug. Isn't that against the rules?

  • Report this Comment On April 24, 2010, at 11:09 AM, gnawbone wrote:

    Bohlmanch, Thanks for your comments; very helpful to me.

  • Report this Comment On April 24, 2010, at 2:30 PM, pipgoss wrote:

    In the 1980s, I was a Commercial Loan Officer at a mid-size, federally chartered bank. About once a year the Federal Reserve Bank regulators would show up for an unannounced audit. These audits included reviewing our loans to make sure borrowers had the ability to repay the loan. An affiliate Bank in Nevada failed their audit because of fraudulent loans. The CEO down to the Commercial Loan Officer was fired because the Nevada Bank did not want to lose their federal charter.

    The Fed's regulators were given these powers because bank deposits were insured by the FDIC. Unlike other businesses, the FDIC, backed by the US Govt. had to cover the bank's losses if withdrawals from checking and savings accounts exceeded the cash on hand.

    Alan Greenspan failed to continue the highly successful audit program. The result was bad loans and poor investments at many banks both large and small. The taxpayer was stuck with bailing out the banks. This is in contrast to Canada who regulated their banks. Canadian taxpayers have not had to pay one dime toward bailing out their banks.

    Also, Community Reinvestment Act (CRA) loans had to meet the same credit standards as all other loans. About 75% of mortgages included in mortgage backed securities were generated at companies such as Countrywide which did not have to meet CRA requirements.

  • Report this Comment On April 24, 2010, at 2:52 PM, stcraven wrote:

    Just another policy statement from the Blamocrats. However, I think focusing on blame instead of trying to change something is better approach to a free market economy than the Fearpublicans might offer.

  • Report this Comment On April 25, 2010, at 6:32 AM, wreelp wrote:

    Greenspan and Summers have both proven themselves to be complete incompetent jerk offs!

  • Report this Comment On April 25, 2010, at 5:12 PM, Pmccorm wrote:

    Reich is a genius and Greenspan is going to go down as a smart guy that did not when to hang up his boots (or tennis racket in his case) and ended up sinking the country...

    I agree that the current reform does not go far enough but it is a start and hopefully will be improved upon over time...

  • Report this Comment On April 25, 2010, at 5:51 PM, GeoffHasler wrote:

    Obama should fire all the guys who did not see the mess coming, or got us into it. Bernanke too since he never heard anything from Greenspan he did not like. What's wrong with Volcker? He's the only one who knows what needs to be done and has the guts to see it through. Excellent credibility too with many Republicans.

  • Report this Comment On April 26, 2010, at 12:13 AM, mdminhk wrote:

    I am sure, Greenspan, Summers and Rubin all had a part in the financial mess that followed. But it would be wrong to alleviate all blame from the politicians that mandated expanding loans to less creditworthy families in order to expand home ownership. The intent may have been admirable, but the results disastrous

    Bottom line government interference only make things worse.

  • Report this Comment On April 26, 2010, at 2:36 AM, ikkyu2 wrote:

    "You do not have to be a brain surgeon to understand that if money is free, banks will take it and lend it out," says Reich. "And if oversight is inadequate, the banks will lend the money to anyone who can stand up straight, and to many who cannot."

    This is not exactly tautology. A bank will only behave this way if it is also insulated from the consequences of defaults on the loans it makes. Turning Fannie and Freddie into teeming cesspools of bad debt had nothing to do with low rates, and everything to do with shielding banks from the consequences of making bad loans at the taxpayer's expense.

  • Report this Comment On April 26, 2010, at 8:04 AM, nnbelani wrote:

    Question for Dr. Reich, how about CRA, Fannie and Freddie?

  • Report this Comment On April 26, 2010, at 9:50 AM, BMFPitt wrote:

    Low rates put the problems on steroids, but it didn't cause those problems. Just look at today, where real rates are solidly negative but banks are mostly just buying treauries (loaning the government it's own money back for a 2% profit.)

    Governmnet manipulation and subsidies on mortgages was the single biggest problem, but the CRA was a miniscule nuisance compared to the abominations that are Fannie, Freddie and the FHA. Today that problem is orders of magnitude worse.

  • Report this Comment On April 27, 2010, at 3:20 AM, ilovesumm wrote:

    Put 2 politicians , I mean liars in a room and what do you expect?

    OF course they were both quite responsible for the diaster , not 100% but definitely not 0% .

  • Report this Comment On April 29, 2010, at 11:16 AM, cerar wrote:

    In my opinion American jobs are being sold to Chinese ever since free trade agreements were signed. Capability of Chinese advanced technologies are improving rapidly and are ever more competitive with USA, due to very low cost of labor and disregard for terms of the Agreement.

    Housing market buble is presently used as an exuse of American missudgment on the free trade agreement. It can be argued that American at large have bougt accomodatins or that thay lost economical potential to service the mortgaes. I believe the latter is true.

    Under present economical practices They have no hope to achieve so needed accelerated employment for decade to come and until new economical minds are born and developed.

  • Report this Comment On April 29, 2010, at 3:01 PM, OOPS747 wrote:

    My Opinion, I think the biggest blame should be on the gov't. Why? They are the ones that let go of the regalutions put in place in 1933. Why did they do that? So businesses can get bigger however you fore go the risk. Also, the gov't should be watching who is naughty. You can't do that if you do not have enough staff, In today's economy, it's too many chiefs and not enough indians.

    In addition, it pays to be well connected. Case in point, the bankers, auto manufactor, etc. screw up and the taxpayer pays, pays and pays.

    PS. It is also important to watch the Fed speak. I've hear it too many times being misquoted.

  • Report this Comment On April 30, 2010, at 9:24 AM, Lordrobot wrote:

    It is very simple really. Short people are shortsighted.

    The third Reich forgets that while he served as Treasury Secretary the Clinton Administration changed the tax code to allow for flipping of houses and avoidance of the capital gains tax. So housing became the de facto gov sponsored investment class... a margined leveraged flipping instrument for one and all. Congrats to the little man on his attempt to throw the blame at taller people.

  • Report this Comment On April 30, 2010, at 2:26 PM, maccdw wrote:

    Lord Robot--> Reich has never served as Treasury Secretary. Clinton used 3: Bentsen, Rubin and Summers.

    Rubin is currently pleading complete ignorance in his rile as Goldman Sucks Chair.

    Summers is whispering sweet nothings into Obama's ear, having apparently come to his senses after realising that he, Rubin and Greenspan screwed up BIG TIME when the 3 of them shouted down Brooksley Born.

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