02 October 2008
Former Federal Reserve Chairman Predicts Economic Rebound
Greenspan says trust must be re-established between markets, investors
Washington — A former chairman of the U.S. Federal Reserve, Alan Greenspan, expressed optimism that U.S. financial markets will recover once trust is re-established between investors and the marketplace.
Speaking at the Georgetown University Law School in Washington October 2, Greenspan, who served as the head of the U.S. central bank for 18 years, said a crisis such as the one currently affecting the financial market “comes along only once in a century” and has come about because of fear on the part of investors of exposing their assets to any type of risk.
The rising number of defaults on home loans — loans made to individuals who could not afford them — has led to the failure of a half-dozen major banks and other financial companies. (See “How Will Washington Prevent Another Financial Crisis?”)
The turbulence in the U.S. financial markets has been described as the worst since the Great Depression of the 1930s. Bush administration officials and U.S. lawmakers have been trying to hammer out a deal that would allow the government to use $700 billion in public funds to act as the buyer of last resort for mortgage-backed and other securities held by the struggling financial institutions. (See “U.S. Senate Endorses Financial Rescue Plan.”)
Greenspan did not refer to the proposed government intervention in his remarks, but said that eventually “the market freeze will thaw as frightened investors take tentative steps toward re-engagement with risk. Broken market ties among banks, pension and hedge funds and all types of nonfinancial businesses will become re-established,” leading to the recovery of the U.S. economy.
He said the current crisis has helped rekindle old arguments such as socialism versus capitalism, “a battle some thought had ended once and for all with the disgrace of central planning.”
The former Fed chairman acknowledged that over the past year, “some of the critical pillars underlying market competition, arguably, have failed,” and the crisis has intensified a global debate on globalization and capitalism that “will define the world marketplace and the way we live for decades to come.”
Wealth creation requires taking risks, and the extent to which investors are willing to risk their assets is determined by the reputation of the investment and the trust that the investor has in it. “Reputation and the trust it fosters have always appeared to me to be the core attributes required of competitive markets,” Greenspan said.
He compared the investment relationship to the trust consumers have every day with total strangers. For example, they trust that their pharmacist will correctly fill a prescription ordered by a doctor or that an auto producer has built a safe product that will run as certified.
“We are not fools,” he said. “We bank on the self-interest of our counterparties with whom we trade to foster and protect their reputation for producing quality goods and services.”
Because of a lack of trust in the accounting records of banks and other financial institutions and an inadequate supply of capital, banks are finding it more difficult to receive loans and this has led to the “freezing-up of credit.”
But Greenspan said “trust will eventually re-emerge as investors dip hesitantly back into the marketplace” in an effort to build wealth. “From that point, history tells us, financial and economic revival sets in. I suspect it will be sooner rather than later.”
