Greenspan Says Subprime Securitization Triggered the Financial Crisis

The global proliferation of securitized US subprime mortgages acted as the “immediate trigger” to the current crisis, according to testimony of former chairman of the Federal Reserve board of governors, Alan Greenspan, before the Financial Crisis Inquiry Commission (FCIC) today. Greenspan said Fannie Mae (FNM) and Freddie Mac (FRE) led to the bubble by paying “whatever price was necessary” to buy the subprime RMBS and meet their affordable housing goals. He told the Senate Banking Committee in February 2004 that the GSEs “need to be limited in the issuance of GSE debt and in the purchase of assets, both mortgages and nonmortgages, that they hold,” according to his testimony today. Greenspan noted “extraordinary changes” in the market place and the actions of Fannie and Freddie kept the Fed’s actions from limiting the growth of subprime. FCIC chairman Phil Angelides noted that the Fed from 1999 to 2006 issued non-binding guidance that covered only 1% of the “abusive” mortgage market. “It’s good that you issued guidance, but I think that’s more evidence there’s awareness of the problem and a failure to act,” he said. Was there a reluctance to regulate these forms of lending? Speaking on Bloomberg news this morning, HousingWire associate publisher, Richard Bitner, himself set to give testimony to the Congress-appointed panel after Greenspan, said that originators of subprime mortgages naturally looked to regulators to set risk standards for the industry. As a former originator, Bitner said that “there was a delusion that overtook this industry,” and pointed to instances where Greenspan lauded subprime lending in the days before the crisis, adding regulators appeared to suffer from “groupthink.” For his part, Greenspan dismissed the accusations of being asleep behind the wheel on the oversight front. “We were on the board in 1998 were obviously aware of the problems,” Greenspan said. “The Federal Reserve is a rule-making agency, not an enforcement agency.” He added the Fed does not have capacity to implement the kinds of enforcement that HUD, for instance, could implement. He said in his 20 years in government, he “was right 70% of the time.” Greenspan said regulators should address capital issues, which would “in a sense solve all the problems.” Although banks don’t like having to put up more capital, but doing so would have a “far greater effect” than any regulation. “Regulators cannot successfully use the bully pulpit to manage asset prices, and they cannot calibrate regulation and supervision in response to movements in asset prices,” he said. “Nor can they fully eliminate the possibility of future crises.” He urged a two-fold focus on increased risk-based capital and liquidity requirements on banks, as well as significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades. “Sufficient capital eliminates the need to know in advance which financial products or innovations will succeed in assisting in effectively directing a nation’s savings to productive physical investment and which will fail,” he said. “A firm that has adequate capital, by definition, will not default on its debt obligations and hence contagion does not arise. All losses accrue to common shareholders.” Write to Diana Golobay. Additional reporting by Jacob Gaffney. Disclosure: the authors hold no relevent investment positions.

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