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Sympathy for Greenspan

BERKELEY – In the circles in which I travel, there is near-universal consensus that America’s monetary authorities made three serious mistakes that contributed to and exacerbated the financial crisis. This consensus is almost always qualified by declarations that the United States has been well served by its Federal Reserve chairmen since at least Paul Volcker’s tenure, and that those of us who have not sat in that seat know that we would have made worse mistakes. Nevertheless, the consensus is that US policymakers erred when:

·    the decision was made to eschew principles-based regulation and allow the shadow banking sector to grow with respect to its leverage and its compensation schemes, in the belief that the government’s guarantee of the commercial banking system was enough to keep us out of trouble;

·    the Fed and the Treasury decided, once we were in trouble, to nationalize AIG and pay its bills rather than to support its counterparties, which allowed financiers to pretend that their strategies were fundamentally sound;

·    the Fed and the Treasury decided to let Lehman Brothers go into uncontrolled bankruptcy in order to try to teach financiers that having an ill-capitalized counterparty was not without risk, and that people should not expect the government to come to their rescue automatically.