Alan Greenspan's Beliefs In The Free Market System
Rebecca Buckmaster
Lucia Farris
ECO 201
August 22, 2013
Alan Greenspan’s Beliefs in the Free Market System Alan Greenspan, Chairman of the Federal Reserve, took part in a documentary about the downfall of the housing market in the United States. His confidence in the free markets, which only allows intervention from the Fed in dire economic times, being able to regulate themselves was unable to keep the economy growing. In contrast with this belief, his expansionary policy led to the Fed’s decision that helped send our economy spiraling downward. Other factors such as the established business cycle of the economy, questionable ethics of investment firms’, and the ineffective regulation of the oversight committees caused the economy …show more content…
to destabilize in direct response to the Fed’s decision rather than producing further economic growth. Oversight committees need to better predict business cycles in order to implement regulations on lending and investment firms at the appropriate time to essentially keep the economy stable. Going against his belief that free markets are outside government control, Greenspan, as chairman of the Federal Reserve, decided to lower the short-term interest rates during a time when our economy was beginning to stabilize in order to stimulate economic growth.
This growth came in the form collateralized debt obligations backed by subprime loans. The subprime loan originators were not regulated properly and lent to those who otherwise would not qualify for a loan. The new homeowners enjoyed a period of prosperity while housing prices exploded. Wanting to cash in on their new found wealth many refinanced to a variable rate loan never expecting housing prices would fall and interest rates would increase. Unfortunately, incomes did not rise therefore when people refinanced and the economy tried to adjust itself for the inflation occurring within the housing market many loans defaulted as interest rates rose and housing prices fell. The subprime loan originators (i.e., also wanted to make a profit and started selling their subprime loans to securities firms. These securities firms, i.e. The Bear Stearns Companies, Inc., made their profit in the packaging and trading of the Mortgage Backed Security or MBS, and the Collateralized Debt Obligations (CDO). The CDOs were a collection of good or prime loans mixed with some bad or subprime loans that were not sold as part of MBSs. These packages were then sent to the credit rating agencies like Moody’s for their credit rating. Moody’s were complicit in giving CDOs that would have been rated as F’s a triple "A" rating meaning they were less risky
investments. “Moody 's paid their analysts far less than the big brokerage firms did and, not surprisingly wound up employing people who were often looking to befriend, accommodate, and impress the wall Street clients in hopes of getting hired by them for a multiple increase in pay. ...Their [the rating agencies] failure to recognize that mortgage underwriting standards had decayed or to account for the possibility that real estate prices could decline completely undermined the ratings agencies ' models and undercut their ability to estimate losses that these securities might generate. (Morgenson and Rosner)” Unfortunately, not one oversight committee like the SEC said anything about the lack of ethics in creating the subprime loans and packaging them into CDOs to be given the highest credit rating of which they were not even close to achieving. In the documentary “House of Cards”, Greenspan maintained the belief that the Fed and the SEC were powerless to stop it unless they broke the economy in order to justify his and the SEC’s lack of regulatory inquiries into the practices surrounding the subprime loans. Eventually, borrowers of subprime loans defaulted on their payments and banks were forced to foreclose. Investors in CDOs started losing money and banks had to use reserves to pay them and as a result incurred great losses.
Then the housing market crashed and the subprime loans were gone. Investment firms up and down Wall Street either closed their doors or were bought by other companies as part of the government bailout. Millions of people lost their jobs and the Great Recession began all because the CDOs were not regulated. If the SEC, the Fed, and other oversight committees had done their jobs the crisis could have possibly been averted without a shock to the economy as Greenspan believes would have happened.
Works Cited
Morgenson, Gretchen and Joshua Rosner. Reckless Endangerment : How Outsized ambition, Greed and Corruption Led to Economic Armageddon. New York: Times Books/Henry Holt and Company, (2011).
Lucia Farris
ECO 201
August 22, 2013
Alan Greenspan’s Beliefs in the Free Market System Alan Greenspan, Chairman of the Federal Reserve, took part in a documentary about the downfall of the housing market in the United States. His confidence in the free markets, which only allows intervention from the Fed in dire economic times, being able to regulate themselves was unable to keep the economy growing. In contrast with this belief, his expansionary policy led to the Fed’s decision that helped send our economy spiraling downward. Other factors such as the established business cycle of the economy, questionable ethics of investment firms’, and the ineffective regulation of the oversight committees caused the economy …show more content…
to destabilize in direct response to the Fed’s decision rather than producing further economic growth. Oversight committees need to better predict business cycles in order to implement regulations on lending and investment firms at the appropriate time to essentially keep the economy stable. Going against his belief that free markets are outside government control, Greenspan, as chairman of the Federal Reserve, decided to lower the short-term interest rates during a time when our economy was beginning to stabilize in order to stimulate economic growth.
This growth came in the form collateralized debt obligations backed by subprime loans. The subprime loan originators were not regulated properly and lent to those who otherwise would not qualify for a loan. The new homeowners enjoyed a period of prosperity while housing prices exploded. Wanting to cash in on their new found wealth many refinanced to a variable rate loan never expecting housing prices would fall and interest rates would increase. Unfortunately, incomes did not rise therefore when people refinanced and the economy tried to adjust itself for the inflation occurring within the housing market many loans defaulted as interest rates rose and housing prices fell. The subprime loan originators (i.e., also wanted to make a profit and started selling their subprime loans to securities firms. These securities firms, i.e. The Bear Stearns Companies, Inc., made their profit in the packaging and trading of the Mortgage Backed Security or MBS, and the Collateralized Debt Obligations (CDO). The CDOs were a collection of good or prime loans mixed with some bad or subprime loans that were not sold as part of MBSs. These packages were then sent to the credit rating agencies like Moody’s for their credit rating. Moody’s were complicit in giving CDOs that would have been rated as F’s a triple "A" rating meaning they were less risky
investments. “Moody 's paid their analysts far less than the big brokerage firms did and, not surprisingly wound up employing people who were often looking to befriend, accommodate, and impress the wall Street clients in hopes of getting hired by them for a multiple increase in pay. ...Their [the rating agencies] failure to recognize that mortgage underwriting standards had decayed or to account for the possibility that real estate prices could decline completely undermined the ratings agencies ' models and undercut their ability to estimate losses that these securities might generate. (Morgenson and Rosner)” Unfortunately, not one oversight committee like the SEC said anything about the lack of ethics in creating the subprime loans and packaging them into CDOs to be given the highest credit rating of which they were not even close to achieving. In the documentary “House of Cards”, Greenspan maintained the belief that the Fed and the SEC were powerless to stop it unless they broke the economy in order to justify his and the SEC’s lack of regulatory inquiries into the practices surrounding the subprime loans. Eventually, borrowers of subprime loans defaulted on their payments and banks were forced to foreclose. Investors in CDOs started losing money and banks had to use reserves to pay them and as a result incurred great losses.
Then the housing market crashed and the subprime loans were gone. Investment firms up and down Wall Street either closed their doors or were bought by other companies as part of the government bailout. Millions of people lost their jobs and the Great Recession began all because the CDOs were not regulated. If the SEC, the Fed, and other oversight committees had done their jobs the crisis could have possibly been averted without a shock to the economy as Greenspan believes would have happened.
Works Cited
Morgenson, Gretchen and Joshua Rosner. Reckless Endangerment : How Outsized ambition, Greed and Corruption Led to Economic Armageddon. New York: Times Books/Henry Holt and Company, (2011).