Greenspan: Regret over this 'credit tsunami'

Former Federal Reserve Chairman Alan Greenspan called Thursday for imposing some of the same sorts of regulations on mortgage securities he resisted when he was in office, acknowledging that the current financial crisis had exposed "a flaw" in his view of how the world and markets function.

In testimony before the House Committee on Oversight and Government Reform, Greenspan said that the United States is heading for a "significant rise in layoffs and unemployment" and many more months of dropping home values as the nation and the world work through a crisis that is "broader than anything I could have imagined."

Greenspan, once viewed as the infallible architect of U.S. prosperity, called the current financial crisis a "once-in-a-century credit tsunami" and said that he remained "in a state of shocked disbelief" that banks and investment firms did not do a better job of analyzing the risks involved with investing in home mortgages extended to less creditworthy borrowers.

He added that "This crisis has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount."

When he stepped down as Fed chairman less than three years ago, Congress treated Greenspan as an oracle, one of the great economic statesmen of all time. Thursday, many members of the oversight committee treated him as a hostile witness.

"You found that your view of the world, your ideology was not right, it was not working?" said Rep. Henry Waxman, D-Calif., the chairman.

"Absolutely, precisely," Greenspan said. "You know, that's precisely the reason I was shocked because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."

The tough talk from Waxman and other committee members reflected a widening sense that some of Greenspan's apparent successes in managing the economy from 1987 to 2006 were in fact illusory, that they came at the cost of building the biggest credit bubble in world history. Waxman ticked off a long list of times that Greenspan had extolled the ability of markets to properly price and manage risk.

"My question for you is simple," said Waxman. "Were you wrong?"

"Well, partially," said Greenspan, before parsing the distinctions between different types of derivatives that might have been regulated better.

As Fed chairman, Greenspan opposed regulation of the practices that allowed subprime mortgages to be bundled into larger securities and sold to investors. Those securities subsequently weighed down the balance sheets of banks and other companies when the underlying loans soured.

Greenspan also oversaw a period of low interest rates that helped encourage sometimes loose lending.

"It was the failure to properly price such risky assets that precipitated the crisis. The whole intellectual edifice ... collapsed in the summer of last year."

Greenspan used the word "mistake" only once during the five-hour hearing, which also included former Treasury Secretary John Snow and current Securities and Exchange Commission Chairman Christopher Cox.

"I made a mistake," Greenspan said, "in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms."

He added that "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity, myself especially, are in a state of shocked disbelief."

In his testimony, Greenspan noted that he warned in 2005 that a "protracted period of underpricing of risk ... would have dire consequences."

"There are additional regulatory changes that this breakdown of the central pillar of competitive markets requires in order to return to stability," said Greenspan, who also predicted that home prices will continue falling for "many months in the future."

Greenspan's comments came as policymakers try to determine how to fix problems many feel can be traced to policies he advocated. Those policies helped expand home ownership, but they also put millions of people in homes they could not afford with loans they cannot repay.