Stupidity in Hindsight, This Is!

A not-so-fond look back at the days when Yoda ran the Fed and an attack on the great Ayn Rand. Stupidity Factor: 7.5/10

Greenspan's '63 Essay Foretold Subprime Inaction
Commentary by Jonathan Weil

Dec. 19 (Bloomberg) -- Why did Alan Greenspan fail to act while the roots of the subprime-mortgage crisis spread? Here's one possible explanation: The Ayn Rand disciple held fast to his unwavering laissez-faire beliefs. Another way to look at this would be that Greenspan figured poor people with less than stellar credit should be given a shot at home ownership.
Yesterday's New York Times carried a front-page article chronicling the many warnings the former Federal Reserve chairman received about aggressive subprime lenders luring unsuspecting customers into crazy mortgages they never could afford. What kind of imbecile applies for a mortgage and is then surprised by their first payment? Or their second? Or the one hundredth? Apparently the answer is about 10% of subprime borrowers? If you can’t pay for it…don’t buy the house. It’s not Greenspan's job or the banks to make sure you aren’t an idiot. ``Where was Washington?'' the newspaper asked. And where was Alan? Where was personal responsibility?
There was Edward Gramlich, the late Fed governor, who urged Greenspan in 2000 to have Fed examiners investigate the industry. Greenspan said no. Activists from a California housing group, the Greenlining Institute, met with Greenspan in 2004, urging him to press lenders for a voluntary code of conduct. How does one “press” that which is voluntary? Greenspan wasn't interested and didn't give a reason. He offered a weak defense: The Fed wasn't equipped to investigate and wasn't to blame for the housing bubble and bust.

Greenspan's recent memoir, ``The Age of Turbulence,'' offers no satisfactory answers either. Greenspan said he knew ``the loosening of mortgage credit terms for subprime borrowers increased financial risk.'' Yet he ``believed then, as now, that the benefits of broadened home ownership are worth the risk.'' Didn’t I just say that? Giving people who are riskier bets the chance to own a home is still a good thing. Of course, thanks to knee jerk, drive by columnists like our friend Jonathan, that opportunity went bye-bye around the first week of August. Poor people will be crashing on your sofa soon John. Hope you stocked up at Costco this week.
No, I believe the best answer can be found in an August 1963 article called ``The Assault on Integrity'' that Greenspan, then 37, wrote for Rand's monthly journal, ``The Objectivist.'' Judging by how he rebuffed Gramlich and others, it looks like he followed his old instincts as the subprime mess festered.

Agent of Consumers

``Protection of the consumer against `dishonest and unscrupulous business practices' has become a cardinal ingredient of welfare statism,'' Greenspan began his essay, which Rand included in her 1967 book, ``Capitalism: The Unknown Ideal.''
``Left to their own devices, it is alleged, businessmen would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. Thus, it is argued, the Pure Food and Drug Administration, the Securities and Exchange Commission, and the numerous building regulatory agencies are indispensible if the consumer is to be protected from the `greed' of the businessman.
``But it is precisely the `greed' of the businessman or, more appropriately, his profit-seeking, which is the unexcelled protector of the consumer.
``What collectivists refuse to recognize is that it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product.''
``Reputation, in an unregulated economy,'' Greenspan said, ``is thus a major competitive tool.''
Do Nothing
This view of the world might well explain why Greenspan did nothing. Yet if he'd said these words anytime in the past 20 years, they would have rung false to many people familiar with the 1980s savings-and-loan crisis, the corporate scandals touched off by Enron Corp., or the housing bust. Well, actually, Enron was unscrupulous and went out of business, proving Greenspan, Rand and every other person with a brain right in thinking that less regulation=good.
``He still believes philosophically what he wrote 30, 40 years ago,'' says Greenspan biographer Jerome Tuccille, author of the 2002 book ``Alan Shrugged.'' ``But he must know we don't have a truly competitive free-market economy, and that's the context he was writing about. He must know the propensity of corporations to put greed ahead of their reputations.'' Do you think we might be confusing profit for greed? Of course corporations work for profit, which is why they aren’t non-profits. The point is you can only push so far against what consumers think is right before they will stop buying your stuff. I’ll let you review my dealing with AT&Ts customer service department if you still question this.
Greenspan wrote: ``It requires years of consistently excellent performance to acquire a reputation and to establish it as a financial asset. Thereafter, a still greater effort is required to maintain it: a company cannot afford to risk its years of investment by letting down its standards of quality for one moment or for one inferior product; nor would it be tempted by any potential `quick killing.'

Opposite Result

``Newcomers entering the field cannot compete immediately with the established, reputable companies, and have to spend years working on a more modest scale in order to earn an equal reputation. Thus the incentive to scrupulous performance operates on all levels of a given field of production. It is a built-in safeguard of a free enterprise system and the only real protection of consumers against business dishonesty.''
Government regulation, he went on, ``is not an alternative means of protecting the consumer. It does not build quality into goods, or accuracy into information. Its sole `contribution' is to substitute force and fear for incentive as the `protector' of the consumer.'' Well, it also adds another layer of costs and keeps trial lawyers busy, but I digress. Minimum standards, he said, gradually become the maximums, and regulation undermines the moral base of business dealings.
``It becomes cheaper to bribe a building inspector than to meet his standards of construction. A fly-by-night securities operator can quickly meet all the S.E.C. requirements, gain the inference of respectability, and proceed to fleece the public. In an unregulated economy, the operator would have had to spend a number of years in reputable dealings before he could earn a position of trust sufficient to induce a number of investors to place funds with him.

Don't Stop Believin'

Journey reference aside, Jonathan, should we instead embrace the beliefs of the collectivists who flourish around the world in….in…Cuba? If anyone needs to abandon their way of thinking it is the people whose social experiments have failed time after time.
``Protection of the consumer by regulation is thus illusory,'' he said. ``Rather than isolating the consumer from the dishonest businessman, it is gradually destroying the only reliable protection the consumer has: competition for reputation.
``While the consumer is thus endangered, the major victim of `protective' regulation is the producer: the businessman.''
The largely unregulated subprime-lending industry, of course, didn't turn out this way. Countless mortgage brokers and lenders didn't care about their reputations. And now they have no companies and no jobs. Gosh it’s almost as if capitalism works. Oh, wait, it does! Wall Street banks, which packaged and pitched the loans as AAA securities, didn't care about theirs either. There were quick killings to be had. And money to be lost. Apparently there was a cost to taking on risky loans. Bet no one does that for a while. Once again, yay capitalism.
Four decades later, Greenspan's argument seems almost childlike in its idealism. Actually it is the consistent belief that government creates safety that is child like. Believing that government can step in and make things better by force of will is so naïve in the face of all the data of everyday life that all I can say is Jon Jon, time to grow up. Yet, judging by his inaction, it looks like he never stopped believing.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.) And they are stupid.
To contact the writer of this column: Jonathan Weil in Boulder, Colorado, at jweil6@bloomberg.net