Greenspan: World in Midst of a 'Credit Tsunami'

Greenspan: World in Midst of a 'Credit Tsunami'

Former Federal Reserve Chairman Alan Greenspan says the current global financial crisis is a 'once in a century credit tsunami' that policymakers did not anticipate.

Former Federal Reserve chairman Alan Greenspan called today 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.

The absence of significant controls on how mortgages are repackaged into larger and more complex securities has been cited as a central cause of the current financial crisis.

In testimony before the House Government Oversight Committee, Greenspan said that as a result of the current situation the United States is heading for a "significant rise in layoffs and unemployment" and a continued downturn in home values as the world works through a crisis that is "broader than anything I could have imagined."

Greenspan, who called the current financial crisis a "once-in-a-century credit tsunami," 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.

Under questioning from Rep. Henry Waxman (D-Calif.), the committee chairman, Greenspan acknowledged that the failure of that expected self-regulation represented "a flaw in the model" he used to analyze economics. "I was going for 40 years or more on the perception that it was working well."

As Fed chairman for 18 years, Greenspan opposed regulation of the practices that allowed those sub-prime 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 began to sour.

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

But the assumption was that sophisticated analysts at banks, investment firms and hedge funds would properly account for the risks involved, and price the investments accordingly.

"It was the failure to properly price such risky assets that precipitated the crisis," Greenspan said, by encouraging investors worldwide to look at U.S. subprime loans as a "steal" rather than an uncertain bet that relied on escalating home values. "The whole intellectual edifice . . . collapsed in the summer of last year."

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

Today, he said he saw "no choice" but to force the financial firms that package mortgage loans to "retain a meaningful part of the securities they issue" -- thus keeping them on the line if the underlying loans go bad.

"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 represent a shift for the influential economist, and they come as policymakers try to determine how best to fix problems many feel can be traded to policies he advocated. Although those policies helped expand home ownership -- considered a plus for the economy -- they also put millions of people in homes they could not afford with loans they cannot repay.

In separate testimony before a different committee, Federal Deposit Insurance Corp. chairman Sheila C. Bair said today there has been a "failure to effectively deal with" the mortgage foreclosure problem, and said the government may start guaranteeing the mortgages of some homeowners who are heading for default.