Yves Smith at Naked Capitalism puts her finger on Alan Greenspan’s fatal flaw, which is a desperate need to be liked. In the job that Greenspan held for a fifth of a century, you need to be willing to infuriate almost everyone from time to time, and Greenspan has never shown a willingness to do that.
(You also need to be able to look at your own decisions objectively, which Greenspan is still unable to do. But that’s an even more common problem.)
Alan Greenspan had a brief moment when he seemed capable of being redeemed, when he admitted before Congress that he was wrong about his assumptions that firms could regulate themselves. I have yet to see another central figure in the banking meltdown admit error. But he has now gone back to trying to salvage burnish his reputation.
Irving Fisher, arguably the most famous economist of the 1920s and a big backer of that era’s new financial and economic paradigm, was virtually impoverished by the crash and spent the next few years trying to figure out what went wrong. Although his contemporaries (save Keynes) saw him as hopelessly tainted, posterity has been more kind. Fisher’s debt deflation theory is now seen as a useful, perhaps even fundamental framework for viewing financial crises.
But Greenspan when he was chairman of the Fed, and to this day, still wants to be liked. And that means he is still far too willing to enable those in power, no matter how destructive their pet plans may be. Yet the most effective counsellors I have seen are able to tell people when they think their ideas stink (admittedly, it takes a great deal of interpersonal skill to pull that off without offending often insecure people in high places) and in fact, are sought out for their candor.
From the Financial Times:
The extraordinary risk-management discipline that developed out of the writings of the University of Chicago’s Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators.
But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions….
Yves here. Dear God, Greenspan prostrates himself before the false icon of bankrupt methodologies. This is embarrassingly bad.
Has NO ONE clued him in that the Markowitz based constructs are close to rubbish? They assume Guassian (normal, bell curve) price distributions. Benoit Mandelbrot proved back in the 1960s that that just ain’t so. There have been, as John Dizard put it, terabytes written about this. Worse, these models work really well on a day to day basis, but they are terrible at accurately measuring the risk of a big blow up, and that was one of their important uses.
Bottom line: The problems didn’t begin in August, 2007, around the time that Greenspan left office. They began in the 1980s, came into full force in the late 1990s, and then bloomed with crowning magnificence in the housing bubble of the early 2000s. And then, finally, like Mr. Madoff’s Ponzi scheme, when the sysem came under stress and the problems could no longer be covered up, everything collapsed.