Greenspan's '63 Essay Foretold Subprime Inaction: Jonathan Weil
2007-12-19 00:25 (New York)

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.
     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. ``Where was Washington?'' the newspaper asked. And where
was Alan?
     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.
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.''
     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.
     ``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.''
     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.''
     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'

     ``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. 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.
     Four decades later, Greenspan's argument seems almost
childlike in its idealism. Yet, judging by his inaction, it
looks like he never stopped believing.