U.S. regulators should consider breaking up large financial institutions considered "too big to fail," former Federal Reserve Chairman Alan Greenspan said. Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on Foreign Relations in New York."If they're too big to fail, they're too big," Greenspan said today. "In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."
You know we're in big trouble when Alan Greenspan agrees with me about busting up Wall Street. (On his night table does Das Kapital now lie next to Atlas Shrugged ?)
For the apostle of free markets to admit that financial free markets are not self-correcting is an enormous concession.
Unlike the ideologues on cable financial programs, Greenspan has the intellectual honesty to say that this crash was caused not by government regulations or because other outside pressures interfered with inherently stable, self-correcting financial markets. To the contrary he is admitting that financial free markets crashed and burned on their own.
1. He admits, albeit indirectly, that financial markets left to their own devices will grow ever more concentrated into larger and larger institutions.
2. Those large institutions then have an implicit bailout guarantee and no longer suffer the consequences of their own failure, an essential feature of functioning markets.
3. When such institutions do fail, the systemic risk they create is so great that they must be bailed out. Not doing so would send the economy into another Great Depression.
4. By implication he is also saying that once an institution realizes it is too big to fail, it will act as if it no longer faces severe market discipline. It knows it won't be allowed to fail so it can gamble even more (with other people's money of course).
5. Therefore, we must do what the populists and progressives forced us to do at the turn of the 20th century...Bust the Trusts!
But there's more to his admission that is left unsaid. Because too-big-to-fail institutions distort markets, it also means that they distort the pay mechanisms of those markets. Because they can take risks without bearing the full consequences, they also can reap outsized rewards. Distorted markets inevitably lead to distorted profits and pay.
This was in-your-face week for distorted profits. The too-big-to-fail institutions that should have crashed last year under their own weight, now are showing record profits during the worst economic downturn since the Great Depression. Amazingly, these profits are even larger than the excesses reaped during the peak of the housing bubble. (Meanwhile the BLS U6 Jobless Rate hovers at 17.0 percent.)
Of course, Greenspan knows full well that these profits, and the recored bonuses that will soon to follow, are fundamentally illegitimate. They exist only because of the bailout. (For those who believe Goldman Sachs, JP Morgan Chase, and Morgan Stanley succeed because they have the best talent, imagine where those frims would be right now if we hadn't bailed out A.I.G and if we hadn't pumped more than $13 trillion in TARP funds, liquidity, and asset guarantees into the financial markets. Those genius institutions would all be in bankruptcy court.)
Milton Friedman and Ayn Rand provide no guidance for Alan Greenspan or the rest of us for how to deal with the aftermath of too big to fail. Greenspan's call for busting up the big boys is only part of the solution. The other part is repatriating these illegitimate profits and pay before they end up in offshore bank accounts. The welfare kings of Wall Street have no right to pocket our money. It's also economically unsound for the economy to allow these distortions to continue.
The solution is obvious:
-- A windfall tax of 90 percent on all Wall Street profits retroactive to January 1, 2009.
-- Institute the President's Wage Cap: No one in institutions that are too big to fail shall receive more pay than the President of the United States until the unemployment rate drops below 5 percent. (Oh the suffering of having to live on only $400,000 a year!)
It's doubtful that Alan Greenspan would go this far. But I suspect that in the confines of his own mind, he would understand both the logic and justice of this argument.
Before financial amnesia sets in (caused by the latest Dow 10,000), we need to remind ourselves again and again that this crisis was caused by the failure of financial markets. Big government didn't cause the crash. Regulations didn't cause the crash. We let markets run wild just the way Friedman and Greenspan had wanted. And those markets imploded. Financial institutions became too big to fail. They were bailed out. And now they are gorging themselves on government welfare.
Greenspan is willing to admit part of his mistake and to call for drastic government interference to correct the gigantic distortion in financial markets. Let's hope the rest of us have the courage to advocate the additional steps needed to end our pell-mell slide into the billionaire-bailout abyss.
Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It, Chelsea Green Publishing, June 2009.