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Greenspan Is Back to Lead the Charge Against Responsible Regulation

Posted: 04/21/11 08:44 AM ET

Wall Street bankers, with help from key Republicans in the House and Senate, have begun a major campaign across the country to kill the regulations currently being developed to enforce Dodd-Frank Wall Street Reform. A recent speech by the leader of Wall Street bankers, JP Morgan's CEO Jamie Dimon, took direct aim at financial regulation and new, more rigorous capital standards.

The same week, Alan Greenspan -- just a year removed from his mea culpa on "self-regulation" -- said the Dodd-Frank legislation would create the "largest regulatory-induced market distortion" in the US since wage and price controls. Very shortly afterwards Senator DeMint introduced a bill to repeal Dodd-Frank. And House Financial Services Committee Chairman Spencer Bachus led 34 of the committee's Republicans in sending a letter to the six agency heads charged with implementing the Dodd-Frank Act stating that the members are "troubled by the volume and pace of rulemakings."

It is very hard to believe that anyone would propose going back to the policy of "self-regulation" on Wall Street and elsewhere. We tried that during the last 20 years, and it catastrophically resulted in the worst financial meltdown in 80 years, almost destroying the US and world financial systems. It caused more than 3 million homes to be repossessed, drove the unemployment rate over 10 percent, and left millions in economic, and emotional, shock.

Where was the regulatory backstop that should have been the last line of defense? Completely dismantled by Washington policymakers who bought the view that self-regulation would work and markets could police themselves -- the same ideology that they are boldly pressing now, so soon after its complete failure.

The question of whether regulation is necessary has been asked and answered, painfully so for many Americans. We are not living in the abstract, debating hypotheticals about what would happen without regulations.

Before the meltdown, market fundamentalists and Wall Street bankers argued that our financial actors could police themselves, that their self-interest in remaining financially viable would create sufficient incentive to avoid failure -- far exceeding the ability of regulators to limit excessive risk by rulemaking. Systematically, these fundamentalists worked to dismantle many of the prudential New Deal era banking reforms. Their crowning achievement: the repeal of Glass-Steagall (which, passed in the aftermath of the Great Depression, kept our financial system stable and growing for 60 years) in 1999.

Wall Street and Washington were possessed by this laissez faire ethos over the past 20 years. It was this philosophy, and the decisions that sprang from it, that led us blindly down the path to the financial crisis.

Before his recent (re-)conversion, Alan Greenspan admitted that this dominant concept of self-regulation was ill-conceived. In a speech on February 17, 2009 before the Economic Club of New York, the former Fed Chairman conceded that the "enlightened self-interest" he had once assumed would ensure that Wall Street firms maintain a "buffer against insolvency" had failed.

Mr. Greenspan, perhaps more than anyone else, should have known better. But instead of playing the role of the markets' fire chief, he played that of head cheerleader. For example, Mr. Greenspan applauded the trend of financial disintermediation, proclaiming that new innovations would allow risks to be dispersed throughout the system.

Of course, this was just the tip of the iceberg. Despite having the power to write and enforce consumer protection standards, the Federal Reserve did nothing to combat deteriorating origination standards in mortgage and consumer loans.

He could have implemented common-sense rules like minimal capital requirements for systemically important financial institutions. That would have been a critical emergency-brake when the Bear Stearns/AIG tailspin began.

Instead, Mr. Greenspan signed off on regulations that gave banks the ability to set their own capital standards. He allowed banking institutions to leverage excessively by gorging on short-term liabilities and, in some cases, creating off-balance-sheet entities to warehouse their risky assets.

This makes it hard to believe that Greenspan would return to his old talking points, joining the offensive coordinated by Wall Street banks and others saying that the Wall Street Reform Act will never work, and its implementing regulations should be delayed or watered down.

Trust alone will not work in business, just like it does not work in sports. Many of us, as fans, are frustrated at the referees and umpires for constantly interfering with the free flow of the game. But they enforce the rules and regulations developed to keep the game orderly and protect the participants. Perhaps a football game would go smoothly for a bit without referees, but I would not want to be at the bottom of the second or third pileup.

Rebuilding effective regulatory policies and agencies will take time, but that work is absolutely essential. Not every business will follow the call to build trustworthy practices. Only the hammer of fair and consistent regulatory penalties and fraud laws will deter wrongdoers.