WASHINGTON – Badgered by lawmakers, former Federal Reserve Chairman Alan Greenspan denied the nation's economic crisis was his fault on Thursday but conceded the meltdown had revealed a flaw in a lifetime of economic thinking and left him in a "state of shocked disbelief."
Greenspan, who stepped down in 2006, called the banking and housing chaos a "once-in-a-century credit tsunami" that led to a breakdown in how the free market system functions. And he warned that things would get worse before they get better, with rising unemployment and no stabilization in housing prices for "many months."
Gloomy economic reports backed him up. New jobless claims soared to just under 500,000 for last week, and Goldman Sachs, Chrysler and Xerox all said they were cutting thousands more workers. On Wall Street, the Dow Jones industrials bounced erratically all day before finishing up 172 points — after a two-day drop of nearly 750.
The financial crisis even prompted the Republican Greenspan, a staunch believer in free markets, to propose that government consider tougher regulations, including requiring financial firms that package mortgages into securities to keep a portion as a check on quality.
He said other regulatory changes should be considered, too, in such areas as fraud.
Also looking for solutions, another banking regulator told Congress the government was working on a loan-guarantee plan that could help many homeowners escape foreclosure as part of the $700 billion bailout legislation. That plan is being discussed by the Treasury Department and the Federal Deposit Insurance Corp., said FDIC Chairman Sheila Bair, who is pushing the idea.
Greenspan's interrogation by the House Oversight Committee was a far cry from his 18 1/2 years as Fed chairman, when he presided over the longest economic boom in the country's history. He was viewed as a free-market icon on Wall Street and held in respect bordering on awe by most members of Congress.
Not now. At an often contentious four-hour hearing, Greenspan, former Treasury Secretary John Snow and Securities and Exchange Commission Chairman Christopher Cox were repeatedly accused by Democrats on the committee of pursuing an anti-regulation agenda that set the stage for the biggest financial crisis in 70 years.
"The list of regulatory mistakes and misjudgments is long," panel chairman Henry Waxman declared.
Greenspan, 82, acknowledged under questioning that he had made a "mistake" in believing that banks, operating in their own self-interest, would do what was necessary to protect their shareholders and institutions. Greenspan called that "a flaw in the model ... that defines how the world works."
He acknowledged that he had also been wrong in rejecting fears that the five-year housing boom was turning into an unsustainable speculative bubble that could harm the economy when it burst. Greenspan maintained during that period that home prices were unlikely to post a significant decline nationally because housing was a local market.
He said Thursday that he held to that belief because until the current housing slump there had never been such a significant decline in prices nationwide. He said the current financial crisis had "turned out to be much broader than anything that I could have imagined."
Greenspan's much-anticipated appearance before the House panel came as the Senate Banking Committee held its own hearing on what the government is doing now to get out of the mess.
Assistant Treasury Secretary Neel Kashkari, who is overseeing the $700 billion financial rescue effort that passed Congress on Oct. 3, said the administration was not only working to get federal purchases of bank stock started quickly but also the program to mop up troubled mortgage-related assets. He also said the government was working to make sure that directives in the legislation to help struggling homeowners avoid foreclosure were being addressed.
Kashkari said the plan could include setting standards that banks should follow for reworking mortgages to make them more affordable. He said the administration was considering a recommendation to provide government loan guarantees to cover the reworked mortgages to make the program more attractive to banks.
"We are passionate about doing everything we can to avoid preventable foreclosures," Kashkari told the committee.
The FDIC's Bair told the same Senate panel that the government needs to do more to help tens of thousands of people avoid foreclosure.
She said the FDIC was working "closely and creatively" with the Treasury Department to come up with a plan.
Greenspan was asked to defend a variety of actions he took as Federal Reserve chairman — resisting recommendations to use the Fed's powers to crack down on subprime mortgages, for one. And opposing efforts to impose regulations on derivatives, the complex financial instruments that include credit default swaps, which have also figured prominently in the current crisis.
He said that outside of credit default swaps, the bulk of financial derivatives had not caused major problems. He said the boom in subprime lending occurred because of the huge demand for investment opportunities in a global economy, and he blamed the crash on a failure by investors to properly assess the risks from such mortgages, which went to borrowers with weak credit.
As for firms that package mortgages into securities, he said, "As much as I would prefer it otherwise, in this financial environment I see no choice but to require that all securitizers retain a meaningful part of the securities they issue."
On the billions of dollars of losses suffered by financial institutions because of their investments in subprime mortgages, Greenspan said he had been shocked by the failure of banking officials to protect their shareholders from their bad loan decisions.
"A critical pillar to market competition and free markets did break down," Greenspan said. "I still do not fully understand why it happened."
SEC Chairman Cox told the House panel that "somewhere in this terrible mess, laws were broken." And Snow said that lawmakers should have responded more quickly to his pleas for stronger regulation for mortgage giants Fannie Mae and Freddie Mac, which were taken over by the government last month.
In the meantime, Kashkari, the Treasury official overseeing the bailout program, said there has been much progress, resulting in "numerous signs of improvement in our markets and in the confidence in our financial institutions." Still, he cautioned, "the markets remain fragile."