Former Federal Reserve Chairman Alan Greenspan said in an interview with Bloomberg Television’s “Conversations With Judy Woodruff,” airing today, that Congress should let former President George W. Bush’s 2001 tax cuts expire as scheduled at the end of this year.
(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)
JUDY WOODRUFF: Doctor Alan Greenspan, thank you for talking with us.
ALAN GREENSPAN: My pleasure.
WOODRUFF: Fresh evidence this week of a slowdown in the economic recovery. You’ve said recently that you think this is a typical pause. When do you think the economy is going to start strongly going again? What is it going to take?
GREENSPAN: Well, let me add to that, because I also said in a quasi-qualification that we have just been through, and indeed are still in the throes of, the greatest financial crisis globally ever. We have never seen a shutdown in the availability of short-term credit of the extent to which that occurred around the world following the bankruptcy of Lehman Brothers in September 2008.
So this is a different world. I nonetheless do conclude on the basis of all the balance of the evidence that what we are going through now is the typical pause that usually is associated with recovery. But this is not going to be a full-blown recovery.
WOODRUFF: So what do you think the GDP is going to be this year and next year?
GREENSPAN: Well, it is going to be slow. The second quarter, which looked to be in April fairly robust, now looks to be down to 2.5 percent growth rate. And we have not yet got all the figures for the month of June. We are estimating and guessing at certain of these numbers.
But there is no evidence that there is a big pick up coming, but there is also no evidence of an actual double dip. So, I think it is sluggish. We should be in the area maybe of 3 percent growth for the rest of this year, after we come out of this temporary slump.
WOODRUFF: And when do you -- what do you think the jobless rate, which is now 9.5 percent, is going to be a year from now?
GREENSPAN: It will be lower, but not all that much lower. The strange fact about this is that what has kept the -- part of the reason why the unemployment rate has stayed high, as the economy has come back, is there was an extraordinary amount of squeeze going on in the corporate sector having as is invariably the case a major expansion of output. They were not looking at their cost structure. They are now, and they squeezed it down to the point where probably it cannot go much lower.
WOODRUFF: So how long before we get back to even 6.5, 7 percent unemployment?
GREENSPAN: That is not this year and probably not next.
WOODRUFF: Befitting a central banker, you have always -- you have long expressed concern about deficits. They are bigger now than ever before.
Everybody seems to be worried about the long term deficit issue, but in the short term, there is a debate about whether something should be done right now. The chief economist for Goldman Sachs, Jan Hatzius, for one, is saying the economy clearly needs a boost now from a government stimulus. Is he wrong?
GREENSPAN: No, he is not wrong, but it is less conclusive than he stipulates. The reason is we do not really know the full impact of government stimulus. We can estimate the number of dollars of GDP which are created by certain government expenditures, because they are part of our actual GDP. And we probably could measure it, to a certain extent, the gross additions to jobs from that.
WOODRUFF: Would that argue then for a government stimulus now?
GREENSPAN: No, it would not largely because of the fact that the argument goes -- and it is again difficult to prove -- that one of the reasons why there is such uncertainty and risk aversion in the business community is fearful, of the inability on their part to judge what actions are coming next, and uncertainty is the death knell of capital markets.
WOODRUFF: And you are saying government intervention -- government spending would be uncertainty?
GREENSPAN: It is the size of government, it is the issue of the fact that an ever-increasing part of the American economy in the last year or so has moved under the aegis of government. And because it is very difficult to forecast what the actions of government is going to be, that creates an attitude on the part of the business community which is retrenchment, and you can see it everywhere.
WOODRUFF: Is the United States more likely, Doctor Greenspan, to experience a debt crisis like what Greece has gone through, or a slow growth deflationary crisis like what we see Japan experiencing?
GREENSPAN: It is going to depend very much on what we do from here. There is a growing fear, political set of pressures to come to grips with the deficit. I think it going to be far more difficult than anybody imagines. We are in a state of years -- a decade -- of major increases in federal spending and major tax cuts, none of which other than with borrowed money.
WOODRUFF: Financial reform -- President Obama is shortly going to be signing a sweeping reform of financial regulation. You said last week that unless significant changes were made in that legislation, that you would be uncomfortable with it becoming law, in part because these new consumer protections in your view would reduce lending. But my question is, if everybody is following the rules, why would you expect that there would be less financial activity than before?
GREENSPAN: Well, first of all, it is quite apparent that if you are making more stringent rules -- and I am not against that, I think that is the right thing to do -- you are restricting the amount of credit. We have not had a single subprime mortgage loan since January 2008. That market at the moment is dead.
I mean, I have always thought it was very useful to have what turned out to be a very small, but very effective, subprime market until securitization took hold in 2004. And it expanded minority home ownership and I thought that was all to the good. That has now come to a dead halt.
There are a lot of loans made currently by the banking system which are marginal. These loans will be eliminated and those marginal loans are largely the lower credit risks, lower income groups, and people who before would be going to pawn brokers. I do not think that is necessarily a good trend.
WOODRUFF: Can this consumer agency be truly independent if it is housed inside the Federal Reserve?
GREENSPAN: I do not know, but there is a much broader question here which relates to this. And that is, we in fact do not know what the consequence of this legislation is going to be. And the reason that an inordinately large part of it relegates to the regulators the -- it empowers them to make all sorts of rules on the principles put forward in the legislation. That is a very broad discretionary range.
And I can go read through the 2,000-plus pages, which I have not done, and I will learn a lot about what the act is about. That will tell me a lot less than you might imagine as to what it actually is mandating, because until you get a regulation essentially promulgated by the individual regulators who are empowered to do so, you have no idea what the impact is going to be.
WOODRUFF: Do you believe that this reform legislation leaves the Fed stronger or weaker?
GREENSPAN: Well, it leaves it slightly weaker in the sense of its structure.
And I was very concerned early on, when there was discussion of taking away supervisory authorities of the so-called community banks in this country, or some of the community, I should say, some of the community banks. I thought that would have been a very bad mistake. They did not do that.
And the type of structural changes they made in the nature of the Federal Reserve banks is minimal. I would prefer they did not do it, but overall I would say it is a wash. Strangely, the additional power that the Fed has been given, I had not been in favor of. I do not think they can actually prevent the next crisis.
What the mistake -- fundamentally, in a regulatory structure was -- is we misjudged the amount of capital financial institutions needed to have to meet the provisioning for losses.
If we had adequate capital, Lehman Brothers would not have failed. And if they had, for example, 15 percent capital instead of 3 percent, and if Bear Stearns had similar numbers, they would have lost a great deal of money, but it is their shareholders who would have lost the money, not their lenders. What causes contagion is default of debt, and if you had adequate capital, by definition you prevent that.
WOODRUFF: Quick follow -- do you think banks today are adequately capitalized?
GREENSPAN: No, I do not. By that, I mean that they are not lending freely, and the reason they are not lending freely is they do not believe they are going to get their money back. And what that is essentially saying is that until you get capital up -- in my judgment -- a couple of percentage points more than it is, at least, you are going to find that banks are not going to feel sufficiently free to lend.
And there is -- two concepts here, which I think is important to recognize. One of regulatory capital; the other is what the market requires. The market right now is requiring more than they actually have. Regulators are moving up to where the market requirements are. They are not there yet, but they will get there. And that is where we should be because, right now, our financial institutions are undercapitalized.
WOODRUFF: Looking back for a moment, you get asked this question all the time, are there one or two decisions you made when you were Fed chairman, in light of this financial crisis, that you would have made differently?
GREENSPAN: Well, the major mistake that I made, in retrospect -- and indeed, unfortunately, most everybody made pretty much the same mistake -- is we misjudged what economists call the negative tail of the probability distribution of risk. I know that is pretty highfalutin and complex. But it is very critical, because how you made that judgment as to what that tail was, and we had no historic evidence of what it was, was critical that the amount of capital required.
We all acknowledge the fact that it was probably what we called a fat tail, which meant there was more risk than usual. What we did not recognize is that it was really obese.
WOODRUFF: You embraced the tax cuts of former President Bush, George W. Bush, in 2001, with the caveat that this hinged on keeping the deficit under control. In retrospect, do you wish that you would have spoken out any louder as it became clear that that deficit was growing?
GREENSPAN: Well, I thought I did. In fact, there are all sorts of hearings. I remember conversations between Barney Frank and myself, where he was saying, in a sense that, do I understand you essentially saying that effectively unless the second tranche of the tax cut -- which was then occurring in the context of deficits -- was adjusted by pay-go -- meaning financed -- that you would not support it. And the answer was I would not support it. And I did not support it.
The trouble is, there is a very selective reading of history out there. I mean, I find it unfortunate, but there are a lot of things that happened which I discussed in great detail and it sort of is -- my main concern myself is the fact that we ought to go back and look at the records.
You know, for example, the Federal Reserve has been accused of being lacking in regulation of subprime mortgages. That is actually not accurate. We did everything that Congress requested us to do, because we had very little discretion in the regulatory area. So the Fed is being tarred as being lax in the subprime area, where in effect we were doing everything that Congress was asking us to do.
WOODRUFF: On those tax cuts, they are due to expire at the end of this year. Should they be extended? What should Congress do?
GREENSPAN: I should say they should follow the law and let them lapse.
WOODRUFF: Meaning what happens?
GREENSPAN: Taxes go up. The problem is, unless we start to come to grips with this long-term outlook, we are going to have major problems. I think we misunderstand the momentum of this deficit going forward.
This argument of stimulus versus non-stimulus, in my judgment, is not a critical issue, in one sense. We are going to be doing very well if we can keep the deficit to where we are now projecting it. The notion that we are somehow going to bring it in far more sharply is just utterly, politically unrealistic.
So it is not a question, do you have more stimulus now or do you have basically a significant contraction in the deficit? We are going to have continued expansion in government spending and increasing debt, because there is no evidence that we are closing the debt -- the gap between receipts and expenditures yet. And it is going to be very tough to go up against the momentum that is currently going on.
WOODRUFF: So to those interests who say but wait a minute, if you let these taxes go my taxes go up, it is going to depress growth?
GREENSPAN: Yes, it probably will, but I think we have no choice in doing that, because we have to recognize there are no solutions which are optimum. These are choices between bad and worse.
WOODRUFF: You and Paul Volcker -- the two men probably most associated with the Federal Reserve, the central bank in this country -- seem to have vastly different views now on Wall Street, the banking industry, financial regulation, the economy. Has one of you changed or has this always --
GREENSPAN: Oh, no, I think we are sticking to our basic long-term positions. I would disagree with much of what Paul Volcker is saying, but you have to understand that if you take the whole array of bankers and central bankers, you will find we are a largely independent lot and the coming together on all issues is unlikely. And I would say that in many respects -- I would say that the vast majority of issues, I say we probably agree -- we agree.
WOODRUFF: Democrats like Larry Summers, Tim Geithner, Paul Volcker; Republicans like Henry Paulson, current bank regulators like Sheila Bair - all seem to have a more favorable view of financial regulation. Is Alan Greenspan the outlier here?
GREENSPAN: Partly, but not wholly. I mean, I have changed my view. In other words, I have essentially argued, as indeed the vast majority of people in the financial sector are arguing, that counterparty surveillance, meaning the individual financial institutions, would have a far better understanding of what the risks are in lending than the regulators.
You have to remember, regulators cannot do all that much beyond what is done with the internal auditors of banks, the outside auditors. We bring to bear a broad issue. Now, what has in fact turned out to be the case is, that fundamental premise has turned out to be wrong. You cannot, and we were not able to, do that, and one of the reasons is we had inadequate capital.
So does that mean we have to change? Yes, we do have to change. And I am in favor of change. It is just the question, I want to make sure that the change makes sense, addresses the problems that really exist and not those which are fantasy.
WOODRUFF: I gather you do not think about this a great deal, but how do you think the events of the last few years will change or shape the Greenspan legacy?
GREENSPAN: Well, most -- I think other people worry about that more than I. That is not something over which I have particular control. And the fact of the matter is, I just go on doing what I am doing, say what I think is correct.
I will be wrong a significant amount of the time because I am a professional forecaster. If we get it right in forecasting where the economy is going, or where the markets are going, better than 50 percent of the time, we are doing very well. And I do very well. I have done very well since I have been in this business, for over 60 years.
So there were ups and downs. There were adulation that I was given years back which I did not deserve. There is criticism I am getting today which I do not deserve. So it balances out.
WOODRUFF: Doctor Alan Greenspan, we are delighted to have you as a guest. Thank you very much.
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