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Greenspan Made ‘Complete Mistake’ on Oversight, Millstein Says

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Greenspan Made 'Complete Mistake' on Oversight
Jim Millstein, chief restructuring officer for the U.S. Treasury Department, testifies at a Congressional Oversight Panel hearing in Washington. Photographer: Melissa Golden/Bloomberg

Oct. 8 (Bloomberg) -- Alan Greenspan blundered by limiting oversight of financial firms when he led the Federal Reserve, the U.S. Treasury Department’s restructuring chief said.

“Regulators fell down on their jobs, overcome by the belief in the power of markets to self-regulate,” Treasury’s Jim Millstein said at a conference yesterday in Dallas.

“That attitude was epitomized by former chairman of the Federal Reserve Alan Greenspan’s belief that the management of the big banks had so much of their equity at risk that they could be counted on to be prudent,” Millstein said. “And therefore he relaxed prudential risk management and oversight among the regulators. And, as we now know, that was a complete mistake.”

Millstein is working to unwind the Treasury Department’s $49.1 billion investment in American International Group Inc., the insurer that was bailed out in 2008 after losses on wagers tied to subprime loans. Financial firms including Citigroup Inc. and Bank of America Corp. also needed government aid to recover.

The Financial Products unit at New York-based AIG that made derivative bets on mortgages was the “ultimate rogue” in the system, Millstein said during the conference at the University of Texas at Dallas sponsored by the Institute for Excellence in Corporate Governance. Millstein said his remarks at the event reflect his personal views and not those of the Treasury.

Boards of companies that required bailouts are also at fault for increased leverage, Millstein said.

“They can’t be golfing buddies with the managers,” Millstein said of directors. “Management will always have an inherent bias in increasing leverage because it’s a way of increasing compensation.”

‘Credit Tsunami’

Greenspan, 84, told Congress a month after AIG’s bailout that a “once-in-a-century credit tsunami” had engulfed financial markets and conceded his free-market ideology shunning regulation was flawed.

“Yes, I found a flaw,” Greenspan said in response to grilling from the House Committee on Oversight and Government Reform. “I was shocked because I’d been going for 40 years or more with very considerable evidence that it was working exceptionally well.” Greenspan added he was “partially” wrong for opposing the regulation of derivatives. An aide to Greenspan had no immediate comment yesterday.

Greenspan, who pointed out at the hearing that he voted for every regulatory action the Fed moved on, opposed increasing financial supervision as Fed chairman from August 1987 to January 2006. He said the Fed didn’t know the size of the subprime mortgage market until late 2005.

‘A Nightmare’

President Barack Obama in July signed a financial overhaul meant to help prevent failing firms from threatening the financial system while ensuring companies bear the costs of risks they take. The Dodd-Frank Act gives the government powers to unwind failing firms, creates a risk regulator in charge of systemically significant companies, imposes new rules on derivatives markets and forms a consumer-protection agency.

The U.S. must raise taxes and cut spending to deal with its budget deficit, Millstein said. The shortfall was forecast by the White House to be a record $1.47 trillion for 2010 and $1.42 trillion for fiscal 2011, which started Oct. 1.

“The budget deficit will become in three or four years, if we don’t persuade the bond markets that we’ve got it under control, it will be a nightmare for us the way it has become a nightmare for Greece,” said Millstein, a former Lazard Freres & Co. managing director.

Greece’s credit rating was cut to junk by Standard & Poor’s in April amid concern that worsening sovereign finances may undermine the global recovery.

‘More Angry’

AIG was previously overseen by the Office of Thrift Supervision because the insurer has a lending operation. The insurer said in August that the Federal Reserve could become its regulator if the firm is deemed a savings and loan holding company or a potential risk to financial markets.

Fed Chairman Ben S. Bernanke told lawmakers last year that AIG operated like a hedge fund and that having to rescue the insurer made him “more angry” than any other bailout of the financial crisis.

“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke said in a March 2009 hearing in Washington.

To contact the reporter on this story: Hugh Son in New York at hson1@bloomberg.net; Natalie Doss in New York at ndoss@bloomberg.net

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net

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