Don't Use Fed as "Magical Piggy Bank": Greenspan

Troubled by the Bear Stearns debacle, former Federal Reserve Chairman Alan Greenspan is advocating a new way of dealing with government bailouts of companies whose sudden collapse could wreak havoc on the country's economic and financial stability.

Greenspan says Congress needs to give the government new powers to handle troubled companies to minimize any potential losses to American taxpayers. A self-described libertarian Republican, Greenspan has a reputation for being wary of giving the government extra powers.

However, in crisis situations, there needs to be a clear process for handling bailouts, rather than depending on the Fed to do so, he reckons. A high-level panel of financial officials should be given broad authority to quickly determine whether a failing company poses a sufficient threat to the entire U.S. economy, he recommends. If so, the company would be shut down.

"We need laws that specify and limit the conditions for bailouts -- laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly rather than circuitously through the central bank as was done during the blowup of Bear Stearns," Greenspan wrote in a new epilogue to the paperback edition of his memoir, "The Age of Turbulence: Adventures in a New World." (The paperback will be released Sept. 9; the hardcover came out last year.)

Greenspan envisions the formation of a group akin to the Resolution Trust Corp. (RTC) to step in, take a troubled company into conservatorship, wipe out the equity, impose some charge or "haircut" on its debts before guaranteeing them and then selling its assets.

The RTC was created in 1989 to deal with the aftermath of the savings and loan crisis. It disposed of the assets of failed savings and loans and then went out of business. Costs to taxpayers would still be a concern, he acknowledges. As with the RTC, however, the public cost could be minimized, he says.

Moral Hazard

Critics in Congress, in academia and elsewhere worry that the Fed's unprecedented actions -- including financial backing in March for JPMorgan's takeover of Bear Stearns -- are putting taxpayers on the hook for billions of dollars of potential losses. They also say it encourages "moral hazard," that is, allowing financial companies to gamble more recklessly in the future.

Fed Chairman Ben Bernanke, who took the helm after Greenspan, has repeatedly defended the Fed's actions, saying they were necessary to avert a meltdown of the entire financial system, which would have devastated the U.S. economy.

Bernanke's Fed also has taken a number of unconventional -- and some controversial -- actions to shore up the shaky financial system and to get credit, the economy's lifeblood, flowing more freely. It agreed in March to let investment houses draw emergency loans directly from the central bank. And, in July, the Fed said Fannie Mae and Freddie Mac also could tap the program.

For years, such lending privileges were extended only to commercial banks, which are subject to stricter regulatory supervision.

Greenspan, 82, who ran the Fed for 18 1/2 years and was the second-longest serving chief, says he is concerned that Capitol Hill will look to the Fed's actions "as a wondrous new font of seemingly costless federal funding -- a magical piggy bank." The United States has long "abandoned the notion that we should leave crises to be resolved solely by the marketplace," Greenspan says in making the case for new powers in this area.

The ex-Fed chief says he is skeptical of a sweeping plan, put forward by Treasury Secretary Henry Paulson, that would turn the Fed into a uber cop of sorts -- responsible for policing financial market stability.

"Much as we might wish otherwise, policymakers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances," Greenspan says. Greenspan calls the current crisis "one of those rare, once in a century or half-century events." The full closure on this crisis is "a way off," he says.

The U.S. economy, he observes, appears to be "on the brink of recession." And, worldwide inflation, he warns, is creeping, which will pose a challenge to central bankers, he says.

Looking back, Greenspan says governments and central banks probably could not have altered the course of the once high-flying housing market and broken through investors' fevered euphoria.

He believes that the government should have gone after fraudulent mortgage practices, however. "Bank regulators, who are expert in accounting, banking law and risk management, are not equipped for this job," he says. "It requires law-enforcement professionals."

Greenspan has taken much criticism for failing to crack down on dubious lending practices that eventually came to roost with the subprime meltdown and for failing to act as a forceful banking regulator. He also has been blamed for keeping interest rates too low for too long, feeding the housing bubble.

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