WHEN: Today, Thursday, July 1st at 7AM ET

WHERE: CNBC's "Squawk Box"

Following is the unofficial transcript of a CNBC EXCLUSIVE interview with former Federal Reserve Chairman, Alan Greenspan, today on CNBC's "Squawk Box" from 7-8AM ET.

All references must be sourced to CNBC.


LIESMAN: For the next hour, former Federal Reserve Chairman Alan Greenspan is our special guest. We'll be discussing issues affecting Wall Street and Washington, from Europe to jobs to the housing market and, of course, his outlook for the economy. Mr. Chairman, thank you for joining us.

Mr. GREENSPAN: Good morning.

LIESMAN: I think there's only one place to start. The stock market, the bond market looks like they're forecasting a pretty severe downturn or slowdown in the economy. Is that your view?

Mr. GREENSPAN: No, it's not my view. But I'm fully recognizing that the one thing that we don't pay enough attention to in the economics profession is the fact that the stock market is not merely an indicator, it's a cause of economic activity. It's not paper profits, but the capital gains themselves have very significant economic consequence. I mean, we're all aware and I think it's obvious that that's true in the consumer area. I mean, for example, up through March for maybe a year we had $800 billion increase in the market value of 401(k)s and other defined contribution plans. A significant amount of that is actually spent because the data show that most people do not distinguish income that comes in their paycheck and that shows up in their 401(k)s. Now, what this actually means in practice is that it is the large--it's higher income brackets which do most of the spending. I shouldn't say most, but it's close to half. In other words...

LIESMAN: Mm-hmm. Right.

Mr. GREENSPAN: ...approximately the top 20 percent in the first quarter accounted for probably 45 percent of total personal consumption expenditures. And that's been rolling the economy together with, obviously, other forces, which has been the dramatic inventory swing, the TARP helped a great deal. I know it's called the bank bailout. I call it the TARP. But it was actually a quite positive phenomenon. The problem is that we have, for example, a weekly industrial production index which works pretty well. It rose fairly significantly until the last week in May and then stopped dead. And indeed, what we're looking at is an invisible wall which we've run into here which essentially, as far as I can see, is a typical pause that occurs in an economic recovery.

And for--I will--I will grant you that this is not a normal economic recovery. We've just come out of what I believe is the most extraordinary and virulent global financial crisis that the world has ever seen. Now, this is not an economic crisis. I mean, obviously, the Great Depression was a much greater problem than we're going through now, as bad as it is. But there is no doubt here that we are in the midst of a very extraordinary set of events. And I think we have to recognize there are a lot of things going on. For example, it's--as I've said previously and it still exists in the data, this recovery has been and continues to be dominated by large banks, higher income individuals and bigger business. You know, small business is in real serious trouble.

LIESMAN: The ADP data shows that large businesses are doing most of the hiring.

Mr. GREENSPAN: Yeah. Well, I think that is very...

LIESMAN: Which is the opposite of the way it normally is, right?

Mr. GREENSPAN: It sure is. In other words, we usually perceive small business carrying the load of recoveries, and it has been in extraordinarily difficult shape.

QUICK: Is that--is that because the small businesses can't get loans?

Mr. GREENSPAN: Well, in part that's the issue. But remember, the problem there is that the small banks which are used in many of the smaller communities as their source of funds are loaded up with commercial real estate.

QUICK: Right.

Mr. GREENSPAN: And commercial real estate loans are the least best of all possible investments one can conceive of, so they're not lending.

QUINTANILLA: When you refer to this invisible wall, are you suggesting that the market is scaring itself over elements that aren't that scary, or scary enough to warrant the correction?

Mr. GREENSPAN: Well, I'm always reluctant to try to indicate why I think the market is doing what it's doing. I understand that's you're job and you've got to do that, and I'm glad to watch you, but not want to participate. What we do know is that stock prices are a leading indicator, and that means that at turning points by definition they don't move with the rest of the economy.

LIESMAN: But the joke is that--we said it the last hour--the stock market has correctly predicted 10 of the last five recessions. So as a leading indicator, it's not perfect, I guess, is...

Mr. GREENSPAN: No, it is not. But is a leading--it's an official leading indicator in all of the analysis, the...(unintelligible).

LIESMAN: All the advice, right.

Mr. GREENSPAN: But the issue here is it's obvious that you can see the realized capital gains beginning to squeeze a little bit. And remember, what really moved this whole financial system back up to normal is capital gains throughout the system. We had a huge increase up through mid-April or late April in equity values in the United States, but most importantly throughout the rest of the world. And that has actually filled out a lot of the disruption or reversed a lot of the disruption in financial intermediating. Remember, it was the collapse in equity values which disabled financial intermediation during the crash. And it's the comeback, we're about halfway, around the world--it's interesting, because everybody's stock market moves the same, which isn't a new phenomenon, in my experience. But that tells me we're in a global economy that's being driven to a very large extent by the emerging east Asian economies which are now beginning to falter a little bit because China is running into obvious problems. So it seems to me that while ordinarily we're saying that the stock market is driven by economic events, I think it's more in the reverse.


JOE KERNEN, co-host: It's interesting, Mr. Chairman, because yesterday we had this discussion that perhaps the bond market might be sending a false signal in the 10-year in that maybe it's fear, not an imminent slowdown in economic activity, that's causing it to trade at these almost crisis levels in the--in the two-year--in the 10-year. And we had a case made by two guys that did invest in stocks that multiples, yields, the attractiveness of the stock market vs. the bond market, that all of these things--add corporate profits that we're expecting for the second quarter, all of them are looking strong, and that maybe this is a time where the bond market isn't going to be right about whether there's a double dip.

Mr. GREENSPAN: Well, I think the bond market--the 10-year note all a sudden took a swoon down in rates. And that's more coincident with the European situation because prior to that, through the month of March, we had the very unusual circumstance where I think for the first time ever the 10-year swap rate yield was under the 10-year Treasury. And that suggested basically that there's this huge overhang of securities in the market which is pressing down on the 10-year note and actually, if anything, moving the rates up. We got a reprieve from Europe. And the huge turnaround--what the euro/dollar exchange rate is reflecting is a very dramatic shift in the availability of safe haven funds from Europe to the US and, as I wrote in The Wall Street Journal editorial op-ed piece the other day, I think we're running into problems with respect to borrowing capacity, and that's what the markets are saying to us. But this recent decline is more international than it is a domestic affair, as far as I can see.

QUICK: How bad are the problems in Europe right now? I mean, is...

Mr. GREENSPAN: Pretty bad. Bad in the sense that there's an inherent instability in the euro system. And the best way of thinking about that is to recognize that when you have a single currency for a group of currency--for a group of countries, it's important that they all have very much the same culture with respect to spending and deficits and the like. And as a consequence of that you have a stable system, and that's what everyone expected to happen. Namely, everyone recognized, for example, that a number of the members of the euro--eurozone were not as conservative as the Germans. But there was this odd view that once they got into the euro they'd look like--or they'd talk like Germans or they'd act like Germans. Now, in fact, they didn't. If you look at the cost structures within the euro--16 eurozone countries, it's very obvious that all of the countries that are, say, below Milan, the southern segment, have been increasing their cost structure in recent years at a much faster pace than Germany or the Netherlands, Finland. And the consequence is that they're beginning to run large deficits and they have to keep borrowing. But as we're observing now in the so-called peripheral European states, they're having great difficulty in borrowing.

LIESMAN: So, Mr. Chairman, I just want to come back to the US for a second. We're going to talk about Europe a little bit later. The centrality that you put to the stock market for the economy, it must mean that you think raising the capital gains tax rate, or the dividend tax rate would be disastrous for the US economy.

Mr. GREENSPAN: I don't use the word disastrous but...

LIESMAN: I used it for you.

KERNEN: I was going to go the same place, Steve.

Mr. GREENSPAN: No, I'll--well, I think you can keep it. I will--I will say it's ill-advised.

LIESMAN: Ill-advised over any time frame, if it was next year or two years or...

Mr. GREENSPAN: Well, the problem basically is that if you're going to argue, as I would, that we don't look at the asset values of the world as a determinate of economic activity in the way we should, if that is the case, what you want is a maximum flow of capital and essentially a ability of corporations to invest. And one of the interesting correlations which I've said has been existing for years, and it's working today, is that capital investment is to a surprisingly large extent driven by stock prices. Now, I'm fully aware that the econometric models don't work all that well. But little simple equations...

LIESMAN: The argument of those in favor of raising the capital gains tax are going to say, `Hey, we had a fantastic and buoyant market at the older, higher rate.'

Mr. GREENSPAN: I'm saying that capital gains taxes are not the only factor, and very powerful forces, positive forceare operating. The markets will go up irrespective of that. The--I mean, for example, when we used to have the marginal tax rate at 90 percent, the economy didn't collapse but it was being inhibited. So you got to distinguish between where we are in all other effects. There are so many things that affect the world. You can't take one thing and say that's doing it.

KERNEN: Mm-hmm. So...

QUINTANILLA: We've heard from a number of executives in recent weeks and months arguing that this administration's policies inhibit job growth and capital investment in this country. Do you think they do?

Mr. GREENSPAN: Some do, some don't. But remember that one of the major problems in job growth in this country is the extraordinary rise in productivity. I mean, we keep a monthly series on nonfarm business productivity, and I will tell you right after the Lehman bankruptcy it just took off. And indeed, through May it's still showing a fairly pronounced pace. I mean, for example, the annual rate from May to three months earlier is over 3 percent, and that is a low rate for the recent period. What that is is, of course, that the shock of the collapse scared business silly, and they pulled back in all sorts of ways. And that created a tremendous increase in measured output per hour. Now, that's not--some of it's real productivity, because there's an awful lot of waste that went on in a big expansion part of the cycle. And it's invariably the case, when you get into the other side, you begin to find wonderful areas in which you can literally improve productivity. But this is much too much. There is clearly a short-term fear factor involved. People don't want to hire because they're terribly concerned they may have to let them go. And one of the ways you can tell, and it's going to be very interesting to see tomorrow what the numbers look like, but the average workweek has been going up, which is another way of telling you that they're more intensively using what they got before they're hiring.

KERNEN: Mr. Chairman, it's a tough time to make a case for Wall Street politically in--after--we've now assigned the crisis and the causes to Wall Street. That's--you know, and it's resulted in fin reg. But I remember initially we said we need TARP because Wall Street is Main Street. That's been the loss, though, in the populist response to what's happened. And I--just hearing you, it almost sounds antiquated to say what's good for Wall Street is good for Main Street. I mean, I agree with you and I--it's--I think it's essential.

LIESMAN: He didn't make any friends in the American public by saying that.

Mr. GREENSPAN: I--no, no, I--I'm actually going to put it the other way around.


Mr. GREENSPAN: That if Main Street doesn't prosper, neither can Wall Street. Because remember, if you look at the distribution of incomes in this country, you will find that the income originating in the financial sector, let's say finance and insurance, has been rising quite considerably over the years. And all of the income that is engendered within the financial area has got to be initiated by services required by the nonfinancial system. Wall Street can sit in its own little room and debate and do their...

LIESMAN: But it's zero sum.

Mr. GREENSPAN: It's a zero sum game and they can't produce a single cent. Whereas the data...

QUICK: But right now Main Street's...

LIESMAN: That's a really important point.

KERNEN: But how about fin reg?

QUICK: But right now Main Street's not doing so great and Wall Street's doing just fine. Is that just a temporary blip?

Mr. GREENSPAN: I wasn't aware of that fact. The last time I looked it wasn't doing too well.


QUICK: Well, Wall Street may be on that. But if you look back at the amount of--the salaries that are there, if you look back at how things have gotten better on Wall Street, how there's been hiring that's come back to Wall Street and not necessarily to Main Street, is that just a temporary gap until it catches up?

Mr. GREENSPAN: Yeah. Maybe I'll get to this later, but there's a very important question here as to whether in fact the level of financial services and their complexity, and the whole infrastructure is essential to maintain the level of productivity in the nonfinancial area. This is an argument which I think is going to arise because if indeed the regulatory system is going to squeeze down on the profitability of Wall Street, we're going to find problems emerging in Main Street. I mean, as you know, the major thrust that's come against some of the proposals on over-the-counter derivatives has come from the major corporations who use those vehicles.


Mr. GREENSPAN: They didn't 30, 40 years ago. This is new. And what they are doing is endeavoring to develop a risk profile which is optimum to them. The average CEO 50 years ago didn't even understand the concept. And so there's a very interesting question here as to will we overdo this regulatory structure. I frankly don't know. I mean, I think that we have to have higher capital. I think the cause fundamentally of what the crisis was all about is all of our sophisticated risk management systems broke down. And they broke down largely because we in the business of trying to judge risk significantly underestimated the extreme tail risk, the so-called--the risk involved in very low probability events and what their consequences would be should they happen. And we, up until the Lehman bankruptcy, we had pretty much gotten an idea of what that distribution looked like, because we had a number of crises, we could measure it. We never had the tail risk at the tail end measured. And when we saw it in real life, after September of 2008, it was downright scary. But it was that which meant that we did not have enough capital in place for running the system. And so I argue that we need a good deal more capital. I'm arguing, from analyses I've done, we're going to need something like 4 percentage points increase in capital...

LIESMAN: So if we're 8 now, if there's 8 cents behind every 100 dollar--every dollar, you want to go to 12? Is that what you're saying, 4 percentage points?

Mr. GREENSPAN: No, I--no, I'm saying, first of all, that prior to the--prior to the, let's say...

LIESMAN: Let me just--let me just...(unintelligible)...this is important because we're having a global debate over this right now...

Mr. GREENSPAN: Yeah. OK. Yeah, yeah, I understand.

LIESMAN: ...over what the appropriate capital levels are.

Mr. GREENSPAN: Yeah. No, I'm fully aware of that. I'm saying this, that as I discuss in some detail in a Brookings paper that is now--I just saw the--saw the page proofs and OK'd them, so it should be out reasonably shortly, but what that is showing is what the market investors are requiring. I mean, there is no such concept as government decides what the number is and then it imposes it. I mean, I can tell you all of the discussions about what capital should be, all--in Basel, for example, where they do a good deal of this intergovernmental discussion, were all in the area of looking at what private companies have the best risk management systems, and we would try to replicate that. Because remember, there are numbers of Nobel Prizes that were given for risk management. And so what we're dealing with here is a very tricky problem where we just didn't know when we should have known. And having not known, we undercapitalized the system. And that means implicitly that there is this subsidization going on in the private sector for everything except the tail risk.


Mr. GREENSPAN: And when the tail risk shows up, we pay the price. Or I should say, the taxpayers paid the price.

QUINTANILLA: So if you're in favor of higher capital requirements...

Mr. GREENSPAN: I am. I'm basically saying--I'm not saying that I am, I'm saying the market is going to require that.

LIESMAN: The market is.

QUINTANILLA: Oh, I understood.

KERNEN: We could have done that in one page. We have 2299 other pages.

QUINTANILLA: Right. I--are you--are you ready to pass any judgment?

KERNEN: I mean, are any of the other pages...

Mr. GREENSPAN: Have you read them all?

KERNEN: No, I haven't.

Mr. GREENSPAN: No? I don't know anybody who has, myself.

KERNEN: Net positive or net negative to, I mean, not just Wall Street, but to the overall economy, in your view?


KERNEN: And I know you're never political, but, I mean, are we doing--we're overdoing it again and we're going to kill the--kill the goose?

Mr. GREENSPAN: We always--we always--we always overdo it.

KERNEN: Right.

Mr. GREENSPAN: I mean, the forecast I will make here with some degree of confidence, you will see another technical correction bill coming out within a year. There's got to be unanticipated consequences to what's going on. I frankly don't know all that can conceivably occur because I took a look at the bill and I went off and played golf. I mean, it just struck me as an impenetrable problem that you have when a lot of the sentences in that bill are written by junior people who are staff members either on the Hill or in administrative agencies, and they don't really fully understand what they're doing in certain cases.

LIESMAN: They're not...

QUINTANILLA: You--you're not suggesting the bill was written irresponsibly?

Mr. GREENSPAN: No. It was written like it's written always in the--the strange thing about it is that the one--the big undisclosed secret is that when the Congress passes legislation or is in the process, they always came to the Federal Reserve to tell--to write the legal language. So as far as banking regulation is concerned over the years, it's really been very responsibly done. But we haven't had anything like this. And look, the crisis has been such a shock to the American people. That there should be a response is wholly appropriate, and it would be inconceivable to me if it were not otherwise. So that there would be a lot of increased regulation is something which in fact, from my point of view, is probably appropriate. I made the assumption, because I've been around for a long time and observed the fact that you can depend on the private risk managers to protect their own equity in the financial system.


Mr. GREENSPAN: I mean, I served on the JPMorgan board for 10 years, and believe me, they had a AAA rating at the time and that was sort of the holy grail. And so my basic view was that in the complexity of this system you have to depend on the owners or the managers or whatever stakeholders there are in a financial system to protect their equity; I mean, to protect the value of the firm. And when you got Bear and Lehman down to 3 percent tangible capital, I mean...

LIESMAN: Mm-hmm. And to the...


QUICK: What went wrong then? Did they not realize what...

LIESMAN: But you were wrong--you were wrong about that. You acknowledged being wrong about that.

Mr. GREENSPAN: I was, I was. Oh, yes, indeed. In other words, I have watched regulation function close up for 20 years, and it doesn't work very well. And the consequence is that in the Federal Reserve and indeed of necessity, not the politics, there is nothing that beats counterparty surveillance as a...

KERNEN: By the...

Mr. GREENSPAN: the private sector--it's what the regulators depended on. We don't have enough government regulators. I mean, you know, you got an internal--you got internal auditors, you got outside auditors, and then you've got a small little group of government auditors. I mean, they can't do anything of any great significance that's not uncovered by the external auditors or the internal auditors. So they have to presume that there's enough sensibleness in the system...

QUICK: But what went--what went wrong? What happened?

Mr. GREENSPAN: Well, I think what went wrong, I don't fully know yet and I think we're going to find out over the years. But the system broke down. In my--as I say in this Brookings paper and I think I also did in a book I wrote three years ago, that when you get a period of extraordinary prosperity--I mean, we've--since, well, I guess going back to the early 1980s, from the early 1980s onward through I guess basically mid-2007, we had very shallow recessions. You know, remember the dot-com boom crashed, as all bubbles do, without any significant economic consequences.

LIESMAN: Shallow recession.

Mr. GREENSPAN: Yeah. And so it's very difficult to tell investors that things are somewhat better. I mean, you can even argue, look, if in 20 years the economy is doing well and you say, well, it's got to be temporary, but for the next six months what's the probability that it'll go down? Rationally, not very high. And what happened was that euphoria took hold. You could see it in the very significant declining risk spreads. I mean, one of the things I love to watch, doesn't mean very much, but there's a CCC yield over the US Treasuries, and it's, you know, sort of the extreme you can find in the statistics. That went to a record low in early 2007.

LIESMAN: Is there a role, in your opinion, Mr. Chairman, for the Federal Reserve and/or regulators to step in and actually take action when CCC junk, I assume you're saying, gets to be tight to riskless?

Mr. GREENSPAN: The problem that you have is that history suggests that you can always tell when bubbles are emerging and risk is being very significantly underpriced. But it may be four years before anything happens. I mean, I, in 1996, was getting very nervous about the speculative behavior of the stock market.

LIESMAN: Mm-hmm.

Mr. GREENSPAN: And I'd do what is very rarely done by Federal Reserve chairman and I sort of--sort of put my toe in the water and sort of obscured my concerns in a paragraph which even I don't understand to this day. Then--and in there was irrational exuberance.

LIESMAN: Mm-hmm.

Mr. GREENSPAN: And what I was trying to convey was that there was a euphoria which history tells us leads to problems. Well, you know what happened. The market went down for a day and then it proceeded to rise for the next four years.

LIESMAN: There's history that the Federal Reserve identified commercial real estate concentration and residential concentration under your watch in '04. Now, the bubble didn't burst for three or four years later, but the question remains on the table from a policy standpoint: Is there anything regulators can and should do when they see that kind of behavior?

Mr. GREENSPAN: Well, I think that essentially they do do things. I mean, for example, you know, people are not aware of the fact, but there is a basic book that is published within the Federal Reserve which is mainly for outsiders to understand how the system works. And it lists the three basic functions of the Federal Reserve, which is monetary policy, regulation and systemic risk. So we have been looking at systemic risk for decades. We just didn't call it what they now call it. And one of the real problems I have with the regulatory structure is the presumption that there will be effectively a group of individuals who can sit around the table and judge when a crisis is going to arise. I mean, for example, the IMF, which has got the best group of economists I know, in the spring of 2007, wrote that risk is declining over the previous six months and that the American economy is improving and this is within weeks of BNP Paribas discovering this huge toxic asset. Now, does that mean that they are just inadequate? No. They are as good as they get and it is just not feasible to forecast a financial crisis because a financial crisis...

LIESMAN: Even in a six month window, you can't do it.

Mr. GREENSPAN: In any window.


Mr. GREENSPAN: Because a financial crisis by definition is a sharp, abrupt, unexpected decline in asset prices.

QUICK: Right.

Mr. GREENSPAN: And remember that leading up to the 2007 problems, it was going to be the American current account deficit and the dollar, which is going to be the problem. Well, everybody agreed to that, so what did they do? They proceeded to drive the dollar down sharply from I think it was about 110, it got to 130. They arbitraged away the problem and however one analyzes this current crisis, you don't put the current account deficit of the United States as a critical factor in this issue.


Mr. GREENSPAN: So we cannot forecast. I mean, it's--the fact that a lot of people do is the normal distribution. There'll be some who do and some who don't. There is some--there are very few people in the Street who actually do forecast consistently. I think I know them all.

QUICK: And you can count them all on one hand.

LIESMAN: You said in a recent speech that--recently you said that there's been very little advancement in the success of economic forecasting since the 20s.


LIESMAN: Or since the '30s.

Mr. GREENSPAN: Well, the reason for that is that the wall that you have to get over is rising as well.


Mr. GREENSPAN: In short, back in--back in the '50s, or actually in the late '40s when I started, nobody knew anything, so if you knew a little bit, you were sort of a forecaster. But with that bit of knowledge today, you'd be an assistant clerk.

QUINTANILLA: Well, imagine what they'll say about us 50 years from now. I don't know if I want to hear that. We're going to continue this talk with the chairman in a little bit. Stick around. We're going to have a lot more to come. We'll try to talk some housing, some Europe and some China as well. We continue to watch futures on this first day of the third quarter as we await jobless claims in a little less than an hour's time. SQUAWK will be back in a second.

QUICK: All right, welcome back, everybody, to this special edition of SQUAWK BOX. We are live with former Fed Chairman Alan Greenspan this morning. We've had a wide-ranging interview. We've got a lot more topics to discuss, though.

And Mr. Chairman, you touched on Europe and what you see happening there right now, but what do you think this may mean down the road, what this may mean coming back here and some of the problems it's going to mean for the euro?

Mr. GREENSPAN: Well, as I was saying earlier, the competitive imbalances that are arising in Europe because the cost structure are changing or dispersing when they all have the same currency. meaning, internationally competitiveness is critically spreading out, in other words, dispersing in Europe rather than converging. And one implication of that is that if, for example, the euro were to disable, the value of the Deutsche mark relative to the euro would increase significantly.

QUICK: Mm-hmm.

Mr. GREENSPAN: Whereas the drachma, relative to the euro, would decrease. It's a zero sum game. But that means there are unrealized capital gains in Germany...

QUICK: Mm-hmm.

Mr. GREENSPAN: ...and the Netherlands and elsewhere, and unrealized losses. And the political pull of that worries me. In other words, I don't think the solution in Europe is going to end up being determined in the boardrooms of the finance ministries of the EMU. I think it's going to be on the streets of Athens, Lisbon, Madrid and elsewhere and we're starting to...

QUICK: And Germany, too.

Mr. GREENSPAN: Well...

QUICK: If they get tired of carrying that.

Mr. GREENSPAN: Well, the problem with Germany is the fact that if they become aware of what the pressures on Germany are and what they're foregoing to hold the system together, I mean, as Merkel just ran into problems with what looked like a gimme putt on the presidential election, there could be considerable pressures within Germany.

LIESMAN: And we solved those problems inside the United States through labor mobility and--like, for example, if people in New Jersey are less productive than the people in North Carolina, then there's a movement of capital, there's a movement of labor, and those imbalances work themselves out.

Mr. GREENSPAN: There's no question that when the issue originally arose on the development of the euro was an idea, exactly this point was being made, that language differences and mobility differences differentiated the United States from what was then perceived to be a new Europe.

LIESMAN: Mm-hmm.

Mr. GREENSPAN: And it's clearly been the case.

LIESMAN: So would you say the euro area is doomed? Is it--does--will it not hold together?

Mr. GREENSPAN: No, no. I think that I don't know where the end game is, but something has got to give here. One possibility is there are fewer members of the European Monetary Union. Now this is a very--I mean, it's very easy from this distance looking over there and saying, `Oh, you pontificate.' I know what they're going through over there because I have sit in--sat in on a lot of those types of meetings. It is a very tough call because it's very easy to talk about a destruction of the euro, but the consequences of that are very formidable. I mean, I'm saying there are very major pressures that are working against the euro, but I also fully understand that there is a very good reason why the euro is there. And look, I was one of the early skeptics of it and I was wrong. They made it work and they made it work very well. And Jean-Claude Trichet is as good as they get. And if you look at the makeup of the European Central Bank board, it's really remarkable how many good people they have.

KERNEN: Have you--have you, Mr. Chairman, just shifting gears a little, has recent history caused you to change philosophically your strong beliefs in Randian free market economics? I--is--have you softened at all? Do--are we headed down--we're in the middle of another battle royal vs. government and the free markets.

Mr. GREENSPAN: Right, right.

KERNEN: And I thought we had it settled years ago and apparently we don't.

Mr. GREENSPAN: Well, if you're asking me do I still believe that the most effective type of economic system is market capitalism, I do. The problem we've had here has got nothing to do with the actual mechanism. What it's got to do is a failure to perceive a fundamental problem in the financial markets that most of the practitioners missed. And there's also the basic question that we do have a--ranges of euphoria and fear, which dominate the system and that's human nature, you won't change it. But I anticipated a much more self-interested view on the part of the financial community than in fact I saw. And one of the reasons I think is that I was brought up in an era when investment banking were partnerships.


QUICK: Mm-hmm.

Mr. GREENSPAN: And they wouldn't lend you a nickel overnight. I will say that if you had the type of capital that was behind, say, Lehman and Bear Stearns back then...


LIESMAN: So maybe you're right, maybe you're right. Maybe the problem was that there wasn't any exercise of judgment by--if they're playing with the public's money...

KERNEN: It's all--OPM. Other people's money.

QUICK: Yeah, is it--right.

LIESMAN: Either the government guarantee through the deposit system or...


QUICK: Stocks, yeah.

LIESMAN: ...shareholders, stock money...

KERNEN: Right.

LIESMAN: ...then maybe there just wasn't any exercise at all of the self-interest.

QUICK: Yeah.

Mr. GREENSPAN: Well, the problem is unquestionably when you get a too big to fail...

KERNEN: Right.

Mr. GREENSPAN: ...psychology...

LIESMAN: house money.

Mr. GREENSPAN: It is house money and one of the things I put in this Brookings paper as I sort of, with nostalgia looked at the old investment banking thing, I said, you know, if Bear had, say, not 3 percent tangible capital but 20 percent tangible capital, they'd still be around.

QUICK: Mm-hmm.

LIESMAN: Mm-hmm.

QUICK: That's the...

QUINTANILLA: With that in mind...

QUICK: Just really quickly on that point, is the problem corruption because people didn't care? Is it greed because they were just trying to make an extra dollar or is it just the idea that things are so complicated they didn't actually understand what would happen on the other end of it?

Mr. GREENSPAN: I think it's partly the last, but it is--there is a change where, for example, as I noted in the op-ed piece I wrote for The Journal recently, back in the 1950s, there was a sort of naive view that fiscal budgets had to be balanced the same way that household balances. Now every economist will tell you that's crazy. But you know something? It actually is a factor of solidifying the system. There was a general view about risk and the like, which gradually eroded and I would be the first to say that the degree of sophistication that we mathematicians imposed on the financial system was a little bit differentiated from reality, if I may put it in those terms.

KERNEN: The--we won't--free market capitalism will eventually prevail in this country?

Mr. GREENSPAN: It's not--I think--I don't know what the alternative is.


QUINTANILLA: Well, like Churchill said, there are others, but this is the least worst, right?

KERNEN: Right. Because Americans, I think, do recoil at the notion of when you get away from your individuality in sort of a central planning situation. And they're recoiling already. And I wonder if by November we will know whether free markets are embraced again or whether we continue to decide the government is the answer at this point.

Mr. GREENSPAN: Well, government can't be the answer, especially if we continue our global free trading system. Right now, I am really impressed, if not fascinated, by the fact of how little protectionism there has been.

QUICK: Mm-hmm.

Mr. GREENSPAN: And this really, I think, is a fall back to the Great Depression, everyone recognized how much problems there were. But you can't have a free market global system and tight domestic regulation. I mean, it may well be that we'll put in all the tight regulations and then remember--we remember the development of the--of the euro dollar when we put interest rate caps on deposits...

LIESMAN: Mm-hmm.

Mr. GREENSPAN: ...and all the money moved to Europe and developed what was a remarkable system over there. It never moved back.


Mr. GREENSPAN: Now we're going to lose a lot of business if this bill in its current form goes through, basically because in this global market, there's no need on your computer to, you know, push the button--the button says New York? Well, you move your finger a little bit and hit London.

QUICK: Mm-hmm.

Mr. GREENSPAN: And I think we're going to see a goodly part--and if London creates a big regulatory system, there's going to be some sovereign state...

KERNEN: Somewhere.

Mr. GREENSPAN: the South Pacific...


Mr. GREENSPAN: ...which will develop...

KERNEN: Speaking...

LIESMAN: Speaking of the Pacific, though, how much concern do you have that the United States is at or close to a Japan-style decade, that we become Japan, that we have a problem of persistent deflation and don't really ever get our growth going?

Mr. GREENSPAN: I'm not concerned yet because the culture in Japan is really quite different from the culture in the United States. But there is no doubt that we're on a deflationary edge. In other words, as much as I argue that our real long-term problems are inflation, there is no question that the pressures, especially in the context of the euro crisis, is to pull in, and that is a deflationary force. And remember, so long as the international financial system, or more explicitly, amongst the developing nations, is part--is still partly disabled, it's very difficult to engender inflation. I mean, for example, we now have maybe 11 percent capital instead of let's say what I assume the markets are needing, which is as much as 14 percent. That means that individual banks are frightened to lend. And the way you can tell that, incidentally, is we've got over a trillion dollars sitting in depository institutions--deposited at the Federal Reserve banks. And all they have to do is to move that capital from 25 basis points out to say 3.3 interest rate for a C&I loan six to eight months out, and they don't do. And you have to ask yourself, well, why aren't they doing it? And the answer is, they're afraid they will not get repaid.

LIESMAN: Leaving 325 basis points on the table.

QUICK: Mm-hmm.


LIESMAN: It's amazing.

KERNEN: Mm-hmm.

QUINTANILLA: Before we talked about the causes of the crisis and bad behavior at banks and we haven't even mentioned Fannie or Freddie.


QUINTANILLA: But I'm wondering how often do people still come to you and try to pin blame on you for keeping rates low? And what's your--what's your--what's your response to them?

Mr. GREENSPAN: Well, the point at issue is that we did keep rates low into 2003. Why? Because we're looking at the same sort of plunge in the price indexes that we're seeing now. Now it could have been a serious problem, and we were aware of it. I mean, we knew we were balancing risks and to this day I think it's the right move. But there is no question that when you look at the implications of the globalization of finance that occurred subsequent to the end of the Soviet Union, when there's this huge shift. I mean, talk about capitalism, the most capitalistically dynamic economy now is China and they moved from a Maoist system, and the effect was a huge increase in income in the developing world, which because of their culture and because of no financial infrastructure, they couldn't spend. So that this whole big block of savings lands in the developing world, pushes global interest rates down, and indeed in 2006, they had all converged in the developing world, and most of the developing world to single digit long-term interest rates and inflating rates for the first time ever. Now what that meant was that the mortgage rate in the United States, which the data show is the major determinant of the whole business--the whole price structure in housing, what that did was locked itself into an arbitrage international financial system. Historically, the correlation between the federal funds rate and the 10-year note was very high. But starting probably in the early part of--maybe just about 10 years ago, you could see the delinking and we called it a conundrum in 2004...

LIESMAN: Mm-hmm.

Mr. GREENSPAN: ...when we at the Fed raised rates and for the first time in our experience, the 10-year note did not go up. Indeed, it went down.


Mr. GREENSPAN: And so what we were observing there is yes, it was low interest rates that caused the housing bubble, but it was low long-term interest rates...

LIESMAN: Mm-hmm.

Mr. GREENSPAN: ...not the federal funds rate.

QUINTANILLA: You don't think there was ever such thing as a Greenspan put?

Mr. GREENSPAN: Well, I heard that. Look, the--look, if the facts do show that in recessions the Federal Reserve eased more quickly than it tightened on expansions, but then the unemployment rate was rising for I think something like 15 percent of the time, and so that because the economy--when it went into a recession, was moving far more quickly, we had to also move quickly.


Mr. GREENSPAN: But if you look at a trendless unemployment rate, you end up with a trendless federal funds rate. But it goes down more sharply than it goes up because economies go down much more rapidly. Now if that is the Greenspan put...


Mr. GREENSPAN: ...I...


Mr. GREENSPAN: ...I shake--I shake at the term.

KERNEN: Mr. Chairman...

Mr. GREENSPAN: So be it.

KERNEN: said we'll lose some business because of this fin reg bill, probably. But you also said it was appropriate, given what we've been through. And I'm just trying to summarize and I think you said within a year we'll have a good idea of the unintended consequences and we'll fix it.

Mr. GREENSPAN: No, that's a little more...

KERNEN: Nasty, political than...

Mr. GREENSPAN: No, no.

KERNEN: Is it going to continue to hurt our employment situation? When will you have a feel when we can see some below 9 percent?

Mr. GREENSPAN: Oh, yeah. In other words, we will begin to see it when the markets start to improve and output per hour starts to slow down because we...

KERNEN: We can do that, I guess, because we're working way too hard.


KERNEN: I mean, there's too much productivity.

Mr. GREENSPAN: Look, a goodly part...

KERNEN: Let's start today.

Mr. GREENSPAN: It's hard to argue that the economic recovery was really faulty. I mean, the snap back from the huge inventory liquidation came on with a real powerful force and industrial production really took off. Manufacturing has really done extraordinarily well. The basic problem is that you don't hire when you're fearful and you squeeze and squeeze and squeeze. But you get to the point when if your orders are coming in, you have no choice.

QUICK: Mm-hmm.

Mr. GREENSPAN: And we're beginning to see that. But you cannot get a really significant pick-up in employment until you get output per hour slowing down. And that will happen because we're running well above expectations.

LIESMAN: Do you think the government stimulus was appropriate?

Mr. GREENSPAN: This is going to be a very big debate and I think the reason essentially is that it's very hard to know what those stimulus--what stimulus does. I mean from just strictly a technical point of view, we do know that if you use econometric models, you can determine what the so-called impact multiplier is of various different types of government spending or tax cuts. And if you feed that into the computer, you will engender a specific amount of economic activity without any advertence to what's going on in the rest of the world. It's all in the computer and it's all in the actual amount of government spending, which is appropriated. Now the problem is is that we're using most of those analyses on computers whose ability to forecast is awful.

QUICK: Yeah.

Mr. GREENSPAN: And why one would presume that the internal coefficient structure of a computer model which doesn't forecast very well, is going to give you the impact multipliers. Now having said that, I mean, I've seen some of the stimulus analysis details, for example, from the Congressional Budget Office. It's a first rate economic analysis. I mean, it's a very sophisticated and I think a very good analysis, but it rests upon the quality of the data. And then on top of that is a very critical other issue. We can estimate if you believe the models are working, gross stimulus. We can't really measure net because there is a negative and the negative, basically, is that long-term interest rates are a function of the deficit.


Mr. GREENSPAN: And we don't--there's been a very big debate, there are very interesting studies. We at the Fed did one in which I thought we fairly successfully demonstrated that the long-term deficits forecast by the CBO, for every percentage point of GDP you increased long-term rates by 25 basis points.


Mr. GREENSPAN: Now, it's a very fuzzy relationship, and the point is, nobody applies it as a subtraction from...

LIESMAN: But every stimulus you get on the front end.


Mr. GREENSPAN: And we know that--we know that the coefficient is positive, but we don't really know what it is.


Mr. GREENSPAN: Now, the trouble is that CBO does endeavor to use interest rates as an offset, but I won't get into the details.


Mr. GREENSPAN: I don't like their equations.

KERNEN: All right. We've got to go.

LIESMAN: That's an hour.

KERNEN: I guess off camera you'll answer about fin reg, though? That was the wrong...

QUINTANILLA: Give him the answer he wants.

KERNEN: Was that the wrong take that it's appropriate, but we're--it's going to overshoot and then we'll have to fix it? That's not what you were...

Mr. GREENSPAN: Let me say this. We are in a democratic society.


Mr. GREENSPAN: When you're in a democratic society, the majority must rule. The fact that Main Street felt, in many respects, appropriately...

QUICK: Mm-hmm.

Mr. GREENSPAN: ...harmed by what went on following the Lehman crash, I think requires that they act. And in many respects, I think we were not regulated the way we should. I mean, I have always said that we have missed the boat here...

KERNEN: Right.

Mr. GREENSPAN: being unable to really focus and do what the capitalist system is supposed to do.

KERNEN: Mm-hmm.

Mr. GREENSPAN: Protect your equity. We didn't do it. And as a consequence, we've brought a lot of other innocent people down in the process.

KERNEN: OK. Well, It was wonderful having you for the extended period. Maybe we can do it again sometime. Should I ask you now or should we--we'll have--we'll have Steve be our liaison again. Thank you...

Mr. GREENSPAN: Steve is...

KERNEN: ...for joining...

Mr. GREENSPAN: Steve is my agent.

KERNEN: I know. I know he is.

QUINTANILLA: I think you're in real trouble.

KERNEN: And we're buddies now, right? We're BFFs.

LIESMAN: Because we agree.


LIESMAN: We agree.

KERNEN: Anyway, thank you, Doctor.

LIESMAN: That's another segment.

QUINTANILLA: How quickly they fall.

QUICK: Thank you.

KERNEN: As I said, we want to thank Dr. Greenspan, former Federal Reserve chairman, for his time this morning. I think he'd go longer--he's got something to do, though. Anyway, thanks.

LIESMAN: But we understood it all.

KERNEN: Yeah, we did.

LIESMAN: That's the thing that's blowing me away right here.

QUINTANILLA: The tennis court awaits, right?

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