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Greenspan Should Have Stuck With the Clarinet

A Commentary By Froma Harrop

Tuesday, October 28, 2008

The 1949 movie of Ayn Rand's novel "The Fountainhead" ends with Patricia Neal elevating to the top of a new skyscraper to greet its godlike architect, Gary Cooper. He is the archetypal Rand hero, an individualist who triumphs over the tradition-bound forces of mediocrity.

Oddly, Cooper's masterpiece of modernism resembles one those public housing projects that got blown up in the '70s. For today's audiences, it's quite an anticlimax. To think they took down perfectly good tenements to build that.

Long before he ever dreamed of becoming Federal Reserve chairman, Greenspan played the clarinet and soaked up Rand's philosophy of radical individualism and laissez-faire capitalism. Rand believed that one's own happiness is the highest value and rational self-interest a moral imperative.

Lots of young intellectuals read Rand's books and enjoyed her politically incorrect hymn to selfishness. But they moved on. Not, it would seem, Greenspan. He gave up on music as a profession, studied economics and joined Rand's Manhattan salon.

All three decisions seemed to come together in his later support for unregulated derivatives, or what the more earth-bound Warren Buffett called "financial weapons of mass destruction." Once derivatives got a green light, it took a mere eight years for the edifice of regulation-by-self-interest to blow itself up.

In a moment for history, Greenspan last week sat in the congressional hot seat as Rep. Henry Waxman, Democrat of California, unloaded on him and his ideology. Greenspan owned up to the flaw in his philosophy.

"Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief," he told the House Committee on Oversight and Government Reform.

Greenspan never saw it coming. Not even last year. In his 2007 book, "The Age of Turbulence," he conceded that loosening credit terms for subprime mortgages had increased financial risk. "But I believed then, as now, that the benefits of broadened home ownership are worth the risk. Protection of property rights, so critical to a market economy, requires a critical mass of owners to sustain political support."

CBS's "60 Minutes" recently offered a tutorial on derivatives' role in sinking the economy. The mortgage-backed securities were the TNT, Steve Kroft explained. "The rocket fuel was the trillions of dollars in side bets on these mortgage securities called credit default swaps."

Credit default swaps are pure gambling. They are wagers on whether people will default on their debts, such as mortgages. They are not to be confused with insurance against loans going bad. Insurers must hold reserves against risk.

What happened? When the market seized up, people demanded payment on those credit default swaps, but there was no money behind them. "There was no 'there' there," as New York State insurance regulator Eric Dinallo put it.

It's happened before. The Panic of 1907 was fed by "bucket shops," where people took derivative interests -- that is, made bets on a security, commodity or whatever without actually buying or selling it. New York state outlawed bucket shops in 1909, and other states followed suit.

The 2000 Commodity Futures Modernization Act revived the bucket-shop bet. It was a rider attached to 11,000-page appropriations bill hours before Congress planned to leave for Christmas recess. Page 262 forbade states to ban or regulate financial derivatives.

The Republican Congress passed the legislation, and Democratic President Bill Clinton signed it. Whatever Alan Greenspan wanted, he got, which was capitalism unlocked from its regulatory chains.

You have to credit Greenspan for manfully acknowledging the yawning gap between his free-market ideology and reality. It's hard to dislike him, but also to avoid this thought: He really should have stuck with the clarinet.

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