I just took a look at Alan Greenspan’s term paper for The Brookings Institution (called “The Crisis”), in which he rephrases “too big too fail” as “too interconnected to be liquidated quickly.” If, in addition to monetary policy and bank regulation, the former Chairman had been in charge of naming TV shows, Lost would be called Individuals Whose Whereabouts Are Less than Fully Understood.
I would totally watch that show.
Anyway, speaking of things that are less than fully understood, Mr. Greenspan heaves some big sighs here over the “indecipherable complexity” that plagues our financial system and the products it churns out:
Neither bank regulators, nor anyone else, can consistently and accurately forecast whether, for example, subprime mortgages will turn toxic, or to what degree, or whether a particular tranche of a collateralized debt obligation will default, or even if the financial system as a whole will seize up.
OMG, it’s all so terribly complicated, whines the Maestro. He concludes that our best bet is to adopt “regulations embodying a forecast fail with regularity.” In other words - and, dude, we need some other words - we shouldn't expect regulators (including whatever systemic risk regulator we end up creating) to foresee the next crisis and head it off before it happens. The best we can do, the man is basically saying, is to make sure we’re in a better position to survive disaster.
What does this boil down to, regulation-wise, in Greenspan's view? Mainly, he thinks the government should require risk-takers to hold more regulatory capital and maintain more liquidity. And sure, we're all for that. But is that all there is?
Sadly, Mr. Greenspan is right that even brainiacs can't grasp the risk of modern-day financial products, let alone stay on top of global systemic risk. Himself included, it seems. But there’s a weird passivity to his argument. He accepts without question the continued presence in our lives of CDOs and other structured products that may be backed by assorted crud of unknown toxicity. What about the notion, floated by people like Kansas City Fed head Thomas Hoenig and, gee, Warren Buffett, that level-headed people ought to take arms against a sea of complex products and, by opposing, end them?
No, laments Mr. Greenspan, we can only prepare to suffer the slings and arrows of outrageous fortune, or, as he would put it if he were in charge of Shakespeare, “extreme negative tail risk.”