Alan Greenspan Explains Why Financial Reform Can't Work

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One of the criticisms of Alan Greenspan's role in the financial crisis is that he preferred to let the financial system regulate itself. In this article he gives his reasons for believing that government should not attempt to impose more regulatory controls on the financial system. He covers a wide range of proposed reforms but he believes that they will make the system worse rather than better. His critique of the Dodd, Frank reform bill differs dramatically from other those of other critics who believe that the bill does not go far enough.

In essence, Greenspan invokes the invisible hand of Adam Smith to defend his views. The financial system is guided by the invisible hand which makes the market work efficiently. The problem is that the invisible hand is, in fact, invisible. The system is too complex and opaque to be understood by government regulators. We are better off letting the invisible hand work its magic than to let regulators mess with what they do not understand. He predicts that regulatory reform will have unintended consequences because the system works so mysteriously. He describes some of the unintended consequences of reform in this article

He also defends the complexity of the financial system by linking it to economic growth and innovation. By tinkering with complexity, and the resultant growth of finance in the world economy, we may destroy the engine of economic growth.

I agree with Greenspan that what eventually comes out of Congress as financial reform may have unintended consequences and that reform may not prevent future crises. I disagree strongly, however, with his view that we are better off to let those who caused the financial system to collapse, and destroy the lives of millions of people, should be left totally in control of a system that they obviously do not understand well enough to manage in the public interest. Moreover, many of the problems that led up to our financial crisis were apparent to many people, and their consequences were understood. It was the failure of government to respond to the red flags that were raised that was the problem. Chief among those who preferred to ignore the red flags was Alan Greenspan.