Aug. 11, 2008

Greenspan's Remarks about Regulation and Financial Crises

Alan Greenspan recently rebutted allegations about his excessively expansionary monetary policy giving rise to the housing bubble and remarked that regulations would not reduce financial crises.

I agree that monetary policy is indeed not the cause of the US housing bubble. It is also true that regulations cannot eliminate financial crises. But inadequate regulations will certainly lead to more crises.

With the subprime crisis, inadequate regulations certainly played a role. Indiscriminate lending, with loans generously extended to people who did not have any financial commitment to the homes they bought, and who might not even have the ability to service the loans, reduced the quality of the “collateral.” This should not have been allowed.

Because there is often no or very little down-payment with many subprime loans, there was really no real collateral. Borrowers have little commitment to service their loans should home prices head south, and lenders had virtually no margin of safety.To say that regulators had little responsibility behind the turn of events that led to major write-downs among banks and investment houses is irresponsible. If the US had followed the HK Monetary Authority in requiring banks to lend at most 70% or even 60% of appraised values(the latter, more conservative, ratio applies to luxury homes) there would have been no crisis. The HK Monetary Authority requires borrowers to buy default insurance if the loan ratio exceeds these ratios.

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