turning a new leaf?

Mr. Dollar testified before the Financial Crisis Inquiry Commission today about the challenges of a self-regulating market and the dangers that lie ahead. While his belief in free market capitalism remains unshaken, Greenspan’s warnings about the key attributes that should underpin a stable banking system — adequate capitalization, liquidity, and regulatory oversight — cast a surprising shot across the bow of modern banking giants who have grown a little too comfortable with their bailout blanket and artificially low interest rates.

Whether the economy tips back into chaos or not remains to be seen, but the rare regulatory prudence recommended in the Maestro’s testimony is a welcome conservative voice in the growing chorus to reign in banking titans who seem unwilling or unable to learn from their mistakes…

Greenspan Warns of Future Crises


WASHINGTON—Former Federal Reserve Chairman Alan Greenspan urged U.S. policy makers on Wednesday to place significantly higher capital and collateral requirements on the financial-services industry, warning of the likelihood of future financial crises if steps aren’t taken to address “too big to fail” firms and the inability of the private market and regulators to predict major risks.

Mr. Greenspan, appearing before the Financial Crisis Inquiry Commission on Capitol Hill, said in prepared remarks that the events of the last few years are likely to be viewed “as the most virulent global financial crisis ever.” Putting in place new standards to make the financial system more resilient is necessary, he said, because future financial crises are likely and will involve financial products “which no one has heard of before, and which no one can forecast today.”

“But if capital and collateral are adequate…losses will be restricted to equity shareholders who seek abnormal returns,” Mr. Greenspan said. “Taxpayers will not be at risk. Financial institutions will no longer be capable of privatizing profit and socializing losses.”

Mr. Greenspan also endorsed efforts to eliminate the concept that any firm is too big, or too interconnected, to not be liquidated or allowed to fail, a concept he said “cannot be allowed to stand.”

Though he acknowledged that there are few good solutions in dealing with firms that pose a systemic risk, expressing doubt that risks can be identified in time for the government to react proactively, Mr. Greenspan said market participants must be convinced that the bailouts of the last two years won’t occur in the future.

“The productive employment of the nation’s scarce saving is being threatened by financial firms at the edge of failure, supported with taxpayer funds, designated as systemically important institutions,” he said.

Mr. Greenspan’s testimony before the bipartisan commission has been highly anticipated, in part because of the criticism that has been heaped on him and the Fed under his tenure for their role in setting the stage for the financial tumult that occurred after he left the central bank in 2006. Lawmakers on both sides of the aisle, including those intimately involved in efforts to overhaul regulation of U.S. financial markets, have blamed the Greenspan-era Fed for not doing enough to protect consumers and identifying potential risks to the economy from the booming mortgage market.

“Why does the Fed deserve more authority when it failed to prevent the current crisis?” Sen. Christopher Dodd (D., Conn.) asked at a hearing last July with Mr. Greenspan’s successor, current Chairman Ben Bernanke.

Mr. Greenspan on Wednesday defended his legacy on consumer-protection matters, arguing that subprime mortgages were not a “significant cause” of the financial crisis, and that the Fed under his watch “was quite active in pursuing consumer protections for mortgage borrowers.”

“I consistently voted in favor of consumer protection initiatives when they were brought before the Board, and support the positions reflected in the various guidelines we issued over the past decade,” Mr. Greenspan said.

The Fed has come under specific criticism for its slow pace in implementing protections for homeowners passed by Congress in 1994 to address “unfair” and “abusive” lending practices. Mr. Greenspan said the central bank took the steps necessary to make sure the law was “faithfully implemented,” and that the Fed and other federal regulators carefully monitored the growth of subprime lending.

“The Federal Reserve engaged in real-time assessment of developing risks in the subprime and nontraditional mortgage sectors, and endeavored to adjust to ever-evolving market behavior,” he said.

Mr. Greenspan’s support of more stringent capital and collateral requirements could boost efforts by the Obama administration and congressional lawmakers wrestling with legislation to overhaul U.S. financial markets. Members of both the House and Senate have favored various efforts to require financial firms to better insure against potential risks, and Mr. Greenspan said such requirements might have helped slow the market panic of late 2008.

“I believe that during the past 18 months, there were very few instances of serial default and contagion that could have not been contained by adequate risk-based capital and liquidity,” he said, noting that higher capital requirements would likely result in smaller executive pay at financial firms.

He also supported an idea to require banks and some other financial firms to hold a special type of “contingent capital bond” to help address “too big to fail” situations. Firms could hold the debt, and in the event their equity capital fell below a certain trigger it would automatically be converted to equity. If that wasn’t enough to stabilize a firm, Mr. Greenspan said, Congress should consider a special bankruptcy mechanism to unwind major financial institutions that wouldn’t be able to fail quickly.

Addressing the causes of the financial crisis, Mr. Greenspan laid the blame on financial firms, the credit-rating agencies they depended on to offer positive assessments of risky products and regulators. Firms that were increasingly undercapitalized thought they would be able to predict any market problems with enough time to prepare themselves, but “they were mistaken,” he said. Regulators likewise were unable to mitigate against the cascading defaults and liquidity crunch, he added.

“Even with the breakdown of private risk-management and the collapse of private counterparty credit surveillance, the financial system would have held together had the second bulwark against crisis—our regulatory system—functioned effectively,” Mr. Greenspan said. “But, under crisis pressure, it too failed.”

Write to Michael R. Crittenden at michael.crittenden@dowjones.com