Tags: Greenspan | Dodd-Frank | banks | fail

Greenspan: ‘We Ought to Allow Big Banks to Fail’

By Dan Weil   |   Friday, 15 Mar 2013 12:12 PM

The Dodd-Frank financial reform law hasn’t succeeded in addressing the “too big to fail” issue, and the solution is to let big banks fail, says former Federal Reserve Chairman Alan Greenspan.

“The issue of too big to fail is the most important regulatory issue that there is,” he tells CNBC. “At the moment we are doing very little, if anything, to address that problem. … Dodd-Frank is not working.”

So what should change?

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

“My basic view is that we should not be supporting the banks the way we are,” Greenspan says. “If you look at the big banks, you see a significant discount on what they're paying for their liabilities relative to even the medium-size and the smaller banks.”

That’s because the widely held assumption in financial markets is that none of the big banks will be allowed to fail in the next crisis, he explains. “If they're not going to be allowed to fail, you're not going to lose your money on a venture.”

Breaking up the big banks through separating their commercial and investment banking entities doesn’t make sense at this point, Greenspan notes. His basic argument is that a complex economy requires complex banking entities.

“But if push comes to shove and there was no other way to eliminate the too-big-to-fail problem, which is getting worse since the financial crisis, I would be in favor of breaking up the banks. I hate very much to see that happen. But it's less worse.”

So what should trigger a move to break up the banks?

“It's way too soon to make such a judgment,” Greenspan maintains. “My view is we ought to allow banks to fail, go through the standard Chapter 11 type of liquidation and allow the markets to adjust accordingly. That has worked for a very long time. I think we will get the best of both worlds.”

Meanwhile, Greenspan, who said famously in December 2006 that the stock market may have been going through a phase of “irrational exuberance,” says that description doesn’t apply now.

“By historical calculation, we are significantly undervalued,” he states. For a while stock prices were restrained by troubles such as Europe’s debt crisis, Greenspan says.

“I think you can fully explain the rally in terms basically of the removal of what is called tail risk. That is what has been sitting out there virtually most of this year and part of last as well has been the European problems.”

Europe’s mess has “every characteristic of caving in the economies of the world as a whole,” Greenspan says. “And that has been temporarily removed. The result is removing that key factor has allowed the markets to move up. It's not because earnings are moving all that well.”

And the stock rally “still has a way to go,” he says. The same is true of the housing rally, as the home ownership rate remains low, Greenspan says.

Others share the former Fed chairman’s bullishness on stocks, which just rose 10 days in a row as measured by the Dow Jones Industrial Average.

“Fund flows really have reversed direction, and money started moving out of money markets and some from fixed income to equities,” Tim Ghriskey, chief investment officer of Solaris Asset Management, tells Reuters.

“This kind of trend doesn’t change easily, so we can expect a lot more to come in.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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