WASHINGTON — Alan Greenspan spent years denying "too big to fail" even existed and yet on Wednesday the former Federal Reserve Board chairman argued there is no escaping it.
Not even a constitutional amendment would prevent the government from finding a way to save the largest financial firms, he said.
Exhibit A is Fannie Mae and Freddie Mac, which during his years at the central bank Greenspan argued could fail. But Wall Street believed otherwise and gave the government-sponsored enterprises cheap funding until ultimately the government stepped in to bail out the companies last September.
"Our government has lost credibility on this issue," Greenspan said in a speech to the American Enterprise Institute. "I don't think you can pass legislation today that would say the government cannot bail out financial institutions because the market would say, 'We didn't believe you previously, so why should we believe you today?' "
Greenspan's comments came the same day that his successor, Ben Bernanke, spent the morning on Capitol Hill noting glimmers of hope that the financial crisis might be easing and investor confidence returning to the banking sector.
As Bernanke and other policymakers work to prevent a recurrence of the financial crisis, Greenspan said many of their efforts could be for naught. He labeled "too big to fail" as a problem, in effect, with no acceptable solution.
"All efforts, of which I am aware, at addressing TBTF have drawbacks," he said.
Still, he described a few tactics that could blunt the impact of this reality.
"At a minimum, we will be forced to offset the TBTF borrowing cost advantage by imposing a comparable cost — such as increased capital requirements of a sufficient magnitude to offset the implicit government-created guarantee, a tricky calculation at best."
An alternative, he argued, would be to rewind several decades and require nonbanking business to be conducted only by partnerships.
"As partnerships, investment banks were an exceedingly cautious bunch," he said. "It is inconceivable that, as partnerships, investment banks would have taken the enormous risks that turned out so badly this decade."
But such a structure still leaves something to be desired in a system where investment and commercial banking are intertwined.
"One problem with turning back the clock in this way is that commercial banks, for good reason, are currently authorized to engage in investment banking," he said.
"It is possible that financial nonbanks organized as partnerships might simply convert to bank charters so they could more safely (for them) take on risk."
Greenspan said he was "puzzled" that more banks have not been formed during the financial crisis.
"With interest rate spreads so wide, a new bank without a legacy of toxic assets could be quite profitable," he said.
In an appearance that lasted nearly an hour, Greenspan's main point was that expectations of a systemic risk regulator should be realistic.
Pointing to weaknesses in the United Kingdom's Financial Services Authority, the Basel Committee on Banking Supervision and the regulatory structure in this country, he said no supervisory framework can predict the next financial crisis.
"Such evidence of failure is common to every financial crisis and points up to the broader problem that forecasting the onset of financial crisis, except by chance, has always proved to be beyond our reach," he said.