In 66 pages, Mr. Greenspan fails to use the word "responsibility" even once. The word "blame" does not appear. The word "mistake" occurs once; financial firms made them. The word "failure" appears 14 times. None of them are self-referential. To have expected the phrase "mea culpa" would of course be asking too much.

I agree with the Chairman on two points. The first is his defense of the Federal Reserve against the charge of having violated the Taylor Rule. One of the few things more insufferable than this paper is that formula. Mr. Greenspan effectively rebuts the idea that low interest rates per se caused the crisis.

The second good point lies against the "global savings glut" argument. As Mr Greenspan says, "The main problem with that explanation is that there is no actual evidence of a global savings glut."

In view of this statement, Dr. Sawhill's remark that the Chairman "lays most of the blame on a glut of global saving" seems odd. Well, the phrase quoted occurs on page 43. Perhaps Dr. Sawhill didn't read that far.

The remaining noteworthy parts of this paper are substantially a meditation on two themes. The first consists of whatever reminders one can find that Chairman Greenspan really did foresee the crisis. He goes all the way back to his 1996 comment about irrational exuberance! On the housing bubble, he writes that "almost all market participants of my acquaintance were aware of the growing risks." He quotes himself in the quiet sanctuary of the FOMC in 2002, that the "extraordinary housing boom... financed by very large increases in mortgage debt... cannot continue indefinitely."

So he did know. He wasn't the innocent he made himself out to be, in October 2008, before Congress, when he said he was in a state of "shocked disbelief." Did he tell the public? Did he get up on his incomparable soapbox? Did he warn against the dangers of option ARMS with teaser rates? He did not. On the contrary: he went on record encouraging their use.

The second main theme is that nothing could have been done. The whole thing started with the fall of the Soviet Union. It was global. It was a "hundred year flood." "The aftermath of the Lehman crisis traced out a startlingly larger negative tail than most anybody had earlier imagined." And even if they had tried, they would have done more harm than good:

"The complexity of our financial system in operation spawns, in any given week, many alleged pending crises that, in the event, never happen and innumerable allegations of financial misconduct. To examine each such possibility in the level of detail necessary to reach meaningful conclusions would require an examination force many multiples larger than those now in place in any of our banking regulatory agencies. Arguably, at such levels of examination, bank lending, and its necessary risk taking, would be impeded."

I'm sorry, but that's garbage, in one word.

The most telling omission in this paper is that the word "fraud" does not appear. But the world knows that the collapse of the financial system had, at its core, the largest financial fraud of all time. That fraud was in the origination, the rating, the underwriting and the issuance of credit default swaps against sub-prime mortgages issued largely by private originators and securitized by the largest banks.

The FBI knew this in 2004, when it warned in public of an "epidemic of mortgage fraud." When Fitch Ratings in 2007 undertook a small sample survey of "high CLTV, stated documentation loans" here's what they found: "The result of the analysis was disconcerting at best, as there was the appearance of fraud or misrepresentation in almost every file." But Mr. Greenspan will not say the word aloud.

The Federal Reserve is a regulator. Alan Greenspan was the chief regulator for 18 years. He failed spectacularly. So did his colleagues, at the Office of Thrift Supervision and elsewhere. These facts are not obscured here. They are ignored.

I suppose the First Amendment applies to former Federal Reserve Chairmen attempting to cover their tracks. I wish it didn't. At the very least, as a constitutional compromise, there might be a word limit.

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Legislation to increase financial stability should not try to decide on the appropriate size of banks. Instead, it should require banks to increase capital at a faster rate than asset size increases. Small banks should be exempt. After some minimum size, say $10 billion in assets, bank capital should increase 1.1% for every 1% increase in assets. That places responsibility for risk and error on management and stockholders. It uses incentives to limit size and risk.

Greenspan argues that monetary policy didn’t contribute significantly to the housing bubble; he lays most of the blame on a glut of global saving that lowered interest rates worldwide. He also argues that if the Fed had tightened more in response to “irrational exuberance” it would have damaged the real economy at a time when overall inflation was under control. He provides some empirical evidence to support these arguments but I still find it hard to believe that the fed funds rate didn’t affect longer-term rates, including ARMs, and thus the housing market. But he makes a good point when he argues that it’s hard for central bankers to deliberately burst a bubble when the real economy seems to be doing well – even though in retrospect it might have been less harmful if we had had a moderate recession earlier in this process, thereby potentially forcing some much earlier deleveraging without the disastrous effects we later experienced. His argument that higher capital requirements and contingent debt along with “living wills” spelling out how a firm will unwind if disaster strikes all seem like good ideas. He is opposed to the idea of a systemic regulator on the grounds that it’s impossible to foresee when a “black swan” is going to appear.

One of the most interesting portions of the paper is called “the purpose of finance.” Here, he argues that the sector is vital to efficiently funneling saving into productive investments. He notes that the sector has grown as a share of GDP over recent decades but not because more assets are under management. The question that intrigues me is whether the productivity gains in the real economy are linked in any way to the growth of this sector – perhaps because of greater complexity and the need for greater skill in managing the process – or whether the sector has reaped big rents because of the scarcity of what I would call “reputational capital” and the inelasticity of the demand for its services. It may be some of both but rents are, in my view, a big part of the picture. Investment bankers earn rents for the same reason that real estate brokers earn rents: their fees are a small portion of the total cost of the deal and no buyer wants to risk engaging a new or unknown entrant into the field with a big and important transaction.

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The Fed’s four-year dramatic departure from the Taylor Rule, allowing the fed funds rate to remain substantially below the levels consistent with the Taylor Rule, very much contributed to the underpricing of risk leading up to the crisis. Many microeconomic studies of loan pricing in various countries provide compelling evidence that the underpricing of risk tends to occur in unusually low interest rate environments. Mr. Greenspan's attempt to defend his actions, while understandable, do not fit the facts. The history of banking crises teach us that a necessary condition for a banking crisis is loose monetary policy, and this crisis was no exception.

That is not to say that the Fed was the only, or even the main, cause of the crisis. Many episodes of loose monetary policy in history occurred without producing banking crises. In other words, loose monetary policy is a necessary but not a sufficient condition for a banking crisis. Microeconomic incentive problems are a key additional ingredient, and these lay at the root of the subprime crisis, too. As in the past, it was the combination of microeconomic incentive problems that encouraged risk taking and loose monetary policy that were most important in explaining this banking crisis. US housing policy, and the subsidization of mortgage risk by Fannie Mae, Freddie Mac, FHA, the Federal Home Loan Banks, and a long list of policies, were the prime contributors to the underpricing of risk that produced the crisis. Fannie and Freddie ended up holding more than half of the subprime mortgage risk created during the boom ($1.6 trillion of the total $3 trillion). Their actions in making markets for no-docs mortgages beginning in 2004 substantially accelerated the boom and encouraged lax underwriting. And when the housing market stalled in mid-2006, leading to the departure of many investors (Deutsche Bank, Goldman, etc.), Fannie and Freddie continued to make the market in subprime, effectively offering a put option to anyone wishing to sell the instruments; that allowed peak origination volumes to persist for nine months after the clear signals in mid-2006 that should have ended the boom. There are, of course, many other contributing influences, too.

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