The Oracle was blindsided.
Former Federal Reserve chairman Alan Greenspan told angry lawmakers Thursday he was "shocked" to discover — as a once-in-a-century financial crisis spread — that his bedrock belief that financial firms could police themselves turned out to be "flawed."
"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity," Greenspan, described as a maestro and an oracle while at the central bank, told a House committee. Greenspan called that "a flaw in the model ... that defines how the world works."
He said the nation faces a "once-in-a century credit tsunami."
Greenspan, who left the Fed in 2006, spent much of the hearing pushing back against lawmakers who said he did not do enough to protect consumers at the Fed.
"You had the authority to prevent irresponsible lending … and now our whole economy is paying its price," said Rep. Henry Waxman, D-Calif.
Waxman asked Greenspan if his free-market ideology "pushed you to make decisions that you wish you had not made." Greenspan, for example, opposed efforts to regulate derivatives: financial products whose value depends on the movement of other assets like commodities or stock indexes.
Greenspan said many parts of the derivatives market are performing well. He said it was difficult for Fed officials, who oversee just one slice of the U.S. banking industry, to gauge the breadth of problems in the mortgage market.
Greenspan and former Treasury secretary John Snow said they pushed Congress unsuccessfully to tighten rules for mortgage giants Fannie Mae and Freddie Mac. The government took over the firms last month.
"I feel like I'm looking out there at three Bill Buckners," Rep. John Yarmuth, D-Ky., told Greenspan, Snow and Securities and Exchange Commission Chair Chris Cox, who also testified. Buckner was a Boston Red Sox player who made a critical error in a 1986 World Series game.
The hearing came as the Bush administration stepped up efforts to combat the crisis. The government should have a plan to help homeowners rework their mortgages within weeks, Treasury official Neel Kashkari told a separate Senate hearing.
One possibility is loan guarantees for financial institutions that modify mortgages to make them more affordable. Federal Deposit Insurance Corp. Chairwoman Sheila Bair backed the guarantees.
The financial crisis even prompted the Republican Greenspan, a staunch believer in free markets, to propose that government consider tougher regulations, including requiring financial firms that package mortgages into securities to keep a portion as a check on quality.
He said other regulatory changes should be considered, too, in such areas as fraud.
Greenspan's interrogation by the House Oversight Committee was a far cry from his 18 1/2 years as Fed chairman, when he presided over the longest economic boom in the country's history. He was viewed as a free-market icon on Wall Street and held in respect bordering on awe by most members of Congress.
Not now. At an often contentious four-hour hearing, Greenspan, Snow and Cox were repeatedly accused by Democrats on the committee of pursuing an anti-regulation agenda that set the stage for the biggest financial crisis in 70 years.
"The list of regulatory mistakes and misjudgments is long," panel chairman Henry Waxman declared.
Greenspan, 82, acknowledged that he had also been wrong in rejecting fears that the five-year housing boom was turning into an unsustainable speculative bubble that could harm the economy when it burst. Greenspan maintained during that period that home prices were unlikely to post a significant decline nationally because housing was a local market.
He said Thursday that he held to that belief because until the current housing slump there had never been such a significant decline in prices nationwide. He said the current financial crisis had "turned out to be much broader than anything that I could have imagined."
Greenspan was asked to defend a variety of actions he took as Federal Reserve chairman — resisting recommendations to use the Fed's powers to crack down on subprime mortgages, for one. And opposing efforts to impose regulations on derivatives, the complex financial instruments that include credit default swaps, which have also figured prominently in the current crisis.
He said that outside of credit default swaps, the bulk of financial derivatives had not caused major problems. He said the boom in subprime lending occurred because of the huge demand for investment opportunities in a global economy, and he blamed the crash on a failure by investors to properly assess the risks from such mortgages, which went to borrowers with weak credit.
As for firms that package mortgages into securities, he said, "As much as I would prefer it otherwise, in this financial environment I see no choice but to require that all securitizers retain a meaningful part of the securities they issue."
On the billions of dollars of losses suffered by financial institutions because of their investments in subprime mortgages, Greenspan said he had been shocked by the failure of banking officials to protect their shareholders from their bad loan decisions.
"A critical pillar to market competition and free markets did break down," Greenspan said. "I still do not fully understand why it happened."
Contributing: Associated Press