A critique of Alan Greenspan’s retrospective on the crisis

Jerome Stein

Journal of Financial Transformation, 2010, vol. 30, 9-21

Abstract: Alan Greenspan’s paper (March 2010) presents his retrospective view of the crisis. His theme has several parts. First, the housing price bubble, its subsequent collapse, and the financial crisis were not predicted either by the market, the Fed, the IMF, or the regulators in the years leading to the current crisis. Second, financial intermediation tried to function on too thin layer of capital – high leverage – owing to a misreading of the degree of risk embodied in ever more complex financial products and markets. Third, the breakdown was unpredictable and inevitable, given the “excessive” leverage – or low capital – of the financial intermediaries. Greenspan now focuses on desirable capital requirements for banks and financial intermediaries. Too high a capital requirement will not provide a sufficiently high rate of return on financial assets to attract capital. Too low a capital requirement unduly raises risk and endangers bank solvency. The Fed, IMF, the Treasury, and the market lacked the appropriate tools of analysis to answer the following questions: what is an optimal leverage or capital requirement that balances the expected growth against risk? What are theoretically founded early warning signals of a crisis? I explain why the application of stochastic optimal control (SOC)/dynamic risk management is an effective approach to determine the optimal degree of leverage, the optimum and excessive risk, and the probability of a debt crisis. The theoretically derived early warning signal of a crisis is the excess debt ratio, equal to the difference between the actual and optimal ratio. The excess debt starting from 2004-05 indicated that a crisis was most likely. This SOC analysis should be used by those charged with surveillance of financial markets.

Keywords: Greenspan; Capital requirements; Stochastic Optimal Control; Warning Signals of crisis; Optimal Leverage and Debt ratios; bubbles (search for similar items in EconPapers)
JEL-codes: C61 G11 G12 G14 (search for similar items in EconPapers)
Date: 2010
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ris:jofitr:1506

Access Statistics for this article

Journal of Financial Transformation is currently edited by Prof. Shahin Shojai

More articles in Journal of Financial Transformation from Capco Institute 77 Water Street, 10th Floor, New York NY 10005.
Bibliographic data for series maintained by Prof. Shahin Shojai ( this e-mail address is bad, please contact ).