Greenspan Defends Fed's Role in Averting Long-Term Capital Collapse

Strategic Insights -

Alan Greenspan, Federal Reserve Chairman, testified before the House Banking Committee, defending the central bank's decision to intervene in the collapse of Long-Term Capital Management L.P. Greenspan emphasized that the Fed acted to prevent a broader market collapse, citing the potential for substantial damage to financial markets and economies worldwide. The hearing marked a rare instance of criticism for Greenspan, who typically receives praise for his stewardship of the economy.

Key Takeaways:

  • The Federal Reserve's intervention in the collapse of Long-Term Capital Management L.P. was motivated by concerns for the stability of the financial markets, rather than a desire to assist the firm's wealthy owners.
  • Greenspan acknowledged that the failure of Long-Term Capital could have triggered a broader market collapse, potentially impairing the economies of many nations, including the United States.
  • Lawmakers expressed concerns about the Fed's decision to use its influence to arrange a $3.6 billion rescue package for Long-Term Capital, questioning whether the Federal Reserve and regulators should do more to regulate hedge funds.
  • Greenspan argued that regulating hedge funds could drive them to operate in countries with looser regulations, undermining the ability of the United States to monitor them indirectly.
  • The Federal Reserve Chairman acknowledged that the approach he advocated – relying on lenders to assess risks and deny credit to those taking unwise bets – had failed in the case of Long-Term Capital.

Statistics:

  • $3.6 billion: The amount of the rescue package arranged by the Federal Reserve for Long-Term Capital Management L.P.
  • 10%: The percentage of Long-Term Capital's stakes retained by its owners under the rescue plan.
  • 5 years: The period during which Greenspan stated that only a few market failures had occurred.
  • Unspecified: The number of derivatives traders expected to be regulated under restrictions proposed by the Commodity Futures Trading Commission.

Sources:

  • "Greenspan Defends Fed's Role in Averting Collapse," New York Times, page C1.
  • "Greenspan Addresses Questions on Long-Term Capital," New York Times, page C3.