High amounts of risk taking prior to the credit crisis were likely to have dire consequences, but it has turned out to be much broader and more damaging than anything former Federal Reserve Chairman Alan Greenspan imagined.
In his prepared testimony to U.S. lawmakers, the former Fed chairman called the crisis a "once-in-a century credit tsunami" that will result in a significant rise in unemployment.
"In 2005, I raised concerns that the protracted period of underpricing of risk, if history was any guide, would have dire consequences. This crisis, however, has turned out to be much broader than anything I could have imagined," Greenspan said in his testimony to the House Committee of Government Oversight and Reform on Thursday.
Greenspan said a stabilization in home prices is the ultimate solution, but that is many months away "at a minimum". In the interim, he said the $700 billion Troubled Assets Relief Program is adequate to avoid a severe retrenchment in the economy and banking industry.
Greenspan traced the causes of the crisis to the securitization of home loans, which was fuelled by demand for pooled mortgages. The high demand spurred increased issuance and the risks were badly mispriced.
"The consequent surge in global demand for U.S. subprime securities by banks, hedge, and pension funds supported by unrealistically positive rating designations by credit agencies was, in my judgment, the core of the problem," he said.
Once the crisis abates, Greenspan said the financial landscape will be far different and characterized by exceptional caution.
"It is important to remember, however, that whatever regulatory changes are made, they will pale in comparison to the change already evident in today's markets," he said.
By Adam Button and edited by Nancy Girgis
©CEP News Ltd. 2008