Greenspan: Fed Should Have Let Banks Fail

Former Federal Reserve Chairman Alan Greenspan is taking government regulators to task for not letting more big financial houses fail back during the credit crisis.

Every rich-country government must choose between setting aside wealth to contain catastrophes or use that wealth for its own prosperity.

Since the 2008 crisis began, the U.S. government has erred heavily on the side of caution to the detriment of its own growth, Greenspan writes in an Op-Ed in the Financial Times.

Alan Greenspan (Getty Images photo)

“American policymakers, in recent years, faced with the choice to assist a major company or risk negative economic fallout, have regrettably almost always chosen to intervene,” Greenspan writes.

U.S. banks are holding on to $1.6 trillion in reserves as buffer capital courtesy of the Federal Reserve. This is the result, Greenspan contends, of the U.S. decision to bail out Bear Stearns rather than letting it crash.

If the investment bank had been allow to collapse, he writes, banks such as AIG and Lehman might have put more money aside to protect themselves from the same fate. They clearly did not, and the government was forced into the market to save them.

Since banks now can sit on their Federal Reserve money and earn interest at no risk they have less incentive to lend it and the U.S. economy is stagnating, Greenspan writes.

“This bias leads to an excess of buffers at the expense of our standards of living,” he maintains.

Meanwhile, investors nervously eye the latest potential calamity — a presumptive default by the U.S. government within days — and it’s unclear whose head is on the chopping block, if anybody’s.

"If there is a financial meltdown and panic, you don't know where investors will go," Gifford Combs, a portfolio manager at Dalton Investments, told The Associated Press.