Alan Greenspan Admits His Economic Model for 2008 Omitted "Fear" and "Euphoria"

Those powerful "animal spirits" John Maynard Keynes first wrote about — the impact of powerful human emotions like "fear" and "euphoria" — have more to do with the sharp upward and downward  direction of stock and bond prices than Alan Greenspan ever recognized during his estimable career as prognosticator for 315 million Americans.  Five years after the financial system almost went down the former Fed chieftain says his major error was in not adding a factor for "fear" and "euphoria" into his prognostication. That's why he was wrong, not as he divulged  in a Congressional hearing that he had misplaced confidence in our largest financial institutions being prudent with their shareholders capital. What a dreamer!

In his compelling and hugely enlightening new book, "The Map and the Territory: Risk, Human Nature, and the Future of Forecasting," former Fed chairman Alan Greenspan writes "I have come around to the view that there is something more systematic about the way people behave irrationally, especially during period of extreme economic stress, than I had previously contemplated." Regulation of the banks Greenspan says should be  simply a function of "large generic equity capital requirements as reserve against losses that will happen." He isn't facing up to the  leverage used by the banks of nearly $30 of debt for each $1.00 of equity capital in 2008. He isn't facing up to his role in quashing regulation of derivatives and his refusal to raise margin requirements, the curse of staying a libertarian as to the financial behemoths.

Today, Greenspan admits, we can make use of  "fear" and "euphoria" to predict "emerging asset bubbles in equities, commodities, and exchange rates — and even to anticipate the economic consequences of their ultimate collapse and recovery." All I've got to say is that at the ripe old age of 87, it's about time, Alan. He now admits that any "fully detail model" of the economy must factor in the dynamics of "fear" and " euphoria" as well as interest rates, corporate earnings and price-earnings yields. Easy enough to  say, maybe next to impossible to do. 10,000 mea culpas for you Alan.

It appears from this book, published this week, that Greenspan is blaming intense " fear" following intense "euphoria" for the wipe-out of $50 trillion in value globally during 2008- 2009, rather than  the vacuum in oversight of Wall Street   in  accordance with his long-held antipathy for tight regulation of financial institutions. He was dead wrong to be certain  the masters of the universe  would act prudently in order to protect the value of their franchise and shareholder capital. No mea culpa on this score in "The Map and the Territory" as far as I could see.

No matter. This exposition of a lifetime as a practicing economist is full of insights and lessons for financiers, security analysts, business students and public policy makers, especially Presidents, congressmen, central bankers and the FDIC, SEC, CFTC, FHLB. It should be required reading for some of the insights into the way markets perform.