US economy in tug-of-war situation: Greenspan

In an interview to CNBC, Alan Greenspan, Former Fed Chairman said, “We are in throes of a recession. So the real problems are occurring basically from the areas of the sources of revenues and at some point this tug of war is going to either is going to solve the financial problem or is going to pull down the real economy and I do not think that we have enough knowledge of how the system works to make that judgement definitive.”

Greenspan added, “What we are looking at, is a tug of war between the real economy, both in US and the rest of the world and the financial systems since the last August - we start off back then, with one of the very important consequences of a decline in interest rates was the ability of the American co-operations and indeed of all others to fund their short term liabilities, significantly reduce their interest costs and basically have no real pressures on the need for funds.”

Excerpts from an exclusive interview with Alan Greenspan:

Q: Let me ask you to look back at the policy decisions you made in those periods. Cutting interest rates from 01 to 03. Can you look back and say I should have doene this differently. What do you regret, sir?

Greenspan: We have to differentiate between what the policy was at the time and whether it was a rationally constructively policy based on the evidence of that time. I have said to many questions of this nature that I have no regrets on any of the Federal Reserve policies that we initiated, because I think they were professionally done. If we can get forecasts right 60% of the time, we are doing extraordinarily well. In retrospect, do I think it would have been if we had a higher record of forecasting accuracy? Of course. Do I think it's possible? No. Do I think we could have had better? I don't think human nature is such that we are given insights that enables us to do that. What I am concerned about is basically the economic analysis involved in saying the Federal Reserve is responsible for the housing bubble. We lost control of the long end of the bond market probably sometime around 2002 or 2003 as global forces began to dominate the market. As I said on many occasions, there is over USD 100 trillion of arbitrage of the long-term assets out there. The Federal Reserve that lost its ability to influence long-term rates several years ago and indeed the failure in 2004, is what I call a conundrum whose expiration of the consequence of that is basically that Central Banks no longer have the capability to do very much in the long end of the market. We tried and we failed and believe I have spoken to other Central Bankers in recent years and they agree with that proposition.

Q: We see this enormous need for capital on the part of our financial institutions and our viewers are thinking how tough is it? How worried should they be? How close do you think the global financial system came to really seeing a halt or a seizure in the last couple of weeks before the Bear Stearns’ bail out?

Greenspan: I am talking about the non-financial sector of the economy. It still is an extraordinary good shape and we're seeing little in the way of borrowing requirements, but it is under pressure basically not because of the borrowing, but the revenues are beginning to become depressed by pressure. Largely because the consumers are beginning to shrink and the automobile markets are contracting and production is beginning to ease. We are in the throes of a recession, so that the real problems are occurring basically from the areas and sources of revenues. At some point this tug of war is either going to solve the financial problem or it is going to pull down the real economy and I don't think we have enough knowledge of how this system works to make that judgment definitively.

Q: Real quick on the financial services companies, that's where I was focused, not on the non-financial. How worried are you?

Greenspan: For the first time in my memory that we had both the banking system and the securities markets in trouble, historically it was one or the other and we found that in 1989 and 1990 when the banks were under severe pressure, the whole opening began and the intermediation of savings into investment was facilitated by the securities markets. Other times when the markets were there, the banks were viable. This is the first time when both were under pressure and at this stage, it's evident. What is happening in the markets at this stage is that an ever-increasing need for additional capital in all financial institutions from banks, hedge funds and investment banks, I think when we come out of this, the markets will demand a much higher ratio of economic capital and lower leverage and it's a matter of time before the link to the old system will be revised as will be the regulatory requirements in all forms of institutions fundamentally to raise capital.