Greenspan warns of more bank bail-outs

By Krishna Guha in Washington

More banks and financial institutions could end up being bailed out by governments before the credit crisis is over, Alan Greenspan, the former chairman of the Federal Reserve, warns in an article in Tuesday’s Financial Times.

However, Mr Greenspan cautions that a heavy-handed regulatory response to the crisis would do more harm than good because it would depress global share prices. He worries that governments, already troubled by inflation, might try to reassert their grip on economic affairs.

“If that becomes widespread, globalisation could reverse, at awesome cost,” he says.

The former Fed chairman says this financial crisis is a “once or twice a century event deeply rooted in fears of insolvency of major financial institutions”.

Highlighting the examples of Northern Rock in the UK and Bear Stearns in the US, he says: “There may be numbers of banks and other financial institutions that, at the edge of defaulting, will end up being bailed out by governments.”

Mr Greenspan says this “insolvency crisis” will end only when home prices in the US begin to stabilise.

He says that “later this year” suppressed housing starts will feed through into a significant decline in home completions, allowing for a “rapid rate of liquidation of the inventory glut”. But this “assumes that current levels of demand for housing hold up”.

Mr Greenspan says the performance of world stock markets will be crucial in determining how well the financial system holds up in the interim, and to banks’ ability to recapitalise themselves.

He says a key determinent of global equity prices is the rate at which investors discount future cash flows, and this in turn is influenced by the degree of market capitalism and globalisation.

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