Fraud and Alan Greenspan

In a fascinating story first printed in Stanford Magazine, former head of the Commodity Futures Trading Commission Brooksley E. Born recounts her 1996 lunch with Alan Greenspan during which he told her

“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls. Greenspan, Born says, believed the market would take care of itself.

When I read that sentence today, it took my breath away. First of all, I had recently blogged about Bill Moyer's interview with former bank regulator William K. Black about the central role that massive fraud played in the meltdown and the need to get to the bottom of that fraud. But more viscerally, it took me back to the first month of my Secured Transaction course with Prof. Robert C. "Boots" McClure at the University of Minnesota Law School, in which that former FBI special agent taught us all about famous frauds, such as Billie Sol Estes and the O.P.M. computer leasing scandal. It was a great, practical introduction for a future deal lawyer to some of the characters you might run into and some of the risks against which you might need to help protect your clients. Knowing the huge financial losses that followed in the wake of those scandals (and how creative and energetic those purveyors of fraud had been), I couldn't believe that a government official who had served as long and in such high and important positions as Alan Greenspan could take such a casual attitude toward fraud.

To be fair, Mr. Greenspan responds, in the same article, that "This alleged conversation is wholly at variance with my decades-long held view" (as set forth in his 2007 Age of Turbulence) that

"An area in which more rather than less government involvement is needed, in my judgment, is the rooting out of fraud. It is the bane of any market system. Indeed, Washington would do well to divert resources from creating new regulations to greatly stepping up the enforcement of anti-fraud and anti-racketeering laws¹."

One searches Age of Turbulence in vain, however, for any concrete action that Mr. Greenspan took (or even wished to take) against fraud. For example, a casual reader of Mr. Greenspan's observation that "The inflation of the seventies — compounded by mismanaged deregulation and, ultimately, fraud— did hundreds of [savings and loans] in" might not appreciate that Mr. Greenspan actually had a front row seat at "the inflation of the seventies" and its "mismanaged deregulation and, ultimately, fraud" because Mr. Greenspan served as chairman of President Ford's chief economic advisors. Mr. Greenspan also explains that, "as a private consultant," he came to issue an opinion that one of the most notorious of those savings and loans, Charles Keating's Lincoln Savings, was financially healthy enough to be allowed to invest directly in real estate, and "I told the New York Times that I was embarrassed by my failure to foresee what the company would do, and added, 'I was wrong about Lincoln.'"

Not so embarrassed, however, as to prevent Mr. Greenspan from uttering the following pronouncements in Age of Turbulence:

I concluded, and I suspect most regulators agree, that the first and most effective line of defense against fraud and insolvency is counterparties' surveillance ... As first a bank director (at JPMorgan), and then a bank regulator for eighteen years, I was acutely aware of how much better situated and staffed banks were to understand what other banks and hedge funds were doing as compared with the "by-the-book" regulation done by government financial regulatory agencies. As good as some bank examiners are in promoting sound banking practice, they have little chance of uncovering most fraud or embezzlement without the aid of a whistle-blower.

Mr. Greenspan's communication style is famously opaque, but it sure seems a very short step from the foregoing statement to the Alan Greenspan who (allegedly) took Brooksley E. Born out to lunch in 1996 and told her that "the market would take care of" fraud.

In all events, that rock-solid reliance on "counterparties' surveillance" didn't work out so well. In the words of Mr. Greenspan's testimony before the Congressional Committee of Government Oversight and Reform on October 23, 2008:

... those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance ... As much as I would prefer it otherwise, in this financial environment I see no choice but to require that all securitizers retain a meaningful part of the securities they issue. This will offset in part market deficiencies stemming from the failures of counterparty surveillance ... There are additional regulatory changes that this breakdown of the central pillar of competitive markets requires in order to return to stability, particularly in the areas of fraud, settlement, and securitization.

So, now that the "central pillar" of "counterparty surveillance" has fallen, Mr. Greenspan is (as much as he would prefer it otherwise) finally prepared, as of October 2008, to accept that maybe it's time to let the government make laws against fraud.

It is important to note just what a radical course Mr. Greenspan espoused. There has never been a time in the history of Anglo-American law when fraud has been legal! Consider Sir William Blackstone, writing in 1753:

... if any person shall by any false pretence obtain from any other person any chattel, money, or other valuable security, with intent to cheat or defraud any person of the same, every such offender shall be guilty of a misdemeanour, and, being convicted thereof, shall be liable, at the discretion of the court, to be transported for seven years, or to suffer fine or imprisonment, or both, as the court shall award

Mr. Greenspan wasn't seeking merely to "push back" the New Deal era securities regulation; he was pushing back English common law at the time of Blackstone.

Where is Boots McClure, now that we need him?

¹ Alan Greenspan, The age of turbulence: adventures in a new world (Penguin Group, 2007). Accessed here on 2009-05-15.

² Sir William Blackstone, Commentaries on the Laws of England in Four Books. Notes selected from the editions of Archibold, Christian, Coleridge, Chitty, Stewart, Kerr, and others, Barron Field’s Analysis, and Additional Notes, and a Life of the Author by George Sharswood. In Two Volumes. (Philadelphia: J.B. Lippincott Co., 1893). Chapter: CHAPTER XII.: OF OFFENCES AGAINST PUBLIC TRADE. Accessed from http://oll.libertyfund.org/title/2142/198909/3159937 on 2009-05-15.