Former Federal Reserve Chairman Alan Greenspan said the US may be doing too little to repair its financial system and promote an economic recovery.

“The amount of money in both these pots may not be enough to solve the problem,” Greenspan said in an interview before a speech Tuesday to the Economic Club of New York.

The comments highlight the difficulties Obama faces in fighting the steepest recession in a generation. The economy contracted at an annual pace of 3.8 percent in the fourth quarter of last year, the most since 1982.

In the speech, the former Fed chairman said, “what we are currently going through is a once-in-a-century type of event. It will pass.”

Greenspan, who now heads his own Washington-based consulting company, warned in his speech that the positive impact of the stimulus package on the economy would peter out if the US fails to fix its financial system.

“Given the Japanese experience of the 1990s, we need to assure that the repair of the financial system precedes the onset of any major fiscal stimulus,” he said.

Bank losses

US bank stocks have been hammered as their loan losses have mounted. Citigroup Inc., the bank that received $45 billion from the government last year, fell 43 cents to $3.06. JPMorgan Chase & Co., the second-largest US bank by assets, declined $3.04 to $21.65. Bank of America Corp. dropped 67 cents to $4.90.

The Obama administration last week laid out a multipronged plan to aid the banks, drawing on the remaining money in the $700 billion Troubled Asset Relief Program (TARP). Greenspan said that would not be enough.

“To stabilize the banking system and restore normal lending, additional TARP funds will be required,” he said.

He highlighted the importance of building up banks’ capital. “Banks are not going to increase their lending until they feel comfortable with the amount of capital they hold,” he said in the February 16 interview. “That is not going to happen for a while.”

The 82-year-old economist also stressed the importance of halting the decline in house prices that is battering banks. “Until we can stabilize the asset side of bank balance sheets, this crisis will not come to a close,” he said.

Mortgage-related assets

US banks have sustained $758 billion in credit losses since the crisis began. Many of those losses stemmed from mortgage-related investments that declined with the collapse in the housing market.

Home prices in 20 US cities fell 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index.

“Unfortunately, the prospect of stable home prices remains many months in the future,” Greenspan said in his speech. “Many forecasters project a decline in home prices of 10 percent or more from current levels.”

Greenspan estimated the collapse in housing, coupled with the steep drop in equity prices worldwide, had wiped out more than $40 trillion of wealth, equivalent to two-thirds of last year’s global gross domestic product. US stocks tumbled to a three-month low Tuesday, extending a decline that began overseas.

“Certainly, by any historical measure, world stock prices are cheap,” Greenspan said. “But as history also counsels they could get a lot cheaper before they turn.”

Gripped by fear

He said that investors were gripped by a degree of fear not seen since at least 1932. Those fears should dissipate once the rate of decline in the economy and the financial markets starts to slow, he added.

“A rise in equity prices could help offset the impact of falling house prices” on the economy, he said in the interview.

Yet he warned that a stock market recovery could be derailed if inflation fears resurface because of the money the government is channeling into the economy.

“The recent rise of long-term interest rates appears to be signaling market concerns about inflationary pressures,” he said. “It could turn out to be the canary in the coal mine.”

The yield on the 10-year Treasury note ended Tuesday at 2.65 percent, down from 2.88 percent a day earlier, yet still well above the 2.05 percent level set on December 30.

Responding to questions after the speech, Greenspan blamed insufficient regulatory oversight in part for failing to recognize the degree of risk that was accumulating in the banking system.

‘Behind the curve’

“The regulatory structures, especially internationally, were way behind the curve,” he said.

Greenspan said he was skeptical that officials can adopt a policy that prevents asset bubbles from forming without harming other parts of the economy. To help resolve the banking system’s problems, financial institutions may need higher capital reserves to help restore them to health, he said.

“There is a general belief that somehow we can regulate very complex organizations, and we cannot,” he said. “What we have got to do is to try to make them more efficient, to put far more capital into these organizations.”

Source: Bloomberg