THE FREE MARKET FAIRY HAS BEEN SLACKING

Alan Greenspan and Nouriel Roubini offer warnings about the economic condition.

Greenspan says more banks, institutions may founder
Mon Aug 4, 2008 6:46pm EDT

LONDON (Reuters) - More banks and financial institutions are likely to face insolvency and need bailouts before the global financial crisis is over, according to former Federal Reserve chairman Alan Greenspan.

Writing in the Financial Times, Greenspan called the current crisis -- which started a year ago -- a once or twice in a century event and said insolvency would only end once U.S. house prices stabilized, underpinning mortgage-backed securities.

Unfortunately, Greenspan still clings to the Fairy:

Greenspan said increased market regulation was not the answer, and could do more harm than good.

"The cause of our economic despair, however, is human nature's propensity to sway from fear to euphoria and back, a condition that no economic paradigm has proved capable of suppressing without severe hardship," he said.

"Regulation, the alleged effective solution to today's crisis, has never been able to eliminate history's crises."

Instead of believing that more rigidity in the system would prevent breakdown, he said continued flexibility was required.

"We may not easily confront or accept the price dynamics of home and equity prices, but we can fend off cries of political despair which counsel the containment of competitive markets.

"It is essential that we do so. The remarkably strong performance of the world economy since the near-universal adoption of market capitalism is testament to the benefits of increasing economic flexibility."

Nouriel Roubini says the losses may mount to $2 trillion before the end of the crunch. (h/t The Big Picture)

Yes, That's $2 Trillion of Debt-Related Losses
Nouriel Roubini, Economist and Professor, New York University
By ROBIN GOLDWYN BLUMENTHAL

I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic. But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn't a ceiling, it's a floor. And the banks, as I've said, have written down only about $300 billion of subprime debt.

Nouriel also reminds of Uncle Alan's role in this mess:

The damage was done earlier, beginning when the Greenspan Fed lowered interest rates in 2001 after the bust of the technology bubble, and kept them too low for too long. They kept cutting the federal funds rate all the way to 1% through 2004, and then raised it gradually instead of quickly. This fed the credit and housing bubble.

Also, the Fed and other regulators took a reckless approach to regulating the financial sector. It was the laissez-faire approach of the Bush administration, and (tantamount to) self-regulation, which really means no regulation and a lack of market discipline.