Alan Greenspan on CNBC: Dodd-Frank Based on Faulty Understanding of Financial System

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Part Two:

CNBC Squawk Box hosts Joe Kernen, Becky Quick and Carl Quintanilla interviewed Alan Greenspan June 3 from the Department of Labor in Washington, D.C., where they had traveled to broadcast the show remotely.

In his comments, Greenspan says that one of the missing parts of the economic recovery is the construction sector, missing partly because of the weak housing sector. According to research by his firm, Greenspan said, If the production of longer-lived assets had recovered as it has in the past, unemployment would be at 6 percent.

Greenspan also supports raising income tax rates to the Clinton era levels, if necessary, for a budget agreement that reduces the deficit and debt outlook.

Greenspan also does not believe that there will be a crisis after August 2, as Secretary Timothy Geithner has suggested, if the debt ceiling is not raised. Treasury is high likely to continue paying interest on the nation's debt service. The problem is that a 40 percent decline in government spending (40 percent of each dollar is borrowed) would negatively impact the economy.

While he opposed the idea of the debt limit on principle, in this instance it provides a real opportunity to address the serious issue of deficits.

Business Uncertainty

Greenspan said part of the problem facing business is that they cannot get an idea of what the outlook is going to be 20 years or more from now.

The uncertainty is holding back long-term business investment, he added.

"One of the reasons is that there's too much government activism in a technical sense," he said. The high level of government activism has a very negative impact on potential rates of return. When calculating the rate of return on a long-term investment, such as an aluminum rolling mill, which Greenspan said he had done, the distribution of potential rates of return is very wide.

"The distribution [of rates of return], if it is very wide give you agebraicly very low risk-adjusted rate of return," Greenspan said.

The coming onslaught of regulations, "the structure of activism," from new laws in response to the crisis, as well as Obamacare, are factors in the reluctance of business to expand or hire.

"I don't think the structural framework of how the financial system actually works is captured in the philosophy of Dodd-Frank," Greenspan said.

"in other words, they are specifying if you do this (moves hand right), this (moves hand left) will happen. All the evidence of which I'm aware is that it will not. It will do this (raised hand)," he added.

Greenspan said that he did not see how the 200 rule-makings at the Fed could be accomplished. "When I was at the board, if we had 10 a year, that was a big work load," Greenspan said.

Greenspan believes that federal entitlement programs will necessarily face the budget knife.

"Medicare or any other kind of defined benefit program cannot persist in the type of economy that we are going to be viewing over the next decade," Greenspan said.

One of the reasons is that as highly educated productive people retire, new entrants into the labor force will not be able to make as much of a contribution in terms of productivity because of the failures in the U.S. educational system, according to Greenspan.

The former Fed chairman also believes that because banks have been parking their excess reserves rather than lending them out to earn more money, the end of quantitative easing will not necessarily have a huge negative impact. Banks have not lent, he said, because of capital constraints.


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