Greenspan on Financial Regulation: 'They Don't Fully Understand What They're Doing'

When unqualified people perform a high-level task on “Dancing with the Stars,” it makes for great entertainment. But in Washington, D.C., major legislation is on the line.

On CNBC’s July 1 “Squawk Box,” former Federal Reserve Chairman Alan Greenspan predicted that if it's signed into law, the current round of financial regulation legislation that passed in the House and await a vote in the Senate will require a correction bill in the future. The reason: The people writing this bill have no idea what they’re doing.

“We always overdo it,” Greenspan explained. “The forecast I will make with some degree of confidence – you'll see another technical correction bill coming out within the year. There's got to be unanticipated consequence to what's going on. I frankly don't know all that could conceivably occur because I took a look at the bill and I went off and played golf. It just struck me as an impenetrable problem that you have when a lot of the sentences in that bill are written by junior people who are staff members either on the Hill or in administrative agencies and they don't fully understand what they're doing in certain cases.”

Greenspan said that though new regulation is warranted, but due to the unchartered waters legislators are attempting to navigate they should coordinate with the Federal Reserve to craft the legal language of the bill.

“It was written like it's written always,” Greenspan said. “The strange thing about it is that the big undisclosed secret is when the Congress passes legislation or is in the process, they always came to the Federal Reserve to write the legal language. So as far as banking regulation is concerned over the years, it's really been very responsibly done. But we haven't had anything like this. And look, the crisis is such a shock to the American people. That should be a response. It's wholly appropriate. And it would be inconceivable to me if it were not otherwise. So that there would be a lot of increased regulation is something which, in fact, from my point of view is probably appropriate.”

Greenspan told “Squawk Box” viewers that he miscalculated how much risk investment banks would be willing to take. He explained that traditionally risk managers were more guarded.

“I made the assumption because they've been around for a long time and observed the fact that you can depend on the private risk managers to protect their own equity within the financial system,” Greenspan said. “I mean I served on the J.P. Morgan board for 10 years, and believe me, they had a AAA rating at the time and that was sort of the Holy Grail. And so my basic view was that in the complexity of the system, you have to depend on the owners or the managers or whatever stakeholders there are in a financial system to protect their equity and to protect the value of the firm.”

But despite that miscalculation, he still said he believes it would be difficult for government to regulate as well as their own internal and external auditors.

“Remember, I have watched regulation function close up for 20 years,” Greenspan continued. “And it doesn't work very well and the consequences that in the Federal Reserve and indeed out of necessity, not the politics – there's nothing that beats counter-party surveillance as the private sector – it's what the regulators depended on. We don't have the government regulators. You got internal auditors, you’ve got outside auditors and then you have a small little group of government auditors. They can't do anything of great significance not uncovered by the external auditors or the internal auditors. So, they have to presume that there's enough sensibleness in the system.”