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Thursday, October 23, 2008

"Greenspan Follies"

Dean Baker on Greenspan's admission that he made a mistake in resisting regulation of credit markets:

Greenspan Follies: The World Is as Ayn Rand Would Have Predicted, by Dean Baker: Alan Greenspan has finally acknowledged that he may have made some mistakes in allowing an $8 trillion housing bubble to grow unchecked. (Look for rivers flowing upstream.)

This modest act of contrition should be welcomed, but analysts have been far too quick to describe Greenspan as a prisoner of his free market ideology and the current crisis as a story of the free market running wild. ...

First, insofar as Greenspan acted (or didn't act) out of ignorance of the true situation, it was because he was ignoring Ayn Rand, not because he was following her.

Let's set the stage. Bear Stearns, Goldman Sachs, Citigroup and the rest of the big banks are run by hotshot Ivy League business school types. These are bright, hard working ambitious people who want to make lots and lots of money.

The executives at these banks are sitting on enormous piles of money that they can get access to as a result of being at these huge banks. The hotshot executives know that they can get huge bonuses by taking risky gambles with the banks' money.

The executives can make bets, that if they pay off, will get tens of millions a year in bonuses and other compensation. Of course, if they lose they can bring down the house, meaning that they bankrupt Bear Stearns, Lehman, etc.

What would Ayn Rand expect to happen? On the one hand we have the hot shot executives, on the other hand the schmucks who own stock in these banks. Would Ayn Rand expect that the executives would put aside their ambition, their lust for success, their greed, in order to benefit shareholders who are too dumb to even know what a credit default swap is?

Not for a second; Ayn Rand would watch the Wall Street big boys run roughshod over their shareholders' interests and be applauding them every step of the way. That is how the game is played. If Greenspan didn't think the Wall Street crew would rip off their shareholders for every last penny, then he was not a worthy disciple of Ayn Rand.

As far as this being a story of the market having run amok, that is only partially true. The banks were able to get access to vast amounts of capital because everyone had faith in the "too big to fail" doctrine. In other words, all the people who lent Bear Stearns, Lehman, AIG, Goldman and the rest money felt secure because they thought the government would come to the rescue at the end of the day if the hotshots messed up big time.

With the exception of Lehman Brothers, these folks were right..., they were gambling with the taxpayers' money...

This is not to say that we would want a real free market in finance. It's not even clear what that would look like. But it is clear that Wall Street hotshots who brought us this disaster ... want to be able to operate with a government security blanket while not being required to contain risk or pay for this insurance. Calling them, or their patron Alan Greenspan, free market ideologues is far too generous.

I always wonder if the people making the decisions actually had these thoughts, i.e. if they explicitly made decisions based upon the assumption that there was a large possibility of a bailout if they blew things up. Do you think they did?

Update: Arnold Kling answers.

    Posted by on Thursday, October 23, 2008 at 04:50 PM in Economics, Financial System, Housing, Monetary Policy | Permalink  TrackBack (1)  Comments (53)

          

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    » Mark Thoma's Question from EconLog

    He writes, I always wonder if the people making the decisions actually had these thoughts, i.e. if they explicitly made decisions based upon the assumption that there was a large possibility of a bailout if they blew things up. Do... [Read More]

    Tracked on Thursday, October 23, 2008 at 06:16 PM


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