Archive for October 25th, 2009

Greenspan’s Confession

It’s been almost one year to the day from one of the most remarkable confessions in recent political history.  Alan Greenspan, speaking before a Congressional hearing, admitted that he had been wrong.   Not only had he been wrong about policy, but wrong about “how the world works.”  Greenspan said it was distressing, but his ideology — the lens through which he interpreted reality — turned out to have been proven faulty.

Greenspan was a libertarian, a firm believer in markets and devotee of Russian fiction writer and political activist Ayn Rand.  In fact, she and he were friends, and he counted her as among the greatest influences in his life.   Rand’s work, for those who haven’t read her, is very inspirational.  It connects emotionally with the desire and need people have to take control of their lives and be masters of their own destinies.  She tried to turn her work into a philosophy (which she called ‘objectivism,’ an odd term since it can also be an adjective that describes even Marxian philosophy), but in that endeavor she failed.   To really buttress libertarian ideology you need to turn to the likes of Friedrich Hayek, who offered a more profound defense of markets.   Still, her spirited defense of laissez-faire capitalism and, as Greenspan always used to say “the markets get it right” shaped the world view of the former Federal Reserve leader.

Greenspan admitted that he had to make compromises with his principles to become a Central Banker.  He would have to enforce laws he didn’t agree with, and work in a system which he felt was fundamentally flawed in its embrace of big government.  Yet he also believed he could work from within the system to reform it, rather than stand on the sidelines and curse.   In that, he was effective.   His work assured that even the liberal Clinton administration would embrace the free market principles Greenspan promoted.

Last week Frontline aired a segment on PBS called “The Warning,” which detailed the losing battle of Brooksley Born , head of the Commodity Futures Trading Commission, to try to regulate the growing over the counter derivative market.   These financial instruments allowed big players to leverage small amounts of capital into vast fortunes, and thus make a killing in the market.   She saw, correctly, that this kind of instrument was very dangerous, and could cause a financial meltdown if not regulated.   As it was, no one knew the extent of the trading, fraud was easily possible (these trades weren’t reported), and the entire financial system was at risk.

Greenspan, Jerry Rubin and Lawrence Summers (the latter two on Obama’s economic team) lead the free market charge against reform, working with banking industry lobbyists and Congress to fight against the regulations, and ultimately take the power to regulate these markets away from the CFTC.  That lead to Born’s resignation in 1999, and Greenspan for the next few years seemed king of the economic world — the wizard, the guru, the genius that somehow managed to shepard in a long period of GDP growth, low inflation, and vast expansion of stock and then property values.  Things would never be as good as they were in 2006, the year Greenspan retired.

We know now, of course, that these unregulated financial instruments caused disaster in the system.   While some want to blame it on mortgages to people who couldn’t afford them, that sector of the market would have been small and insignificant if it hadn’t been fodder for derivative leveraging and other shady unregulated financial instruments.   In fact, the reason why so many experts dismissed the subprime crisis as minor is because they thought it was simply a problem with some loans that shouldn’t have been made.   They didn’t realize that a stack of cards had been built on that shaky foundation, and whose collapse would endanger the entire world economy.

What’s amazing in watching the video of an obviously distressed and some would say broken Alan Greenspan is that he saw his life’s work and reputation going from that of a successful economic genius guided by a clear moral and economic philosophy of free markets, to the man whose inaction and inability caused economic crisis.  He was unable to recognize the way in which “stupid mistakes” and “irrational exuberance,” unregulated, could bring immense harm to an entire economic system.    He realized too late that markets are not magic, and cannot work without effective rule of law and regulation.

Greenspan let an ideology guide his view of practical reality.  That has been proven disastrous throughout history.  Yet humans, wanting to have a coherent view of the world, and wanting to think themselves “right,” grasp at ideologies as ways to explain reality and justify their actions and political perspectives.   It’s much like religion — people want to think they have the capacity to understand reality and how it works, and they seek an set of beliefs and assumptions to structure that understanding.  There’s nothing wrong with that, as long as it doesn’t become dogma.

As long as someone recognizes and embraces the fact that, as a fallible human, his or her beliefs might be wrong, and thus recognizes the need for not only tolerance of other views, but real consideration of diverse perspectives, it’s good to have a coherent core belief system.  As long as one is not just other-critical but also self-critical, it is something to build upon.  Greenspan was convinced he was right, and for awhile, the evidence seemed to strongly support that view.

Yet when he sat before that committee chaired by Henry Waxman, he had the intellectual integrity to admit to the country, the Congress, and most importantly to himself that he had gotten it wrong.   The world doesn’t work the way he thought it did, the world surprised him.

The lesson from Greenspan to us all is that no matter how much we think we understand reality, and no matter how convincing our own core beliefs seem to be, any of us may be wrong.   Greenspan is a genius.  He had apparent success for decades.  Yet he really should have seen the warnings on the horizon.   In hindsight it’s easy to recognize the inevitability of this crisis and, to be fair to libertarians, another libertartian economist, Peter Schiff (Austrian school) did see how the economy was heading for a collapse.

We humans have a real hard time with cognitive dissonance.  We will go to great lengths, sometimes consciously, but usually subconsciously, to find ways to fit reality into our pre-existing belief system.  We will interpret events, religious teachings, philosophy, and history to fit our beliefs of how the world works.  I do that.  You do that.  That seems to be a constant of human nature.

Greenspan, like all of us, are not completely right or completely wrong, but right on many points and wrong on many others.  An ideology is also not correct or incorrect, but a simplification of reality designed to help us understand and predict.   Ideologies inevitably work well dealing with some aspects of reality, but fall short on others; indeed, the meaning of an ideology varies across cultural contexts.   Greenspan’s confession does not mean all of what he believed was disproven, it means only that reality didn’t quite hang together the way he thought he did.

And lest we get too smug about the Chairman’s fall, we’re all in the same boat — our errors usually aren’t as easily noticed and publicized.  And, of course, all humans tend to need a crisis now and then to jerk them out of their complacency.   To really embrace this view is, in its own way,  liberating.   If we realize that we can’t be right all the time, then we relieve ourselves of the pressure of thinking we must.