In his book The End of Wallstreet, Roger Lowenstein writes:
“Rates were guided in their downward path by the person of Alan Greenspan, the economic consultant and Ayn Rand disciple turned interest-rate guru who served as Federal Reserve chairman from 1987 to February 2006…It would be an oversimplification to credit (or blame) Greenspan for everything that happened to interest rates over that period, but it was his unmistakable legacy to stretch the boundaries of tolerance, to permit a greater easing of credit than any central banker had before…It was a central tenet of the Greenspan worldview that market excesses — ‘bubbles’ — could not be detected while they were occurring. This stemmed from his faith in the seductive doctrine of the new finance, a core element of which was that financial markets articulated economic values more perfectly than any mere mortal could. People might be flawed, but markets were pure — thus ‘bubbles’ could be ascertained only after the markets had corrected them. Greenspan’s was a Rousseauean vision of markets as untainted social organisms — evolved, as it were from a state of nature. (It overlooked the obvious point that markets were also human constructs — made by men.)”
– pages 3-4
In my first year seminar “The Future of the US,” we’re now talking about the economic crisis we’re facing, one that started with policies in the early eighties when the US started amassing massive government and private debt, setting up a series of bubbles that persisted until the financial meltdown of 2008. Fundamental to the errors that caused the problem was a flawed view of markets as being the best regulator of economic activity, and superior in all ways to government bureaucracy.
Greenspan was appointed by Ronald Reagan, who first broke with the old orthodoxy by instituting a massive wave of tax cuts, while at the same time stimulating the economy with an unprecedented increase in government debt. The “borrow and spend” mentality spread to the public. Naysayers like David Stockman, Reagan’s first budget director who later harshly criticized the total disregard of the Reagan Administration for fiscal constraint, were brushed off. The economy is growing (how could it not, if you deficit spend during a boom!) and inflation was absent.
The dirty secret behind this apparent capacity to borrow, spend and avoid inflation (thus keeping interest rates low and igniting the hyper-consumerist era of the 90s and 00s) is that there was a massive shift in who produced the goods Americans consumed. Instead of being produced by well paid union workers in the US, production shifted to third world states and by the 90s, China. Inflation didn’t increase because the cost of goods went down. The quality went down as well — compare, say a toaster made in 1975 to one made in 2005 — but quality wasn’t really considered in the consumer price index.
Lowenstein’s book, of course, focuses primarily on the bizarre world of credit default swaps, collateralized debt obligations (explained very well here) and the financial collapse of 2008. While “mere mortals” were warning of high debt and the de-industrialization of America, high profits on Wall Street and a faith in the wisdom of markets guided policy makers. Policy makers, especially at the highest levels, get disconnected from average folk. They are connected to the movers and shakers on Wall Street and in big business, and that’s who they take advice from. Bill Clinton — while at least not deficit spending during a boom (under Reagan debt increased from 30% of GDP to 60% of GDP, it held steady under Clinton who ultimately balanced the budget for a couple years) — seemed to worship the advice of ‘big money.’
China and other sellers of consumables to the US rode the credit wave for all it was worth, even buying bonds to help finance its continuation. It was a good deal for China — they got the power to totally subvert the US economy if they wanted to, became America’s top creditor, and the money flowed back to them when consumers bought stuff at Walmart.
An example of the shortsightedness of this market faith is the fate of the effort of Brooksley Born (detailed in this Frontline video) to start regulating a vast market called “over the counter dervivatives.” This involved markets for bonds, swaps, and other financial instruments which had absolutely no transparency. Massive amounts of money were moving into derivatives, with no one knowing exactly what was happening. Derivatives are transfers of risk (the most common form being a futures market), and the new trading was unprecedented, exotic — and ultimately toxic. Greenspan, Summers and Rubin got Congress to shut her down. Markets get it right, Greenspan extolled.
Just as mere mortals were ignored when they warned about high debt and lack of production, they were also warned when they wanted to regulate the fastest growing part of the bond market. They were ignored when they warned about the housing bubble. “Just let the market handle it.”
Well, at one level Greenspan was right — the market will ultimately adjust. And now we’re seeing how it adjusts, with a major recession and a fundamental weakening of the US economy and US position in the world. If humans had intervened, we’d maybe still be producing, we’d not have got caught up in the housing bubble, and the derivatives market would not have threatened to take down the entire global financial system in 2008. If we had not run up debt and unleashed cheap credit, we’d have not become addicted to cheap foreign goods, and the hyperconsumerism which has damaged society on so many levels (detailed in Benjamin Barber’s aply titled book “Consumed: How Markets Corrupt Children, Infantalize Adults and Swallow Citizens Whole“), might have been avoided.
Rather than the roller coaster bubbles followed by a deep recession, we might have more mills and factories still open in Maine, and we’d not be facing the risks we face in this global economy. It’s not so much that markets are bad, only that without regulation and control they get manipulated by the powerful whose interests are usually not those of average folk. Their interests are myopic and short term — profit in any way possible. The faith that how the wealthy structure the game to profit themselves will work out “best” for society is irrational. The idealization of markets has been thoroughly disproven many times in history.
The theory is seductive and yields a very simple, objective world view, one in which many people find comfort. A lot of people don’t like the complexity and nuance of how a very diverse world of imperfect humans with flawed judgment functions. Many prefer to cling to Hayek, Rand, and Greenspan who offer a clear vision of the morality and superiority of markets. Seductive theories, be they communism or market libertarianism are dangerous.
So let markets operate — they do a good job of communicating demand through price, and stimulating innovation. Markets create incentives and allow people to make choices and adapt. But especially in the world of high finance, big business and global trade, they need strict oversight and regulation. Without that regulation markets fail, and instead a rigged game that benefits the elites take over, ironically defended by many who are their victims, but yet believe the system is market driven. Markets cannot function properly without such regulation. Unfortunately, even with some significant reforms, the Obama Administration has not yet made the changes we need to try to really get on the right path. Tim Geithner is smart, but he’s also a Wall Street insider. True, Wall Street is not the enemy, but it’s driven by a conventional wisdom that distrusts needed regulation. Perhaps Obama should tap Brooksley Born to come back to government and help design a new regulative scheme.
With the GOP taking control of the House, it’s unlikely the lessons we should have learned in 2008 will be turned into policy. That bodes for more economic bad news down the line for a country far deeper in crisis than most Americans realize.