Tuesday, October 28, 2008

The end of reason

Almost three years after stepping down as chairman of the Federal Reserve, a humbled Alan Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending. "Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief," he told the House Committee on Oversight and Government Reform.

During the hearing, last Thursday, Mr Greenspan came in for one of the harshest grillings of his life, as Democratic lawmakers asked him time and again whether he had been wrong, why he had been wrong and whether he was sorry.

"You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others," said Representative Henry Waxman of California, chairman of the committee. "Do you feel that your ideology pushed you to make decisions that you wish you had not made?"

Mr Greenspan conceded: "Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact."

Mr Waxman noted that the Fed chairman had been one of the nation’s leading voices for deregulation, displaying past statements in which Mr Greenspan had argued that government regulators were no better than markets at imposing discipline.

"Were you wrong?" Mr. Waxman asked.

"Partially," the former Fed chairman reluctantly answered.

Since Mr Greenspan’s testimony, a plethora of scathing attacks on his chairmanship of the Fed have emerged. Many commentators blame him for the financial crisis. Much of the attention is devoted to the irresistible dichotomy of blaming Mr Greenspan for the current turmoil, having previously worshipped him as the god of all things shiny and bling.

Following the attacks on Mr Paulson, Dr Bernanke, every CEO on Wall Street and now Mr Greenspan, it appears that the Government and the media’s appetite for blaming people for this crisis is insatiable. Don’t get me wrong, I have little sympathy for investment bankers or government officials. What is intriguing is that apparently, while Mr Greenspan and other officials were blundering about the Fed and investment bankers were indulging their narcissistic desires, every senator, journalist and media blog commentator could see the crisis coming and was waiting for the recession to hit.

If I had a dollar for every time I read a phrase like “one doesn't need a Nobel prize to know what brought about the collapse of the markets”, I would have enough money to prop up the economy myself.

Is the answer really that obvious? Ignoring the actual mechanics of the crisis, yes the answer does seem pretty obvious. Did most people see it coming? I think people knew it could happen, but the conclusion was too repugnant for most to accept.

So what was the cause? Mr Greenspan says it himself, we misjudged human behaviour. Mr Greenspan, Wall Street and the supporters of capitalism are guilty of failing to grasp, and possibly even denying, three key tenants of human nature: the primacy of greed, our tendency towards sheep mentality and a predisposition to panic.

Now that these traits have come to the fore, officials and the media are calling for a total rethink of how the financial sector operates and how Government’s interact with the economy.

What is not being discussed, however, is that these behaviours paint a very dim view of human nature. If we accept these notions of ourselves, then the implications go well beyond rethinking the economy. We should also consider the role of government and the design and purpose of social policy.

Is this really what be believe about ourselves? Historically, we have characterised the distinctive qualities of human nature in terms such as egalitarianism, independence and rationality. I suspect these qualities are still very relevant.

Surely one overreaction should not be addressed by another.

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