How Free-Market Delusions Destroyed the Economy

[Joanne98]

By Raj Patel, Picador Press
Posted on November 30, 2009, Printed on November 30, 2009
http://www.alternet.org/story/144151/

The following is an excerpt from Raj Patel's new book, The Value of Nothing (Picador, 2010).

If war is God’s way of teaching Americans geography, recession is His way of teaching everyone a little economics. The great unwinding of the financial sector showed that the smartest mathematical minds on the planet, backed by some of the deepest pockets, had not built a sleek engine of permanent prosperity but a clown car of trades, swaps and double dares that, inevitably, fell to bits. The recession has not come from a deficit of economic knowledge, but from too much of a particular kind, a surfeit of the spirit of capitalism. The dazzle of free markets has blinded us to other ways of seeing the world. As Oscar Wilde wrote over a century ago: "Nowadays people know the price of everything and the value of nothing." Prices have revealed themselves as fickle guides: The 2008 financial collapse came in the same year as crises in food and oil, and yet we seem unable to see or value our world except through the faulty prism of markets.

One thing is clear: The thinking that got us into this mess is unlikely to rescue us. It might come as some consolation to know that even some of the most respected minds have been forced to puzzle over their faulty assumptions. Perhaps the most pained admission of ignorance happened in a crowded room in front of the House Committee on Oversight and Government Reform when, on October 23, 2008, Alan Greenspan described the failure of his worldview.

Greenspan was one of the acknowledged legislators of the world’s economy over the past nineteen years in his role as chairman of the Federal Reserve. A card-carrying member of the free market brigade, he used to sit at the feet of Ayn Rand who, although largely unknown outside the United States, remains influential long after her death in 1982. Her 1957 book Atlas Shrugged, in which heroic business moguls fight the scourge of government officials and union organizers, has once again scaled the bestseller lists. Regarding altruism as “moral cannibalism," Rand was the cheerleader for an extreme free market libertarian school of thought, which she called “Objectivism."

Drawn into her circle by this heady philosophy, Greenspan earned himself the nickname “the Undertaker" for his jolly demeanor and dress sense. When Greenspan chose a career in government, it was rather like a hippie joining the marines, a lapse that his former friends could never forgive. Despite this, Greenspan remained largely faithful to Rand's philosophy, continuing to believe that egoism would lead to the best of all possible worlds, and that any form of restraint would result in disaster.

At the end of 2008, Greenspan was summoned to the U.S. Congress to testify about the financial crisis. His tenure at the Fed had been long and lauded, and Congress wanted to know what had gone wrong. As he began to read his testimony, Greenspan looked exhausted, his skin jowly and sagging, as if the vigor that once kept him taut had all been spent. But he came out swinging. In the first round, he took aim at the information he’d been working with. If only the input had been right, the economic models would have worked, and the predictions would have been better. In his words, a Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.

Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

This is a garbage-in-garbage-out argument: The model worked just fine, but the assumptions about risk and data, based only on the good times past, were faulty and so the output was correspondingly wrong. Greenspan’s nemesis on the panel, Henry Waxman, pushed him to a deeper conclusion, in this remarkable exchange:

Waxman: The question I have for you is, you had an ideology, you had a belief that free, competitive -- and this is your statement -- “I do have an ideology. My judgment is that free, competitive markets are by far the unrivalled way to organize economies. We have tried regulation, none meaningfully worked.” That was your quote. 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. And now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?

Greenspan: Well, remember, though, what an ideology is. It’s a conceptual framework with the way people deal with reality. Everyone has one. You have to. To exist, you need an ideology. The question is, whether it is accurate or not. What I am saying to you is, yes, I found the flaw, I don’t know how significant or permanent it is, but I have been very distressed by that fact.

Waxman: You found a flaw?

Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

Waxman: In other words, you found that your view of the world, your ideology, was not right, it was not working.

Greenspan: Precisely. That is precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.

The flaw, to be clear, wasn’t a minor one of shoddy data. Nor was it the bigger Black Swan problem that writers like Nassim Taleb discuss, a problem of failing to account for highly unlikely events that, should they happen, involve catastrophic consequences. Greenspan’s flaw was more fundamental still. It warped his view about how the world was organized, about the sociology of the market. And Greenspan is not alone. Larry Summers, the president’s senior economic advisor, has had to come to terms with a similar error -- his view that the market was inherently self-stabilizing has been "dealt a fatal blow." Hank Paulson, Bush’s Treasury Secretary, has shrugged his shoulders with similar resignation. Even Jim Cramer from CNBC’s "Mad Money" admitted defeat: "The only guy who really called this right was Karl Marx." One after the other, the celebrants of the free market are finding themselves, to use the language of the market, corrected.

The extent of Greenspan's admission has passed most of us by. If you trawl the oped pages of the financial press, you'll find plenty of analysis that fits Greenspan's first gambit, with pundits offering stories about how risk was incorrectly priced (which it was), how the lack of regulation allowed the panic to feed back into the financial system (which it has), how the incentive structures rewarded traders who were able to push financial risk far into the future (which they did) and how free market ideologues removed the sorts of circuit-breaking policies that might today have helped (and they did that too). But these are all it-could-have-been-fixed-if-we'd-planned-better responses. I am not sure that we're able to comprehend what Greenspan's admission might really mean for us. It would be too big a shock to have the fundamentals of policy in both government and the economy proved wrong, and to have nothing with which to replace them.

continued>>>
http://www.alternet.org/workplace/144151/how_free-market_delusions_destroyed_the_economy_

[FiveGoodMen]

1. K&R