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Donald Cohen

Donald Cohen

Posted: October 29, 2008 10:06 PM

The Education of Alan Greenspan


Greenspan 1963: Writing in Ayn Rand's Objectivist Newsletter, Greenspan declared as myth the idea that businessmen "would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. It is in the self-interest of every businessman to have a reputation for honest dealings and a quality product."

Greenspan 2008: Testifying before the House Committee on Oversight and Government Reform, Greenspan recanted: "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.... This modern [free market] paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."

Greenspan's life spanning quotes are the bookends of the dramatic ascendance, dominance and ultimately demise of the radical right's unquestioning faith in unfettered free markets.

Greenspan's pronouncement in 1963 marked an inauspicious beginning of the new Free Market Fundamentalism in the midst of the coming LBJ landslide and Goldwater defeat. But Rick Perlstein's Before the Storm, an account of the roots of the coming conservative movement, detailed how the Goldwater debacle launched a 40-year project to construct a sophisticated conservative movement and create a new American conservative consensus.

For the Free Market Faithful, those early years were dark days of "big government" marked by the Great Society, landmark civil rights legislation, Medicare and Medicaid. Dominant public opinion even drove progressive policy-making well into the Nixon and Carter years with major environmental and workplace legislation and new regulatory agencies.

But the Fundamentalists, with revolutionary zeal, kept their eye on the prize and systematically built the infrastructure for a conservative triumph. Their greatest accomplishment was the shifting of mass public opinion towards a set of agenda-enabling free market beliefs - that the government could do no right, and the market could do no wrong. They posited, successfully, that the laws of markets were as immutable as the laws of nature.

Throughout the period of conservative dominance there were always those who understood the fallibility of unregulated markets. In 1992, the GAO, asked by Democratic Congressman Ed Markey to study the impact of new and complex financial derivatives, concluded presciently that "The sudden failure or abrupt withdrawal from trading of any of these large U.S. dealers could cause liquidity problems in the markets and could also pose risks to others, including federally insured banks and the financial system as a whole. In some cases intervention has and could result in a financial bailout paid for or guaranteed by taxpayers."

In 1994, a bi-partisan bill was introduced in Congress to tighten the supervision of the complex and growing derivatives in the banking industry. The bill would have had the regulatory agencies establish standards for capital requirements, disclosure, accounting and examinations and audits. As expected, the banks argued that no new laws were needed. Greenspan sealed the legislation's defeat (as he was able to do with all attempts to establish updated regulation for the financial industry) by testifying that the Fed had the powers it needed and that a taxpayer bailout caused by derivatives was remote.

Greenspan claimed with the resolute faith of a true believer that "risk in financial markets, including derivatives markets, are being regulated by private parties... There is nothing involved in federal regulation per se which makes it superior to market regulation." There were doubters, but Greenspan, in the heady days of free-market mania, was the ultimate silencer of doubt.

In 2003 Greenspan continued to praise derivatives as "extraordinarily useful." As recently as September 2005, in a speech to the National Association for Business Economics, Greenspan proclaimed his continued confidence in derivatives in free, un-regulated capitalism, the inherent ability of unfettered markets to self-correct in times of economic distress and the overwhelming dangers of government intervention.

Greenspan spoke glowingly about the "development of financial products, such as asset-backed securities, collateral loan obligations, and credit default swaps, that facilitate the dispersion of risk." He claimed, with remarkable lack of foresight, that "these increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago."

The argument was an old one. The inviolability of the laws of the market would generate the information needed to establish appropriate asset value and risk and self-regulate to prevent excessive speculation. Government regulation would, by definition, get in the way of natural market forces.

He did admit that the Fed, concerned about the irrational exuberance of the Tech Bubble, considered and rejected aggressive action to reign in the speculative excess of the late 1990's. They chose not to "risk recession" and decided to "wait for the eventual exhaustion of the forces of boom." Unfortunately, exhaustion turned into global collapse.

Now, just three years later, the economic crises and its obvious roots in a fanatical aversion to regulation led to Greenspan's striking admission that he and his fellow believers had been wrong.

The dramatic collapse of the banking industry finally exposed several key flaws in the Book of Greenspan. First, the entirely self-evident fact that economics is a behavioral science - that economic conditions are the sum total of human actions, emotions, vice and virtues. Ultimately it was a very human vice - greed - that became the paramount driver of economic growth. Greed, inherently incapable of recognizing excess or limits, inevitably leads to economic distress.

Second, predictions that market signals would cause the necessary corrections turned out to be stunningly false in the face of financial instruments so complex that no one could accurately determine the value of assets or level of risk.

Greenspan's awakening signals a turning point for American capitalism. It's the beginning of the end of the fundamentalist free market epoch, underlined by calls from Democrats and Republicans alike for greater regulation, far more government oversight and even public ownership of private capital.

The rise of the free market zealots is a study of how a movement, driven by the clarity of purpose and a commitment to the long haul, created a narrative of the American economy that clouded the steady erosion of American living standards and the death march to the environmental precipice wrought by global warming. Their fall is a lesson for progressives who, shellshocked and silenced by right wing ideological dominance, couldn't see the way back to a more progressive future.

Progressives have plenty to do to undue the damage and fully untangle America from the sway of the free-market faithful. Still, distrust of government is high, the institutions of government have been hobbled and the right wing message machine is still intact even if on the run. Fortunately, the progressive intellectual infrastructure, more developed and more capable than even just a few years ago, is ready to drive a new New deal, focused on 21st century economic and environmental challenges and reinvigorated with 21 century ideas.