Friday, October 24, 2008

Objectivism & Economics, Part 4

Market failure: Greenspan’s testimony Alan Greenspan’s curious testimony before a House panel on Thursday brings forth a curious admission from the former Rand acolyte. According to an AP report:

Greenspan called the banking and housing chaos a "once-in-a-century credit tsunami" that led to a breakdown in how the free market system functions. Accused of contributing to the meltdown, but denying that it was his fault, Greenspan told a House panel the crisis left him -- an unabashed free-market advocate -- in a "state of shocked disbelief."

The longtime Fed chief acknowledged under questioning that he had made a "mistake" in believing that banks in operating in their self-interest would be sufficient to protect their shareholders and the equity in their institutions. Greenspan called it "a flaw in the model that I perceived is the critical functioning structure that defines how the world works." ...

Committee Chairman Henry Waxman, D-Calif., suggested that Greenspan contributed to "irresponsible lending practices" by rejecting appeals that the Fed intervene to regulate a surging subprime mortgage industry. "The list of regulatory mistakes and misjudgments is long," Waxman said of oversight by the Fed and other federal regulators. "My question for you is simple," Waxman told Greenspan. "Were you wrong?"

"Well, partially," Greenspan said. But [Greenspan] went on to assign the blame on soaring mortgage foreclosures on overeager investors who did not properly take into account the threats that would be posed once home prices stopped surging upward. He said what had been "a critical pillar to market competition and free markets did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened."


After reading this, Objectivists can take consolation in the fact that Greenspan no longer considers himself one of their number—and perhaps never did. Yet his vision of the free market is not so very different from Rand’s. Self-interest, Greenspan believed, would be sufficient to motivate banks to act in such as to protect their shareholders’ equity. Apparantly not so—much to Greenspan’s confusion and dismay!

Greenspan would have done well to have heeded Joseph Schumpeter’s insight about the sociological flaws of a free market based on “self-interest.” “[N]o social system can work which is based exclusively upon a network of free contracts between (legally) equal contracting parties and in which everyone is supposed to be guided by nothing except his own (short-run) utilitarian ends,” Schumpeter warned.

4 comments:

meg said...

Maybe Greenspan is getting senile in his old age or something. I do not think deregulation is the only factor, or even necessarily a main factor in the economic crisis. Banks acting in their self interest would not be inclined offer subprime loans and mortgages to people with bad credit who will probably never be able pay them back. The push to open up credit markets to people with low incomes and low credit ratings came from liberal Democrats, in the name of ending mortgage discrimination. Blacks and Hispanics have a lower average credit rating. The result was that banks had to charge higher or adjustable interest rates to these high risk individuals, in order avoid making massive losses on bad loans.

This is an example of the futility and negative consequences of trying to impose equality without thinking of the feasibility of the approach.

JayCross said...

I agree. There's this far-left (though often funny) rapper called Immortal Technique, who says in one of his songs:

"And you wonder why people don't own their homes? It's cause the fuckin' racist banks wouldn't sign the loans!"

My best friend and I always laughed at that, knowing that banks make or don't make loans based on experience, statistics, and probability. As soon as the market crashed, he called me up and said "I guess we know what happens when the racist banks sign the loans."

gregnyquist said...

Meg: "The push to open up credit markets to people with low incomes and low credit ratings came from liberal Democrats, in the name of ending mortgage discrimination."

While this is true, it would be a mistake to regard this a prime force behind the credit debacle. The fact is, the financial markets desperately needed new sources of debt so they could securitize them and use them as leverage to keep asset prices rising. It didn't matter whether the debt was unsound, because it could be washed clean by insuring it with derivative financial instruments.

Damien said...

greg,

Since we're talking about Objectivism and Alan Greenspan, here's an article by an Objectivist who isn't too happy with him. His name is Edward Cline, and he's often a guest commentator over at the Infidel Bloggers Alliance.