Alan Greenspan Learns a Lesson


(Via The Washington Independent, Rand and Greenspan)


When he was young, Alan Greenspan suckled at the bony breasts of Ayn Rand, drinking in as his mother’s milk libertarian and Objectivist thought. After being furthered mentored by Milton Friedman, Greenspan rose to ranks of policy making until he became Federal Reserve chairman. In that position he was the world’s pre-eminent advocate of neo-liberalism, always quick to lecture on the need for deregulation so that markets could do their magic.


And now with the current global financial crisis something completely unexpected has happened. Greenspan, age 82 and a very old dog indeed, has learned something new: that markets don’t always give you the best result.


Grilled by members of the U.S. Congress, Greenspan admitted “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.”



Greenspan further confessed, “”I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works. That’s precisely the reason I was shocked… I still do not fully understand why it happened and obviously to the extent that I figure where it happened and why, I will change my views. If the facts change, I will change.”


Aside from commending Mr. Greenspan for still being open to new facts and theories, it might be worth asking where he went wrong and what other books he should have been reading apart from Ayn Rand and Milton Friedman.


Over at Crooked Timber, John Quiggin pinpoints  pinpoints one of the flawed models that Greenspan was relying on, the Efficient Markets Hypothesis. As Quiggin helpfully explains: “In its most relevant form, the EMH states that prices observed in asset markets (for stocks, bonds, foreign exchange and so on), reflect all known information, and provide the best possible estimate of the value of earnings that assets will generate.”


Quiggin provides a summary of whats wrong with the EMH and where the failure of this model leaves us:


The EMH implies that, provided governments get prices right (avoiding distorting taxes, internalising externalities and so on) it’s impossible to improve on the allocation of investment capital generated by private markets. The converse doesn’t hold automatically. Even granting that private markets are subject to bubbles and fads, and that their investment decisions may not make sense in the light of publicly available information, it doesn’t necessarily follow that governments can do better. Still, for large scale infrastructure systems, the case for leaving investment planning as, in Keynes words ‘the by-product of the activities of a casino’, looks a lot weaker now than in did before this crisis. Of course, for anyone who cared to look, the ludicrous investment decisions made during the dotcom boom had already undermined the EMH.



Once the EMH is abandoned, it seems likely that markets will do better than governments in planning investments in some cases (those where a good judgement of consumer demand is important, for example) and worse in others (those requiring long-term planning, for example). The logical implication is that a mixed economy will outperform both central planning and laissez faire, as was indeed the experience of the 20th century. I’ve written a more detailed version of this argument here here.


So, Greenspan (and those who think like him) should take a remedial economics course and start boning up on Keynes.


A few other suggestions are in order: the great problem with neo-liberalism is that it’s a fundamentally ahistorical mode of thought. Trying to apply 18th century models of equilibrium and harmony to the modern economy, neo-liberals typically fail to notice that modern corporations are nothing like the private firms that Adam Smith studied. Of course, there is a formidable body of thought that does try to think about economics historically, emphasizes the reality of crisis rather than equilibrium, and is very sensitive to the shift from entrepreneurial enterprises to early corporations to global capital: Marxism, particularly as its been revised by writers like Ernest Mandel, Robert Brenner, and David Harvey.


I doubt that Greenspan will crack open any of the modern Marxist classics. What he might find more palatable are books by moderate social democrats who from the 1930s onward have called attention to the fact that the managerial class that runs the modern corporation has its own agenda, and often works to enrich its own coffers and perpetuate its own powerbase at the expense of the shareholders and the larger public. I’m thinking here of writers like Adolph Berle and John Kenneth Galbraith. The great achievement of these theorists is that they saw modern capitalism as a matter of institutions, rather than just markets. 


These institutional theorists were of course enormously influenced by the Great Depression and they (along with Keynes) helped build the regulatory state that allowed capitalism to regain its footing. This regulatory infrastructure led to the golden age of modern capitalism, the period from 1945 to 1973,  when a mixed economy led to the greatest improvement of the lives of ordinary people in the history of the world.


Alan Greenspan, its worth recalling, enjoyed his early manhood during this golden age (he was 19 years old in 1945). Indoctrinated by ideologues like Rand and Friedman, Greenspan thought that the economic prosperity of the period was the product of the free market, rather than the mixed economy. So Greenspan spent his life working to undermine (usually very successfully) the regulatory infrastructure that moderate social democrats had so carefully built. That was the root of the “flaw” in his thinking that he now has to come to terms with, as do we all.

8 thoughts on “Alan Greenspan Learns a Lesson

  1. I am not an economist, but I will say that this is a lot broader view of efficient markets than I learned in my fanance classes when I got my MBA. In those classes, this theory was basically that the price of a (sufficiently liquid) security at any moment was “correct” — that the market, taking into account all public information, priced it all in. Therefore, it was impossible to use arbitrage to make a riskless profit. (Such arbitrage would involve taking two securities that should be priced the same but aren’t, longing the underpriced one and shorting the overpriced one, and making a profit thereby.) This was a powerful theory that helped do away with much of the voodoo around studying stock charts. Since then, behavioral economists have challenged it pretty well as have statistics-oriented academic financial economists, and we all know what happens now when you have opaque, lightly traded securities — the market can’t find prices for them, trust erodes, banks won’t lend, and capitalism goes begging to government to be rescued — again. I guess what I’m saying is that EMH has always had a narrower meaning than what you and Quiggan seem to be saying. That may simply be a by-product of how it was taught to me, however.

    What you both seem to be talking about is the laissez faire approach that markets (in the broadest sense of all commerce, not just securities) always are the most efficient at allocating resources; this mainly comes from Hayek, right? Of course, these kinds of things are argued that selling tin on the open market allocates the tin more efficiently than having a central planner decide who has the tin. This kind of either-or is absurd, and disproven, as you say, by the fact that mixed economies (where markets coexist with “planners”) have done really well for the past 100 years.

    I’m not disagreeing with your major point, just your terminology. Although I am more informed by Keynesian thinking than Marxist thinking.

  2. Robert, You’re right that there is a more narrow definition of the EMH (along the lines you suggest above) but over the years the EMH was generalized and applied to markets as a whole. It was seen as a sexy new way to validate the arguments of Hayek and Friedman. So the problem is not with the original EMH but the way it was applied to where it didn’t belong.

  3. This crisis was not a failure of laissez-faire capitalism, it was a failure of intensive regulation —in unbelievable, mass stupidity, the most commonly touted solution is more regulation!

    From The American Competitive Enterprise Institute:
    While the Dow collapses, we have a bull market in government regulations. The 50-plus departments, agencies and commissions are now at work on 3,882 rules; 757 will affect small businesses. More than 51,000 final rules were issued from 1995 to 2007.

    That’s 51,000 NEW regulations, added to what was there before, in only 12 years!.

    On another of their web pages:
    Well over 48,000 final rules were issued from 1995 to 2006–that is, during Republican control of Congress.

    That is hardly Rand’s laissez-faire capitalism; that’s fascism/corporatism & socialism. At root, those are the very ideologies Rand spent her lifetime hoping to save Americans and America from. Now, when the effects of those destructive ideologies from Washington hit the fan, everyone is blaming laissez-faire capitalism instead. They are ridiculous, uninformed, or dishonest.

    Greenspan dropped any pretense of understanding Rand’s arguments sometime before he became head of the Fed., and he then became a major part of the problem. His monetary policy and suppression of interest rates, when Rand would have said “let the market decide” were an appalling government intervention. Add in The CRA, CDS, Fannie Mae, Freddie Mac and the recipe for a distorted market was complete.

    Now imagine, there YOU are, the CEO of a large financial organization. Your competitors are complying with the regulations and are making good for their shareholders, while things are getting tight for your firm. What do you do?

    You join in, of course. If you are able to understand the fraud in the government’s game, you build yourself some protection for when the bubble bursts… but most people, like you and your commenters, are not that smart. Still, none of you would have dared to play the ‘game’ Washington’s way if it were not for a handful of people in the US government who believed they were more intelligent than the free market. Without those people, lending rates would have adjusted themselves years ago, paper money would not have been printed like it grew on trees (e.g. “helicopter Bernanke”) and the present crisis would not even have been imagined.

    Consider carefully reading, or re-reading “The Virtue of Selfishness” & “Capitalism: The Unknown Ideal”, to see how, rational egoism is the essence of business. and is the reason for individual rights. Capitalism is the only moral system. A geopolitical and historical look at nations shows that those which are more free have citizens who prosper more, and live more peacefully.

  4. This has been a fascinating and well-informed discussion. Over the past couple of months, I’ve tried to spend a little bit of time each day reading articles and expert blogs on the financial crisis, and while I now know a lot more about concepts like credit default swaps and the CBOE volatility index, I remain almost cowed by the complexity of the global system that, day by day, is being revealed to us. So I have no diagnoses to offer, and no solutions. What I will observe, however, is that all economies — whether capitalist Anglo-American, mixed-economy European, or authoritarian/corporatist Asian — have suffered disastrous losses and have been shown to have participated almost equally in this high-risk race for profits. Human greed, next to lust, is one of the most powerful forces there is, and I think that perhaps the only lesson we can take from this mess so far is that it afflicts all societies and all systems.

    You start with Christ, and you end up with indulgences.

  5. “Greenspan, age 82 and a very old dog indeed, has learned something new: that markets don’t always give you the best result.”

    The more important fact that neither you nor he has yet learned is that it is regulated markets that don’t always give you the best result.

    Meanwhile, the honest minds among us are noting that of all the economies collapsing like dominoes the world around, not a single one of them is a free market.

  6. MichaelM and RnBram–there will never be a “free” market that satisfies truly anarchistic or Randian libertarians, just like there will never be any sort of idealized Marxist or Communist economy nor left-anarchist utopia. Actual human beings will never allow it. Which I guess is good for ultra-libertarians (or marxists or left-anarchists) because it means whenever something goes wrong with, say, deregulated markets as we have in the U.S., you guys can complain that it was because they weren’t “really free”. Just like marxists can complain that the failures of Russia/China/Cuba/whatever were because they weren’t “really Marxist” and that “real Marxism” has never been tried.

    And those of who live in the real, non-utopian world can work on finding real, politically feasible solutions–which will undoubtedly be imperfect compromises that will require constant tinkering until the next crisis. Like always.

  7. Try defining your terms before you broadcast conclusions like these.

    There is only one alternative to “free” in politics. It is “force”, specifically physical force. The task of separating government policies and actions that leave humans free to interact voluntarily from those interactions that are coerced by physical force is an easy task anyone can master. No human is precluded by his nature from choosing to be the constituent of a majority in a given geographical region that would opt for a government with the sole task of preventing the use of force to impede voluntary exchanges of values among men (radical capitalism).

    That is why your “there will never be” is just an expression of a wish on your part. And since such choices by men are possible, then your “utopian” slur fails as well. Also, the implication that such a government would not be “feasible” relies on ignoring the ethical foundation on which the idea of laissez-faire capitalism rests. That politics is ultimately feasible, because it is moral while your mix of freedom with coercion is impractical at the get-go, because obtaining values from others by physical force is immoral in the long run, regardless of how “practical” the results in the short run may appear to be to you.

    Therefore, if you wish to repudiate Rand’s radical capitalism, you need to go where Greenspan never went — to the Objectivist ethics and repudiate that first. Then and only then would it be worth anyone’s time to carry on a discussion with you (or Greenspan) about the viability of capitalism.

    Once you are cognizant of the actual meanings of these words rather than just their fuzzy emotional connotations, you will find that in your beloved “compromise” between a little bit of freedom and a little bit of tyranny, only tyranny stands to gain while all of us stand to lose.

  8. Frankly, regarding the fact that the managers of corporations acting to serve their own interests instead of their shareholders, contribute to economic meltdowns, I’ve seen conservative economists use this as an excuse for scandals and economic probelms. This blames the upper-level employees, rather than the rich. As government-spending skeptic Charles R. Morris wrote in his book The Two Trillion Dollar Meltdown, this is called The Agency Problem, i.e. that agents for those who provide the capital, whether they be CEOs, advisors, etc., make the decisions. Morris said that this was one of the main reasons for the economic meltdown, along with deregulation and the blind faith in computerized economic models.

    Also, as the introductory laissez faire textbook Principles of Economics, by N. Gregory Mankiw, Fourth Edition, copyright 2007, says, “But from 2003 to 2005, I had the opportunity to leave the ivory tower and become the chairman of Council of Economic Advisers. For two years, I was President Bush’s chief economist.” This book came out just before the economic meltdown, but after scandals such as Enron’s made the news. The book blames these scandals on “agents,” i.e. The Agency Problem. Lay Skilling and Fastow, after all, were just employees of the capitalists, and blaming employees seems just fine.

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