Alan Greenspan and the death of libertarian economics


11:20 am - April 9th 2010

by Carl Packman    


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US Economist Alan Greenspan has been giving his testimony before the Financial Crisis Inquiry Commission, criticised for failing to implement rules that would have curbed an overstretched banking system.

As the Telegraph reported:

In one of the most heated moments of his testimony, Brooksley Born, who chaired the Commodity Futures Trading Commission for three years from 1996, blasted: “The Fed utterly failed to prevent the financial crisis. Failed to prevent the housing bubble, failed to prevent the predatory lending scandal.”

Greenspan, who chaired America’s central bank from 1987-2006, said that he hadn’t “regulate[d] sub-prime mortgages because, by 2005, more than half of such home loans were being originated by institutions outside of the central bank’s control.”

For a man otherwise known for his strong libertarian, anti-governmental regulation and pro-laissez-faire views this was a shock.

His problem was that the origin of home loans were too far scattered about to be properly managed and controlled, thus the uncontrollable housing bubble that ended in a global economic catastrophe.

William Dudley, the President of the Federal Reserve Bank New York noted that central banks should be putting more emphasis on regulation, just hours before Greenspan went to admit misjudging the severity of the housing bubble.

This is a rather indicative appeal to the one that came about in 2008 when Greenspan, though refusing to accept blame, admitted ‘that his belief in deregulation had been shaken.

This is made all the more significant by the fact that Greenspan has also been considered one of the most well-known and highly regarded champions of the theories of Ayn Rand – the Russian-American novelist and philosopher – who felt that capitalism as an ideal should have no interruptions by the state whatsoever.

Greenspan was an associate of Rand’s during the early fifties all the way until 1982 when Rand died. They were so close in fact that Rand stood beside Greenspan while he was being sworn-in as Chair of the Council of Economic Advisors in 1974.

But the crash that Greenspan was instrumental in producing is proof that markets need regulation so as they don’t spin out of control.

Furthermore, it is not good enough to say that capitalism is the best “alternative” for “higher standards of living” in a “democratic society” – Rand didn’t say that capitalism was the better of a bad lot of systems (like Churchill did) but she insisted this was best because human nature rendered it so.

In short, the crash – and others before it – does indict Rand; Greenspan should be informed enough now to acknowledge this.

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Carl is a regular contributor. He is a policy and research analyst and he blogs at Though Cowards Flinch.
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Reader comments


Oh dear – I’m not sure you’ve grasped the concept of libertarian economics.

Libertarians, or Hayekians at any rate (are there many Randians?) are the harshest critics of the very existence of the Federal Reserve, and were at the forefront of criticising Greenspan’s inflation of the great credit bubble.

2. Luis Enrique

“proof that markets need regulation so as they don’t spin out of control”

Financial markets and banking, absolutely. Markets in general – also absolutely (mainstream economists who advocate free markets always do so in the context of appropriate regulations, and place a lot of emphasis on market supporting institutions) but the appropriate regulation may be light and have less to do with “spinning out of control”. How does the market in underarm deodorant spin out of control?

It is almost an iron law of internet debate that the longer a thread critical of “libertarianism” or “Libertarians” goes on, the more likely it is that libertarians queue up to claim that X isn’t really true libertarianism.

In this case it only took 1 comment.

Well if you can explain how the state controlling the level of interest rates is “libertarian” I would be most grateful.

“How does the market in underarm deodorant spin out of control?”

It can certainly stop functioning efficiently, say if a monopoly develops, or a price-fixing cartel*. However, this is unlikely to bring down the entire financial system, so therefore regulation needs to be tuned to the likely worst consequences, so you should have anti-monopoly regulators for underarm deodorant and well-paid (this is important) financial sharks on the state payroll watching out for the finance industry dreaming up some scheme to make money out of instability, as they always will.

* or, to look at it another way, an incumbent supporting regulation which results in high barriers to entry for new competitors

Of course the “maestro’s” reputation (and didn’t Brown give him an honorary knighthood?) is deservedly toast.

http://www.businessinsider.com/alan-greenspans-slow-downward-spiral-2010-4

@3 To be fair Planeshift, the same is true of socialism… 😉

3 – it comes down to a dispute between the more hardcore Austrian School and the less hardcore Chicago School (monetarists etc). The former favour free banking and oppose government control of interest rates. Many also favour a 100% reserve gold standard. They were also predicting the collapse. However, as the Austrian viewpoint is a minority one people tend to assume libertarian = Chicago/Friedman/monetarism etc.

“Well if you can explain how the state controlling the level of interest rates is “libertarian” I would be most grateful.”

Well it depends what you mean by “libertarian”? 😉

But there isn’t really any doubt that Greenspan was part of the pro-free market and de-regulation brigade. Perhaps it would help matters if we could come up with a term to describe the policies of de-regulation, privatisation and tax-cutting associated with Thatcherite and Reagan politics. And then we’ll reserve the term “libertarian” for people who would have gone far further economically speaking, and extend their libertarianism into social policies like ending the prohibition of the war on drugs.

Well you can count me in on the latter!

The collapse proves that all forms of socialist management (fiat currency, centrally set interest rates) fail, and that applies EVEN if you have libertarians in charge of it. Still, at least Greenspan kept the show running for a while. Now we know the only real alternative, a return to sound money.

3. Are you happy to associate yourself with socialists like Mao and Stalin? I very much hope so.

13. Mike Killingworth

[4] If you think a banking system can exist without a lender of last resort, how come the banks don’t by-pass the government and set one up? And if there is such a lender, how, if it isn’t the State, can it be sure of having enough to lend? In any case, it sure will set an interest rate it lends at. And that rate will shape the market.

Please don’t reply in hypthetical terms – what I’d really like to know is why actually existing capitalism doesn’t operate the way you’d like it to. Or, in other words, why you know better than the likes of Warren Buffett do.

14. Planeshift

12 – Not particularly, but I’m not a socialist and don’t claim to be one. So any point you had doesn’t apply to me.

I am not a strong libertarian wrt to the banking system, though I can see the attraction of a gold standard – I don’t know whether that counts as a libertarian position or not.

how come the banks don’t by-pass the government and set one up?

Well the modern FRB was indeed the creation of bankers (led by JP Morgan) – hell, if you were a banker why wouldn’t you want to have the state on hand just in case to bail you out?!

And you can see for yourself how the Fed has continued to act as the bankers’ best friend in the terms of the recent bailout.

Mike Killingworth – big business is in favour of state intervention when it suits them. That’s why Roosevelt’s progressive legislation at the beginning of the 20th century was supported by a lot of the large companies who were losing out to smaller rivals – they wanted them regulated out of business.

17. Luis Enrique

I’ve posted this before, but it’s worth remembering that even Milton Friedman advocated a lender of last resort and government bailouts in moment of crisis.

18. Luis Enrique

Tom,

yes: “appropriate regulations” and “market supporting institutions”

After Lord Turner, chairman of the Financial Services Authority in Britain, came out with his review of Global Financial Regulation in March of last year with a string of proposals for extending regulation of financial markets and institutions, presumably Libertarians were all issued wax images of him to stick pins into:
http://www.fsa.gov.uk/pages/Library/Communication/PR/2009/037.shtml

Speaking at the World Economic Conference at Davos in January this year, Turner renewed his call for powers to deal with asset-price bubbles:
http://www.ft.com/cms/s/0/d2bf7a9c-0b4c-11df-9109-00144feabdc0.html

The Bank of England has issued a discussion paper on macroprudential regulation:
http://www.bankofengland.co.uk/publications/other/financialstability/roleofmacroprudentialpolicy091121.pdf

Of course, the call for better regulation of financial markets is all about locking stable doors next time before the horses have bolted. We been fortunate this time round: the global economy didn’t rerun the 1930s depression but that was because of massive keynesian fiscal boosts by G7 governments.

As for house-price bubbles in America and Britain, try this:

“American house prices rose 124% between 1997 and 2006, while the Standard & Poor’s 500 index fell by 8%; half of US growth in 2005 was house-related. In the UK, house prices increased by 97% in the same period, while the FTSE 100 fell by 10%.”
Robert Skidelsky: Keynes – The Return of the Master (Allen Lane 2009) p.5.

I do find this all terribly amusing. A collapsed banking system shows that libertarianism is wrong.

But the Swedish banking system collapsed in the 1990s and I’ve not heard anyone claiming that this proves that social democracy is wrong. There are any number of similar examples as well.

21. Luis Enrique

Here is a nice response to Greenspan’s testimony from Baseline Scenario

Readers might like to know of this recent piece in The Economist on: Alan Greenspan and Ben Bernanke still do not believe monetary policy bears any blame for the crisis:
http://www.economist.com/business-finance/economics-focus/displaystory.cfm?story_id=15719180

‘If you think a banking system can exist without a lender of last resort, how come the banks don’t by-pass the government and set one up? And if there is such a lender, how, if it isn’t the State, can it be sure of having enough to lend? In any case, it sure will set an interest rate it lends at. And that rate will shape the market.’

Well they do kinda already. There is no lender of last resort for hedge funds. They just borrow money, lend/invest money. Sometimes they do well, sometimes they go bust. No major crises associated with them.

More generally, it would be very difficult for an entirely independent banking system to be set up due to legal tender laws. Anyone can be required to accept sterling as payment in the UK. The result is that no bank could bother competing with sterling on reputation or stability, because they will just be paying out in higher quality notes than they can be forced to receive: http://en.wikipedia.org/wiki/Gresham%27s_law

So the reason why they don’t exist is because the Government claims an implicit monopoly on currency through making it fiat.

Here is a historical example of how an entirely free banking system worked in practice: http://economics.about.com/cs/moffattentries/a/scot_banking.htm

25. gastro george

Avoiding the term libertarian, I’d have more respect for de-regulators if they were prepared to rescind laws that cover limited liability and trusts, which protect them from losses and protect their assets. Otherwise they’re just like the pro grammar school brigade who kind of forget that they’re also pro secondary modern.

26. Richard W

13. Mike Killingworth

‘ [4] If you think a banking system can exist without a lender of last resort, how come the banks don’t by-pass the government and set one up? And if there is such a lender, how, if it isn’t the State, can it be sure of having enough to lend? In any case, it sure will set an interest rate it lends at. And that rate will shape the market.

Please don’t reply in hypthetical terms – what I’d really like to know is why actually existing capitalism doesn’t operate the way you’d like it to. Or, in other words, why you know better than the likes of Warren Buffett do. ‘

The reality is if there was no central bank the banks would set one up. Most of the 2007/08 problems in the UK banking sector were caused by the central bank stopping doing what central banks should do. An amiable but useless Governor who did not believe it his role to provide unlimited liquidity at times of financial stress gives an insight to the regular chaos that would ensue without a central bank.

23. Nick 4:12 pm, April 9, 2010
‘ More generally, it would be very difficult for an entirely independent banking system to be set up due to legal tender laws. Anyone can be required to accept sterling as payment in the UK. The result is that no bank could bother competing with sterling on reputation or stability, because they will just be paying out in higher quality notes than they can be forced to receive: ‘

There are very few ‘ legal tender laws ‘ in the UK. The only status that sterling enjoys under the law is when currency is unspecified in a contract. If a currency is not specified the law assumes that the currency of settlement should be sterling. Anyone is free to sell goods and services in any currency that they choose.

Anyone who thinks the financial crisis can be explained by low interest rates alone is incredibly naive. Things like too much credit and too much debt are symptoms not the cause. The cause was international trade imbalances which meant that floods of excess Asian savings were flowing to the West. Base rates were not a cause on their own if the system had been effectively regulated. The system blew up in repo in the shadow banking system and this was almost entirely unregulated.

Consider Canada right next door to the US with similar interest rates to the US throughout the noughies. There was no meltdown in the Canadian banking system because they were effectively regulated. Moreover, for those calling for banks to be broken up to provide more competition. Canada has relatively few banks and the ones they do have are large players. Too much competition in banking could counterintuitively lead to excessive risks being taken as margins are eroded through competition. Therefore, competition on its own is not a panacea.

The reason so many banks got into trouble was because they were undercapitalised. Therefore, the best form of regulation is to force them to hold more capital. The banks like operating with capital at a minimum because it is more profitable but it puts the whole system at risk when assets are declining in value. Higher capital requirements including off-balance-sheet liabilities will be more effective than expecting regulators to keep up with people who are quite frankly cleverer than the regulators.

Alan Greenspan did not set out to wreck the financial system. He is only one of many to blame. There are a few senators more to blame than him. His whole ideology was based on that no institution would behave in a way that threatened their existence. Moreover, every institution would act to generate the best returns for their shareholders. An naiveness that only afflicts the ideological.

“There are very few ‘ legal tender laws ‘ in the UK. The only status that sterling enjoys under the law is when currency is unspecified in a contract. If a currency is not specified the law assumes that the currency of settlement should be sterling. Anyone is free to sell goods and services in any currency that they choose.”

If that is the case, then there might in fact be a space for a non-government banking system to emerge, and this crisis might be the spur to make that happen. I know of several libertarian/mutualists who are interested in this approach.

“Moreover, for those calling for banks to be broken up to provide more competition. Canada has relatively few banks and the ones they do have are large players. Too much competition in banking could counterintuitively lead to excessive risks being taken as margins are eroded through competition. Therefore, competition on its own is not a panacea.”

In the main, calls for large banks to be broken up do so, not because they fear that there is insufficient competition in the banking market, but rather because they fear that a bank that is “too big to fail” (to use the normal jargon) is incentivised to take excessive risks as “it” (its employees and managers really) knows that the government can’t — and won’t — let it fail for fear of severely damaging the payments system and thus the physical economy.

How does the market in underarm deodorant spin out of control?

If poppies managed it…

It is almost an iron law of internet debate that the longer a thread critical of “libertarianism” or “Libertarians” goes on, the more likely it is that libertarians queue up to claim that X isn’t really true libertarianism.

…more evidence (as if it were needed!) that libertarians are currently at the same point on the self-awareness curve that communists were back in the mid 1980s.

31. Planeshift

“Sometimes they do well, sometimes they go bust. No major crises associated with them.”

Long term capital management – late 90s.

A highly recommended book: SM Reinhart + Kenneth Rogoff: This Time is Different – Eight Centuries of Financial Folly (Princeton UP, 2009)

Rogoff, now at Harvard, was previously chief economist at the IMF.

See, too, Rogoff’s piece in the FT:
Why we need to regulate banks sooner, not later:
http://www.ft.com/cms/s/0/c2d523c0-8c21-11de-b14f-00144feabdc0.html?nclick_check=1

“A highly recommended book: SM Reinhart + Kenneth Rogoff: This Time is Different – Eight Centuries of Financial Folly (Princeton UP, 2009)”

Err, Bob ?

That book is indeed very good but, umm, it’s about sovereign defaults. You know, about governments not paying back the money they owe?

It really ain’t about banking systems. It’s about things like, just as an example, Greece has been in default for some 50% of the country’s existence.

In short, it’s about how governments steal money from savers.


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