Saturday, October 3, 2009

Is Market Fundamentalism Sound?

In a world where the financial sector becomes the determining factor in economic well-being — rather than a mere medium for economic activity akin to highways or coin-making facilities — calling oneself a libertarian may be almost beside the point.

Government does heavily influence the monetary supply and banking, and even if the long-term goal is to fully privatize and deregulate those things, our wellbeing for a long time to come may depend on how they are governed rather than on the mere fact that they are and shouldn’t be.  Being a libertarian — while it’s still the correct position — might in the near term be as beside the point as saying “On U.S. politics, I’m a committed anti-monarchist,” the natural response to which is, “Well, great, but now tell me something useful for making my next political decision.”

I don’t expect to find enough spare time to become expert about the financial sector (I barely remember to check how my own meager stocks are doing), but I can at least praise the special financial crisis issue of Critical Review (with contributors ranging from Nobelist Joseph Stiglitz to Nobelist Vernon Smith).  Apparently the first full-length scholarly journal issue devoted exclusively to attempting to explain the financial crisis, it seems to this admitted layman to do a very good job.


The fact that some of the contributors disagree with each other doesn’t even undermine the overall impression that they’re on the right track.  It merely confirms — as many smarter, more cautious observers have suspected for almost exactly one year now — that the financial crisis is a sufficiently complicated event that one can easily be tempted to pick out a few aspects of it (especially aspects that suit one’s own ideology) and fashion them into the essential narrative about why it all happened, the way one might pick several different one-word explanations for World War II (even at its best, ideology is, after all, a thumbnail sketch for dealing with a more complex reality — that’s precisely why it’s useful but also why it can be dangerous).

Stiglitz, who struck me as disappointingly pundit-like when I saw him speak at an event at the start of the crisis, tells a story of the terrible consequences of free-market fundamentalism and deregulation run amok, a story that could just as easily have been written by his fellow Nobelist/pundit Paul Krugman.  (I think it’s only people who lean toward socialism who actually believe we’ve been living in a world dominated by “market fundamentalism” for decades, while the tiny handful of actual market fundamentalists I know, if I can even call them that, have spent all those years warning of impending doom from our socialist excesses and constant regulatory interference in the market.)  Vernon Smith, less offensively by my ideological standards, seems a bit narrowly focused on the crisis as one in a predictable series of housing bubbles over the past several decades.

Editor Jeffrey Friedman (a political scientist here revealing a grasp of finance I never imagined he possessed) does a nice job in his intro essay of surveying multiple factors leading to the crisis and — while genuinely being more cautious, I think, than some of our libertarian brethren about placing the blame on government — nonetheless reaches the general conclusion that the financial wizards failed more at predicting changes in (and the reliability of) regulation than at predicting mere market activity per se.


Government picked the accounting standards, government licensed the triopoly of ratings agencies and banned challengers, government or its licensees decided what constituted certified-safe investments and what constituted safe levels of reserve funds in banks, government urged more housing investment.  Financial wizards innovated recklessly in response, but they weren’t really operating in a pure market environment — and, disturbingly, Friedman notes that the very homogeneity and predictability fostered by across-the-industry regulations may have made industry-wide, systemic collapse more likely.  If some schemes are destined to lead to disaster, it’s best to have a diversity of schemes, not one purportedly best, approved way of doing things.

My accountant/lawyer friend Alex Dickerson said much the same thing to me a decade and a half ago about S&Ls, which she said (with pity) were mostly doing what Congress steered them into doing (all the while claiming it was for the S&Ls’ own financial safety) back when they collapsed in the late 80s.  (And she was decidedly not a doctrinaire anarcho-capitalist — though, like a few lawyers I know with financial-sector ties, she had libertarian leanings in some areas while at the same time defending things like anti-trust law and insisting that anarchy must lead to chaos akin to a parody of the Dark Ages.)


The disturbing thing about the Critical Review analysis, if you really take some of the most damning essays to heart, is that you get the impression we’ve been doing everything wrong for decades in the financial sector (and in ways that the regulators, crucially, have been no wiser about than the traders).  This radical thought strikes me as somewhat liberating, though, if only because it suggests our options may not be as limited, in the long term, as they now appear.

I recall how I once suggested to Megan McArdle — an early advocate of a financial-sector bailout, as we must never let her forget — that perhaps the whole institution of limited liability was a bad idea (as some Austrian School economists suggest — some of them also questioning fractional-reserve banking, I might add).  She insisted I was being ridiculous and that not only would the stock market as we know it not exist without limited liability but neither would the Industrial Revolution (and furthermore, she somehow knew, we’d never have gotten bauxite out of mountains any other way, the sort of specific technocratic assertion that makes me think someone’s overreaching).

And yet after the financial crisis, as one Critical Review essay notes, it looks more reasonable to say that perhaps the whole trend toward impersonal, follow-the-market management (IPOs, etc.) was a dangerous one — and that perhaps we could use an economy built less upon publicly-traded companies and more upon, for instance, family-owned businesses (which, after all, can be as gigantic as Koch Industries, not just little mom and pop stores) about which one can acquire more meaningful, long-term managerial impressions than just current blind-leading-the-blind stockholder trends.

I could be completely wrong, and maybe our current model is largely OK, but I’m struck more and more as I age by how few data points we really extrapolate from in concluding we’re doing things the right (or wrong) way.   The industrial world that we live in has really only existed for a century or so, yet we treat both capitalistic and socialistic principles (and mixed-economy practices as well) derived from that brief time period’s experiences as if they are principles rooted in knowledge as old as human history.  A few simple principles date back to the dawn of things, yes, but not the technical details we most often fight about, really, much as that would help to ground things.

A mere two centuries ago, corporations as we know them were so novel that Americans were debating whether and how we should even legally define them — and citizens were often baffled by the idea that corporations might be seen as non-state entities, given that virtually all citizens were instead farmers on individually-owned plots of land, which struck people in the Jeffersonian era as the natural — and perhaps only — real mode of free, individualistic, commercial existence.  Things have changed drastically since then, as most people recognize — but they have also changed very rapidly, in the grand scheme of things, as fewer people admit, and we may thus not have things as clearly worked out yet as we think we do.

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