So, Alan Greenspan admits a flaw in his ideology, that financial institutions really can't be relied upon to regulate themselves because it's in their own interest to do so. What's amazing is that he, a True Believer in the Gospel of St. Milton, admitted this. What's also amazing is how strongly he maintained that belief in a theory that -- his assertion of 40 years of empirical support notwithstanding -- never really held together.
I do feel sorry for Greenspan (though I feel more sorry for myself and all of us peons who are hoping that some day in the future we will be able to recoup at least some of our losses). I feel sorry for him because it must really come as a shock to find that the theoretical explanations you really believed were true simply aren't. And it's doubly hard to do that when it seems that this one flaw in your ideology has wiped out all recollection of your skillful balancing of inflationary pressures in order to allow growth over a lot of years.
Greenspan forgot that two major assumptions in his causal theory were just that -- assumptions.
Assumption 1: In a free market buyers and sellers don't coerce each other.
The truth is that coercion happens all the time, generally through fraudulent behavior, or business practices that are "legal" but are so misleading that they really, truly are fraudulent.
XM Radio just coerced me into paying $106.30 that I didn't want to pay. How? When I called to cancel my subscription, the "customer service" (Hah!) representative told me that he could not shut off my service right away so I could enjoy the radio until it shut off. (I told him I didn't want to listen to it. I don't like XM Radio. It's a waste of money.) He offered me 3 free months if I was willing not to cancel. I told him that no, I wanted to cancel. "Well," he said, "we'll give you the free months anyway."
Without my approval this person then recorded on my account a notation that I had agreed to continue my subscription after receiving a 3 month free promotion. THIS WAS A LIE.
I didn't know that this fraud had been perpetrated. So, I followed closely for a couple of months to make sure that XM was cancelled and that I wasn't charged for it any more on my credit card. Indeed, it seemed to me that the cancellation had happened as I had demanded.
Four months later (when I was no longer watching carefully), XM started charging me again for this service that I had cancelled. I didn't notice it at first -- I know, I should have looked at those credit card statements more closely, but I am (this will suprise you) human. It did not occur to me that a large cooperation would engage in fraud so I was not on "high alert." Eight months later I noticed the charges. XM refused to refund the fraudulent charges. Now I'm fighting with the credit card company.
It's government that is supposed to create the conditions in which these kinds of practices don't happen or when they do happen, our grievances can be redressed. It's government that we look to in order to prevent this type of cooercion, especially the kind of fraudulent business practices that even the emptor who pays the most attention to the caveats is likely to miss.
The mortgage crisis began with fraudulent behaviors like lying to customers and telling them they can afford mortgages they can't afford. Since the mortgage lender is seen by the mortgage supplicant as someone who is knowledgeable, the mortgage supplicant does not recognize when the mortgage lender is intentionally feeding him or her misleading information. Then somehow mortgage brokers dealing in subprime mortgages mislead others into buying those mortgages. Then rating agencies -- paid by the businesses they are evaluating! -- came up with ratings that were much higher for securitized mortgages than they should have been. Why? Could any of this have something to do with the coercion implicit in the rated paying for the ratings?
Assumption 2: In a free market, buyers and sellers have pretty good (if not perfect) information.
Intentional failure to disclose information, complexity of the information and the specialized knowledge that one would need to understand it, and false information are all prevalent in markets. The truth is, things are so complicated today that it's impossible for the buyers and sellers to really have good information. Oh yeah: There's plain old lying, too.
Look at the history of suppressed information about the health effects of cigarettes, and the more recent suppression of adverse effect information concerning Vioxx and Celebrex. How would some person entering the market (in other words, a patient who gets a prescrition for a drug) even know what questions to ask? How well can the average person decipher the medical journal articles that one might want to look at to see whether taking the drug is a good idea? And what's true for the complexity of medical information is also true of the complexity of insurance plans, derivatives, loans of all kinds, and more.
We need government to create conditions to make information flow more freely and truthfully. That's another kind of regulation.
Because assumptions about free exchange and pretty good information are wrong, free markets don't function unless government steps in to correct these problems (call them market failures).
Until there are perfect people, there will be no perfect markets. Unless governments create the conditions for fair commerce, we will not have free trade.
