In the previous episode our contemplative economist left New York thoroughly humbled and humiliated. In the face of such display of wealth and success, who would still dare to doubt the superiority of this system, driven by “the deep selfishness of competition” (1) and supported by mathematico-financial wizardry.
The success of free market capitalism may well lay in its smart, illusion-less exploitation of humankind’s selfish urges: innovation and productivity apparently thrive best when spurred on by self-interest. The US success is furthermore propelled by the Americans’ perpetual optimism and urge to action (2).
Whereas centrally planned economies are said to suffer from a certain naïveté: an unwarranted belief in people being productive & innovative also when there’s no personal gain and an equally unwarranted belief in some central intelligence which through rational calculations would be able to steer the economy as a whole.
Animal spirits (3) , selfish greed and even speculation may be great drivers for economic enterprise – think of the 19th C railway mania, the 1990s dotcom and telecom bubbles: without the greedy thirst for great riches, no one would have been ready to venture his capital for these hazardous enterprises.
And though these bubbles in the end ruined the speculators (especially the naive ones who joined the gold-rush last) they did add to society’s tangible wealth (railway-systems, internet & telecom innovation etc).
But of course, free market apologists usually gloss over the social costs associated with the wild mood-swings, the booms and busts, so typical of untrammeled free markets. They also neglect to point out that unrestricted free enterprise can be unrestrictedly selfish and irresponsible . In short, public institutions and regulation are needed to temper the mood swings and especially to make sure that individual greed works at the profit of society as a whole.
And that’s where it went spectacularly wrong over the last decades. An absolute belief in free markets and in auto-regulation by the private sector made us forget that greed never ever regulates itself . A sacred awe for the sophisticated mathematical models of high finance made us forget that mathematics never ever rein in greed. Statistical confidence intervals lulled us into sleep, making us forget that a statistically improbable event, however improbable, is still not impossible.
Finance no longer humbly supported real economic enterprise but had become a self-feeding industry (the financial sector has been the fastest growing industry over the last 20 years, representing an ever growing share of world economic output)(4) .
In the end, this whole disastrous “liquidity and credit crisis” , replete with sophisticated instruments whose outcome can only be calculated by complex mathematical models, is nothing more than the result of a vicious circle of human vices. A shrewd insight in human nature would have done more to prevent it all that the most advanced of quantitative models.
It was the toxic combination of over-optimism, greed and moral hazard (+ plain stupidity?) that got us into this mess. The mathematic-financial wizardry then diligently worked towards amplifying it all and towards distributing its effects all over the globe(5) (6) .
And either governments (ie all of us) will now bail out the troubled financial institutions (at great cost, we speak of more than 700 bln dollars) or else those financial institutions will auto-destruct by an exaggerated fear of lending to each other (now belatedly overcompensating for the complete evaporation of any sense of credit or liquidity risk beforehand).
And though some might cheer at the demise of great and mighty financial institutions, the sad truth is that when they go – people’s savings go, credit goes and we all might as well go back to growing vegetables on a plot of land.
And the culprits? Can they be identified? Will they be punished for their irresponsible greed? Hmmm, the clever ones undoubtedly got out in time, taking with them all the money they made. Laughing all the way from their shaky bank to their lavish homes.
And what are they doing with those heaps of cash? Well, this week while the financial world was burning, stocks and bonds tumbling – millions were forked out for Golden Calves and Sharks at an auction of Damien Hirst works.
This then may be the free market’s ultimate justice : those who made millions by selling stinking Mortgage Backed Securities to unsuspecting investors may now be splurging that money on Dead Animals in Formaldehyde…. (7)
This was yet another solid Footnotes-Backed-Post!
(1) Elizabeth Gaskell – North and South. The week that one of the world’s leading brokers went bust and that the US government had to bail out the world’s largest insurer, the week that panic gripped the financial markets, raising the specter of a total collapse of the global financial system in the wake of “the immense speculations that had come to light in making a bad end in America”. That week our contemplative economist contemplated all worst case scenarios and, though partially choked by fear, was even more enchanted by the uncanny parallels between this unfolding 21st century financial panic and a 19th century economic bust as described with such insight & empathy in Gaskell’s 1855 novel …
(2) Some even venture to say that American optimism and hyperactivity (easily apt to veer into mania) are linked to a gene-variant typical for migrants who left everything behind to start a new life : American mania – when more is not enough
(3) John Maynard Keynes – the only economist with a keen sense of metaphor (frequenting Virginia Woolf may have helped) was also equipped with a good deal of psychological insight. He wrote: “Most, probably, of our decisions to do something positive […] can only be taken as a result of animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. “
(4) JMK : “speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation”
(5) Bubbles are nothing new – every decade has had its shameful example – but the sheer vastness of this particular boom&bust is mind-boggling.
(6) *** Over-optimism & greed of prospective home-owners: house price are rising, good, they will go on rising! So if I borrow and buy a house now, even if I haven’t got the means, I can sell on my house at a higher price later so , yay let’s go and get a mortgage even I can’t really pay the interests. *** Over-optimism & greed of lenders: oh, a whole new consumer-segment to tap! Let’s go and offer them mortgages – never mind they’re not the most creditworthy borrowers, those mortgages are backed with a house , so we can always sell that one if the borrower can no longer pay what’s due. And who cares about people thus losing their home*** Moral hazard --- oh all those low quality & high risk loans we’re getting on our books – no reason at all to limit that activity, since I can bundle them all in a security, call it a Mortgage Backed Security, get a mathematico-financial smokescreen to make it all look safe and then sell it on to staid investors too impressed with the sophistication of these instruments to critically look into what’s behind it all.
(7) Each epoch has the artists it deserves - our shallow, greedy, manic free-market era definitely deserves Damien Hirst. Actually, Hirst may be an essential part of today's financial eco-system, offering expedient ways to evacuate the system's excess money.