Greenspan Continues . . .


Speaking at a Congressional hearing, Alan Greenspan has already recanted his formerly unassailable wisdom as Fed Chairman. Now he continues his apology, although this time in a much less personal op-ed in the WSJ. Here are a few excepts.

Global market competition and integration in goods, services and finance have brought unprecedented gains in material well being. But the growth path of highly competitive markets is cyclical. And on rare occasions it can break down, with consequences such as those we are currently experiencing. It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.

I am not sure whether Greenspan really means complexity or whether he is talking about complicated. I suspect the latter because then he says:

However, the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living. Remember, prior to the crisis, the U.S. economy exhibited an impressive degree of productivity advance. To achieve that with a modest level of combined domestic and borrowed foreign savings (our current account deficit) was a measure of our financial system's precrisis success. The solutions for the financial-market failures revealed by the crisis are higher capital requirements and a wider prosecution of fraud -- not increased micromanagement by government entities.

I cannot comment on the specifics of his analysis and suggestions as I am not an economist. But I can argue that he does not understand how complex systems behave. Success in the past is no guarantee that a complex system can or will return to its levels once the crisis has past. While admitting that new regulations (or other governance mechanisms) are needed, his recommendations sound like he is still the Fed Chair--speak softly and say nothing uncontroversial. They are self-evident and tautological. The one interesting feature is his warning that whatever is to be done should not be “heavy” or “ overly intrusive.” I agree, but not for the reasons he does.

If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows. Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.

This concluding paragraph suggests that he is coming from an ideological foundation (limited government is always better) more than from an understanding of complexity in general (prudent, small steps are less risky that big ones, once a crisis has been staunched). "Micromanagement" is dangerous, again not for ideological reasons, but because it suggests that it is possible to tweak the system as if it were a machine with the parts re-oiled after they froze up. Tweaking and learning from the results and repeating this cycle is more likely to get the desired results, but at the expense of making errors along the way. Unfortunately, our polarized, dichotomous political system penalizes mistakes. Gregory Bateson had it right when he observed that, "Lack of systemic wisdom is always punished."