News Flash: Greed and Stupidity Can Coexist!

Last week columnist David Brooks of the New York Times published an op-ed setting
out two explanatory narratives of our current economic crisis, which he
dubbed the "greed narrative" and the "stupidity narrative." Brooks
describes the greed narrative (as detailed in Simon Johnson's Atlantic piece "The Quiet Coup"
as an explanation of how the growing political power of Wall Street
enabled it to write its own rules with minimal governmental oversight
or regulation. Brooks then describes the stupidity narrative as the
story of the intellectual hubris of bankers who thought that
statistical modeling and complex financial instruments allowed them to
disregard systemic risk. After describing these two narratives,
however, Brooks makes an inexplicable and bizarre move - insisting that
we must choose either one narrative or the other, rather than
benefitting from the insights of both. "[O]ne has to choose a guiding
theory," he asserts without explanation, before stating that he finds
the stupidity narrative "more persuasive." However, discarding the
greed narrative in favor of the stupidity narrative is the old tale of
the blind men and the elephant - a refusal to recognize that both trunk
and tail are parts of the same animal.

Both greed and stupidity contributed to the crisis in which we find
ourselves, and only a solution that addresses both aspects of the
problem has any chance of fixing it. The greed narrative could also be
called the political side of the story, while the stupidity narrative
could be described as the economic side. The dichotomy between the two
is false - it is precisely the political success of Wall Street in
enacting its deregulatory agenda that enabled the financial stupidity
of a relative few to have such disproportionate consequences -
consequences that now threaten the global economy. Indeed, Johnson
lists the accumulating political successes won by Wall Street in recent
decades that, in hindsight, allowed relatively minor errors in
financial judgment to wreak such catastrophic harm: the insistence on
free movement of capital across borders; the repeal of Depression-era
regulations separating commercial and investment banking; a
congressional ban on the regulation of credit-default swaps; major
increases in the amount of leverage allowed to investment banks; a
minimal SEC role in regulatory enforcement; an international agreement
to allow banks to measure their own degree of risk; and an intentional
failure to update regulations so as to keep up with the tremendous pace
of financial innovation.

A crucial function of government is to protect us from the
consequences of the stupid decisions of other people - we should not
have to worry that a nuclear power plant operator will decide that
certain safety precautions simply aren't profitable or necessary. In
the nuclear example, were the government to succumb to industry
pressure and repeal certain safety regulations on nuclear plants, any
resulting accident would be the result of policy as well as stupidity.
In other economic sectors, regulations exist to prevent the
profit-maximizing incentives of various industries from creating
unacceptable levels of public risk. That such safeguards were
systematically dismantled across the financial services industry
demonstrates the power of crony capitalism to create a regulation-free
zone in which stupidity could flourish.

The reasons for Brooks' unexplained dismissal of the political
causes of the current economic crisis become clearer as we come to the
policy conclusions of his piece. As a free-market conservative, he
wants to argue that only minimal regulation is necessary to fix the
current situation, and he seems to fear that recognizing the systemic,
political causes of the crisis will justify more aggressive intrusion
into the financial sector than he is willing to support. However,
although Brooks advocates making banks "more transparent,
straightforward and comprehensible" in the short term, in a longer
view, the profit-maximizing incentives of banks and bankers will always
lead them into complexity and opacity. Banks and bankers have every
reason to continue with their practices of brinksmanship - to create
the new financial instrument, to make the new market that will give
them an edge over their competitors. There is nothing wrong with such
behavior, so long as sufficiently robust oversight prevents financiers
from imposing unacceptable risks on other people's pensions and 401(k)
plans. Only a political system that is not captive to the financial
services industry can guarantee such safeguards.

In a democracy, we have put our faith in the prediction that the
free market of ideas - in which policy proposals are assessed on their
own merits, rather than according to the financial influence of their
proponents - will prevent stupid policies from gaining ascendance in
the political sphere, just as a free-market economy should prevent
stupid economic decisions from surviving in the economic sphere. Crony
capitalism creates distortions in both the market of ideas and - as
influence is enacted into policy - in the market economy. In both
politics and finance, such an oligarchical distortion will prevent the
best ideas from being disseminated and properly valued, and will allow
bad ideas to prevail irrespective of their policy or economic merit.
Short-term fixes will do nothing to prevent this year's crisis from
recurring unless we also address the systematic influences that make
governmental officials beholden to monied interests rather than to
their own constituents. If government officials are in the pocket of
Wall Street, how can we expect them to identify and defuse problems
before they turn into catastrophes?