Wading through the reams of commentary on the “global economic crisis,” what you’re struck by again and again is just how confused everyone is. This is a dramatic change in a very short period of time. When people said that U.S.-style capitalism had triumphed, after all, what they meant was not merely that U.S.-style capitalism was spreading across the globe. They also meant that it had triumphed intellectually, that the truths which underpinned it–for the most part, the truths of neoclassical economics, with a dash of Schumpeter for flavor–were unimpeachable. If Keynes had said that in the long run we’re all dead, the new paradigm argued instead that in the long run we’re all okay, and that the long run is never that far away.
Now, it’s possible to explain almost everything that’s happened in the global economy over the last year as evidence not of the failure of markets but rather of what happens when markets aren’t able to operate freely. It’s possible, but not convincing. The hedge fund Long Term Capital Management was as unregulated an entity as could be imagined, and its failure nearly sent the entire global marketplace into a tailspin. And if Brazil ends up collapsing in the next few months, it will be because global investors decided that they couldn’t make money there. That’s a collective decision which could precipitate a global slowdown, and if it happens it will be because the market’s responsible.
Saying that, of course, doesn’t mean that there are any easy solutions to what’s going on. One can recognize that markets fail and still not be sure how to keep them from failing and still believe that there’s no real alternative which can deliver the kind of economic growth enjoyed by Asia and Latin America in the last decade. The confusion that prevails among policymakers today is precisely a confusion about this subject. Investors aren’t acting the way they’re supposed to–coolly measuring return against risk–and policymakers don’t know how to make them act appropriately. (The mere fact that the question of how to restore rationality to markets is being raised is, of course, a challenge to conventional neoclassical economic theory, since investors are always supposed to act rationally.)
More importantly, long-accepted truths about the benefits of free capital flow and the value of speculation are being seriously questioned. For the first time since the 1970s, a genuine debate exists. One sign of this was the op-ed piece on Long Term Capital in today’s Wall Street Journal. The piece was co-authored by Daniel Fishel, an astute advocate of efficient-market theory, opponent of all government intervention in the marketplace and a vocal defender of Michael Milken. Fishel sees the Long Term bailout as an example of markets taking care of one of their own. The hedge fund’s lenders stepped in to take over the firm, Long Term’s investors bore all the risk, and the Federal Reserve merely played a role in making the process run more smoothly. Any call for regulation of hedge funds, Fishel argues, is therefore misplaced. No surprises there. What’s interesting, though, is that Fishel recognizes that Long Term’s creditors may very well have bailed out the hedge fund because they realized “the possible broader harms that might result from [its] hedge fund.” In other words, instead of just looking only to their individual interests, Goldman Sachs, et al, thought about the “systemic risk” of Long Term’s failure and acted accordingly. Fishel hails this as “all the better and all the more remarkable.”
But what’s really remarkable is that Fishel believes it’s necessary or rational for investors to think about the collective interest in making their individual economic decisions. The whole point of the invisible hand, after all, is that it’s supposed to turn private vice into public virtue. If everyone just looks after themselves, things will turn out OK. Here, though, Fishel is saying that what’s “remarkable” about the bailout is that Wall Street looked out for everyone else, and so everything turned out okay. But if we need someone to look out for everyone else, it should surely be the government, which we have some measure of control over, and not a group of investment banks. It may be, in the end, that we decide that the invisible hand really is the best way to get out of this. But if we don’t decide that, then we need real regulation, and not an ad hoc reliance on the momentary benevolence of the powerhouses on Wall Street.