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The new consensus is attractive – and misleading. Behavioral economics is a wonderful field, but economists have understood it at least since the 1980s, a quarter century before the Lehman bankruptcy. Contrary to myth, Greenspan himself never believed that markets were effective. In his youth, he wrote lucidly about bubbles and accidents and considered market inefficiencies as obvious as he was trying to exploit them day-to-day. (In the 1950s, it was more difficult than now: Greenspan had to buy a seat on the New York Stock Exchange.) As chairman of the Fed years later, Greenspan often reminded his colleagues that periods of prosperity markets.
Lawrence Summers, who is perhaps the second economist-statesman associated with supposedly blind trust in the markets, is equally aware of their limitations. In a document co-authored nearly three decades ago, shortly after Wall Street had dropped 23% in a single terrifying day, Summers declared that the "efficient markets" hypothesis had collapsed with the remainder of the market on October 19, 1987 ". Summers has helped to create an idea that has become a pillar of the anti-efficiency market vision: there are limits to arbitrage, which means that smart traders can never correct price inefficiencies in the marketplace. presumed level by previous theorists.
In short, blaming the financial crisis on the naivety of key policymakers such as Greenspan and Summers is unjust and unfounded. What is emerging is that this myth is also dangerous.
The myth diverts attention from the fact that political constraints, not intellectual failures, have prevented policymakers from curbing the housing habit. Nobody remembers that in 2001, the Greenspan Fed had banned the most abusive subprime mortgages, for the good reason that the ban had been bypassed. But why was he bypassed? The answer is that the capture of Congress by financial lobbies ensured the balkanization of regulation into an alphabetic soup of agencies, many of them being underfunded and ineffective. Non-bank mortgage lenders, for example, were placed under the authority of the Federal Trade Commission, which had no resources to carry out preventive supervision. It is no wonder that industry-leading practices have become glaring or that non-banking activities continue to dominate current mortgage activity.
This is not an isolated example either. The Greenspan Fed also tried to force more capital into the banks it oversaw, but it soon realized that it would lead to taking risks in various "shadow banks" that were beyond its control . Greenspan has also advocated for stricter regulation of the Federal Mortgage Association and the Federal Home Loan Mortgage Corporation (aka Fannie Mae and Freddie Mac), the giants of government-backed mortgage loans. Fannie's lobbyists fought back with a television advertisement warning Congress not to support the Greenspan plan. That buried him.
The important lesson of the crisis is not that the markets are fallible, which every thoughtful person already knew. It is that the essential regulations – the kind that Greenspan's anti-regulation law was said to favor – are blocked by fractured government machinery and rapacious lobbies. Even today, the financial system has several controllers before several congressional committees, because this multiplication creates additional opportunities for lawmakers to extract contributions to the campaign.
Large government grants still encourage Americans to take large mortgages; Fannie Mae and Freddie Mac are still working, despite endless discussions about their separation. And although post-2008 regulations ensure better capitalization of banks, lobbyists oppose. Only a decade after the bankruptcy of Lehman put the global economy on its knees, the Trump administration listens to them.
Sebastian Mallaby, author of "The Man Who Knows: The Life and Times of Alan Greenspan," is the Paul A. Volcker Scholar in International Economics at the Council on Foreign Relations. This column was first published by the Washington Post.
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