The Essential Takeaway from “The Love of Money”

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I was watching the BBC documentary “The Love of Money” on the fall of the Lehman brothers, and was particularly bemused by the closing comments of part two from non other than “The Maestro” himself, Alan Greenspan, offering his retrospective on “what went wrong”, why didn’t “the markets” function as expected in full meltdown mode?

The narrator prefaced Greenspan’s remarks with:

An idea that guided Alan Greenspan for his entire career proved flawed:

And then the camera cuts to a seated Greenspan, waxing philosophic in his folksy fed-speak manner:

“Fundamental to the functioning of a market system, is the fact that each individual economic entity works extraordinarily  assiduously to preserve its solvency…

It is such a critical part of the way a competitive free market system works, you have to have that as an essential ingredient in the marketplace, or it will not work

Greenspan is right of course. I could not agree more. But the problem is this: When an entity knows it is considered “too big to fail”, and will be bailed out at the expense of others, Greenspan’s assumption, which he himself considered fundamental to the operation of a market economy, goes out the window.

Thus, going back over decades of government intervention of failed financials, right from the Savings and Loan scandal up, banks took the message to heart: we don’t need to worry about risk, if we screw up, we’ll get bailed out.

The most incredulous sentiment that came out of Lehman Brother’s executives and people who were there in the end was the sheer disbelief that “the Fed” would actually “let them go down”. What people should be in disbelief about was that they didn’t let everybody who got themselves into trouble hang themselves by their own rope.

Yes, it would have been painful, and yes it would have made for a very bleak depression, for about a year or two, but had it been allowed to play out like that, one thing could be guaranteed: The kind of financial folly that got everybody into this mess would not have been attempted again for hundreds of years.

Instead, we have grown accustomed to bail outs, no industry will be allowed to fail and the masses are screaming for stimulus, stimulus and more stimulus. The next financial crisis will be any day now, or any year now, instead of …”never again”.

A relatively unknown retired economist in the U.S  named Vincent LoCascio once sent me a self-published book called The Monetary Elite vs. Gold’s Honest Discipline which should have been required reading for bankers and policy makers ahead of the crisis. In an oft-cited quote of mine, he pretty well nails it:

[P]eople fail to consider that federal guarantees make bank failures more likely by artificially encouraging people to choose the highest interest rates available, which in turn causes bankers to seek riskier, higher-yielding loans and investments”.

“Failing banks do not face the same fate as other failing businesses. Other failing businesses must contract, face more restrictive credit conditions, tighten their belts, and turn adverse results around as quickly as possible to become more viable. Failing banks, however, can ignore the reality of their situation…They can use federally guaranteed deposits to try to speculate themselves out of trouble.

Greenspan is ostensibly right: if everybody knows they can be killed by their own stupidity, they tend to think long term and try not to do stupid things. However, if in practice you take away the simple remedy of consequences, in the name of the public good, no doubt, and given enough time the system is virtually guaranteed to go off the rails.

This in turn brings out proclamations of “the death of Capitalism” or “the failure of free markets” and a swing to the Left. In fact the jerry-rigged system we were operating under in the first place, one that protects reckless speculators from the consequences of their own over-aggressiveness, is neither free market or capitalist.

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