Complication Underlies the Conservative Critique
Jeffrey Friedman’s analysis of the origins of our current economic crisis and assessments thereof is worth reading, but he wraps it in the pose that everybody else is wrong:
To their credit, liberal analysts realized from the start that the cause of the recession was a banking crisis, not a housing crisis. In explaining the banking crisis, however, liberals used a theory drawn straight from the rotten core of contemporary social science: the theory of “moral hazard.” It suddenly became conventional wisdom that the crisis had been caused by banks that rewarded successful employees with big bonuses but failed to penalize losses. This was said to have encouraged recklessness. Later, conservatives came up with their own variant of moral hazard, according to which bankers took too many risks because they knew that their banks, being “too big to fail,” would be bailed out if their bets turned sour; so why not make the riskiest, most lucrative bets?
Most reasonable spectators would, I think, disagree with Friedman in that they’d acknowledge the role of each of these factors — and others, as well. Friedman would respond that the evidence is against them:
The intellectual bankruptcy of these theories lies in their assumption that the bankers knew they were making “reckless” bets. This assumption is demonstrably false: Ninety-three percent of the mortgage-backed bonds acquired by commercial banks either were rated AAA — the safest possible rating — or were issued by Fannie and Freddie, giving them an implicit government guarantee. Because of their perceived lack of risk, these bonds generated less revenue than did bonds with lower ratings. Revenue-hungry bankers who were oblivious to risk never would have bought Fannie, Freddie, or triple-A bonds; more lucrative double-A, single-A, and lower-rated mortgage-backed bonds were always available. Both the liberal and the conservative moral-hazard theories are therefore wrong. For the most part, the bankers didn’t deliberately take big risks, or they would have taken big risks that paid a higher yield.
Friedman ought to have paused before submitting his essay to National Review and considered whether it’s plausible to assert that anybody — anybody with a coherent understanding of events — had really made it integral to their scenarios that entities looking for safe, long-term bets (such as pension funds) had been lured into overt risks. For most people and groups with money in the game, the risk was actual, not intentional, although those advising them might have had some inkling of the instability of the underlying assets.
What appears to have happened, in a nutshell, is that the marketplace — consisting of players with various degrees of savvy and awareness — decreased the degree to which it assessed risk in terms of the thing being traded and increased the degree to which it assessed risk in terms of the entities involved. Investors weren’t betting on the likelihood that the sun wouldn’t come up the next day; they were betting somebody else’s assurances that it would not. Because of implicit government backing, traders and ratings agencies gave mortgage-backed securities ratings on par with those given to the government, and because of their size and the safety of being at the top of the ladder, large firms and their agents behaved as if they expected their losses to be mitigated, should things go awry, and because the above put smiley-face stickers on the trades, everybody else bought in.
For none of those involved is an acknowledgment of risk necessary.
Friedman pivots, on this obvious fact, in order to reach the point that truly interests him: That we have to acknowledge the complexity of life and the possibility of error. What’s interesting about this, to me, is that Friedman thinks he’s introducing something new. Such statements as the following read as if drawn from foundational documents of modern conservative political theory:
The experts, the regulators, and the bankers were ignorant of a risk caused by a complication that hadn’t occurred to them. The experts, regulators, and bankers were wrong; but they were not evil. They were simply outwitted by a complex world. …
A more sophisticated approach would attend to the fallible ideas not just of voters but of bureaucrats, legislators, and judges — and to the roots of these ideas, both mass and elite, in cultural sources of (mis)information and ideology, such as the mass media and formal education.
All Friedman is doing, here, is describing the basic reasons for the conservative worldview — from libertarian principles of limited government to the Christian belief that evil is an illness and delusion, not an individual personal quality.