Greenspan's Folly: The demise of the cult of self-interest
I was wrong, Alan Greenspan said in so many words. Seated before his congressional inquisitors in October 2008, with the worst financial crisis since the Great Depression cascading down Wall Street, Mr. Greenspan confessed that the philosophical principle upon which he had based his highly influential professional judgment is—flawed.
For some two decades as chairman of the Federal Reserve, Greenspan had counseled presidents and Congresses that government deregulation of financial markets and reliance upon self-regulation by self-interest was the way of both freedom and prosperity. The collapse of one insolvent bank after another has called such counsel into question.
Here are Greenspan’s own words: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.... The whole intellectual edifice [of risk-management in derivative markets]...collapsed last summer.” Asked whether his ideological bias led him to faulty judgments, he answered: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”
One pillar in the “intellectual edifice” of Mr. Greenspan’s economic philosophy is the objectivist philosophy of the late Ayn Rand, whose inner circle Greenspan joined in the 1950s. As explained in her book The Virtue of Selfishness(1964), Rand believed that the individual exists solely for her own happiness and thus that rational self-interest is the only objective basis for moral action. There are no moral constraints on the selfish pursuit of personal happiness, except force and fraud. And there is no moral duty to sacrifice individual advantage for any greater good, because there simply is no greater good than personal happiness (“egoism”).
In the view of the objectivist philosophy, the only moral economic system is laissez-faire capitalism, which gives free rein to the selfish pursuit of individual profit. Accordingly, government should be minimal, limited to national defense, property protection and criminal prosecution. In his memoir, The Age of Turbulence, Greenspan acknowledged Rand as a “stabilizing force” in his life and reconfirmed as “compelling” the “philosophy of unfettered market competition.”
Ayn Rand and the Egoist Ethic
As his comments to Congress indicate, Greenspan seemed sincerely surprised (and distressed) that financial institutions managed by self-interested individuals seeking to maximize private gain in unregulated markets would not have more prudently protected shareholder interest from excessive risk. He had assumed, implicitly, that corporate executives would seek what was best for the institution and its investors—and hence, that self-regulated self-interest would align private profit with institutional good. Given a Randian ethic of rational selfishness, however, one should be wary of such assumptions.
The egoist ideal is that, short of force or fraud, I pursue my own advantage regardless of others, because individual happiness is the ultimate good. Consider executive compensation. If I am an executive, then on egoist terms, I have limited rational interest to sacrifice personal gain for shareholder equity on account of risk assessment, as long as my compensation package guarantees me multimillions regardless of stock performance. Even if the company crashes, I escape with my “golden parachute.”
The egoist ethic amplifies this divergence between private interest and common good throughout the financial market. Consider the mortgage market. If I am a mortgage lender, then issuing risky loans that are unlikely to be repaid is a good investment for me, as long as the secondary mortgage market allows me to pass the risk of default to others—say, by selling the loans on the secondary market for bundling into mortgage-backed “securities.” Even if the borrower later goes into default, I have gained in the market as long as I am able to remove the loan from my books and reap my commission.
And if I am an investment banker, then purchasing bonds backed by risky loans is also a good investment, as long as a derivatives market allows me to “swap” the risk with a leveraged investor or an insurance company. Even if the underlying loans go into default, I have still maintained my market position, as long as my credit-default swaps pay out and I cover my losses.
In short, as long as there is an unregulated market for betting on loan defaults and as long as there are investors willing to take the bets, financial risks that promise individual profit with potential cost to the common good make rational sense. Of course, this game of risk is sustainable only as long as the bets continue paying off—which meant in this case, only as long as housing prices continued rising. With the burst of the bubble in the housing market, resuluting in a flood of mortgage defaults, bond sellers and default insurers alike were left unable to make good on their promises, leaving bond holders to absorb the losses they had gambled others would pay. Although the risk-takers have reaped their reward in a whirlwind, it is ultimately stockholders and taxpayers who have borne the real cost through losses to retirement funds and education budgets.
Greenspan’s “intellectual edifice” of self-regulation by self-interest has thus collapsed upon its own presuppositions. Having recognized the “flaw” in his thinking, Greenspan now suggests that financial institutions selling complex products (e.g., securities backed by high-risk mortgages) be required to hold a substantial portion of the bonds they issue in their own portfolio. That is, institutions should be required to expose themselves to the risk they market to others in order to constrain the excesses of self-interest.
Reasonable regulation of capital markets and executive compensation to rein in self-interest, though necessary, does not get to the heart of the matter, however. The deeper philosophical issue is that the egoist ethic underlying Greenspan’s theory is an insufficient foundation for how we envision our economic life. According to the Randian philosophy, rational selfishness is the chief virtue, its constraint the chief vice. What the financial crisis teaches us is that excessive self-interest is economically destructive. Unrestrained selfishness is thus itself a vice, undermining not only the general welfare but also self-interest.
While self-interest is the operative principle of the marketplace, and while Greenspan is correct to argue that markets have made expanding prosperity possible for many, the unrestrained self-interest that egoism values has proved corrupting of the very free market in which it was supposed to flourish. Rational selfishness without moral constraint has corroded the trust between financial institutions that is necessary to sustain the flow of credit upon which a market-capitalist economy depends. Not even the lowering by the Federal Reserve of its lending rate to practically zero has been sufficient to stimulate financial markets in the current climate of mistrust.
Buying into the market, inasmuch as it involves risk, depends on trust; but trust in the market cannot be bought. For trust depends essentially upon the trustworthiness of prospective buyers and sellers, borrowers and lenders. Without mutual trustworthiness, freedom of exchange is undercut, even if the cost of buying into the market (the interest rate, for example) is cut to zero. Virtue thus is prior to freedom; and without virtue, freedom destroys itself. The free market cannot operate by self-interest alone, therefore, but relies on ethical presuppositions.
An Alternate Vision
What is further lacking in the Randian philosophy is a robust concept of the common good. The common good is more than the competing interests of selfish individuals (the view on the right). It is also more than the composite interests of special groups (the view on the left). The common good is “the good we have in common”—the comprehensive communal conditions necessary for the virtuous pursuit of human fulfillment by all in society.
Talk of virtue ethics and the common good is the language of Christian moral philosophy. The financial crisis, then, issues a special call to the faithful. American society needs an alternative vision of economic life to the one that has reigned over the past quarter-century and has now brought so many institutions and investors to ruin.
The first task of this alternate vision—in the face of ingrained individualism and endemic egoism—is to reclaim the very fact of our common life as the basis of our obligations to one another. Times of crisis remind us of our inter-dependence and summon us to our mutual responsibilities. Without sustained focus and reflection, however, such lessons learned can be quickly lost in the public consciousness. (Recall how soon the official message after 9/11 shifted from “let’s pull together” to “everyone go shopping.”)
As a Mennonite philosopher, I have found Catholic social teaching to provide a plentiful resource of reflection on these questions, especially Leo XIII’s encyclical Rerum Novarum (1891), where we can find precisely the principle that we need to re-learn: “Civil society exists for the common good, and, therefore, is concerned with the interests of all in general, and with the individual interests in their due place and proportion” (No. 37).
From the perspective of Catholic social teaching, individual interest is inseparable from the common good. The individual’s claim on the community is bound up with the community’s claim on the individual. Such mutuality implies moral principles for the economic system: individual profit is accountable to the common good; gain for the wealthy is immoral apart from justice for the poor; economic freedom entails social responsibility (see the U.S. Catholic bishops’ pastoral letter, Economic Justice for All, 1986).
Another rich resource for reflection is John Paul II’s centenary reflection on Pope Leo’s encyclical, Centesimus Annus (1991), which includes a comment (No. 17) with a remarkable relevance for the current crisis:
We see how [Rerum Novarum] points essentially to the socioeconomic consequences of an error which has even greater implications.... This error consists in an understanding of human freedom which detaches it from obedience to the truth, and consequently from the duty to respect the rights of others. The essence of freedom then becomes self-love carried to the point of contempt for God and neighbor, a self-love which leads to an unbridled affirmation of self-interest and which refuses to be limited by any demand of justice.
The “unbridled affirmation of self-interest”—among buyers and sellers, borrowers and lenders—was indeed the mantra of the Greenspan era. And the “socioeconomic consequences” of that “error” are now evident to all.
The wisdom of virtue ethics and the common good, as Catholic social teaching itself acknowledges, is not confined to the tradition of the church. It would thus behoove people of faith, when presenting an alternative vision to persons of good will in American society who are not Christian, to seek out sources of such wisdom beyond ecclesial documents.
We could reconsider such classic writers as Aristotle, Aquinas and Tocqueville. They understood civil society as the natural setting for human fulfillment, the common good as the moral horizon of individual pursuit and wise governance to be as important as individual liberty for the sustainable pursuit of living well.
We would also do well to consider contemporary writers like Robert Bellah, Stephen Carter and Amitai Etzioni. They not only remind us of the republican ideal of a common good above private interest, but also call us away from the egoist ethic of selfish individualism toward a civic ethic of shared sacrifice and social virtue.
The need now, for both people of faith and all people of good will, is a return to the ethics of virtue and the philosophy of the common good, within which human freedom and individual interest find their “due place and proportion.” The welfare of the nation depends on it.
From the archives, America's review of Ayn Rand's Atlas Shrugged.