Alan Greenspan's nirvana

I wrote a post a while back exploring some of the silliest things economists were saying before the crisis about how financial engineering was making our economy more robust, stable, efficient, wonderful, beautiful, intelligent, self-regulating, and so on. The markets were, R. Glenn Hubbard and William Dudley were convinced, even leading to better governance by punishing bad governmental decisions. [How that could be the case when markets have a relentless focus on the very short term is hard to fathom, but they indeed did assert this]..

Paul Krugman has recently undertaken a similar exercise in silliness mining -- in this case going through the hallucinations of Alan Greenspan. The Chairman of the Fed was evidently drinking the very same Kool-Aid:

Deregulation and the newer information technologies have joined, in the United States and elsewhere, to advance flexibility in the financial sector. Financial stability may turn out to have been the most important contributor to the evident significant gains in economic stability over the past two decades.

Historically, banks have been at the forefront of financial intermediation, in part because their ability to leverage offers an efficient source of funding. But in periods of severe financial stress, such leverage too often brought down banking institutions and, in some cases, precipitated financial crises that led to recession or worse. But recent regulatory reform, coupled with innovative technologies, has stimulated the development of financial products, such as asset-backed securities, collateral loan obligations, and credit default swaps, that facilitate the dispersion of risk.

Conceptual advances in pricing options and other complex financial products, along with improvements in computer and telecommunications technologies, have significantly lowered the costs of, and expanded the opportunities for, hedging risks that were not readily deflected in earlier decades. The new instruments of risk dispersal have enabled the largest and most sophisticated banks, in their credit-granting role, to divest themselves of much credit risk by passing it to institutions with far less leverage. Insurance companies, especially those in reinsurance, pension funds, and hedge funds continue to be willing, at a price, to supply credit protection.

These increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago.

As Krugman notes, this can all be translated into ordinary language: "Thanks to securitization, CDOs, and AIG, nothing bad can happen!"

Of Idols and Crises

Here's a quote of the day, perhaps the best metaphor I've heard for where we are now in this financial and economic crisis, a few years downstream of the initial fractures, as authorities (and bankers) in Europe are still trying to duck necessary pain and loss through clever financial slight of hand. From novelist John Lanchester, quoted in Business & Finance:

"It's like there was a giant rumbling noise, the foundations shook, there was a crack in the altar and the golden idol fell down," he says. "And then there was a silence as they picked up the idol, polished it and put it back on the altar and now they're hoping that nobody had noticed. The fact is, we've had three or four supposedly unprecedented crises in the last couple of decades, and these events seem to be getting bigger and more frequent. That suggests to me that we really need to fix the whole architecture of world capitalism, but nothing I've heard suggests that anybody's doing that." 

Truly, nobody is doing that. For the moment, in Greece, in the US, and elsewhere, everything is patchwork, a few small repairs, even the illusion of repairs, and that's it.