Alan Greenspan recently argued in the FT that the Dodd Frank Act fails to meet the test of our times.
In defence of this view, Greenspan paints a disturbing view of the modern world as a financial dystopia in which humans are at the mercy of a financial machine they have built but can no longer hope to manage. Greenspan argues:
The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest of modern financial systems. Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.
I can swallow the metaphorical hand that is invisible yet opaque, but I draw the line at “notably rare” instability.
Notably rare? This modern financial world has not been operating for more than 30 years. (By many metrics, the period of rapid financial innovation was kicked off by the inflation and oil shocks of the 1970s and got underway in earnest with the rise of computing power and worldwide regulatory reform starting around 1980.) Suppose we set aside the S&L crisis, the lost decade(s) in Japan, the Asian financial crises of the late 1990s, etc. Let’s focus on the latest crisis, which many of us would not confine to a neat little box in 2008. If we attribute three years of misery to the crisis, “notably rare” is up to 10 per cent of the time.
Greenspan’s bleak vision, like Orwell’s before him, may prove correct. My view is that the financial crisis was not a sad by-product of modernity but rather a new episode in a very old story: systems that allow risk taking and innovation are inherently subject to periodic crises. We can surely avoid another crisis by outlawing all risk taking. The alternative is to strive provide a stable backdrop in which productive risk taking can flourish. The history of financial progress has, arguably, been one of generally increasing stability‐‐in economies where development has been allowed to occur‐‐supported by an evolving system of market and political institutions, laws and regulations.
Greenspan is right that the Dodd Frank Act, like every hasty response to upheaval, is grossly imperfect. The Patriot Act comes to mind. The Federal Reserve Act of 1913 was itself a crisis response and was substantially modified over more than 20 years before reaching the form we recognise today.
We should continue the job of reform and not surrender to Greenspan’s dystopian vision.