The evil man theory of failure

By Megan McArdle

Both right wing Austrians and many liberals have a common theory of how all this happened:  Alan Greenspan dunnit.  The mechanisms by which he accomplished his foul task are different in the two cases, of course.  Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable.  The liberals think that by failing to regulate . . . er, something (usually either mortgage originations or CDS's) more closely, he made the crisis inevitable.  In the latter case, sometimes Phil Gramm, with an assist from Conservative Ideology, fills in the role of convenient demon.

Here's the problem:  if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital?  The alternative question for the liberals:  if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?  If your preferred system is really that fragile, then maybe we should be looking into alternatives.

Update:  Let me expand a little.

Austrians:  If the market does not price the injection of short term capital into its actions, why would we trust it to price anything else correctly?  If the markets treat short-term capital as substantially equivalent to long-term capital, we have much bigger problems than Alan Greenspan.

Gramm/Greenspan haters from the left:  If regulation is so impotent that a single rule change, or even two, can leave the system vulnerable to this kind of collapse--indeed, make it worse with other rules that are still there--then why the hell do we bother regulating?  If your regulators need to get it right 100% of the time, we might as well pack it in now, because there is no system on earth that can guarantee no one will ever be wrong.  If one guy can leave us in a position where the regulatory system makes things worse rather than better, we may well be better off without the regulatory regime.

This article available online at:

http://www.theatlantic.com/business/archive/2008/10/the-evil-man-theory-of-failure/4256/