When Queen Elizabeth opened London's high-tech Millennium Bridge in 2000, the bridge began to tilt and sway alarmingly when the first crowds started to walk across it. They tried to limit the number of pedestrians, but to no avail -- the bridge continued its distressing behavior and it was closed while engineers studied the problem.
It turns out that when a few people happen to fall in step on a bridge, they generate lateral forces that cause a very slight sway. Unconsciously, more people fall in step with the motion, and it becomes a self-reinforcing feedback system that runs out of control. Eventually, stabilizers were installed on the bridge and it's fine now.
Repairing our financial system, whose stabilizers have been removed by decades of utopian free market ideology won't be as easy. Michael Moore's "Capitalism: A Love Story" chronicles the short-term thinking, greed and stupidity that fueled our financial bubble and its disastrous aftermath. But individual greed and stupidity also fuel normal markets, which supposedly correct for them through the operations of Adam Smith's "invisible hand." What went wrong? Cassidy puts it this way:
Unfortunately, the real causes of the crisis are much scarier and less amenable to reform: they have to do with the inner logic of an economy like ours. The root problem is what might be termed “rational irrationality”—behavior that, on the individual level, is perfectly reasonable but that, when aggregated in the marketplace, produces calamity.Cassidy, whose article is excerpted from his upcoming book, How Markets Fail, focuses on how this played out in a financial marketplace where so many of the safeguards had been removed and largely unregulated new financial instruments moved into the void.
Although the players and many of the instruments they were trading were new, the chaotic dynamics of the market were as old as markets themselves. They were analyzed by John Maynard Keynes many years ago, and his work was behind many of the New Deal financial reforms, including the Glass-Steagall Act, which kept traditional banks from engaging in investment banking and brokerage activities. That was repealed in 1999, paving the way for today's "too big to fail" financial giants with their hands so deeply embedded in the public till. As Cassidy notes, the Obama Administration has shown no interest in reinstating Glass-Steagall.
But the lessons of history seem to be there mostly to be forgotten. What are the chances of meaningful reform that put some stabilizers back into the system? Cassidy doesn't seem too optimistic about Obama Administration reform initiatives and closes on an apprehensive note.
As memories of September, 2008, fade, many will say that the Great Crunch wasn’t so bad, after all, and skip over the vast government intervention that prevented a much, much worse outcome. Incentives for excessive risk-taking will revive, and so will the lobbying power of banks and other financial firms. “The window of opportunity for reform will not be open for long,” Hyun Song Shin wrote recently. Before the political will for reform dissipates, it is essential to reckon with the financial system’s fundamental design flaws. The next time the structure starts to lurch and sway, it could all fall down.