Republic, Lost_ How Money Corrupts Congress--And a Plan to Stop It - Lawrence Lessig [29]
The cause that I find least convincing, however, is irrationality. Some argue that it’s just craziness that explains the crisis. That somehow, and inexplicably, everyone just became insanely greedy—irrationally borrowing more than they could repay, irrationally lending more than was prudent, irrationally ignoring the warnings of impending doom—and now that this fever has passed, we can look forward to another fifty years of financial stability. Like the measles or small pox, if you survive it, you don’t get it again.
This is a criminally incomplete understanding of the disaster that we’ve just suffered. And while it would take a whole book to make that case convincingly, in the few pages that follow, I sketch one part of the argument with enough detail to make it relevant to the argument of this book.
For the core driver in this story was not craziness. It was rationality. The behavior we saw—from borrowers to lenders to Wall Street to government officials—was perfectly rational, for each of them considered separately. It was irrational only for the system as a whole. We need to understand the source of that irrationality—not an individual, but a systemic irrationality—to ask whether the policy judgments that produced it could even possibly have made sense.
That source is tied directly to regulation.1 In my view, the single most important graph capturing the story of American finance was created by Harvard Business School professor David Moss (Figure 6).2
FIGURE 6
Moss explains the picture like this:
Financial panics and crises are nothing new. For most of the nation’s history, they represented a regular and often debilitating feature of American life. Until the Great Depression, major crises struck about every 15 to 20 years—in 1792, 1797, 1819, 1837, 1857, 1873, 1893, 1907 and 1929–33.
But then the crises stopped. In fact, the United States did not suffer another major banking crisis for just about 40 years—by far the longest such stretch in the nation’s history. Although there were many reasons for this, it is difficult to ignore the federal government’s active role in managing financial risk. This role began to take shape in 1933 with the passage of the Glass-Steagall Act…. The simple truth is that New Deal financial regulations worked. In fact, [they] worked remarkably well.3
If you want to understand where the craziness began, we should begin where the “New Deal financial regulations” begin to end. This is the delta in the environment. Or it is at least the one self-conscious change that should be the first target of suspicion.
The most efficient entry into this argument is a quote from Judge Richard Posner. Judge Posner sits on the U.S. Court of Appeals for the Seventh Circuit in Chicago. He is among the most prolific legal academics and the most prolific judges in the history of the nation. He is certainly among the most influential. His book Economic Analysis of Law (1973) founded the law and economics movement. Since then he has written fifty more books, hundreds of articles, and thousands of judicial opinions. He was appointed to the federal bench by Ronald Reagan thirty years ago. Whatever we can say, we can be certain, Posner is no socialist.
Among Posner’s fifty-some books are two that deal specifically with the financial crisis.4 And at the core of Posner’s argument is an insistence that we understand the rationality behind this insanity. As he writes, criticizing a government report on the crisis:
The emphasis the report places on the folly of private-sector actors ignores the possibility that most of them were behaving rationally given the environment of dangerously low interest rates, complacency about asset-price inflation (the bubbles that the regulators and, with the occasional honorable exception,