Keynes and the FT
Winston Churchill Blogs About November 13, 1940

Neoliberal Economists Agonistes

Felix Salmon shifts ground from Charles Ferguson's Larry-Summers-Is-Corrupt to the alternative Larry-Summers-Has-Been-Intellectually-Captured-by-Wall-Street interpretation:

Summers’s incentives: But this misses the point: Summers had already been captured when he was Treasury secretary, and he was hired by DE Shaw partly because he was captured. Being captured is not some kind of intellectually dishonest overt bribe, where you truly believe A but profess to believe B because doing so makes you rich. It’s much more subtle than that, based partly in the wealth and success and sterling reputations of those (like your mentor Bob Rubin, perhaps) who believe B. And it’s a survivorship-bias thing, too: if you don’t believe B, you’ll never rise to the kind of position where your opinions matter as much as Larry’s do and did.... Summers has a pretty unique way of perceiving, analyzing, and solving problems. Many policymakers, including Barack Obama, value his particular insights. But the fact is that most of the time Summers seems to end up doing and proposing exactly what Wall Street would most want him to do. Pace Brad, he might well be fully aware of the problems with Wall Street. But yes, by using words like “Luddite”, he does dismiss those concerns, or persuade himself that the costs of acting on them are greater than the benefits...

This is, I think, a considerable improvement.

But "intellectually captured" does not capture it. It brings up images of that awful Star Trek episode where the gigantic disembodied brains bet on cage matches between Enterprise crew members with thrall collars on their necks.

Let me suggest a better metaphor: one of those bear traps that closes around the ankle. Not "captured," but rather "trapped"--something you could escape from by gnawing off a limb. And Larry was never trapped by belief in the efficient market hypothesis. Instead, he (and I) were trapped by belief in what I might as well call "Greenspanism."

He (and I) never were believers in the efficient markets hypothesis. How could we be? Look around: there are idiots! The market's prices are the results of a wealth-weighted voting mechanism: the more money you have, the bigger is your weight in the market's average. People who have done well in the recent past thus have more weight than people who have done badly. But those who have done well me be irrational trend-chasers who have been lucky and those who have done badly may be sober-sided fundamentalists whose time has simply not yet come. The questions of the degree to which the limited amount of risk-averse smart money can leverage itself and profit from all this noise in the market by reducing it is a fascinating and subtle one. But nobody thinks that the answer is that the noise simply does not matter, is ironed out into insignificance.

But let me switch to what I am really interested in. Let me talk about me. After all, my mind is what I know best. And it is the case that the most powerful lobe of my brain is the one that is always running an instantiation of the Larry Summers thought emulation module on top of its native wetware code:

What we did believe? We believed that the Federal Reserve could handle whatever financial crisis the markets could throw at it. We believed that the Federal Reserve had the policy tools, the risk management skills, and the incentives to firewall the real economy from financial dislocations, and to clean up whatever financial messes were left behind. There were solid reasons for these beliefs: they were called 1987, 1991, 1997, 1998, and 2001. In all of those episodes--some of them involving financial losses much greater than those of the initial subprime mortgage crisis--the Federal Reserve had successfully firewalled the real economy off from financial turmoil.

Once we had concluded that the Federal Reserve had the tools and the competence  to absorb financial shocks, the jaws of the trap snap shut. Leverage then appears to be a positive good rather than a danger. Why? Because if the past two centuries of financial market history prove anything, it is that the markets are woefully short of patent capital willing to bear risks. The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many--for that is what low long-term returns on "safe" portfolios tell us--and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few.

The argument is bullet-proof and correct--as long as Greenspanism is true doctrine, as long as the Federal Reserve does in fact have the policy tools, the risk management skills, and the incentives to firewall the real economy from financial dislocations, and to clean up whatever financial messes were left behind.

Here it is worth stressing that these intellectual commitments are not the result of being hypnotized by the princes of Wall Street. They are the result of disciplined and concentrated analysis of the historical patterns of asset prices and returns. They are the result of confidence in the intellectual power of the discipline of monetary economics as applied through the policy instrumentality of the Federal Reserve. And they are the result of the economists' insight that whenever there is an area of economic activity that pays huge, outsized rewards the odds are that we need more of it done.

But "captured" is the wrong word. "Trapped" is much better. And not trapped by the efficient market hypothesis. Trapped, instead, by confidence in modern central banking.

And while these intellectual commitments are certainly fueled by too-close attention to and admiration for central bankers, they are not especially closely tied to contacts with or worship of the princes of Wall Street.