The Capitalist Manifesto: Greed Is Good

The simplest safeguard American regulators have had, of course, is the interest rate on credit. In responding to almost every crisis in the past 15 years, former Fed chairman Alan Greenspan always had the same solution: cut rates and ease up on money. In 1998, when Long-Term Capital Management collapsed, he suddenly and dramatically slashed rates, even though the economy was roaring along at 6 percent growth. In late 1999, buying into fears about Y2K, he swamped the markets with liquidity. (One effect: between November 1998 and February 2000, when rates finally rose, the NASDAQ jumped almost 250 percent, increasing in value by more than $3 trillion.) And finally, when the technology bubble burst and 9/11 hit, Greenspan again lowered rates and kept them low, this time inflating a massive housing bubble.

Greenspan behaved like most American political leaders over the past two decades—he chose the easy way out of a hard situation. William McChesney Martin, the great Fed chairman of the 1950s and 1960s, once said that his job was to take the punch bowl away just as the party had begun. No one wants to do that in America anymore—not the Fed chairman, not the regulators, not Congress and not the president.

Government actions should be "countercyclical"—that is, they should work to slow down growth. So, in boom times, the Fed would raise rates and require banks to have higher capital and lower leverage. Fannie Mae and Freddie Mac would start worrying about too much easy credit, raise standards for loans and disqualify buyers unlikely to be able to afford houses. Banks would be urged to slow down the supply of credit cards and other credit instruments. In fact, this is exactly how the governments of China and India behaved in 2007, when their economies were booming. At the peak, consumption in India actually declined as a percentage of GDP.

In the United States, the opposite happened: consumption surged from 67 percent to 73 percent of GDP. Presidents and congressmen extolled the virtues of homeownership for everyone. Congress pushed Fannie Mae and Freddie Mac to extend more loans. Regulators eased up on banks, and the Fed kept rates low. And the public cheered this pandering at every step.

Since Ronald Reagan's presidency, Americans have consumed more than we produced and have made up the difference by borrowing. This is true of individuals but, far more dangerously, of governments at every level. Government debt in America, especially when entitlements and state pension commitments are included, is terrifying. And yet no one has tried seriously to close the gap, which can be done only by (1) raising taxes or (2) cutting expenditures. Any sensible proposal will have to feature both prominently.

This is the disease of modern democracy: the system cannot impose any short-term pain for long-term gain. For 20 years, most serious structural problems—Social Security, health care, immigration—have been kicked down the road. And while the problem is acute in America, Europe and Japan face many of the same difficulties. Right now, the U.S. government's boldness is laudable, but it is being bold in spending money. In a few years, when the bills come due, and Congress must enact major spending cuts as well as raise taxes (and not just on the rich), that's when we will see if things have changed.

In reality, the problem goes well beyond Washington. It also goes beyond bad bankers, lax regulators and pandering politicians. The global financial system has been crashing more frequently over the past 30 years than in any comparable period in history. On the face of it, this suggests that we're screwing up, when in fact what is happening is more complex. The problems that have developed over the past decades are not simply the products of failures. They could as easily be described as the products of success.