It’s rarely a good idea to pick fights with one’s friends–especially the clever ones–but I’ll take issue with Gideon Rachman’s column, “Conservatism overshoots its limit“. Gideon writes:

The market for ideas – like the market for shares – always overshoots. Ideas become fashionable and get pushed to their logical conclusion and beyond, as their backers succumb to “irrational exuberance”. Then comes the crash.

What we are experiencing now is the bust that has followed the 30-year bull run in conservative ideas that began with the Thatcher-Reagan revolution of 1979-80.

You can get a sense of how quickly the intellectual atmosphere has changed by picking up a copy of Alan Greenspan’s The Age of Turbulence, which was published last year. Mr Greenspan, head of the Federal Reserve from 1987 until 2006, heaped praise on the magic of financial markets and decried the foolishness of those who called for more regulation: “Why do we wish to inhibit the pollinating bees of Wall Street?” he asked rhetorically. Why indeed?

Mr Greenspan was considered such a guru that last year Senator John McCain suggested putting him in charge of a committee on tax reform, adding: “If he’s alive or dead it doesn’t matter. If he’s dead, just prop him up and put some dark glasses on him.” But Mr Greenspan’s reputation is now on the slide and Mr McCain has reinvented himself as a champion of regulation – and is denouncing the “corruption and unbridled greed that has caused a crisis on Wall Street”.

This kind of ideological whiplash is what happens when an intellectual bull market crashes. The current financial crisis can be traced to three of the central ideas of the Reagan-Thatcher era: the promotion of home ownership, financial deregulation and a fervent faith in the market. Each of these ideas did sterling service for 30 years, increasing prosperity and freedom. But pushed too far – and combined – they have created a disaster.

This seems to me to conflate three quite separate points, one true, one false, and one questionable.

What is undoubtedly true is that intellectual fashions come and go. The default rhetorical position that many governments (by no means just conventionally conservative ones) have lately adopted–favouring market forces and competition, accepting of globalisation (with varying degrees of reluctance), sceptical about big regulatory initiatives–stands discredited all right. If ever an economic and political philosophy were out of fashion, this one now is. But I say “default rhetorical position” advisedly. What is certain is that the terms of political debate are transformed, and this will surely have consequences. I will come to what these might be in a moment. If Gideon had confined himself to what politicians say, as opposed to what they do, I would have been nodding in agreement all through the column.

What is false, I think, is the claim that pushing too far the central ideas of Reagan-Thatcher–said to be home ownership, financial deregulation and a fervent faith in the market–created this disaster.

I’m not sure even Reagan and Thatcher had a “fervent faith in the market”, but I would not accuse Bill Clinton, George Bush (1 and 2), Tony Blair or Gordon Brown of such a thing. And has the role of government been transformed by three decades of this fervent belief? I grant you privatisation: there has been a lot of that. But privatisation is regarded (even now, is it not?) as a mostly uncontroversial success. Is anybody in Britain calling for the steel industry to be renationalised? In other regards, though, fervent belief in the market has made rather small advances, I would say. I don’t see that public spending’s share of GDP (a vastly larger cake, after decades of growth) is much, if at all, lower anywhere.

As for policies supporting home ownership, these have been a bipartisan undertaking in the US, and if anything Democrats have pushed this agenda harder. Financial deregulation has happened–but not so much recently. It was certainly not a conservative project. In the US it was a messy decades-long process and arguably made its greatest strides during the Johnson, Carter and Clinton administrations. What drove it was not ideology but facts on the ground: the rules then in place were breaking down because of inflation (to begin with) and innovation. By the time the present crisis rolled in, banking was still the most heavily regulated industry in the country.

Ken Rogoff puts it well when he says that in the run-up to this emergency there was de facto, rather than de jure, financial liberalisation. In the past decade, innovation has overwhelmed the regulatory apparatus. Regulation did fail to keep pace, and it is true that key officials like Alan Greenspan rationalised their inactivity in pro-market terms. They were wrong. But did opponents of conservatism press for new regulation of non-bank mortgage origination and mortgage securitisation–the innovations that really did the damage? Just the opposite. Republican attempts to subject Fannie Mae and Freddie Mac (the essential quasi-public enablers of these changes) to tighter regulation were defeated by Democrats. They agreed with Greenspan: let that lending flow. Voices like that of Ed Gramlich, pointing to the dangers of the subprime explosion, were few and far between.

Conservatives did not create this disaster by pushing too far. They and their surrogates just happened to be standing there when the hurricane came in. Yes, they should have built the levies up when they had a chance to, and they failed–in one crucial instance, in the US, because Democrats got in their way. But it is wrong to say, as Gideon does, that they deliberately dismantled the levies. Regulatory failure in the face of bewilderingly rapid innovation is not the same thing as “deregulation”. And it is not a distinctively conservative trait.

The third point–the questionable one–concerns the nature of the coming backlash. Conservatism overreached, Gideon says, and now the liberals (US) and social democrats (Europe) will get a turn at the controls, and overreach in their turn. To repeat, Gideon is right about the rhetoric. That pendulum has already swung right back–taking McCain with it (as Gideon points out). But what about the policy pendulum? That is a very different thing. Especially in the US, swings in policy are usually very much smaller than you would expect, if all you did was listen to politicians.

Whatever happens, financial regulation will get a complete overhaul. As the details of this are worked out, however, the same difficult trade-offs that confound policymakers of every stripe will reassert themselves. There is no simple alternative paradigm–”re-regulation”–waiting to be taken down off the shelf. In other areas of policy, we will just have to see how much difference having a post-emergency market-sceptical Democratic administration in place is going to make.

In one respect–health care reform–I hope it makes a huge difference. But I don’t know whether the crisis advances or retards the prospect of real reform in that area. It could go either way. (See Robert Reischauer’s comment on National Journal’s new Health Experts blog.)

As for the rest, don’t take the rhetoric at face value.

October 9, 2008 3:43pm in Economics, US Politics | Comment