The authors’ criticisms of the Fed’s response to the crisis are no less trenchant. “In its rush to prop up the financial system,” they observe, the Fed rescued insolvent financial institutions, exposing taxpayers to losses on toxic assets while helping to “sow the seeds of bigger bubbles and even more destructive crises.”

But although Roubini and Mihm draw attention to some ways in which the government contributed to the crisis, they go seriously wrong in claiming that the boom “was primarily underwritten not by Fannie Mae and Freddie Mac but by private mortgage lenders like Countrywide”: Although Fannie and Freddie didn’t originate any subprime loans, they bought and (implicitly) guaranteed plenty of them, including a very large share of Countrywide’s Community Reinvestment Act (CRA) “Best Practice” loans. What Fannie and Freddie didn’t buy other lenders did, to meet their own CRA requirements. Such facts undermine Roubini and Mihm’s conclusion that “the significance of government intervention was dwarfed by the significance of government inaction.”

Roubini and Mihm’s reform proposals also fail to properly weigh government policy’s contribution to the crisis. They start well again by insisting on the need to restore to financial services “the creative destruction that Schumpeter saw as essential for capitalism’s long-term health.” Although Lehman Brothers’ failure revealed the shortcomings of ordinary bankruptcy as a means for resolving large and heavily leveraged financial firms, Roubini and Mihm note how those shortcomings could be avoided by means of “living wills” or by splitting ailing firms into “good” and “bad” parts, so that the latter might be declared bankrupt without raising Cain.

But some of Roubini and Mihm’s other proposals appear useless at best, including their endorsement of a “beefed-up” Glass-Steagall that would forcibly break up enterprises that become too big to fail, with its implicit suggestion that Gramm-Leach-Bliley contributed to the crisis. In fact that 1999 “repeal” of Glass-Steagall merely allowed commercial banks to affiliate with investment banks and played no important part in the insolvency of Lehman Brothers and other independent broker-dealers that was at the heart of the crisis.

A beefed-up Glass-Steagall Act might of course spin a much tighter web of firewalls than the original did. But as Roubini and Mihm themselves suggest, many TBTF firms exist only thanks to “heavy helpings of government largess,” including guarantees and actual bailouts, and could be left to break up naturally once improved bankruptcy procedures are in place. Perversities in executive compensation might likewise vanish on their own once imprudent decisions lead to bankruptcy rather than bailouts.

The most disappointing part of Crisis Economics is the second chapter’s hackneyed history of thought. Here Adam Smith is portrayed as a Walras-Debreu manqué who blinked at capitalism’s “vulnerabilities,” while Marx is credited with the “hugely important insight” that crises are “part and parcel of capitalism”—as if he’d predicted occasional financial panics rather than a steady decline in firm profits. The incomprehensible parts of the General Theory are treated, per usual, as proof of Keynes’s genius rather than of his being, well, incomprehensible. Finally and most disappointingly, by confusing the Mises-Hayek view of the business cycle with Schumpeter’s notion of creative destruction, Roubini and Mihm overlook the one theory of crises that best fits the housing boom-bust story.

Crisis Economics’s occasional references to the Great Depression must also be taken with a pinch of salt. It wasn’t Hoover but FDR who, in February 1933, stood by while “thousands of banks” went under; and it was growth in the money stock rather than fiscal stimulus that fueled the post-1933 recovery. The deflation of 1937–38 was mainly caused not by FDR’s belated attempt to balance the federal budget but by the Fed’s doubling of bank reserve requirements. Finally, corrected statistics show that World War II brought further stagnation rather than sustained recovery.

In short this “crash course in the future of finance” has both strengths and weaknesses. Although it contains much useful information about the subprime debacle, it understates the government’s contribution to the crisis, and although it suggests some desirable reforms, it suggests others that could prove counterproductive. Readers looking for straight A’s are advised to cram with caution.

First, something that is right.

With one major exception (discussed below), the typical economist, when doing economics (and regardless of political bent), doggedly avoids ad hominem explanations. That is, economists don’t explain observed reality as resulting from specific human personalities or personality traits. Instead, economists (try to) identify the constraints and opportunities that confront decision-makers and then explain patterns of human activities as being predictable outcomes of the ways that individuals—any individuals—respond to identified constraints and opportunities.

This avoidance of ad hominem explanations is the source of one of the most important lessons that economists teach: greed explains nothing. Because greed—or, more accurately, “self-interestedness”—is largely unchanging across time, no observed changes in the economy can be explained by it.

Greed can’t explain rising fuel prices, for example, given that fuel sellers (and also fuel buyers) are just as greedy when prices are lower as they are when prices are higher. Likewise with booms and busts. Because people’s greed remains constant something else must explain booms and busts. And so too for any other economic phenomena you care to name—everything from the fact that Americans are richer than Armenians to the fact that, say, big-box retailers’ market shares are growing while those of mom-’n’-pop retailers are shrinking.

Of course the particular constraints and opportunities identified by economist Doe as being most relevant for explaining some phenomenon often differ from those identified by economist Jones for explaining the same phenomenon. Doe, for example, might identify an increase in the rate of growth of the money supply as the most crucial factor for explaining an observed boom and bust, while Jones identifies an easing in government regulation of banks as the crucial factor. But neither Doe nor Jones explains the boom and bust as caused by the likes of greed or ignorance.

Economists’ refusal to use always-popular (and often half-baked) romantic notions about human behavior to explain economic phenomena goes a long way toward making economics a genuine science, and it accounts for much of whatever good economists have managed to bestow on society.

What’s Wrong

Turning now to something that is wrong with economics, much of the harm that economists inflict on society is a direct result of the one area in which economists too often embrace such ad hominem explanations: analyzing government involvement in the economy.

Despite a long-established tradition in economics of studying the “public” sector using the same analytical tools that we use to study the private sector—and despite two founders of this Public Choice tradition being awarded Nobel Prizes (George Stigler in 1982 and James Buchanan in 1986)—far too many economists persist in sloppy, unanalytical ad hominem thinking about government.

For too many economists government is assumed to be able to escape many of the constraints that unavoidably bind and trip up people in the private sector. Asymmetric information, moral hazard, and adverse selection, as well as confirmation bias and the legions of other alleged “irrationalities” identified by behavioral economists, are just some of the “imperfections” economists find in markets and then too frequently simply assume can be dealt with effectively by government.

Overlook here the fact that many of the problems alleged to be unavoidable in the private sector are in fact handled quite well by human beings acting without government who exhibit far more ingenuity than the typical economist believes is possible in private-sector settings. (It’s notable that Elinor Ostrom, the first woman to win the Nobel Prize in economics, isn’t a professor of economics but instead of political science. She won the prize in 2009 for her work showing how creative people in private settings often overcome obstacles—such as free-rider problems—that most economists naively assume can be overcome only by government.)

Unanalytical Assumptions

Focus instead on economists’ bizarre stumble into an unanalytical assessment of government. That stumble goes like this: “Omigosh! There’s an imperfection in this private-sector market! My textbooks and the many refereed journal articles I’ve read and written make quite clear—with lots of difficult mathematics—that this market will therefore fail. My textbooks and journal articles also imply, and in many cases explicitly state, the conclusion that the government—and only the government—can solve the problem. Models prove this conclusion.”

Such stumbling is common. From today’s insistence that America needs more stimulus spending, through the support that many economists express for the new Consumer Financial Protection Bureau, to economists’ overwhelming belief that countries need central banks, too many economists unscientifically reach their conclusions about the alleged efficacy of government intervention without first asking how the information available to government officials, and how the incentives these officials face, will affect government decision-making.

In short, economists mysteriously conclude that desirable public-sector outcomes follow from the praiseworthy intentions that economists assume motivate most public officials.

Nowhere does this mystery run more deeply than in fiscal policy. Even if it were true that increased government spending can hasten an economy’s escape from a recession, the large number of economists who today endorse such spending is discouraging. Seldom do these economists inquire into the incentives facing government officials in charge of spending. The assumption is that these officials will spend the money in ways sure to promote the public interest. Also, seldom do these economists inquire into the information asymmetries and other constraints that might hamper even well-meaning officials’ efforts to carry out fiscal policy effectively.

Save for the relatively few economists steeped in Public Choice economics, the typical economist today remains a political naif—and a dangerous one at that. He is bloated with unjustified confidence in models which show that if government officials behave in the public interest and if these officials are immune to the same decision-making quirks and knowledge limitations that afflict decision-makers in private markets, then government can perform all manner of marvels. This economist then uses his authority to support interventions that are utterly unjustified by genuine scientific standards.

It’s shameful.

Well, Progressive commentators, what say you?

There is very little either complicated or interesting about poverty. Poverty has been man’s condition throughout his history. The causes of poverty are quite simple and straightforward. Generally, individual people or entire nations are poor for one or more of the following reasons: (1) they cannot produce many things highly valued by others; (2) they can produce things valued by others but they are prevented from doing so; or (3) they volunteer to be poor.

The true mystery is why there is any affluence at all. That is, how did a tiny proportion of man’s population (mostly in the West) for only a tiny part of man’s history (mainly in the nineteenth, twentieth, and twenty-first centuries) manage to escape the fate of their fellow men?

Sometimes, in reference to the United States, people point to its rich endowment of natural resources. This explanation is unsatisfactory. Were abundant natural resources the cause of affluence, Africa and South America would stand out as the richest continents, instead of being home to some of the world’s most miserably poor people. By contrast, that explanation would suggest that resource-poor countries like Japan, Hong Kong, and Great Britain should be poor instead of ranking among the world’s richest places.

Another unsatisfactory explanation of poverty is colonialism. This argument suggests that third-world poverty is a legacy of having been colonized, exploited, and robbed of its riches by the mother country. But it turns out that countries like the United States, Canada, Australia, and New Zealand were colonies; yet they are among the world’s richest countries. Hong Kong was a colony of Great Britain until 1997, when China regained sovereignty, but it managed to become the second richest political jurisdiction in the Far East. On the other hand, Ethiopia, Liberia, Tibet, and Nepal were never colonies, or were so for only a few years, and they rank among the world’s poorest and most backward countries.

Despite the many justified criticisms of colonialism and, I might add, multinationals, both served as a means of transferring Western technology and institutions, bringing backward peoples into greater contact with a more-developed Western world. A tragic fact is that many African countries have suffered significant decline since independence. In many of those countries the average citizen can boast that he ate more regularly and enjoyed greater human-rights protections under colonial rule. The colonial powers never perpetrated the unspeakable human rights abuses, including genocide, that we have seen in post-independence Burundi, Uganda, Zimbabwe, Sudan, Central African Empire, Somalia, and elsewhere.

Any economist who suggests he has a complete answer to the causes of affluence should be viewed with suspicion. We do not know fully what makes some societies richer than others. However, we can make guesses based on correlations. Start out by ranking countries according to their economic systems. Conceptually we could arrange them from more capitalistic (having a larger free-market sector) to more communistic (with extensive State intervention and planning). Then consult Amnesty International’s ranking of countries according to human-rights abuses. Then get World Bank income statistics and rank countries from highest to lowest per capita income.

Compiling the three lists, one would observe a very strong, though imperfect, correlation: Those countries with greater economic liberty tend also to have stronger protections of human rights. And their people are wealthier. That finding is not a coincidence, so let us speculate on the relationship.

Rights and Prosperity

One way to gauge human-rights protection is to ask to what extent the State protects voluntary exchange and private property. These signify the rights to acquire, keep, and dispose of property in any fashion so long as one does not violate the rights of others. The difference between private property rights and collectively held rights is not simply philosophical. Private property produces systemically different incentives and results from collective property.

Since collectivists often trivialize private property rights, they are worth elaborating. When property rights are held privately the costs and benefits of decisions are concentrated in the individual decision maker; with collectively held property rights they are dispersed across society. For example, private property forces homeowners to take into account the effect of their current decisions on the future value of their homes, because that value depends, among other things, on how long the property will provide housing services. Thus privately owned property holds one’s personal wealth hostage to doing the socially responsible thing—economizing scarce resources.

Contrast these incentives to those of collective ownership. When the government owns the house, the individual has less incentive to take care of it simply because he does not capture the full benefit of his efforts. It is dispersed across society instead. The costs of neglecting the house are similarly spread. You do not have to be a rocket scientist to predict that under these circumstances, less care will be taken.

Nor is nominal collective ownership the only force that weakens social responsibility. When government taxes property, it changes the ownership characteristics. If government were to impose a 75 percent tax on a person selling his house, it would reduce his incentive to use the house wisely.

This argument applies to all activities, including work and investment. Whatever lowers the return from or raises the cost of an investment reduces incentives to make that investment in the first place. This applies to investment in human as well as physical capital—that is, those activities that raise the productive capacity of individuals.

To a significant degree the wealth of nations is embodied in their people. The starkest example of this is the experience of the Germans and Japanese after World War II. During the war, Allied bombing missions destroyed nearly the entire physical stock of each country. What was not destroyed was the human capital of the people: their skills and education. In two or three decades, both countries reemerged as formidable economic forces. The Marshall Plan and other U.S. subsidies to Europe and Japan cannot begin to explain their recovery.

Proper identification of the causes of poverty is critical. If it is seen, as is too often the case, as a result of exploitation, the policy recommendation that naturally emerges is income redistribution—that is, government confiscation of some people’s “ill-gotten” gains and “restoration” to their “rightful” owners. This is the politics of envy: bigger and bigger welfare programs domestically and bigger and bigger foreign-aid programs internationally.

If poverty is correctly seen as a result of the unwise government intervention and lack of productive capacity, more effective policy recommendations emerge.

First, greed or, better, self interest, certainly does in a sense drive material progress and so on, but only if and to the extent that social institutions, the “rules of the game,” are truly consistent with the free market – that is, private property, free exchange, and the rule of law.

But not everything that looks like a free market is a free market.  If the economic system departs from the rules of the free market, self-interest tends not to promote the general welfare at all.  For instance, private property is violated every time special interests use government to seek a bailout or protection against competition.

Nevertheless, there is a certain “free-market” attitude, which I am told can even be found on Wall Street itself, that whatever self-interest produces must indeed be good.  Those with this attitude don’t take the trouble to sort out the basic requirements of the free market from the various regulations, protections, and transfers that are at odds with it.  You know, the sort of “free marketer” that Steven Colbert satirizes on his television show.  To such persons, the collapse of the financial market and the recession are evidence of failure of the “free market” and unbridled capitalism.

Two Kinds of Free Marketers

I think this attitude can be traced to two different mindsets that you could call free-market-friendly.  One of these sees self-interest itself as a virtue, and unfettered self-interest in particular as the highest good.  But what does “unfettered” mean?

While the subject is far too involved for me to delve deeply into here, I will say that I think it depends on whether the fetters reside within the agent, in the form of norms and conventions she has internalized, or outside the agent, in the formal rules and regulations that are enforced by external authorities.

Those who tend to use the phrase “unfettered self-interest” or “unbridled capitalism” seem to have in mind a situation in which there is no locus of restraint whatever, either within the agent or outside the agent.  Of course, the complete absence of restraint in this sense would result in the Hobbesian “war of everyone against everyone,” precisely the picture of modern finance that Oliver Stone paints in his movies.

In this rather naïve view the agent is free to pursue her self-interest wherever she finds it, even when it means acting opportunistically and dishonestly – so long as she observes or appears to observe the external rules and regulations.  Thus the hotshot Wall Street operator takes advantage of any opportunity she chances on, even if it violates the norms of honesty and conventions of fair play, since these don’t really exist in her internal moral world.  They believe that “greed is good” even when the rules of the game violate the rule of law, for example, by spreading the cost of risky investments among taxpayers (e.g., Fannie Mae) and concentrating the benefits on a few big players (e.g., Goldman Sachs).

(See Horwitz and Boettke’s “The House that Uncle Sam Built” for an excellent explanation of just how government policy did this leading up to the recent housing/financial crisis.)

Growing-Up

Now, a more mature view doesn’t claim that everything that shakes out of even an ideal free market, whatever that may mean to you, is good and without (even significant) imperfections.  It recognizes that in such a world aggression and fraud would still take place (though probably a lot less than in one dominated by standing national armies) and that nonaggressive behavior ranging from the annoying to the offensive to the deeply disturbing (no need for me to detail what these are for me or might be for you) would still be plentiful.

But the mature view recognizes that honesty, fair play, and trust are all important elements of the free market.  Without these, private property, free exchange, and the rule of law may still be observed under the watchful eye of external authorities, but they would not flourish, and neither would material prosperity and wealth-creation take place on the scale and consistency that we’ve seen since the rebirth of the liberal idea in modern times.

Moreover, this view recognizes that when profits and losses, the good and the bad, redound to those responsible for making the decisions that produce them, market participants tend to grow more responsible and make better decisions.  That is what the free market does: It makes us more responsible by making us more responsible.  As a result, just those kinds of internal restraints against opportunism that grease the wheels of the market process emerge over time: the norms of trust and the conventions of reciprocity and fair play.  This doesn’t mean, of course that “greed is good.”

Rather, the attitude is something like, to paraphrase Winston Churchill on democracy, “the free market is the worst possible system – except for all the others.”

***

The sequel just opened and I haven’t seen it yet.  Let’s see how much the filmmaker has grown up in the past 23 years.

Perpetrators of Ponzi schemes lead clients to believe their money is invested and that their profits are the fruits of the money manager’s savvy. But in fact the “profits” are merely revenue provided by the next group of dupes. Eventually, when no more new dupes can be found, the scheme crashes.

Political leaders say Madoff’s alleged crimes show what’s wrong with the country. President Obama said the “massive fraud . . . was made possible in part because the regulators who were assigned to oversee Wall Street dropped the ball.” Senate Majority Leader Harry Reid added, “[R]egulators have been asleep at the wheel.”

Politicians go on and on about Wall Street “greed” and “irresponsibility.”

But Madoff’s scam was small compared to Ponzi schemes the government itself runs: Social Security and Medicare.

By now we all know the government does not invest our payroll taxes and pay our benefits with the profits our money earns. In the beginning, writes economic historian Charlotte Twight in Dependent on D.C., Americans were told Social Security was an insurance program. But the government was unable to sustain that bald lie.

No-Trust Fund

In reality our money, rather than being invested and kept in an actual “trust fund,” is immediately given to current retirees in Social Security benefits or to their healthcare providers in Medicare benefits. The government’s promise to pay for your retirement pension and medical care is just a promise. And a lie.

In theory, the promise could be kept by raising taxes on future workers, but there won’t be enough of them. Changing demographics are destroying the programs. A large working class can support a relatively small retired class, especially when life expectancy is 61 years and benefits don’t begin until 65. That’s how things were in the early years of Social Security. But when life expectancy grows to 80 and a large generational group—the baby boomers—retires expecting to be supported by a far smaller working class, that’s trouble.

Ten years after Social Security passed in 1935, there were almost 42 workers for each retiree. Five years later, the ratio slipped to about 17 to 1. Now it’s about 3.4 to 1. Thirty years from now, the ratio is projected to be 2 to 1.

Think of the burden on those two to three workers who’ll have to support one retiree for 15 to 20 years.

The money just won’t be there. In the next 75 years Social Security and Medicare have a combined unfunded liability of $40.3 trillion. Social Security’s problems get most of the attention, but Medicare will be the killer. At present it accounts for all but $4.3 trillion of the unfunded liability, and as we aging boomers keep demanding new, improved, and more expensive medical care, the deficit will only get worse

Soon government will have to say what Madoff said: Sorry! The money’s gone.

The government has no legal obligation to make good on its promises. Twice the U.S. Supreme Court ruled that Americans have no contractual rights regarding Social Security benefits. In 1960 (Flemming v. Nestor), the court said, “To engraft upon the Social Security system a concept of accrued property rights would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands.”

Get that? You have no “accrued property rights” under Social Security. It’s a welfare program that exists at the politicians’ pleasure.

Either the government will stiff us outright or, more likely, cowardly politicians will pretend to honor their promises by printing so much extra money to write the checks that the dollar will be worth pennies.

If Bernie Madoff tried to foist Social Security and Medicare on us, he’d be arrested, prosecuted, and thrown in the hoosegow.

There’s one thing I can say on behalf of Madoff: He never forced anyone to participate in his scheme. That’s more than I can say for the government. Through taxation and inflation, it forces us to pay for all its schemes.

Nassim Nicholas Taleb is famous for introducing us to black swans. Though these rare creatures have long been used among academic philosophers to explain the shortcomings of reasoning by induction (“Every swan I’ve ever seen has been white, therefore all swans are white.”), Taleb uses the black swan as a stark metaphor for the inevitability of highly improbable events. In other words, black swans are rare, but one will swim by eventually.

As far as Wall Street—particularly the people with a large stake in getting things right—is concerned, this financial crisis involved a confluence of events. Some of these black swans were set in motion by government, like flexible lending standards to extend home ownership, Fannie and Freddie, and a mortgage-friendly tax code. Others were set in motion by willfully ignorant bankers, big shot risk-modelers, and people believing they could live beyond their means. It all came together in a fantastic cascade of failure. The trouble is, no one—neither government nor market actors—can predict such a large-scale event. Black swans happen.

The other important thing to remember is that the economy is a chaotic system. Most of the time chaotic systems achieve a sweet spot between order and chaos, which is a good thing if an economy is to be robust. Chaotic systems, though, change constantly and involve dynamics that are highly sensitive to initial conditions.

An Ecosystem, Not a Machine

Sadly, we’re getting a whole lot of precisely the wrong kind of thinking in response to this crisis. Indeed most of the bad thinking arises from viewing the economy through the lens of a false metaphor: economy as machine. We’ve heard pundits accuse the government or banks of being “asleep at the switch.” But in a complex system, there is no switch. We’ve heard people ask how to “fix it,” “run it,” or “regulate it,” suggesting if just the right sort of genius controlled the rheostats, we’d get just the right sort of economy.

The economy is not like a machine at all. It is rather more like an ecosystem that no one can run, fix, or regulate. The hubristic sort of person who thinks he or anyone can run an economy is the victim of what Hayek called the “fatal conceit.” If given power, the planner will end up making the rest of us the victims of his false metaphor.

It is ironic that Alan Greenspan—once adored by the press but now pilloried by it—is being blamed not only for wielding a laissez-faire ideology that supposedly caused the crisis, but also for failing to predict a black swan. Greenspan was a single, powerful government bureaucrat in charge of gathering enough data to determine the “right” interest rate for a multitrillion-dollar economy. Given the size of that task, he did pretty well for many years. But he was one man. He was housed in a government building. He held an unelected office and made decisions in a bureaucracy that has a monopoly on money and influences the price of credit, at least in the short run. One can hardly call that free-market fundamentalism. Whether Greenspan offered artificially cheap credit or not, interest rates were only one factor among many. To have asked him to predict the best of all possible worlds and adjust interest rates accordingly would have been to ask him to be an oracle channeling the knowledge only God would have. Greenspan is not omniscient. Nor is Bernanke. No one is. But to “run” an economy would require not only omniscience, but omnipotence as well—a power that would bend the actions of millions to its singular will.

Whatever your ideological persuasion, the economy is a complex system that cannot be planned, designed, or have its black swans regulated away. Far from the caricatures sketched in the papers, this is precisely what serious free-market types have been saying for years. That’s why it’s a little more than silly to blame free-market ideology for the current mess, and a little more than mendacious to claim that government fingerprints won’t appear all over the crisis when the postmortem is done.

Hunting Black Swans with Shots in the Dark

The timeless nostra of the politician are to prime the pump (machine metaphor) and to regulate. It seems so simple. But that response is deceptively linear. If you could ask FDR, might he now concede his policies stretched the Depression out for a decade beyond what was necessary? He listened to J.M. Keynes and a coven of interventionists. If we agree that our mixed economy is a complex system, then we also have to agree that the benefits the partly free market confers are an emergent property of that system. If we attempt to regulate away the rare, unforeseen black swan event, the costs of our hubris will be terrible, for we will regulate away untold benefits, too.

In the real world the question may come down to whether we should accept a couple of years of painful market adjustments or decades of recession caused by the blunt instrument of politics. Devastating unintended consequences and unseen effects will follow government attempts to clean up a mess made in great measure by its own hand. Why? Because no one possesses a God’s-eye view of the economy. Government intervenes within the system as part of it, not from outside of it. Nor is the economy an instrument to be manipulated to positive effect—at least not over the long term. That is why Keynes got it so terribly wrong and why the economy must heal itself from within in a distributed, holistic way.

People want government, like God, to come down and fix the unfixable, or explain the inexplicable. That’s why they’re finding it easier to blame greed for our current financial crises. But greed is rather more like gravity: When you fall, you can blame either Newton or the banana peel on the ground.

The profit motive is a good thing when it operates in an environment where bad bets are punished with losses and good investments are rewarded. Only government can distort that healthy profit-and-loss system, giving people incentives to make bad decisions. And it’s in this environment that greed is no good to anyone. It turns out, however, that greed—or better, rational self-interest—can help our economy stabilize faster than government ever could. As the lubricant of our economic system, self-interest will cause a million market actors to recalibrate and to direct resources to projects that create value in our society. We the people will temper our irrational urges and mitigate our risks if government restores the rules that let profit and loss bring discipline. But if government continues to change the rules to bias the market in favor of irrational behavior, rent-seeking, and corporatism, the chaotic aspects of the system will continue to wobble out of equilibrium. Black swans will become commonplace.

It comes down to greed. That’s what the economic turmoil is all about for many people. Too many of us were greedy, and now everyone is paying the price. Luckily this belief is wrong, because if it were right we’d be up the creek.

The rest of this week’s TGIF, “All About Greed,” is here.Incidentally, as long as we’re on the subject of greed, watch this golden moment in the public career of Milton Friedman. Enjoy!

His theme: “In my view, the least bad option is for the Federal Reserve to print money to help stabilize housing prices and financial markets. Yes, use reflation to soften the pain for Main Street and Wall Street.” Makin justifies this proposal by claiming that a continued drop in housing prices will lead to the nationalization of the mortgage business, and thus inflation is the lesser of the two evils. But what if the current crisis is the result of the Fed’s easy-money policy? Hair of the dog is a bad idea for housing crises as well as hangovers.

Our current economic problems stem from the 2002–06 real-estate bubble. Falling mortgage rates during that period (roughly 7–8 down to 4–6 percent, depending on the mortgage type) led to a refinancing mania and bidding wars among buyers. Many individuals bought homes they could not afford in the hopes that values would rise fast enough to allow them to refinance the mortgages before the high payments kicked in. Almost everybody believed that house prices would continue to go upward without limit, thus creating a bubble. These actions by homebuyers and banks were rational responses to distorted signals carried by prices that were no longer reflecting the true scarcity of housing. The signals were distorted by the Fed’s easy-money policy.

The Fed engages in a countercyclical policy: stimulate the economy when it begins to slow down and dampen it when it gets “overheated.” The Fed stimulates by injecting new money into the market, and takes away the stimulus by removing money from the economy. It injects new money into the system by buying Treasury bonds from banks, a process called open-market operations. When the Fed buys the bonds, private banks get the newly created money (called reserves). The forces of competition among banks flushed with new money drive down the price of borrowing—the interest rate—which increases consumption and investment, stimulating the economy.

The problem is that the Fed stimulated too deeply and for far too long. Responding to the recession of 2001, it lowered the federal funds rate (the Fed’s main interest-rate target) from 6.5 percent in January 2001 to 1 percent in June 2003, kept it there for a full year despite the fact that the recession ended in late 2001, and then slowly brought it back up over the following two years. The monetary base, the fundamental measure of monetary liabilities created and directly controlled by the Fed, went up 30 percent between December 2000 and December 2004—a significant increase. That large amount of new liquidity first went into bank vaults, from where it was loaned out. The problem was that this liquidity was artificial: it did not consist of individuals’ savings, their forgone consumption and sacrifices. It thus fooled most people into thinking that they had somehow escaped the bounds of scarcity—that they could have their cake and eat it, too.

Low interest rates made borrowing attractive, and people responded by buying homes either to live in or as investments, driving up demand and prices. Banks started cutting back on credit checks when doling out mortgage loans, a fact that some now blame for the bubble. And it is true that the bubble was most certainly exacerbated by securitization, which allowed banks to sell their mortgages to hedge funds and avoid holding risky loans. This created incentives for banks to seek out the high-risk marginal borrowers. Hence the infamous “NINJA” loans—No Income, No Job, No Assets.

However, banks were simply responding to the distorted signals in the real-estate markets. Finding themselves swimming in money, they did the only thing they could to get rid of it all: lower the standards on who could get the mortgage loans. As long as housing values were going up so rapidly, they couldn’t lose by making loans, even to high-risk borrowers.

So if the Fed’s expansion of liquidity is the cause of the current mess, can more of it save us? Indiscriminately pumping up liquidity will certainly lead to price inflation, of which there are now increasing signs. When the Fed last opened the money spigots, we saw the dollar plummet against all major currencies, leading to a dramatic rise in the price of oil, commodities, and food. The media and the politicians seem utterly oblivious to the monetary cause of these problems. We are already beginning to deal with the consequences of inflation: cost-of-living increases as prices rise faster than our incomes, destruction of our savings, difficulties setting long-term contracts under inflation uncertainty, and maybe most important, distortions of relative prices, making economic calculation by entrepreneurs and consumers much less reliable.

It’s not surprising that Wall Street wants to be bailed out through inflation. They would receive the benefits of the increased liquidity while the rest of us would bear the costs. Their profits would remain private while their losses would be socialized and spread out among the rest of the society through inflation. It is exactly this kind of policy that contributed to the current mess. In 1998 the Long-Term Capital Management hedge fund was deemed “too big to fail” and was bailed out. In the process, the Fed created a severe moral hazard: by protecting some people from the downside of their risky actions, the central bank encouraged such actions. The Fed’s bailout policy is at least partly responsible for the Wall Street excesses; the hedge funds came to expect that the Fed would not chance a failure of the financial system. The so-called “Greenspan put” is now clearly the “Bernanke put.”

If the Fed continues to inflate, as Makin recommends, it would simply postpone the day of reckoning. Rather than letting the bad investments be cleared out now, reflation would further distort relative prices, likely leading to significant errors down the road and more bubbles in other sectors (as may already be happening in the commodities markets). This is how one crisis begets a bigger one. We must allow the distortions introduced by the activist Fed to be discovered and corrected. The odds that the government will eventually nationalize the mortgage markets will be much higher if the current crisis is treated by planting the seeds for a much bigger one in the future.

Therefore, as the years passed and I read more and more commentators lauding Dickens as a catalyst for collectivist economics and state-centered social programs, I grew discouraged and disquieted. I have come to find, however, that by and large these commentators were not interpreting Dickens at face value, but were in effect putting words into his mouth.

Did Dickens stand up for the poor? Yes. Did Dickens speak out on the conditions in his time? Yes. Was he anti-capitalist? Were his views socialist? Did he advocate for government welfare programs? No. 

Compared to most great novelists, Dickens has inspired an inordinate mass of biographies, and interest in his life, apart from his works, has been unceasingly strong. One reason for this is simply that Dickens lived life fully. He traveled abroad often and made many public appearances. He was an oft-seen figure (though many times anonymous) in the streets of London , exploring the city and meeting people of all backgrounds and walks of life. He was comfortable among England ‘s highest society and among its lowest classes. His understanding of the human condition, therefore, was comprehensive. 

It is no surprise, then, that in both his fiction and his nonfiction Dickens went to great lengths to present his readers with the full range of English society, including many of its most downtrodden. We should not draw political conclusions from the fact that Dickens had a heart—that he painted vivid pictures of those suffering poverty, disability, abuse, and homelessness. That he would try to win his readers’ hearts to the likes of these says nothing about his views on how they should be helped. Such inferences are made today by self-serving ideologues eager to enlist an ever-popular writer into their ranks.

Dickens presented his readers with some of literature’s most touching characters: Tiny Tim, whose handicap would doom him to a youthful death without costly treatment; Oliver Twist, the orphan forced to endure hunger, cruelty, and childhood labor; Mr. Micawber, the genial debtor tragically forced into prison; Little Nell and Jo, who would die well before their time. In presenting such characters Dickens meant to force us to face the plight of society’s least members, but he did not prescribe a collectivist solution to ending their miseries. 

Nor does he blame their plight on the still-evolving capitalist economy of his day. 

We are used to thinking of Dickens as an enemy of capitalism largely because of his timeless lampooning of certain men of business. What he was really doing, however, was attacking the vice of greed. In Our Mutual Friend he blasts the Lammles, who marry each other solely for money (only to find out that neither has any). In the same novel he forced the “mercenary” Bella Wilfer to undergo a transformation before finding happiness. In Martin Chuzzlewit relatives of the title character are ridiculed for their scheming at inheritance. 

And then there is the prototype of the heartless capitalist—Ebenezer Scrooge. But as with other characters, Dickens does not attack Scrooge as a capitalist but as a miser. As Daniel T. Oliver put it in The Freeman (December 1999): 

Scrooge’s character defect is not so much greed as miserliness. He hoards his money even at the expense of personal comfort. While many remember the single lump of coal that burns in the cold office of his assistant Bob Cratchit, the fire in Scrooge’s own office is described as “very small.”. . . Dickens gives us no reason to believe that Scrooge has ever been dishonest in his business dealings. He is thrifty, disciplined, and hard-working. What Dickens makes clear is that these virtues are not enough.

Though the protagonist throughout A Christmas Carol might be Bob Cratchit, there are sympathetic characters who are in fact capitalists. Fezziwig, a man of business, nevertheless treats his employees like family. And then there are the easily overlooked “portly gentlemen, pleasant to behold,” collecting money to “buy the Poor some meat and drink, and means of warmth.” 

Indeed, Scrooge himself, on that transformative Christmas morning, does not renounce capitalism. Instead he promises to be a better man. He will live a fuller life and share his good fortune with those close to him. 

Many libertarians and other supporters of the free market will interject that Scrooge is already benefiting society as an effective businessman. The argument is also made that in lampooning Scrooge’s personality, Dickens also distorts the realities of the labor market. Michael Levin has written:

Let’s look without preconceptions at Scrooge’s allegedly underpaid clerk, Bob Cratchit. The fact is, if Cratchit’s skills were worth more to anyone than the fifteen shillings Scrooge pays him weekly, there would be someone glad to offer it to him. Since no one has, and since Cratchit’s profit-maximizing boss is hardly a man to pay for nothing, Cratchit must be worth exactly his present wages.

Both arguments have merit—Scrooge, like your local banker or financier, benefits society through his business. And yes, Dickens does not express, and most likely did not fully comprehend, the realities of the labor market. But the tale of Scrooge is of personal redemption. It is not particularly realistic nor well-versed in economics. Dickens is not attempting to argue against capitalism, nor is he arguing against a free market for labor. He is arguing against personal callousness and against misanthropy. 

In chapter 33 of Socialism Ludwig von Mises lamented Dickens’s characterizations of utilitarianism and of true liberalism. However, if Dickens’s words were later co-opted to promote a socialist agenda, that is hardly his fault. Utilitarianism can be the basis of a solid capitalist economy. It can also be mutated into a communist state. Dickens might not have understood that, but he did know that utilitarianism without reasonable judgment can turn society—and the state—into something monstrous. 

Private Philanthropy, Not Public Welfare 

A Christmas Carol exemplifies, on a personal level, what Dickens was really arguing for. He was not calling for state intervention, nor for economic regulations. Instead, he argued on behalf of personal philanthropy. In the end, Scrooge helps Tiny Tim not because of socialist ideals, but because his humanity is reawakened, causing him to care for this child. Quite frankly, he does the right thing. 

In fact, a survey of Dickens’s novels shows that his protagonists and his happy endings often have something in common—a person with means helps persons of limited or no means out of the goodness of his heart. Oliver Twist is adopted by Mr. Brownlow. In Our Mutual Friend the Boffins relinquish their fortune to the rightful heir. Martin Chuzzlewit provides for his long-neglected grandchild and his true love. Mr. Pickwick forgives dishonest friends and helps them to establish a new life. And Sydney Carton gives up his very life for a pair of lovers in A Tale of Two Cities. 

One can search in vain through Dickens’s works for calls for government control of the economy or social-welfare structures. As Lauren M. E. Goodland writes in Victorian Literature and the Victorian State regarding Dickens’s treatment of sanitation in Bleak House: 

Here sanitary reform becomes fundamentally necessary to the nation’s moral and physical well-being. Yet it would be a mistake to infer from such remarks that Dickens had become a staunch proponent of the state’s duty to intervene in the lives of individuals and communities. Bleak House memorably dramatizes the need for pastorship in a society of allegedly self-reliant individuals. But it by no means clearly endorses state tutelage, nor, indeed, any other form of institutionalized authority. 

In reality Dickens often criticized state-sponsored institutions. The Ghost of Christmas Present, for instance, chastises Scrooge for relying on such institutions rather than being philanthropic himself. Using Scrooge’s own words he mocks him: “Are there no prisons? Are there no workhouses?” 

Among Dickens’s most moving writings is a nonfiction article called “A Walk in a Workhouse.” In a few short pages he describes the pathetic scene of a state-sponsored parish workhouse, Victorian England’s solution to almost every social burden—orphans, abandoned children, the sick, the aged, the infirm, the insane. The problem of course was that the workhouse took away both a person’s liberty and dignity—not to mention his future. 

In all these Long Walks of aged and infirm, some old people were bedridden, and had been for a long time; some were sitting on their beds half-naked; some dying in their beds; some out of bed, and sitting at a table near the fire. A sullen or lethargic indifference to what was asked, a blunted sensibility to everything but warmth and food, a moody absence of complaint as being of no use, a dogged silence and resentful desire to be left alone again, I thought were generally apparent. 

Such was how Dickens viewed the state’s involvement in society’s welfare. He took great pains to laud the nurses of the workhouse, who cared deeply about their wards. But the place itself—the institution—was an abomination. 

So don’t believe the English professors and the literary theorists. Charles Dickens was not a socialist at heart. Far from being an early proponent of the welfare state, he was sounding alarms for all of us. Let us finally heed his warning.