The Myth Of The Market

For years they preached that the market was perfect, but the financial crisis shows where its weakness lies – with people. The role of government must, therefore, be newly defined.

Homo Economicus is a rare species. He’s knows everything, understands everything, and has no emotions. Most economic scientists, business leaders, and business journalists belong to this species of average, purely economics-oriented people and they try to explain to the rest of us why the market, especially the financial market, is so perfect, and why government has no reason whatsoever to meddle in it.

For years, the proponents of pure neo-liberalism claimed the stock exchanges were the yardstick against which everything should be measured. They preached the principle of shareholder value, i.e., the naïve belief that corporations existed mainly to increase their shareholders’ wealth. They dedicated themselves to the belief that obscure derivatives would be successful in ridding capital markets of risk.

Brainless parroting

That myth became dominant during the last fifteen years. Even the followers of neo-liberalism neglected to remember the words of the German economist Alexander Rüstow, who coined the term neo-liberalism in 1938.

This new liberalism, Rüstow maintained, had to differentiate itself from the laissez-faire policies of the 19th century. Neo-liberalism required “a strong government, a strong state reigning over the economy, over the interested parties, where it belonged.” Instead, Wall Street forced its own rules onto the world. And they were brainlessly parroted in Europe.

Greed and euphoria, fear and panic

Now, during the worst financial crisis in 80 years, this myth pops up anew every day. And Homo Economicus suddenly reveals himself as a person who no longer deals with problems rationally, but displays emotions not foreseen in the old textbooks: greed and euphoria, fear and panic.

Those emotions cause financial markets to act insanely and lead to the conclusion that the global image seen by economists, businesses and many in the media is no longer valid.

Greed: It stands at the beginning of every boom. Without it, there would have been no Roaring Twenties that led eventually to the Great Depression. Without it, there would have been no New Economy, the wild times of the dot-com era in the late nineties that led to the crash of 2000. Without it, investment banks and hedge funds wouldn’t have seen the market for credit packages and derivatives driven to insane heights – a market that is now collapsing and may possibly take the world economy down into the depths with it. Greed is not only at home with both large and small investors, but also in many businesses where executives enjoy obscenely high salaries while wanting to pay their employees third-world wages.

Euphoria: It appears as soon as stock prices begin to rise and the media suddenly starts reporting wondrous stories of market upswings, talking about the dawning of a new era. That’s how it was in the Roaring Twenties when business and the media enthused about airplanes and radio. That’s how it was in the nineties when the Internet began its triumphal march, and that’s also how it was in the derivative boom of the 21st century. They saw only that banks were getting rich, and concluded everything must be fine.

These stories create their own reality. They’re sent worldwide by journalists who join in the euphoria and they’re read by people who in many cases are stockholders themselves. That causes more people to rush into the stock market. Everyone believes rates will continue to rise and that belief itself causes rates to rise, something that business and the media sees as proof that their stories were right.

Flight from anything looking risky

Fear: It causes every bubble to burst. As it grips more and more people who see their profits disappearing, the air goes out of the boom. Panic sets in when the fear of a few people becomes everybody’s fear. Greed is replaced by hopelessness.

But the experts are careful not to express pessimism about the situation. If Josef Ackermann and Peer Steinbrück (CEO of Deutsche Bank and Germany’s Finance Minister, respectively) were to warn of a bank crash in Germany, it would set off a panic in financial markets and inevitably actually cause a crash.

Panic was set off in the United States on September 15th when the Lehman Brothers Investment Bank collapsed. From that point onward, investors began fleeing anything that looked in any way risky. In desperation, they looked for any means to hang on to the fortunes they had amassed in previous years.

A normal boom usually ends with a large-scale sell-off on Wall Street. The rates nose-dive before investors regain any confidence. The boom of recent years, however, wasn’t normal. It was ludicrous, and that’s why the situation requires help from a source able to deal soberly and without emotion. A trusted source. The government. It, and only it, appears to be capable of stopping the crash. Only government can be the guarantor of stability.

But the price that government has to pay for the insane joke of the past few years is extremely high. It has to put up tens of billions – in the United States even hundreds of billions – to bail out the gamblers and the banks or run the risk of a chain reaction similar to the 1930s and even higher costs down the road.

Nobody knows if that’s true. All that is known for sure is that government will put itself in chains for decades. There will be less money for the things that are truly necessary, like education and social programs.

The simplemindedness of the economists

The question of why nobody warned us of this looming crisis in time to avoid it is, of course, a valid one. Most economists were aware that America couldn’t live on credit forever, but almost all of them figured that any problems associated with that could be easily solved.

Whoever disagreed with that assessment found little support. Other than a few experts, who was interested in America’s trade balance even though the dangerous imbalance was the source of all the nation’s problems? And who could get excited about the lack of regulation for hedge funds when they were told that regulating them would result in less retirement income?

And who could (or would) imagine that someday governments in Washington, London or Berlin would step in to save banks? Panic amongst the speculators has now ensured that that would be the case. They’ve destroyed the very imaginary world that they built.

If there are lessons to be learned from this crisis, two of them should be crystal clear: Homo Economicus isn’t fit to be a role model; economists have to adjust their models to fit a more complex reality. Second, the role of government has to be newly defined; it cannot afford to bail out banks over and over again just because they made bad bets.

In the future, government should take its rightful place above commerce, just as Rüstow advised.