Many reputations have suffered in the credit crunch, and few more so than that of Mr Greenspan. Like many economists, I read his memoirs when they were first published in September 2007, just as the crisis was breaking. I thought a long flight was a good moment to read them again, with the benefit of further hindsight.
As so often, what a book tells us is not necessarily what its author intends. The volume divides into two halves, in substance as well as style. The first half is autobiographical and fascinating: the second half, which describes the lessons Mr Greenspan has learnt in his distinguished career, rarely rises above the banal. Mr Greenspan's skills were in politics rather than in economics. His famously Delphic utterances were intended to satisfy his multiple constituencies rather than to conceal more incisive thought.
I am not sure whether Mr Greenspan would today write that “the first and most effective line of defence against fraud and insolvency is counterparties' surveillance. For example, JPMorgan thoroughly scrutinises the balance sheet of Merrill Lynch before it lends. It does not look to the Securities and Exchange Commission to verify Merrill's solvency”. But Mr Greenspan has distinguished himself in the financial world by acknowledging errors on his watch. Most of all, he has recognised that the pursuit of immediate self-interest by financial institutions and their employees did not, after all, secure the long-run health of these institutions.
The problem should have been evident from Mr Greenspan's own analysis. He begins his discussion of bank regulation by observing that “it is remarkable how much trust we have in the pharmacist”. The example is, indeed, striking: we are vulnerable to mistakes or wrongdoing at the hands of a pharmacist. The pharmacy, he observes, illustrates the critical role of trust and reputation in modern economies. Why do we place this trust so readily? Because “we are not fools. We bank on the self-interest of our counterparties in trade”.
But this is to miss the point almost completely. We trust the pharmacist not because we bank on his or her self-interest, but because we are confident that it will be tightly restrained. In part, we rely on the long-run self-interest of the pharmacist in protecting his or her own reputation. But we also feel confidence in buying medicines in a pharmacy we have not visited before and do not expect to patronise again. Our trust in the pharmacist derives in the first instance from our well-founded belief that most pharmacists take pride in doing a good and conscientious job, and in the second instance from our knowledge that their professionalism is reinforced by training and regulation.
Mr Greenspan is, of course, right to say that “government regulation cannot substitute for individual integrity”. But individual integrity is not simply a matter of innate vice or virtue: we operate within a social and regulatory context that can be supportive, or not, of proper behaviour. That is why there is a difference between the relationships between the customer and the provider that we find in the pharmacy or observe on the trading floor.
The difference was well described by Mr Greenspan's hero, Adam Smith. Smith correctly observed that we do not rely on the benevolence of the pharmacist when we file our prescriptions. But – as often with Smith – you need to read the context to understand the comment. Smith's concern was to distinguish between mutually rewarding commercial exchanges and the pursuit of self-interest outside a framework of co-operation and regulation. “Monkeys when they rob a garden throw the fruit from one to another till they deposit it in the hoard, but there is always a scramble about the division of the booty, and usually some of them are killed,” Smith wrote. He might have been talking about bonus time at an investment bank.