However, today Farrell absolutely nailed the hole in Alan Greenspan's deregulatory philosophy:
The problem with the models is that it does assume rational behavior. As
far as an institution protecting its equity, which is what [Greenspan] said,
institutions don’t protect equity, people protect equity. The people in
those institutions saw huge bonuses by pumping this stuff out. So if you
want to call that irrational behavior, it’s irrational as far as the economy
wound up going, but it is very rational for their self-interest. There is
no institutional self-interest. . . . [Greenspan] still just doesn’t get
it.
As I noted in my recent post on Corporations and the Free Market, corporations are imaginary people. They are creatures of law. They do not have instincts like fear and self-preservation. If the regulatory scheme is not designed to tie the compensation of the executives to the long term health of the company and the risk of loss, there is nothing in the nature of the corporation to deter those executives from risking catastrophic losses that will fall on society as a whole in order to earn returns that they will enjoy.
If Greenspan had read about or taken a course in Game Theory, he would have seen the flaw in this theory a long time ago.
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