STAFF NEWS & ANALYSIS
Saving Banks From Themselves
By - February 06, 2009

Our brains are wired for bubbles, it would appear, and strict regulation is the only way to save ourselves from ourselves. Bankers, traders and investors effectively became addicted to the pleasure that comes from making money, while at the same time they increasingly lost touch with how much risk they were taking. The result was a bubble in debt and many other financial assets and the inevitable crash. "The finance industry was adapting to the level of risk," said Gregory Berns, a professor of neuroeconomics at Emory University in Atlanta, who uses brain scanning technologies to try to decode the decision-making systems of the brain. "It is an insidious process, you are not aware of it," Berns said. "You are addicted to returns, you are addicted to risk, you are addicted to cocaine – it's all the same as far the brain goes. – International Herald Tribune/Reuters

Dominant Social Theme: Banker brains need regulation!

Free-Market Analysis: Yesterday we analyzed a Herald article that indicated the citizens of Iceland were irritated that the central bank hadn't properly reined in their commercial banks. We pointed out that it was rather more likely that those in Iceland were annoyed with the central bank for printing so much money – and encouraging their banks to lend well past the point of no return.

We indicated we found it odd that the Tribune would put the matter in such a strange way. The Icelandic central bank was not at fault for not reining in banks. It was at fault for printing the money in the first place, money that provided the fuel for the fire that now has led to Iceland's ruin.

But this is unfortunately, nothing new. Over and over in the mainstream press, the central banking paradigm is confused, minimized or ignored. The above article only adds insult to injury, you could say. It provides us with a notion that is as weird (to a free-market thinker anyway) as it is simplistic.

The best way we suppose we can justify it at any level is to classify it as an aberrant offshoot of the "madness of crowds argument" – one that has certainly been around a long time and is a favorite of Keynesian socialists. Now, we guess we have the "madness of the banking class." Either way, government regulation is trotted out as a necessity in order to restrain the animal spirits of the given scapegoats.

In fact, we have always shied away from the "madness" argument. Markets seem to us largely efficient; their ups and downs are largely explainable within the context of monetary stimulation, not madness. From our perspective, overprinting of money for months or years, or even decades, manifests itself as a kind of metaphorical conveyer belt carrying securities prices to the next level and the next. Finally, and usually suddenly, the scales fall away from the collective eyes of the market. All at once, the extent of the mal-investment is made clear.

Yes, that is how it seems to work. And that is why it is indeed possible for markets to lose a great deal of value overnight as the extent of the latest fiat debacle becomes obvious (all at once). At this point, markets crack. Down they go, often very quickly. But no, they do not necessarily "overshoot." There is no madness to drive them down to overly depressed levels. Markets may simply tend to find a general bottom that is justified by the extent of the mal-investment (and the losses that are suddenly perceived) and the new, depressed levels are further refined as more information comes available.

To a free-market thinker, it is ever thus. It is not that bankers and booms do not mix. Bankers and CENTRAL BANKING do not mix. Human nature and the fiat money system being what they are, central banks inevitably inject too much money into the system. With an honest money standard, booms and busts would still occur, but they would tend to be regional, and far less extreme, according to free-market thinkers like Murray Rothbard.

The problems we face do not have to do with people's brains being hard-wired for bubbles. This is a most ridiculous theory! If you provide people with an overabundance of anything, they will tend to get greedy. (Why shouldn't they if the resource seems plentiful?) It has to do with self-interest and immediate gratification. To insist, as this article seems to, that people cannot control themselves (bankers especially) and that only a series of inviolable rules (enforced by civil servants?) can salvage the capitalist system – wow that's some hypothesis. It completely ignores fundamental financial issues and treats the current system as fundamentally sound rather than fundamentally, or at least partially, flawed.

So many questions "bubble" to the surface when reading an article like this. Who thought of taking this strange theory seriously in the first place? How did it get past the editors? And most importantly, what kind of cultural bias exists at well-read international paper that would allow for the printing of such an extremist interpretation of a primarily market-driven failure.

After Thoughts

Reading such stuff can be difficult, if one has spent any amount of time examining the fundamentals of modern markets. This is one reason, in fact, that the mainstream press is having such a hard go of it. Twenty years ago, before the Internet, these sorts of strange economic interpretations could have been excused. But there is no reason for such ignorance now. Even if one is a full-bore hyper-Keynesian and inclined somehow to accept this weird analysis of the situation, it makes no sense to deliver it without a larger frame of reference – one featuring at least some level of free-market analysis. Otherwise, in our opinion, you end up with stuff that is just plain wacky. This is.

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