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November 15, 2009

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Inside the meltdown

TWO leading financial journalists have made worthy additions to the increasingly crowded shelf of books on our recent economic failure. In very different ways, John Cassidy and Andrew Ross Sorkin address the critical question of what exactly happened on Wall Street. Until we settle on at least a rough answer, we won't have a prayer of preventing the next crisis.

Sorkin, a reporter and business columnist for The New York Times, has written what his publisher calls "a true-life financial and political thriller": 600 pages of dramatic scene play and salty dialogue in which powerful bankers and government regulators clash on the precipice of global depression. Since the broad outlines of these events are now well known, "Too Big to Fail" can't deliver on the thriller billing. But Sorkin's prodigious reporting and lively writing put the reader in the room for some of the biggest-dollar conference calls in history. It's an entertaining, brisk book.

Although Sorkin doesn't attempt much deep analysis, he does concisely summarize what he thinks all the maneuvering and sweaty panic add up to: "The calamity would definitively shatter some of the most cherished principles of capitalism," he writes. "The idea that financial wizards had conjured up a new era of low-risk profits, and that American-style financial engineering was the global gold standard, was officially dead."

Cassidy's much shorter "How Markets Fail" offers a brilliant intellectual framework for Sorkin's narrative. In the process, Cassidy, a writer for The New Yorker, also sheds skeptical light on Sorkin's conclusions. The calamity of 2008 didn't shatter principles of capitalism; there isn't a static set of capitalist principles to destroy. Capitalism has meant different things to different thinkers and economic players.

The recent debacle demonstrated the foolishness of one theory of capitalism: a utopian version of free-market theology that happens to have dominated American economic thinking for two generations. Sadly, the financial wizards Sorkin portrays so colorfully are still very much with us, and their simplistic mythology is far from "officially dead."

Cassidy traces ideas about capitalism from Adam Smith's 18th-century "invisible hand" through Alan Greenspan's hands-off philosophy toward regulating banks as chairman of the Federal Reserve from 1987 to 2006. The theory that Greenspan inherited from Milton Friedman, high priest of the Chicago School, "says simply: self-interest plus competition equals nirvana," Cassidy writes. Greenspan applied this idea in various contexts, perhaps most notably when he opposed government oversight of an increasingly manic Wall Street casino culture based on his faith that rival financiers would police one another and not take potentially self-destructive risks. The blind faith that Greenspan exemplified turned out to be flat wrong. "For him to claim that the market economy is innately stable wasn't merely contentious," Cassidy writes, "it was an absurdity."

Greenspan, as Cassidy recounts, credited Adam Smith, the bookish Scotsman, as a pivotal influence. "Our ideas about the efficacy of market competition have remained essentially unchanged since the 18th-century Enlightenment, when they first emerged, to a remarkable extent, largely from the mind of one man, Adam Smith," Greenspan asserted in his 2007 memoir, "The Age of Turbulence." But how carefully, Cassidy asks, did Greenspan and his ilk read what their hero actually wrote?

When it came to financial institutions, Smith advocated government restrictions - for example, preventing banks from issuing too many promissory notes to unworthy borrowers.

Cassidy writes: "Alan Greenspan and other self-proclaimed descendants of Smith rarely mention his skeptical views of the banking system ... The notion of financial markets as rational and self-correcting mechanisms is an invention of the last 40 years."


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