Morals and the Meltdown

After World War I, H.G. Wells wrote that a race was on between morality and destruction. Humanity had to abandon its warlike ways, Wells said, or technology would decimate it.

Economic writing, however, conveyed a completely different world. Here technology was deservedly king. Prometheus was a benevolent monarch who scattered the fruits of progress among his people. In the economists’ world, morality should not seek to control technology, but should adapt to its demands. Only by doing so could economic growth be assured and poverty eliminated. Traditional morality faded away as technology multiplied productive power.

We have clung to this faith in technological salvation as the old faiths waned and technology became ever more inventive. Our faith in the market – for the market is the midwife of technological invention – was a result of this. In the name of this faith, we have embraced globalization, the widest possible extension of the market economy.

For the sake of globalization, communities are de-natured, jobs off-shored, and skills continually re-configured. We are told by its apostles that the wholesale impairment of most of what gave meaning to life is necessary to achieve an “efficient allocation of capital” and a “reduction in transaction costs.” Moralities that resist this logic are branded “obstacles to progress.” Protection – the duty the strong owe to the weak – becomes Protectionism, an evil thing that breeds war and corruption.

That today’s global financial meltdown is the direct consequence of the West’s worship of false gods is a proposition that cannot be discussed, much less acknowledged. One of its leading deities is the “efficient market hypothesis” – the belief that the market accurately prices all trades at each moment in time, ruling out booms and slumps, manias and panics. Theological language that might have decried the credit crunch as the “wages of sin,” a come-uppance for prodigious profligacy, has become unusable.

But consider the way in which the term “debt” (the original sin against God, with Satan as the great loan shark) has become “leverage,” a metaphor from engineering that has turned the classical injunction against “getting into debt” into a virtual duty to be “highly leveraged.” To be in debt feeds the double temptation of getting what we want as quickly as possible as well as getting “something for nothing.”

Financial innovation has enlarged both temptations. Mathematical whiz kids developed new financial instruments, which, by promising to rob debt of its sting, broke down the barriers of prudence and self-restraint. The great economist Hyman Minsky’s “merchants of debt” sold their toxic products not only to the credulous and ignorant, but also to greedy corporations and supposedly savvy individuals.

The result was a global explosion of “Ponzi” finance – named after the notorious Italian-American swindler Charles Ponzi – which purported to make such paper as safe and valuable as houses. By contrast, the virtuous Chinese, who save a large proportion of their incomes, were castigated by Western economists for their failure to understand that their duty to humanity was to spend.

The key theoretical point in the transition to a debt-fueled economy was the redefinition of uncertainty as risk. This was the main achievement of mathematical economics. Whereas guarding against uncertainty had traditionally been a moral issue, hedging against risk is a purely technical question.

The main uncertainty in life – the destination of one’s immortal soul – nudges one toward morality. Even the existence of mundane uncertainty gives rise to conventions and rules of thumb that embody the best of human experience in dealing with the unknown. The abolition of uncertainty abolishes the need for moral rules.

Future events could now be decomposed into calculable risks, and strategies and instruments could be developed to satisfy the full range of “risk preferences.” Moreover, because competition between financial intermediaries steadily drives down the “price of risk,” the future became (in theory) virtually risk-free.

This monstrous conceit of contemporary economics has brought the world to the edge of disaster. Obviously, the traditional moral taboos surrounding money had to be loosened for capitalism to get going centuries ago. For example, the classical prohibition on usury was softened from a ban on charging interest on all loans to a ban on charging interest on loans for which the lender had no alternative use, i.e., for charging interest on “hoards” or cash balances.

Without the development of debt finance, the world would be a lot poorer than it is. Yet going from one extreme (keeping one’s spare cash under the bed) to the other (lending out money one does not have) is to cut out the sensible middle.

The prudential supervision regime initiated by the Bank of Spain in response to the Spanish banking crises of the 1980’s and 1990’s shows what a sensible middle way might look like. Spanish banks are required to increase their deposits in proportion to their lending and set aside capital against assets in their off-balance sheets.

With little incentive to manufacture “structured investment vehicles,” few Spanish banks created them, thereby avoiding excessive leverage. As a result, Spanish banks typically make provision to cover 150% of bad debts whereas British banks cover only 80-100%, and Spanish homebuyers must pay between 20% and 30% deposit on a house, whereas 100% mortgages have routinely been given in the United States and the United Kingdom in recent years.

H.G. Wells was only partly right: the race between morality and destruction encompasses not just war, but economic life as well. As long as we rely on technical fixes to plug moral gaps and governments rush in with rescue packages that enable the merry-go-round to start up again, we are bound to keep lurching from frenzy to frenzy, punctuated by intervals of collapse. But, at some point, we will confront some limit to growth.