Wild-animal spirits

"Why is finance so unstable?WHEN people look back on a bubble, they tend to blame the mess on crookery, greed and the collective insanity of others. What else but madness could explain all those overpriced Dutch tulips? With hindsight, today’s mortgage disaster seems ridiculously simple. Wasn’t it the fault of barely legal mortgage underwriting, overpaid investment bankers and the intoxication of easy credit? Yet there is an element of the madhouse in that explanation too. Cupidity, fraud and delusion were obviously part of the great bust. But if they are the chief causes of bubbles—which have repeatedly plagued Western finance since its origins in the Italian Renaissance—you have to suppose that civilisation is beset by naivety and manic depression.In fact, observes Abhijit Banerjee, an economist at the Massachusetts Institute of Technology, a little irrationality goes a long way. When reasonable, self-interested people trade with each other, optimism tends to breed optimism—until it subsides into corrosive pessimism. In the words of Willem Buiter, of the London School of Economics, “finance is a scary, inherently unstable, essential activity.” ..." (2009-1-22)

Read more...