Benjamin Lee and Randy Martin - Derivatives and the Wealth of Societies

One of the most revealing moments of the global financial crisis occurred during Alan Greenspans exchange with Henry Waxman at the hearings of the Government Oversight Committee of the House of Representatives held in the fall of 2008:

REP. HENRY WAXMAN : The question I have for you is, you had an ideology, you had a belief that free, competitiveand this is your statementI do have an ideology. My judgment is that free, competitive markets are by far the unrivaled way to organize economies. Weve tried regulation. None meaningfully worked. That was your quote. You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying its price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?

ALAN GREENSPAN : Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have toto exist, you need an ideology. The question is whether it is accurate or not. And what Im saying to you is, yes, I found a flaw. I dont know how significant or permanent it is, but Ive been very distressed by that fact.

REP. HENRY WAXMAN: You found a flaw in the reality...

ALAN GREENSPAN: Flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

REP. HENRY WAXMAN: In other words, you found that your view of the world, your ideology, was not right, it was not working?

ALAN GREENSPAN: That isprecisely. No, thats precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.

In his prepared testimony Greenspan had linked his worldview to the intersection between shareholder value, deregulation, and financial risk management, specifically Black-Scholes, the mathematical model for financial markets containing the derivative investment instruments that had collapsed in the 2008 crisis. Greenspan explained the flaw the crisis had exposed this way:

[T]hose of us who have looked to the self-interest of lending institutions to protect shareholders equity (myself especially) are in a state of shocked disbelief.... It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.

By invoking worldview and ideology, Greenspan, if only for a moment, moved discussion beyond the two available explanations of the financial crisis. These focus either on technical failures (leaky Gaussian copulas and faulty value-at-risk measures) or narratives of greed and speculation. Technical explanations feed into the current hope of discovering some regulatory fix for derivative ills while tales of excess lead to calls for the abolition of derivatives as a form of wealth creation. For one side the goal is to return to some state of business as usual. For the other it is to construct a political economy free from the danger intrinsic to financial speculation with derivative instruments and thereby produce a more just and sustainable sociopolitical world order.

The collaboration this book represents proposes an integration of a social and a technical understanding of derivative finance within a single analytic and interpretive frame to allow discussion to escape the dead end produced by the irreconcilable solutions to the recent crisis offered by its alternative explanations. Our book proposes to use what was disclosed by the financial crisis to show that technical knowledge of derivative finance can be drawn upon to revalue and further peoples capacity to act together constructively in innovative ways. Indeed it argues that new social, aesthetic, and political possibilities are already in play in the abundance of social wealth that derivative finance capitalism has placed within reach during the past forty years. How fundamental technical knowledge of both the social and of wealth production using derivative instruments can be woven into a single coherent interpretive and analytic language of human possibility and well-being in our time is the challenge this first volume to be published from our collaboration takes up.