Taming ‘Animal Spirits’
Investors sometimes behave irrationally, and so do regulators


Kevin D. Williamson

If you wish to sample conventional economic wisdom in its refined form, you could do worse than to consult the McKinsey Quarterly, a recent issue of which contains a curious meditation on the subject of “Animal Spirits” by Yale’s Robert Shiller and Berkeley’s George Akerlof, professors of economics who together have written a book by that title.

“Animal spirits” is John Maynard Keynes’s abstraction of all that goes into quotidian economic decision-making beyond the rigorously rational pursuit of self-interest. He wrote, in Chapter 12 of his General Theory, “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere.” Conservatives are wrong to deny themselves the clarity of Professor Keynes’s insights, and the pleasures of his lucid prose, only because they object to the policies he advocated and to those that are advocated in his name.

Animal spirits are indeed at play, and mischievously so, both in the marketplace and among those who seek to govern the marketplace. It is characteristic of our academic caste that Professors Shiller and Akerlof attend to the former case but are blind to the latter, and so they have produced an essay that is not so much conventional as convention itself, arguing, in a series of bland metaphors, that economic exorcists in Washington must be deployed against animal spirits in the marketplace: “If we thought that human beings were totally rational and acted mainly from economic motives, we, like Adam Smith and his followers today, would believe that governments should play little role in regulating financial markets. . . . But on the contrary, we believe that animal spirits play a significant and largely destabilizing role. Without government intervention, employment levels will at times swing massively, financial markets will fall into chaos, scoundrels will flourish, and huge numbers of people will live in misery.”

There is no need to address the problems of that passage beyond cataloguing them: We have lots of government intervention in the economy, but employment levels do swing, financial markets have fallen into chaos, scoundrels do flourish with great exuberance, etc. And neither Adam Smith nor his intellectual heirs believe that economic man is an icy rationalist, or even that he is rational, broadly defined. Ludwig von Mises put the idea into theoretical form, but it has long been understood that man acts rationally in the sense that he takes actions that seem to him sensible in order to achieve a certain end, but that end itself may be irrational, erroneous, or criminal: Scientific researchers act rationally to achieve certain ends; so do serial killers, religious fanatics, drug addicts, and Wall Street traders.

The fallacy implicit in the conventional argument for more robust financial regulation is that animal spirits — the whole menagerie of greed, panic, pride, thrill-seeking, irrational exuberance — distort only profit-seeking activity. But they are at least as likely to distort efforts to regulate profit-seeking activity. In truth, the animal spirits of regulators probably are more dangerous than those of Wall Street sharks: Competition and the possibility of economic loss constrain players in the marketplace, but actors in the political realm have the power to compel conformity and uniformity among those under their jurisdiction. The entire economy is yoked to their animal spirits, and the housing bubble was a consequence of that fact. We have bred an especially dangerous hybrid creature in the “too big to fail” private corporation, the bastard offspring of a union between Wall Street’s animal spirits and Washington’s.

That may all sound a bit airy-fairy, but it matters. The animal spirits of politics are at this moment informing Washington’s efforts to respond to the financial crisis with much more energy and consequence than are insights gleaned from good economics. That is why we have heard a lot of loose talk about bankers’ pay but very little discussion of the Recourse Rule.