Financial boom, financial bust: What happened?

Every now and then, even the smartest of us need to relearn the lessons of American history. Take Alan Greenspan and the unfolding story of the current credit crisis. Greenspan, former chairman of the Federal Reserve, is “the Oracle” given much of the credit for America’s great economic boom -- and now some of the blame for the bust.

Critics say it was the growth of largely unregulated investments known as derivatives -- which Greenspan encouraged and defended -- that helped produce the present crisis. Greenspan’s defense of these investments was based in part on an optimistic view of human nature. Excesses, he believed, would be prevented because individuals would restrain the worst of their greed and self-interest to protect their own reputations.

In a speech two weeks ago at Georgetown University, Greenspan expressed distress that this turned out not to be true. But he should not have been surprised. A rereading of American History 101 would have reminded him that the framers already went through the same rude awakening about human nature.

Greenspan’s speech at Georgetown was largely a rousing reaffirmation of the vital role played by the Constitution in the growth of the American economy, but he missed the central genius of the document. It was based on a view of human behavior considerably less sanguine and idealistic than Greenspan’s.

The framers did not start out as cynics or realists. The belief that Americans would be better as people and, particularly, as citizens than others had been was widely held among the revolutionaries in 1776. Frankly, it gave them the guts to throw off the English. Both Alexander Hamilton and John Adams, who later would be among the strongest proponents of strong government to channel self-interest, were more optimistic about Americans in the country’s early days. No one captured the belief better than Thomas Paine, who argued that once they were independent, Americans could “begin the world over again.”

Paine believed that the citizens of the new republic would learn the habit of “public virtue” -- and would suppress their individual interests for the public good. Americans rallied to this vision. And from this faith in people, the founders constructed the first version of the United States after 1776, a confederation featuring a central government left intentionally weak because the founders could not imagine that citizens and states would refuse to set aside local or personal interests for the larger good.

The result of this experiment was chaos. The nation was beset by internal factions, greed and self-dealing. The Army nearly starved to death in the field because no one would pay for it. States competed for trade advantages, preventing the creation of any semblance of a national economy.

The entire country, John Quincy Adams noted, was “groaning under the intolerable burdens of ... accumulated evils.” Some Americans were even considering the restoration of a king as the only solution. The most famous founder of them all, George Washington, recognized that the problem stemmed from the rosy view of human behavior on which they had built the government.

When Greenspan said in his Georgetown speech that he was “distressed at how far we have let concerns for reputation slip in recent years,” he sounded a bit like Washington, who in 1786 wrote to John Jay: “We probably had too good of an opinion of human nature in forming our confederation. ... We must take human nature as we find it. Perfection falls not to the share of mortals.” Only the intervention of “coercive power,” wrote Washington, would ensure measures best suited for the common good.

What the framers had learned over the 11 years that separated independence from the Constitutional Convention was that people could not be counted on to suppress their greed and self-interest, but would pursue them relentlessly. In Philadelphia in 1787, the challenge at the Constitutional Convention became how to create the coercive power Washington had referred to without abandoning the dream of democracy -- how to frame a government that would guarantee individual liberty while protecting people from excesses caused by unbridled pursuit of that liberty. They needed, James Madison said, “a republican remedy for the diseases most incident to republican government.”

The answer they came up with was to make a virtue of the vice of self-interest. A reliance on public virtue was to be replaced by a “policy of supplying by opposite and rival interests, the defect of a better motive,” Madison explained. From this flowed the original American idea of separation of powers and checks and balances. The result was the most enduring democratic government in history.

The framers left us their document, the Constitution, and a fundamental lesson in self-government that we could all benefit from recalling: Systems that count on individuals to restrain their self-interest have historically failed, but systems that anticipate and encourage the pursuit of self-interest while creating checks on it can succeed magnificently.

Or, as Madison put it, “But what is government itself, but the greatest of all reflections on human nature?”

Eric Lane, a professor at Hofstra University School of Law, and Michael Oreskes, managing editor of the Associated Press for U.S. news, are coauthors of “The Genius of America: How the Constitution Saved Our Country and Why It Can Again.”