Former Chairman of the Federal Reserve Alan Greenspan found himself "in a state of shocked disbelief" at the failure of individual self-interest to protect our banking system. What really ought to provoke shocked disbelief is that a person who held such views was placed in charge of regulating the American financial system, a position he held from 1987 to 2006.

    Greenspan's long stewardship of the financial system reflected the revived intellectual dominance, since around 1980, of a free-market economic theory once thought to have been permanently laid to rest by the Great Depression of the 1930s. This theory holds that if individual actors, whether ordinary people or officials of large corporations, are free to pursue their own self-interest through market exchanges with other free individuals, the result will be optimal for society as a whole. Government has little role to play in the economy, beyond enforcing the law of contracts and protecting the rights of property owners. In such a world, everyone is supposed to succeed based on her or his own effort, skill, intelligence and other worthy attributes, or fail due to a lack of them. It is an appealing vision in which individual liberty meshes perfectly with the social good. No one has to depend on the good will of anyone else, but instead need only rely on oneself.

    This theory, pushed to the fringes of respectable thought for several decades following the Great Depression, re-emerged and was vigorously, if not entirely consistently, applied to the US and global economies starting nearly three decades ago. This is a world in which the process of production and exchange takes the form of a global system of interconnected corporate institutions. Since 1980, this system has become increasingly interdependent, as virtually every corner of the globe was drawn into the new complex of economic networks.

    In this new world, auto workers in Detroit might work as hard and as smart as ever before, but suddenly their livelihood could disappear due to developments on the other side of the world. In Russia, former college professors turned industrial magnates could become fabulously rich because global supply and demand for natural commodities suddenly pushed their prices through the roof. Soybean farmers in Brazil could grow rich, thanks to a sudden spate of interest in alternative energy sources.

    The irony is that the place where the extreme interdependence of everyone on everyone else is most apparent and most concentrated is in the financial system of global capitalism. Banks and other financial institutions create the credit that makes economic expansion, and even just economic activity, possible throughout this system. They do so by transferring the right to use wealth from those who own it to those who claim to have a use for it. Banks are inherently fragile institutions, since those who provide them with assets can typically reclaim them on short notice, while those who are using these assets typically cannot return them quickly.

    As the American financial system was gradually deregulated during 1980-99, promoted by the resurgent free market ideology, one more experiment based on this theory was put into play. Alan Greenspan did his part by encouraging the experiment to proceed unhindered for his entire tenure at the Fed. Those who ran our banks, investment banks and other financial institutions participated with enthusiasm. They quickly found a much better way to make money than the old humdrum activity of taking deposits, making loans and holding those loans to maturity.

    The banks and other mortgage issuers made loans to people they knew could probably not afford them. Yet the issuers made fortunes by selling them to eager investment banks, which cut them up and turned them into opaque mortgage-backed securities. The investment banks then made even bigger fortunes by selling them to investors.

    Everyone in this chain felt their super-high rates of return were safe, given the supposedly endless rise of home prices and the AAA ratings given to these securities by rating agencies hired by the security issuers. Free market theories of finance insisted that the markets price every security properly, so no one need worry about the spread of these derivative securities throughout the world financial system. Chairman Greenspan's vision played out on a world stage.

    No one who knew any history should have been shocked when this vast experiment collapsed. Of course, home prices can fall as well as rise. Once the housing bubble burst, as it had to at some point, foreclosures were bound to follow. The mysterious derivative securities, that had somehow pumped out huge profits for those who dealt in them, suddenly were revealed to be, in Warren Buffet's words, "financial weapons of mass destruction."

    It is difficult to find anyone or any place in the world not suffering collateral damage from the implosion of the mortgage-backed securities created in the USA. Financial institutions in the USA and abroad that held them have had to be rescued by taxpayers. Now even countries whose banks bought none of them are suffering, as foreign capital flees for perceived safe havens. The world is threatened with the worst global depression since the 1930s. All this is due to an experiment in an ideology that had already been discredited by earlier experiments, in the 1920s and before.

    Hopefully, the lesson will finally be learned. What former British Prime Minister Margaret Thatcher claimed at the start of the free market period - that there is no society, there are just individuals - is belied by what we are now witnessing. We are not disconnected individuals whose fate rests solely in our own hands. We are all dependent on one another. We must rebuild our economy on the principle that we are all in this together. If we are to solve the many real economic problems we face, we have to do so by cooperative effort, not by the pursuit of narrow self-interest.

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    David M. Kotz is professor of economics at the University of Massachusetts Amherst