Richard Posner is one of America’s leading conservative intellectuals, so his insights into this crisis deserve attention. It shows that away from the insanity of the Rush Limbaugh wing, conservatives are reflecting on their beliefs and beginning to move toward a consensus with liberals as to the way forward. Esp note the last paragraph, about the need for reform of our financial regulatory machinery (whose failure is a major causes of this crisis).
I recommend reading this in full. The author, Robert M. Solow is Professor Emeritus of Economics at MIT and won the 1987 Nobel Prize in economics. And, if you have not, also read An important and politically significant guide to the Great Depression (30 April 2009). Both are valuable guides to our current situation — how we got here, and how to dig ourselves out.
“How to Understand the Disaster“, Robert M. Solow, New York Review of Books, 14 May 2009 — Excerpt:
Review of A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression
by Richard A. Posner, 2009, 346 pages
More striking than what the book says is who says it. Posner is a judge of the US Court of Appeals for the Seventh Circuit, and so preeminently a lawyer. In addition, he is an apparently inexhaustible writer on…nearly everything. To call him a polymath would be a gross understatement. A partial list of his publications in the past ten years alone includes How Judges Think; Law, Pragmatism and Democracy; Frontiers of Legal Theory; the seventh edition of his Economic Analysis of Law (first published in 1973); the third edition of Law and Literature; three volumes of essays on The Economic Structure of Law; and books on plagiarism, constitutional aspects of national emergencies, the election of 2000, the US domestic intelligence system, countering terrorism, public responses to the risk of catastrophe, the Clinton impeachment, dealing with the AIDS epidemic, and, significantly, Public Intellectuals: A Study of Decline. There is a prehistory of still more books, and many articles in legal and other periodicals.
… The plainspokenness I mentioned is what makes this book an event. There is no doubt that Posner has been an independent thinker, never a passive follower of a party line. Neither is there any doubt that his independent thoughts have usually led him to a position well to the right of the political economy spectrum. The Seventh Circuit is based in Chicago, and Posner has taught at the University of Chicago. Much of his thought exhibits an affinity to Chicago school economics: libertarian, monetarist, sensitive to even small matters of economic efficiency, dismissive of large matters of equity, and therefore protective of property rights even at the expense of larger and softer “human” rights.
But not this time, at least not at one central point, the main point of this book. Here is one of several statements he makes:
Some conservatives believe that the depression is the result of unwise government policies. I believe it is a market failure. The government’s myopia, passivity, and blunders played a critical role in allowingthe recession to balloon into a depression, and so have several fortuitous factors. But without any government regulation of the financial industry, the economy would still, in all likelihood, be in a depression; what we have learned from the depression has shown that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails. The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.
If I had written that, it would not be news. From Richard Posner, it is.
The underlying argument—it is not novel but it is sound—goes something like this. A modern capitalist economy with a modern financial system can probably adapt to minor shocks—positive or negative—with just a little help from monetary policy and mostly automatic fiscal stabilizers: for example, the lower tax revenues and higher spending on unemployment insurance and social assistance that occur in a weakening economy without any need for deliberate action. It is easy to be lulled into the comfortable belief that the system can take care of itself if only do-gooders will leave it alone. But that same financial system has intrinsic characteristics that can make it self-destructively unstable when it meets a large shock.
… Posner’s chapter on “The Way Forward” is all of sixteen pages long, and fairly disorganized pages at that. This means he does not seriously try to imagine what an effective regulatory regime for financial markets would look like or, above all, how it could be designed to protect the real economy as much as possible from damage inflicted by financial breakdown. Nevertheless he says some useful things; and it is especially significant that they come from a leading conservative (even if never a tamely doctrinaire one). Here is a representative statement:
Other regulatory changes might be desirable, such as limiting leverage; raising credit-rating standards and changing how credit-rating agencies are compensated; forbidding proprietary trading by banks (that is, trading of their equity capital, which puts that capital at risk); adjusting reserve requirements to take more realistic account of the riskiness of bank’s capital structures; requiring greater disclosure by hedge funds and private equity funds; requiring that credit-default swaps be traded on exchanges and fully collateralized; and even resurrecting usury laws.
The financial system does have a useful social function to perform, and that is to make the real economy operate more efficiently. Some human institution has to collect a nation’s savings and put them at the disposal of those who have productive ways to use them. Risks arise in the everyday business of economic life, and some human institution has to transfer them to those who are most willing to bear them. When it goes much beyond that, the financial system is likely to cause more trouble than it averts. I find it hard to believe, and I suspect that Judge Posner shares my disbelief, that our overgrown, largely unregulated financial sector was actually fully engaged in improving the allocation of real economic resources. It was using modern financial technology to create fresh risks, to borrow more money, and to gamble it away.
Posner writes:
As far as I know, no one has a clear sense of the social value of our deregulated financial industry, with its free-wheeling banks and hedge funds and private equity funds and all the rest.
That is already a hint that he thinks its social value is limited. As Posner sees it, talk about greed and foolhardiness is comforting but not useful. Greed and foolhardiness were not invented just recently. The problem is rather that Panglossian ideas about “free markets” encouraged, on one hand, lax regulation, or no regulation, of a potentially unstable financial apparatus and, on the other, the elaboration of compensation mechanisms that positively encouraged risk-taking and short-term opportunism. When the environment was right, as it eventually would be, the disaster hit.
Afterword
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
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To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about the Financial crisis – what’s happening? how will this end?
- about the End of the post-WWII geopolitical regime
- and some Good news about America, a collection of articles!
Some posts about economic history:
- A warning from Professor Niall Ferguson, 5 January 2008
- The greatness of John Maynard Keynes, our only guide in this crisis, 4 December 2008
- About the state of economic science, and advice from a famous economist, 8 December 2008
- Words of wisdom about the global recession, from the greatest economist of our era, 29 December 2008
- Some thoughts about the economy of mid-21st century America, 12 January 2009
- Locked into the bailout state, 4 March 2009
- Economic theory as a guiding light for government action in this crisis, 10 March 2009
- Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
- Napoleon’s advice to President Obama about the financial crisis, 29 April 2009
This is an excellent article. I also commend to your attention: “The Death of Kings,” Nick Paumgarten, Annals of Finance, The New Yorker, 18 May 2009 — Subscription only. Excerpt:
The free-market ideologues are generally keeping their heads down these days; it’s clear to all what led to the present financial collapse. How much of the new consensus will be realized in actual regulations, and how they will be enforced, remains to be seen. Though the President today spoke of requiring CDS and other derivatives to be publically traded in the future, the political class, and the executive branch, seem still to be in the thrall of the big banks — or unable to think outside the paradigm of mild government interference with capital’s necessary freedom to do whatever it wants.
If the past, and the progressive era in particular, is any guide, government will end up doing about what the banks need in order to survive and stay competitive. The banks or their spokespeople will certainly be in the closed-door sessions that write the legislation.
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Fabius Maximus replies: The key characteristic of this crisis to date is the successful mastery of the financial sector firms to manipulate the government to their ends and avoid serious re-regulation. The banks were deeply involved in design of the misleadingly named “stress test.” The bailout has largely consisted of gifts to financial firms (easy borroring at cheap rates from the government, guarantees on their debt, government purchases/loans on their bad investments, etc). Serious attempts to regulate have been defeated, such as allowing mortgages to be treated like other loans in bankruptcy. They own the system and are flaunting it.
Trying to blame just the market is again a little simplistic. I hold responsable both the government and the markets. The Fed under Greenspan did not contribute? CRA was not a part of the mess? The removal of Glass-Segal had no effect? Being a good capitalist requires that not only do you know the positive side but also the negative side of how the system works. The free market will run itself into the ground without some limits, the financial markets specifically. Glass-Segal was a good example of one of those limits. The question I have is, has the State proven to be any better? History shows that no it’s not. The current crop of politicians and bureaucrats really have no clue of what needs to be done nor do I see any hint of wisdom coming to them anytime soon.
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Fabius Maximus replies: Who is “blaming just the market”? However dozens of studies have shown that the Community Reinvestment Act was a trival factor in the housing bust, and I have seen nothing but rhetoric saying otherwise (along with tiny sound bites from speeches).
A free market is not
a) free
b) a free-for-all.
Obviously, a good market does not encourage people in one stall poisoning or running off with the produce from their neighbour’s stall; it does not allow a seller to return to the market if they were caught cheating in any way; it doesn’t work too well if everything is taxed to the hilt with depreciating currency values, retail sales taxes, dishonest labeling, biased laws favoring one type of producer over another won through patronage and other sleight of hand, and so on ad infinitum.
Sometimes when we use the term ‘free market’, we forget a certain amount of order, aka regulation, is necessary for a ‘market’ to be a good one.
Lance Selfa’s article on Counterpunch yesterday, “The Limits of Liberalism“, is worth reading. He makes the point that Democrats and Republicans exhibit merely two different approaches to managing American capitalism. One favors closer supervision of business and some awareness of the needs of labor (not their full needs, but the minimal required to function in a capitalist economy), while the other favors less regulation of business, let the chips fall where they may. Both parties adhere to the basic faith that “what’s good for GM is good for America” (or, “what’s good for Citibank is good for America.”)
Kevin Philips observes that American political attitudes, and administrations, oscillate between two philophies: one of minimal governmentn and unfettered accumulating wealth; the other of active government and tighter regulation, when unfettered accumulation becomes self-destructive. The Progressive Era (following the gilded age) and the New Deal were two instances of the latter, where government had to step in and clean up business’s mess. Philips notes, contrary to the frequently expressed alarms of conservatives, that the minimal government eras in America far outnumber the active government ones.
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Fabius Maximus replies: IMO Kevin Phillips is one of the greatest assets of the Republican Party, as his advice to liberals is self-destructive. Saying that people act against their own self-interest just means he thinks he’s smarter than they are — and his books demonstrate a delusional level of self-esteem which proves him wrong.
Ditto with Selfa’s article. He obviously has not read Martin van Creveld’s “Rise and Decline of the State”. Many of the wonders of socialism he refers to (e.g., post-WWII UK) are not only terrible examples (the UK economy declined for decades, far underperforming Germany, until Thatcher saved it), but ocurred during the last phase of the State’s rise. Now the ebb tide has begun. People increasingly no longer esteer or trust the State, and hence are reluctant to grant it more power.
Since conservatism has failed, that leaves us in a quandry. Where to turn? I suspect some alternatives will emergy. They always do.
“Fabius Maximus replies: The key characteristic of this crisis to date is the successful mastery of the financial sector firms to manipulate the government to their ends and avoid serious re-regulation.”
We can regulate and re-regulate till the end of time, but we all know that nothing changes unless there are CONSEQUENCES for not following the rules that already exist. I know you believe we need to put out the fire first, FM, but the fact that there is no groundswell of public opinion to identify and prosecute the “rule breakers” is astounding to me.
As a nation we seem to put more pressure on those responsible for oversight than we do on those that perpetrate the crimes. That results in more regulation and then over regulation, not to mention more overseers and an ever increasing number of government employees charged with WATCHING OVER smaller and smaller groups who, darn it, just can’t seem to follow the laws we do have without more laws.
You suggest that the financial community is manipulating the government. I am suggesting that our government is manipulating us by turning a blind eye to powerful crooks. They are well aware of our national predilection to call for more oversight, and are more than happy to oblige by increasing the government payroll.
So tell me. Exactly how does bigger government create wealth for its citizens?
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Fabius Maximus replies: The sad thing is that there are few rule-breakers. The changes in the financial regime were largely the result of “regulatory capture”, which in this case means that the changes had either explicit or implicit approval of the regulators. Some key ones, like the increase in leverage at investment banks, required and received government approval. Some, like the changes in mortgage lending, were noted by regulators during audits of the banks and hence inplictily approved. While there were no doubt isolated instances of criminal behavior (as there always are), I doubt this was a significant factor. As so many people have noted — as it is obvious now — the financial sector elites own the system. They can change the rules as needed, so there is no need to break them.
It was a systemic failure, and only systemic change will fix the problem. Unfortunately, as you note, there is zero interest in reform by either our finanical sector leaders or political elites — or the American public.
Anyone who can confuse an economy closely controlled by a central bank “laissez faire” capitalism is not a polymath who should be taken seriously. The economy of the US is intertied to government departments, bureaucracies, regulators, and politicians a hundred ways from Sunday and has been at least since the 1910s.
Obama’s idiotic approach to economics will destroy what little is left of economic vitality in the US. That will make the way clear for America’s enemies in China and closer by.
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Fabius Maximus replies: Nobody of sense compares these things to theoretical absolutes — which never exist. By “laissex faire” people refer to the large-scale deregulation of the finanical sector during the past ten years, which has resulted in such ugly results. Allowing ticking-bomb mortgages (e.g., interest only, short-term option-rate, no-documentation “liars loans”). Corruption of the appraisal and security rating systems. Vast increase in leverage at banks and brokerages. Growth of fake accounting (e.g., off-balance sheet vehicals at banks). All these are regulatory failures, resulting from deliberate changes to the regulatory regime.
From Penny: “..that there is no groundswell of public opinion to identify and prosecute the “rule breakers” is astounding. … I am suggesting that our government is manipulating us by turning a blind eye to powerful crooks.”
FM replies: “…All these are regulatory failures, resulting from deliberate changes to the regulatory regime.”
This last comment is true.But is part of an answer that argues that the systemic problems can be fixed with simple recalibration, i.e. a tune-up. Penny’s astonishment at the lack of general outrage is widely shared. She is also right that ‘the government is turning a blind eye to powerful crooks’.
Simply put, the powerful crooks RUN the government and have done so, increasingly, for a long time. First they infiltrated, then they infested, now they are in control. The neat little divisions of private, public, media, judiciary, House, Senate, Executive, State, Defense,Military,States vs Federal etc. no longer apply.
The aspect of governance in which there is the most broad public participation, the US Presidential election, is a stage-managed long drawn out sham which effectively distracts citizens from actual, or at least substantive, political participation for which latter there is no longer any effective vehicle.
If, FM, you are right that there are only a few rotten apples in a mainly healthy systemic barrel, then the Madoff case should be revealing: if they conduct a thorough investigation and prosecution, then not only Madoff himself, but all his partners which will doubtless include various regulators and investment banks, both here and abroad, will be revealed. It is not possible to hide 50+ billion dollars over several decades without hiding it somewhere, i.e. moving it around. Who helped him do this?
If, as looks increasingly likely, no such information will be forthcoming from the upcoming trial, then the ‘few rotten apples’ theory can be finally put to rest.
But there still won’t be outrage mainly because there is no public square in the culture. Things will have to be a lot worse than they are now – which is difficult but not terrible – for that to ‘upswell’, because it will happen without, or rather despite, the soporific distractions of the gatekeeper national media.
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Fabius Maximus replies: This is an inaccurate reflection of what I have said on this site, in many respects 100% wrong. Try using quotes.
(1) “But is part of an answer that argues that the systemic problems can be fixed with simple recalibration”
The reference page America – how can we reform it? lists 87 posts saying the opposite. That the systemic flaws are deep; that the broken component in the system is us.
(2) “you are right that there are only a few rotten apples in a mainly healthy systemic barrel”
I said nothing remotely like this. If we choose to be sheep the best we can hope to get is a shepard. More likely we will get wolves. This is the natural order, and neither shepards or wolves are criminals. Rather than whine about it, perhaps we should consider not being sheep.
(3) “then the Madoff case should be revealing”
The Madoff case is trivia. It shows that the regulatory mechanism works poorly, but this kind of crime is the least of our problems. Far more serious is the ability of major banks to warp the rules to their advantage, and get government money to cover their losses.
FM reply to comment #5: “Since conservatism has failed, that leaves us in a quandry. Where to turn?”
Do you mean by “conservatism” free-market, small-government philosophy? Most of the comments on this site say the opposite, that the failure is a failure of regulation, the failure to do what the regulator was supposed to do.
The real problem is neither one of small or large government, more or less regulation, but the capture of government by a small financial class. This was the point of my comment at #5 — that conservativism and liberalism are merely two different approaches to managing (supervising, guiding, bailing out, etc) the underlying capitalist economy. Neither conservatism nor liberalism questions the basic tenets of this economy — though each typically, or used to, represents different sectors of it. The point is, the solutions that emerge will emerge from the business class itself, not from some imagined class of enlightened intellectuals. The priests exist at the will of the lords.
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Fabius Maximus replies: I was not clear. Abstract ideas are difficult to disprove, which is why they reoccur throughout history. Communism, fascism, liberalism, etc — they all dance off the stage, change names and clothers, to reappear a few generations later.
I meant conservatism as a political movement, a complex combination of ideologies and people. We vote them in and see how they do. Conservatism failed, and one major flaw was IMO exactly what you describe: its capture by the elites of the finanical sector, which avoided and perverted the established regulatory mechanisms – and said themselves and us onto the rocks.
Now the liberals have a turn at bat. The first 100 days suggest that they might meet the same fate, for the same reason.
(2) “Neither conservatism nor liberalism questions the basic tenets of this economy”
Why should they question the basic tenents of the economy, except during times of extreme crisis? People seldom like massive experimentation with working social systems, as changes usually fail. We might — emphasis might — be entering such a period. In which case it will be interesting. In the 1930’s there were well-developed alternative systems available. IMO today we have none. As we enter an era of the State’s decline, revising the existing systems (all based in one form or another on a strong State) will be difficult or impossible.
(3) “the solutions that emerge will emerge from the business class itself, not from some imagined class of enlightened intellectuals.”
I disagree, totally and absolutely. I dobut you can find many historical examples to support this theory, vs. the many examples of social innovations (new thoughts, values, visions) from philosphers (broadly defined as not businessmen). For the most powerful statement of this see Nietzsche’s “Thus spake Zarathustra”, chapter 12 – The Flies in the Market-Place (see full excerpt here):
Also note the following quote. I cannot find the source, but its variously attributed to Kipling — or a Chinese/Arab/Persian proverb:
Since there was no free market, it did not fail. Government interference and regulation destroyed the economy. Anyone not a libertarian by now deserves poverty, starvation and death.
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Fabius Maximus replies: As I said earlier, there are no absolutes in human societies — so they cannot be disproven. Still, this was a regulatory failure. That is, well-understood and sensible regulations were disregarded or repealed by free-market ideologues. To see this as evidence in favor of libertarian theories is bizarre.
“… deserves poverty, starvation and death.”
That says more about you than about America or economic theory. Please go away, as such things are outside the realm of civilized discourse allowed on this site.
Re yr response to #8: I was referencing this comment (and could have been clearer about that):
What I was saying is the ‘financial sector elites’ are the criminals even if, through gaming the regulatory environment, what they have been doing is not technically illegal sense. So the systemic failure is, fundamentally, one that involves having been taken over by criminal syndicates masquerading as political lobbies, corporations and govt. officials.
Going on further with this theme and viz. yr. excellent point in reply to Seneca about philosophers trumping actors, it could be argued that in fact the philosophers are still in charge in the sense that there is an over-arching ‘modernist’ ‘philosophy’ or view involving secularism, separation of church and state, belief that mercantilism/the profit motive will ultimately sort everything out in the best possible – even though imperfect – fashion, materialist-based teleology on many levels including the materialist-based evolutionary theory and so on. This ‘philosophy’, or contemporary world view, features a hodge podge of widely accepted (supposedly) but internally muddled and inconsistent views on the role of the individual, the collective, the elites, rule of law, freedom and so forth.
In the light of your comment, it would indeed be very helpful for a comprehensive ‘philosophical review’ of our culture in the near future rather than endless stories about war, markets, imminent ecological collapse and pandemics. Currently, I am waiting to read a new book (supposedly somewhat) about this by Margaret Atwood (‘Payback: debt and the shadow side of wealth’). The late Jane Jacobs’ ‘the Coming Dark Age’ is short but pithy wherein she posits five key areas that define the health or sickness of a society in a way that does not separate the moral/philosophical from the practical/economic. (her five ‘pillars’ of a civilised society are: family, community, higher education, science and “self policing by the learned professions.” ) There must be many more such tomes out there but I am not aware of them unfortunately.
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Fabius Maximus replies: I don’t understand what you mean by “financial sector elites are the criminals even if … what they have been doing is not technically illegal.” This suggests that you admire the legal system of Stalin’s USSR — or the government seen in the movie “Brazil.” As in “you violated no law, but we don’t like you so you go to jail.” May we send you movie money on election days (as in take a date to see a movie; don’t vote)?
“criminal syndicates masquerading as political lobbies, corporations and govt. officials”
The groups you name consist of people, citizens who have the right — just like you and me — to influence the government as best they can, within the law. A systemic flaw occurs when their influence becomes so disproportionate that the State becomes dysfunctional in some way(s). That flaw might be structural — something wrong with the Constitution, laws, or apparatus. Or we might be the flaw, operators too lazy to run the system.
If you would like to understand how we got into this mess, I recommend reading Allan Bloom’s “The Closing of the American Mind”.
Does the Fed not control interest rates? Is not the economy and the financial sector heavily regulated? Could one conclude that the regulation of reserve ratios and lending policies as a regulatory failure? Capitalism is not just a profit system it is also a loss system where failures are allowed.
The confusion of this issue is obviously one of philosophy not economics. The United States like all western countries is a mixed economy with a large regulatory frame in which all markets must fit. The business cycle is a fact that is influenced by monetary and fiscal policy.
Properly executed, Free Market Capitalism works by making all participants a little fearful, and a little miserable. The fear of failure makes us smarter, and the misery (of competition) makes us diligent. The combination of intelligence and diligence produces results which can be stunning in terms of rapid wealth creation. Human nature being what it is, inevitably, some will seek to escape the stress of what Rockefeller called, “ruinous competition”. Of course, each success in this area induces regulatory reform which makes sure “That never happens again”. Antitrust, banking reform, even environmental legislation are examples of post hoc attempts at foreclosure of successful schemes to privatize profits while socializing costs. We can fight the last war, and make sure “That never happens again.”, but I doubt it will prepare us for the next cycle of scheming to escape the rigors of capitalism.
We can fix the financial system again after this cycle, but I think the need and opportunity lies elsewhere. The Founders worried more about the balance of power between the people and the ruling class, and I tend to agree, this is where the action is. We need to throw some bums out and cogitate on how to limit media manipulation, and overt propaganda campaigns from working as well as they do now.
The fix to the system would be a full reserve system the separation of the banking powers from the money-creation powers. Governments rarely fix systems as force is contrary to a sensible market system. This whole fiasco is a demonstrable regulatory failure as all central planning is unable to fix markets. If you think the government can do better wait till they regulate health care.
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Fabius Maximus replies: De-regulation is a major cause of the current mess. Here are 4 examples on the long list —
* reducing (both thru explicit policy changes and deliberate refusal to regulate) limits on leverage and banks and brokers,
* allowing forms of mortgages de facto banned since the 1930’s (e.g., interest-only morgages),
* eliminating the “short-sale” rule (preventing selling into falling stock prices).
* lax regulation, such as allowing growth of off-balance sheet borrowing by banks.
As such, I very much doubt that the policy response will be further de-regulation.
As for health care, there are very few metrics by which our system is superior to government-run systems in Canada and Europe. That is, it is difficult (IMO impossible) to justify our system’s far great cost in terms of superior performance.
“Allowing” is the language of regulation. Absolutely none of what you listed was a market failure it was rather policy makers unable to foresee the consequences of the the regulations in place. None of what was listed was in any way deregulation but re regulation, merely the reworking of the chairs on the Fed ship.The fact is that government-guaranteed debt lead to artificially low mortgage rates and the illusion that the financial instruments created by bundling them was low risk; government-licensed rating agencies, which gave AAA ratings to mortgage-backed securities, creating a false sense of confidence; deposit insurance and the “too big to fail” doctrine, whose bailout promises have created huge distortions in incentives and risk-taking throughout the financial system.
Health care is regulated in the USA as every other country, but has no universal socialism. Some countries allow more freedom than others for example in Canada one would come to the conclusion that waiting lists ration the care and reduces the costs. Some people do die before the treatment and this cost is not included in the performance measures. The system in Canada bans private insurance or direct payment that conflicts with the state monopoly.