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).
For information about this site see the About page, at the top of the right-side menu bar.
For more information from the FM site
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
