NY Times Book Review, May 17, 2009
Capitalism’s Fault Lines
By JONATHAN RAUCH
A FAILURE OF CAPITALISM
The Crisis of ’08 and the Descent Into Depression
By Richard A. Posner
346 pp. Harvard University Press. $23.95
“This recession,” President Obama said recently, “was not caused by a
normal downturn in the business cycle. It was caused by a perfect storm
of irresponsibility and poor decision-making that stretched from Wall
Street to Washington to Main Street.” Richard A. Posner is having none
of it. A perfect storm, yes: but a storm of responsibility and
reasonable decision-making. The Crash of ’08 happened because
businesspeople and consumers did what markets and society expect them to
do. Don’t blame capitalists or, for the most part, government. Blame
capitalism.
It comes as something of a surprise that Posner, a doyen of the
market-oriented law-and-economics movement, should deliver a roundhouse
punch to the proposition that markets are self-correcting. It might also
seem odd that a federal appellate judge (and University of Chicago law
lecturer) would be among the first out of the gate with a comprehensive
book on the financial crisis — if, that is, the judge were any other
judge. But Posner is the late Daniel Patrick Moynihan’s successor as the
country’s most omnivorous and independent-minded public intellectual. By
now, his dozens of books just about fill their own wing in the Library
of Congress.
In “Catastrophe: Risk and Response” (2004), he took up the problem of
low-probability, high-impact events. The financial meltdown certainly
qualifies. In this compact and bracingly lucid volume, he offers a
simple, but not simplistic, primer: “a concise, constructive, jargon-
and acronym-free, nontechnical, unsensational, light-on-anecdote,
analytical examination of the major facets of the biggest U.S. economic
disaster in my lifetime and that of most people living today.”
If you read the newspapers, you will not see much in “A Failure of
Capitalism” by way of unfamiliar particulars. Cheap money and an inrush
of foreign capital fueled a lending boom, which poured credit into the
housing market. As prices went up, up, up, even risky mortgages seemed
safe and everyone piled in, including banks. Financiers relied on
securitization and complicated financial instruments to dilute the
attendant risk, but the result was to spread that risk through the
financial system, making it impossible to locate. When the housing
bubble popped, everyone was holding bad debt, but no one was sure how
bad or even how much. With banks suddenly looking undercapitalized,
lenders stopped lending and started selling assets to raise cash. The
faster everyone ran for the exits, the faster asset prices fell,
dragging banks’ balance sheets down with them. Credit markets seized up,
depressing the economy, causing more mortgage defaults and asset-price
deflation, further weakening banks, further paralyzing credit,
depressing the economy still more. . . . Repeat ad nauseam.
You know that story, and Posner tells it well, with a particular flair
for showing how dozens of moving parts interacted. Being Richard Posner,
however, he is not content to be an amiable guide through the thicket.
His real interest is in finding and detonating grenades in the underbrush.
One is right there on the title page, which flaunts the D-word. The
current crisis, Posner maintains, is a depression. True, it is not (we
hope) a great depression. But the typical postwar recession is a partly
self-correcting disinflationary contraction that soon subsides, often
leaving the economy healthier. The present downturn is a self-sustaining
deflationary contraction whose costly aftereffects will linger for
years. The Great Depression led to World War II. Today’s depression
presumably won’t be that bad, but it may cause a huge loss of output, an
immense increase in the national debt, a swing to excessive regulation,
a nasty bout of inflation, a decline in America’s economic and
geopolitical power, and increased political instability abroad.
A typical recession is a market correction, usually of inflation or
other economic imbalances; a depression is a market failure. And it is a
failure (here is grenade No. 2) that the market is powerless to prevent.
“An interrelated system of financial intermediaries” — a banking system,
broadly defined — “is inherently unstable,” Posner writes. Think of it
as “a kind of epileptic, subject to unpredictable, strange seizures.”
Populists and libertarians will hate this book, though I wouldn’t want
to predict which group will hate it more. A perfect storm of
irresponsibility? Hardly. The crisis came about precisely because
intelligent businesses and consumers followed market signals. “The
mistakes were systemic — the product of the nature of the banking
business in an environment shaped by low interest rates and deregulation
rather than the antics of crooks and fools.”
Were a lot of people reckless and stupid? Of course! But that cannot
explain why the whole system crashed, since a lot of people are always
reckless and stupid. The problem, fundamentally, is that markets cannot,
and rationally should not, anticipate their own collapse. “A depression
is too remote an event to influence business behavior.” Any single
business can rationally guard against its own bankruptcy, but not the
simultaneous bankruptcy of everybody else. “The profit-maximizing
businessman rationally ignores small probabilities that his conduct in
conjunction with that of his competitors may bring down the entire economy.”
During the housing bubble, for example, sitting out the mortgage boom
meant forgoing large profits. “Even if you know you’re riding a bubble
and are scared to be doing so,” Posner writes, “it is difficult to climb
off without paying a big price.” So people made decisions that were
individually rational but collectively irrational. To see the crisis
through populist spectacles, as President Obama does when he attributes
it to “irresponsibility,” is to misunderstand the whole problem by
blaming capitalists for a failure of capitalism.
And so — here is the part libertarians will hate — markets, entirely of
their own accord, will sometimes capsize and be unable to right
themselves completely for years at a stretch. (See: Japan, “lost decade”
of.) Nor can monetary policy be counted on to counteract markets’ tippy
tendencies, as so many economists had come to believe.
Alas, economists and policy makers got cocksure. They thought they had
consigned depressions to history. As a result, they missed warning signs
and failed to prepare for the worst. “We are learning,” Posner writes,
“that we need a more active and intelligent government to keep our model
of a capitalist economy from running off the rails.”
By doing what, exactly? Posner thinks laissez-faire economics has
nothing relevant to say. The rest of the economics profession is all
over the map. The system of financial regulation will need an overhaul,
but Posner argues that the time for that is not now, in the heat of
crisis. Anyway, no one is sure what to do. He halfheartedly suggests a
few reforms but concedes they are “pretty small beer.” If pressed, I
suspect, he might also acknowledge some 20-20 hindsight in his
insistence that the government should have prepared for an event that
hardly anyone thought possible.
By the last page, not a single lazy generalization has survived Posner’s
merciless scrutiny, not one populist cliché remains standing. “A Failure
of Capitalism” clears away whole forests of cant but leaves readers at a
loss as to where to go from here. In other words, it is only a starting
point — but an indispensable one.
Jonathan Rauch is a senior writer with National Journal and a guest
scholar at the Brookings Institution.
---
Posted to Marxmail by Michael Perelman on Nov. 2, 2005
Here is a brief note about Richard Posner from my "Fouling the Nest: How
Right-Wing Extremism and Business Incompetence Destroy American Prosperity":
Judge Richard A. Posner has little use for words like fairness and
justice. "Terms which have no content," he calls them. What America's
lawyers and judges need, he says, is a healthy dose of freeâmarket
thinking. From the bench of the U.S. Court of Appeals for the Seventh
Circuit here, Judge Posner applies a standard of economic efficiency in
cases where many others fail to see markets at play. He calibrates
social costs and benefits on questions of religious expression and
privacy. [Barrett 1986]
Not everybody is enamored with Posner's work, despite his prolific
output and its wideâranging scope. According to one skeptic's evaluation:
Posner's arguments are composed of speculative and implausible
assumptions, overbroad generalizations, and superficial descriptions of
and quotations from cases that misstate or ignore facts, language,
rationales, and holdings that are inconsistent with his argument. None
of the cases discussed by Posner support his thesis. Instead, the
reasoning and results in these cases employ varying standards of care,
depending on the rights and relationships among the parties, that are
inconsistent with the aggregateâriskâutility test but consistent with
the principles of justice. [Wright 2003]
Despite any lingering questions about the quality of his work, Posner
certainly knows how to capture attention. In his most famous proposal,
he advocated the purchase and sale of babies:
[The baby] shortage appears to be an artifact of government regulation,
in particular the uniform state policy forbidding the sale of babies.
That there are many people who are capable of bearing children but who
do not want to raise them, and many other people who cannot produce
their own children but want to raise children in their homes, suggests
the possibility of a thriving market in babies, especially since the
costs of production by the natural parents are typically much lower than
the value that many childless people attach to the possession of
children. There is, in fact, a black market in babies, with prices as
high as $25,000 reported recently, but its necessarily clandestine mode
of operation imposes heavy information costs on the market participants,
as well as significant expected punishment costs on the middlemen
(typically lawyers and obstetricians). The result is higher prices and
smaller quantities sold than would be likely in a legal market. [Posner
1977, p. 113]
Major corporations are less interested in baby markets than avoiding
expensive judgments. The attraction of the law and economics movement
lies more in its insistence that all regulations should be narrowly
decided on questions of economic costs and benefits.
Corporations consistently overestimate the costs of regulations, while
the benefits defy measurement. One critical study summed up this
approach to regulation: "Cancer deaths avoided, wilderness and whales
saved, illnesses and anxieties prevented ââ all these and many other
benefits must be reduced to dollar values to ensure that we are spending
just enough on them, but not too much" (Ackerman and Heinzerling 2004,
p. 2004).
More often than not much of the data upon which such decisions rest will
come from the corporations themselves. Conservative activist
organizations have been very successful in using their influence to get
government agencies and the courts to minimize the value of regulatory
benefits while exaggerating the costs.
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