An incomplete analysis of a floundering social system


BOOK REVIEW: A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression, by Richard A. Posner, Harvard University Press; €21 (€17.95)

Richard Posner is an American judge with an interest in economics. In this book he espouses the view that the depression in the US is the result of “normal business activity” in a capitalist system.

Bankers and consumers were acting as one would expect, that is, in their own self-interest.

Mistakes were made, but that, he asserts, is part and parcel of the capitalist system. The author does not believe that the government bears much responsibility for causing the depression.

Moreover, he extends his argument further: bankers cannot be blamed either – anymore than lions can be blamed for eating zebras. Only the capitalist system can be blamed; it is Darwinian. It is flawed, but it is far better than the alternatives.

So, politicians and bankers are not really to blame; it is the system. This is the central thesis of the book. It is surely a naive and pro-establishment one. Even if capitalism is prone to crisis, it is the responsibility of government to prevent or moderate such occurrences. What was the Keynesian revolution all about if not that?

Blaming the system is a cop-out. Economics is not a hard science. No system is imposed from outside; people have free will. Posner’s approach is far too deterministic. It is also a convenient way of exculpating those who ran the system on to the rocks.

He is far too soft on former federal reserve chairman Alan Greenspan, who kept interest rates too low for most of the past decade, fuelled the equity bubble and, later, the property bubble. This was the same man who welcomed the subprime lending market as a good example of financial innovation.

Former US president George W Bush gets off rather lightly as well, given that one could argue he was more concerned with invading Iraq than sorting out the US economy.

Some of Bush’s political appointees behaved abysmally, for example the then chairman of the securities and exchange commission who allowed investment banks to increase leveraging to alarming levels.

The argument that bankers were obliged to take risks because shareholders demanded it is unsound. It is likely that most bankers knew exactly the nature of the risks they were undertaking. That is why, for example, they packaged subprime mortgages and sold them on. It was a deliberate attempt to transfer risk to less sophisticated institutions.

That sort of venal behaviour cannot be written off as system failure. People in positions of influence were, and are, largely to blame. But the author pulls his punches. Not once does he refer to the adequacy or otherwise of legal sanctions. Indeed, one might have expected a legal expert to discuss changes in the law that might help the capitalist system function better, but there is no reference to this area.

The author is on somewhat firmer ground when he describes the low savings ratio of US households as an important warning sign. This, combined with massive capital inflows from China, allowed America to live way beyond its means. But this should have made the various policy-making and regulatory bodies much more alert. But it did no such thing.

Here and there the author seems to bemoan the fact that banks were deregulated in the 1970s, as they were in most countries. This was based on the view that capitalism was a self-healing system. Indeed, in the 1990s a couple of academic economists were arguing that recessions were a thing of the past. Posner is right in believing these views to have been complacent.

Deregulation did not and does not mean that regulation as we know it today is out of fashion. The two forms of regulation were quite different. What really happened is that a rule-based system in the 1960s gave way to a principles-based one – which in the event was not implemented properly.

The author admits that we are all sadder and wiser now. So what does he recommend? Not much. He raises questions about returning to 1960s rules-based regulation, limits on leveraging, more rigorous credit standards, tighter reserve requirements, etc. He discusses the desirability of restricting hedge funds, but leaves the matter unresolved.

His actual proposals are few and far between. He suggests that it might be desirable to play down the ideal of home ownership, to have full disclosure on the remuneration of top bankers, and to cut back on their severance pay. He admits that these proposals are “small beer”.

On the wider question of fiscal versus monetary stimulus, he reviews the pros and cons but does not make a recommendation as such.

Nowhere does he tackle the question of reforming the capitalist system. He advises us to await calmer days before considering regulatory reform. It is unclear what the purpose of this book is, beyond blaming the system and thereby excusing the behaviour of people in power.

Michael Casey is a former chief economist with the Central Bank and former board member of the International Monetary Fund