"Uncertainty vs. Risk"
Op-Ed, New York Times
May 9, 2010
Author: Niall Ferguson, Member of the Board, Belfer Center for Science and International Affairs
It is three years since the failure of two Bear Stearns hedge funds signaled the start of the biggest financial crisis since the Great Depression, and the air is thick with the sound of stable doors being shut long after the horses bolted. At some point this year a vast new picket fence will be built around the entire ranch, in the form of a new financial regulation act.
At the time of writing, two bills exist. The measure devised by Representative Barney Frank and passed by the House last December would (among other things) set up a consumer financial protection agency and regulate the market for exotic financial contracts known as derivatives. It would also empower regulators to prohibit forms of compensation for financial executives that are deemed to encourage excessive risk- taking, and create a new resolution authority to manage bankruptcies of large financial institutions, backed with a $150 billion contingency fund.
Senator Christopher J. Dodd's bill, unveiled in March, would also create a new entity to protect consumers, but it would leave the issue of executive compensation to bank shareholders. And its resolution contingency fund would be one-third the size of the one envisaged by the House bill.
Both these measures recall the old British sitcom "Yes Minister," in which all crises elicited the following response from the clueless politician Jim Hacker: "Something must be done. This is something. Therefore we must do it." As Richard A. Posner argues in "The Crisis of Capitalist Democracy," Congress is rushing to devise remedies for a crisis we have not yet properly understood. Indeed, the House bill explicitly commissions studies of the causes of the crisis while at the same time legislating to prevent its recurrence.
Posner is a man for all crises. Although he made his reputation as a specialist in antitrust law (he is a judge in the Court of Appeals for the Seventh Circuit and a senior lecturer at the University of Chicago Law School), he wrote extensively on the subject of terrorism and other cata strophic threats in the wake of the 9/11 attacks. His indefatigable intellect has been equally engaged by this new crisis. He has written one book, "A Failure of Capitalism," at least 10 articles and umpteen blog posts on the subject. This latest volume is a plea for us to understand first and pass legislation later.
In Posner's eyes, we are living through a second depression. The root causes were a failure of monetary policy (the Fed kept its short-term interest rate too low between 2001 and 2004), a failure of regulatory oversight (the Federal Reserve and the S.E.C. were "asleep at the switch") and a failure of intellectual rigor (economists claimed that the enlightened self-interest of bankers and shareholders would suffice to prevent such a crisis).
After the crisis began, matters were made much worse by the "colossal blunder" of allowing Lehman Brothers to fail. Happily, successive administrations responded by running huge fiscal deficits, a Keynesian remedy of which Posner wholeheartedly approves. Unhappily, the public became distracted by "demagoguery about executive salaries and perks," which were not themselves a cause of the crisis. Worse, Congress began prematurely legislating to increase financial regulation, forgetting that "anything that limits the rights of creditors causes them to raise interest rates, thereby reducing economic activity."
By directing their fire at bankers, Posner suggests, legislators want us to forget that among "the major culprits in our present economic distress" have been "government officials." Moreover, the new regulations being discussed in Congress are tending to increase uncertainty in financial markets, another drag on recovery. More and more, the question is whether or not the United States is actually "governable" - hence "the crisis of capitalist democracy."
A born-again Keynesian who remains an ardent opponent of big government, Posner may remind some readers of the two-headed pushmi-pullyu in the Doctor Dolittle books. On the wickedness of Greenspan and the greatness of Keynes he sounds like Paul Krugman's doppelgänger. But facing the other way on the fallibility of regulators is Posner's free-market Chicago head, which is scathing about attempts to police executive compensation, skeptical about the value of a new consumer protection agency and anxious about spiraling fiscal deficits and the risk of future inflation. For Posner, the American system of government is "cumbersome, clotted, competence- challenged, even rather shady." He confesses himself "perplexed by how government . . . has managed to escape most of the blame for our current economic state." Well, maybe because his fellow Keynesians have relentlessly lauded government as the solution.
In his defense, Posner can cite Keynes's letter to President Roosevelt, published in December 1933, which explicitly warned that "even wise and necessary reform may, in some respects, impede and complicate recovery. For it will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place." This is the essence of Posner's argument here. "Ambitious reforms are premature," he concludes, "pending a rigorous inquiry into the causes of the depression." Rather than hastily drafted thousand-page-long legislative measures, he would like to see an executive commission similar to the 9/11 commission to establish what those causes were.
Otherwise, we should apply lessons that have already been learned in the realm of counterterrorism. We need more rotation of senior personnel among government financial agencies; better funding of those agencies; more pooling of intelligence between those agencies.
"The Crisis of Capitalist Democracy" has been written in haste, and it shows. Characteristically, Posner has not just one but two blogs and too much of this book reads as if it first saw the light of day online. But the trouble with blogging is that the more you blog, the less you read. Since he is not an economist, Posner cannot afford to take as many shortcuts as he does. The result is that confusions occasionally creep in, for example about what exactly constitutes a bank's capital and how exactly bank leverage (the ratio of liabilities to capital) was regulated before the crisis.
Most perplexing of all, the small- government Keynesian calls for a flurry of reforms as half-baked as anything in the current bills before Congress: end the S.E.C. certification of certain credit rating agencies as "Nationally Recognized Statistical Rating Agencies"; tie bank capital requirements to the business cycle, so that they rise in good times; and restore the Glass-Steagall Act that separated commercial and investment banking during the Depression. This last suggestion is especially strange as Posner must know that the preservation of Glass-Steagall would have done nothing whatever to alter the behavior of the men running Bear Stearns, Lehman Brothers or A.I.G.
Posner makes it clear that he understands the risks the United States now faces as the crisis of private finance continues its metamorphosis into a crisis of public finance: an exploding debt relative to gross domestic product; larger risk premiums as investors prepare for higher inflation or a weaker dollar; rising interest rates; a greater share of tax revenues going for interest payments; a diminishing share of resources available for national security as opposed to Social Security. "As an economic power," Posner concludes, "we may go the way of the British Empire." Indeed. It seems not to have struck the judge that British decline and the rise of Keynesianism went hand in hand.
Niall Ferguson is the Laurence A. Tisch professor of history at Harvard University and the William Ziegler professor at Harvard Business School. His latest book is "High Financier: The Lives and Time of Siegmund Warburg."
For more information about this publication please contact the Belfer Center Communications Office at 617-495-9858.
For Academic Citation: