A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression

The financial and economic crisis that began in 2008 is the most alarming of our lifetime because of the warp-speed at which it is occurring. How could it have happened, especially after all that we’ve learned from the Great Depression? Why wasn’t it anticipated so that remedial steps could be taken to avoid or mitigate it? What can be done to reverse a slide into a full-blown depression? Why have the responses to date of the government and the economics profession been so lackluster? Richard Posner presents a concise and non-technical examination of this mother of all financial disasters and of the, as yet, stumbling efforts to cope with it. No previous acquaintance on the part of the reader with macroeconomics or the theory of finance is presupposed. This is a book for intelligent generalists that will interest specialists as well.

Among the facts and causes Posner identifies are: excess savings flowing in from Asia and the reckless lowering of interest rates by the Federal Reserve Board; the relation between executive compensation, short-term profit goals, and risky lending; the housing bubble fuelled by low interest rates, aggressive mortgage marketing, and loose regulations; the low savings rate of American people; and the highly leveraged balance sheets of large financial institutions.

Posner analyzes the two basic remedial approaches to the crisis, which correspond to the two theories of the cause of the Great Depression: the monetarist—that the Federal Reserve Board allowed the money supply to shrink, thus failing to prevent a disastrous deflation—and the Keynesian—that the depression was the product of a credit binge in the 1920’s, a stock-market crash, and the ensuing downward spiral in economic activity. Posner concludes that the pendulum swung too far and that our financial markets need to be more heavily regulated. Read Richard Posner's blog, and his latest article in The Atlantic.

In a recent column assessing the growing literature on the causes of the financial crisis, David Brooks noted that two broad schools of thought have formed: One sees the fiasco as a product of greed; the other, stupidity. Brooks overlooked the school of thought named Richard A. Posner.

Posner, the idiosyncratic and prolific federal jurist, has just published his book for this month:... Washington Post Book Review (read the entire Washington Post review) a surprising volume that explains what happened to the banking system and economy in terms the lay reader can easily understand.

Posner gained broad public notice in the 1980s as the leader of a scholarly movement that analyzed legal questions through the prism of free-market economics. He ordinarily gets categorized as a conservative, which is fair enough if you like one-word labels. He doesn't wring his hands over widows and orphans and sees the mission of judges as promoting unsentimental economic efficiency.

But Posner, a Reagan appointee to the federal appeals court in Chicago, is no party man. The main villains in our current financial saga, he argues, are Wall Street idol Alan Greenspan and the hapless George W. Bush. As chairman of the Federal Reserve, Greenspan propped up stock prices by keeping interest rates low. That policy fueled the borrowing boom that brought us toxic subprime mortgages, reckless securitization and the credit default swaps notoriously hawked by American International Group.

Bush, in Posner's telling, accelerated a decades-old deregulatory surge that allowed everyone from Bear Stearns to Bernard Madoff to run wild. Then, when the whole crazy casino showed signs of crumbling in 2008, Bush went AWOL, Posner writes: "The lame-duck President seemed uninterested in and uninformed about economic matters and was unable to project an image of leadership and instead spent his final months in office in frequent trips abroad and in legacy-polishing while the domestic economy melted away."

Posner knocks down greed or stupidity as a central reason for the crash. In his quirky way, he can't really understand the concept of avarice. He puts the word "greed" in quotes and follows it with the aside "whatever that means." Posner argues that one man's money lust is another's rational profit maximization. If you allow aggressive traders and investment bankers to do whatever they want, of course they're going to get into trouble!

He dismisses stupidity as an explanation, too, because, he contends, everyone knew exactly what they were doing. The home buyers knew they were borrowing too much. The lenders knew they were getting people in over their heads, and the Wall Street financiers knew that bonds confected from dubious mortgages weren't really safe. Everyone hoped that housing prices would keep rising so they could come out on top, no matter how unrealistic the whole hybrid pyramid-Ponzi scheme seems when you stop and think about it.

All economic bubbles eventually burst, and that's what happened to real estate. Rather than castigate greed or stupidity, Posner prefers to emphasize that smart regulators could have contained the damage. Greenspan could have put a floor under interest rates and taken the inevitable political heat. Other fans of the free market could have anticipated that deregulating trucking, airlines, telecommunications and energy — a policy that Posner generally applauds — didn't dictate also unleashing bankers. When trucking companies or airlines fail, they hurt themselves and their employees; when big banks fail, they send a chill through the entire economy that freezes credit and brings business to its knees.

Posner doesn't offer an agenda for reining in Wall Street. Perhaps he had moved on to the next three books he's writing — or his blogs. But even without constructive proposals for reform, his critique is bracing, all the more so because it comes from a right-leaning thinker normally hostile to the ministrations of government bureaucrats.

My only complaint is that his title is confusing. Rather than a failure of capitalism, Posner warns of the dangers of an absence of rational oversight. And his preference for calling our troubles a depression, instead of a recession, seems excessively bleak, at least for the moment. Let's enact some thoughtful regulation and hope for the best.

Paul M. Barrett is an assistant managing editor of BusinessWeek.

Reviewed by Paul M. Barrett, Washington Post Book World (Copyright 2006 Washington Post Book World Service/Washington Post Writers Group)
(hide most of this review)

Not shying away from calling the current economic crisis in the US a "depression," rather than a "recession," prominent judge and legal scholar Posner (who sits on the US Court of Appeals and is a lecturer at the U. of Chicago Law School) offers a general audience a review of the crisis, its causes, and the lessons that can be learned. He attributes the crisis to three key causes--excessive deregulation, neglect of warning signs (such as the massive rise in housing prices), and insouciance about the decline in the rate of personal savings and the safety of such savings--and calls for re-regulating, rather than restructuring, finance and banking, writing that comprehensive structural reform should wait for better days. Annotation ©2011 Book News, Inc., Portland, OR (booknews.com)

Posner presents a concise and non-technical examination of the current financial and economic disasters, and of the, as yet, stumbling efforts to cope with it.

The financial and economic crisis that began in 2008 is the most alarming of our lifetime because of the warp-speed at which it is occurring. How could it have happened, especially after all that we’ve learned from the Great Depression? Why wasn’t it anticipated so that remedial steps could be taken to avoid or mitigate it? What can be done to reverse a slide into a full-blown depression? Why have the responses to date of the government and the economics profession been so lackluster? Richard Posner presents a concise and non-technical examination of this mother of all financial disasters and of the, as yet, stumbling efforts to cope with it. No previous acquaintance on the part of the reader with macroeconomics or the theory of finance is presupposed. This is a book for intelligent generalists that will interest specialists as well.

Among the facts and causes Posner identifies are: excess savingsflowing in from Asia and the reckless lowering of interest rates by theFederal Reserve Board; the relation between executive compensation,short-term profit goals, and risky lending; the housing bubble fuelled bylow interest rates, aggressive mortgage marketing, and loose regulations; the low savings rate of American people; and the highly leveraged balance sheets of large financial institutions.

Posner analyzes the two basic remedial approaches to the crisis, which correspond to the two theories of the cause of the Great Depression:the monetarist—that the Federal Reserve Board allowed the money supply to shrink, thus failing to prevent a disastrous deflation—and the Keynesian—that the depression was the product of a credit binge in the 1920’s, a stock-market crash, and the ensuing downward spiral in economic activity. Posner concludes that the pendulum swung too far and that our financial markets need to be more heavily regulated.Read Richard Posner's blog,and his latest article in The Atlantic.

Richard A. Posner is Circuit Judge, the United States Court of Appeals for the Seventh Circuit, and a senior lecturer at the University of Chicago Law School.

1. The Depression and Its Proximate Causes
2. The Crisis in Banking
3. The Underlying Causes
4. Why a Depression Was Not Anticipated
5. The Government Responds
6. A Silver Lining?
7. What We Are Learning about Capitalism and Government
8. The Economics Profession Asleep at the Switch
9. Apportioning Blame
10. The Way Forward
11. The Future of Conservatism

• Conclusion
• Further Readings
• Index