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 allowing the 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.
Modern capitalism, it is argued, needs only a little government intervention, to function properly and effectively.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.
The Wall Street Journal crowd so argue. Republicans do, also. But there are imperfections that, left unchecked, do reverberate throughout the system, and, as is the case now, take it to the edge of cataclysmic collapse.
That same financial system, states Solow, has intrinsic characteristics that can make it self-destructively unstable when it meets a large shock. One such characteristic is asymmetric information.
Asymmetric information is that some people have more information than others. Other such characteristics are market imperfections (diverging prices for same security) and the ability of financial giants to raise large sums of credit, in amounts and ways that can affect the whole system, without anyone taking account of, or feeling responsible for, the systemwide effects.
Discussing leverage, Solow illustrates 10-1 and 29-1 scenarios, including making and losing money.
Why did I do such a risky and, as it turned out, stupid thing? Well, it had worked in the past, and made a lot of money for many people. If I had backed off, others would probably have continued to make money for a while. I would have looked like a fool, and very likely an unemployed fool.
... it is leverage that turns large banks and financial institutions into ninepins that cannot fall without knocking down others that cannot fall without knocking down still others. That seems to be the key to the potential instability of an unregulated financial system. It happens without any of the private actors violating the canons of self-interested rationality. Those canons would have been different if the SEC, the Fed, and other institutions charged with regulation had insisted both that all transactions be made public and that there be some limits on leverage.
The regulators, Greenspan, Cox, Donaldson, and Bernanke, too, kept hands off, letting the market self-regulate, following the Reagan mantra, that proved disastrous.
It is a noteworthy intellectual event that Posner has come to this understanding and expressed it forcefully and fearlessly. This same understanding must then also be the key to designing regulations that can reduce the frequency of financial crises like the current one, and limit the collateral damage to the real economy that they entail. Regulation should require that the uses and amounts of leverage, still largely hidden, be made public and that limits be set on the amounts of leverage that financial institutions can bring into play.
But the Wall Street Jounral crowd and the GOP still clamor for a self-regulating market and abhor the socialism they charge the President with instituting.
REP. JOHN BOEHNER, R-Ohio, House minority leader: What we see before us is a budget resolution that is nothing short of the most audacious move to a big, socialist government in Washington, D.C., than anything I could have ever dreamed about before I ran for Congress or, for that matter, any time over the last 18 years that I've been here.
Suntan John opines, and said so on the House floor.
Solow discusses the merits of Posner's use of the word depression, versus his use of the word recession. He goes on from there. Solow discusses the Fed's normal response to the recession of 2001, and cites Posner's discussion of the easy money period beginning then and lasting until the middle of 2004. Liquidity, a housing boom, and
certainly a further spurt. About 1.2 million private housing units were started in 1990, 1.6 million in 2000, and 2.1 million in 2005. Posner emphasizes the corresponding run-up in house prices, and he is right to do so. But the housing boom was not just a financial fact. By 2005 the country had clearly built many more houses, maybe two or three million more, than it could afford to occupy and finance. There would have been a housing slump in any case. We have had housing booms and slumps before, with consequences no worse than an interval of slow growth or a brief downturn, met with normal monetary policy and automatic fiscal stabilizers such as changes in tax rates or in public spending.
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