A Failure of Capitalism is Richard A. Posner's – Adjunct Law Professor at the University of Chicago Law School and Appellate Judge (U.S. Seventh Circuit) – second most recent book (his forthcoming book is on the economics of marriage and terrorism). Richard A. Posner is amazing. He must write every day for hours and is not accustomed to being edited. Almost all of his words are posted, published, or filed: he has published 53 books; writes most of his own judicial opinions, unlike most other judges; in addition he blogs with Gary Becker, one of the leading figures of the University of Chicago economics school of thought.
This book – explaining the causes of the ongoing savage recession (I'm writing the review in Fall 2010) – is a publishing feat having been completed with astonishing speed, by February of 2009 within five months of the start of the financial meltdown. (The book is short, but it could have been shorter. Harvard University Press clearly welcomed a crash-book; at heart it is two long essays on the proper government responses to the recession and why most explanations for the crisis are wrong.)
Posner dates the crisis to the collapse of Lehman Brothers in August 2008 (Chapter Nine on ‘Apportioning Blame’ blames the government for letting Lehman Brothers fail) which might explain the book's panicked tone – ‘I do not know when the recovery from this depression will begin’ – and he acknowledges the gravitas of a runaway recession: ‘Had it not been for the Great Depression Hitler would not have become chancellor of Germany’.
Though pension funds and DC funds constitute about 40% of assets under management of U.S. asset managers, unfortunately, Posner ignores their role. Institutional investors and pension fund behavior matter. Most regulators and commentators focus on the, admittedly fascinating, supply of exotic financial products that were under-regulated and implicated in the crash: CDOS, swaps, NINJA Loans. But his focus has a cost. It ignores the source of demand for what would become ‘toxic assets’.
Much of the demand for these financial products came from institutional investors, as well as banks. Alicia Munnell's prophetic argument, in the late 1990s, placed blame on pension practices for fueling a stock market bubble. This was her argument: excessively high assumptions about rates of return to DB plan contributions reduced corporate contributions, which increased profits, which inflated stock prices, which encouraged high rate of return actuarial assumptions.
I, and others, have argued that workers' attraction to 401(k) plans was also fueled by advice that stock prices would remain high so that employers could substitute 401(k)plans for DB plans without worker protest or demand for higher pay or better working conditions. This substitution also reduced total company pension contributions even further, which in turn raised stock prices, which reduced household savings in boom times. These are perverse effects that destabilize the economy.
Therefore, the structure of pension funding fuels bubbles and makes recessions worse. Pension institutions did NOT do what they were supposed to: they did not help workers or companies accumulate surpluses in good times and have let them reduce funding in bad times.
Posner gets to this fundamental cyclical problem; but, it is too bad he didn't connect the dots by analyzing the behavior of pension funders. He wrote, ‘in the topsy-turvy world of depression economics, it is possible to argue almost with a straight face that people should save when they are flush and spend when they are broke – and that inventory that builds in a depression should be destroyed to stimulate new production’. That, of course, is the insight of the macroeconomist.
Posner is savagely critical of Alan Greenspan – 19 years Chairman of the Federal Reserve under Presidents Reagan, Bush, Clinton, and Bush – for dismissing, and thus not planning for the possibility of a drastic fall in asset values and the consequential ripple effect on banks. Posner identifies Greenspan's libertarian ideology and overconfidence, fueled by being lionized in the press as a great economic thinker and steward (and a too-long tenure at the Federal Reserve) for allowing the Federal Reserve to approve the deregulation of the banking industry. This deregulation was promoted by Clinton's and Obama's advisors, Larry Summers and Robert Rubin. Posner surmises the deregulation was motivated by self interest: Rubin had been the CEO of Citicorp and deregulation expanded greatly the profitability of the biggest banks, including Citicorp. Posner allows for the enormous political influence rich banking corporations have over politicians.
Posner certainly rejects behavioral economics' explanations for the crash. Rationality, not irrational exuberance, was at fault. He argues that capitalism is Darwinian: lions eat zebras, but one can't blame lions for depleting the zebra population. So, his metaphor extends: like lions, banks rapaciously leverage if they can get away with it. ‘But although financiers bear the primary responsibility for the depression, I do not think they can be blamed for it – implying moral censure – any more than one can blame a lion for eating a zebra.’
Posner also rejects the idea that stupidity, inattention, or criminality on the part of bankers or subprime borrowers caused the crash. He blames macroeconomists, like University of Chicago economist, Robert Lucas who declared depressions a thing of the past in the mid 2000s. Posner is a Keynesian: he argues that businesspeople, consumers (and lions) cannot take into account the collective and disastrous effects of their behavior when their behavior serves their individual short term needs. Posner wants government to intervene.
However critical of libertarian Greenspan and optimistic macroeconomists and forgiving of bankers and borrowers who acted in self-interest, it is clear by the end of the book, he places blame for the crisis solely on the government. ‘Laissez–faire capitalism failed us, but government allowed the preconditions of the depression to develop and wreak havoc on the economy.’
Posner's remedies are derived from fairly conventional neoclassical, conservative economics. He recommends government regulate leverage and bail out big banks (he opined the Federal Reserve should have saved Lehman) but he argues Bernanke's aggressive activist monetary policy is ‘potentially more socialistic’ than Obama and the Democratic Congress's stimulus plans.
He hearkens back to history to prove the folly of government. He saw Roosevelt's New Deal program as overstepping – he disapproves of the National Labor Relations Act, which provided the framework for unions and collective bargaining and, thus, most of the nation's defined benefit pension plans, which were the precursors to 401(k) plans. (Posner seems unable to resist a swipe at unions, though not anywhere implicated in the crisis. He takes three pages dismissing the auto bailout wrongly predicting the United Auto Workers would refuse to make substantial concessions.)
Posner argues that the only appropriate fiscal stimulus to create jobs is massive military spending (production of weapons and equipment is primarily American) and infrastructure.
Posner wrote in the heat and panic of the beginning of dizzying recession; then unemployment was a terrifying 7.5% (!) and rising. Essentially this is a political book – which is quite ambivalent and, thus, confusing. The last sentence warns of the dangers of government action (though he argues government must step in to blunt the recession): that activist government stimulus and banking reregulation may leave an overhang on the economy, ‘as when an expensive treatment cures a deadly illness but leaves the patient debilitated’.
