Lessons Learned and Soon Forgotten

One year after the collapse of Lehman, the controversial “rescue” of AIG, and the ensuing collapse of world financial markets there are two questions: what have we learned, and what good will it do us?

The second question is essential, because we have learned so much about the functioning of our financial system – and the three main lessons are all rather scary.

First, our financial system has become dangerous on a massive scale.  We knew that the banks were playing games, e.g., with their so-called off-balance sheet activities, but we previously had no idea that these huge corporations were so badly run or so close to potential collapse.

Second, we also learned the hard way – after many revelations – that pervasive mismanagement in our financial system was not a series of random accidents.  Rather it was the result of perverse incentives – bank executives felt competitive pressure to behave as they did and they were well-compensated on the basis of short-term performance.  No one in the financial sector worries too much, if at all, about risks they create for society as a whole – despite the fact that these now prove to be enormous (i.e., jobs lost, incomes lowered, and fiscal subsidies provided).

Third, weak government regulation undoubtedly made financial mismanagement possible.  But poorly designed regulations and weak enforcement of even the sensible rules were in turn not a “mistake”.  This was the outcome of a political process through which regulators – and their superiors in the legislative and executive branches – were captured intellectually by the financial system.  People with power really believed that what was good for Wall Street was great for the country.

But how much good does all this new knowledge now do for us?  There is very little real reform underway or on the table.  We can argue about whether this is due to lack of intestinal fortitude on the part of the administration or the continued overweening power of the financial system, but the facts on the ground are simple: our banks and their “financial innovation” have not been defanged.

In fact, they are becoming more dangerous.  The “Greenspan put” has morphed into the “Bernanke put”, to use the jargon of financial markets, where “put” means the option to sell something at a fixed price (and therefore to limit your losses).  The Greenspan version was always a bit vague, involving lower interest rates when a speculative bubble ran into trouble; the Bernanke version is huge, involving massive cheap credits of many kinds (as well as interest rates set essentially at zero).

Bernanke’s Federal Reserve has shown that, when the chips are down, it can save the financial system even in the face of unprecedented global panic.  But this will now just encourage more reckless risk-taking going forward.  In the absence of full re-regulation of the financial system, the Fed’s policies are asking for trouble.

Lou Jiwei, the chairman of China’s large sovereign wealth fund, summed up the view of big international financial players last week, “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that.  So we can’t lose.”

We have lived through a massive crisis – and learned how close we came to a Second Great Depression – yet nothing is now happening to prevent a repeat of something similar in the near future.

 By Simon Johnson

This is a slightly edited version of a post that appeared first on the NYT’s Economix blog.  It is reproduced here with permission.

71 responses to “Lessons Learned and Soon Forgotten

  1. Michael Brenner

    What then is the justification for not resisting Bernanke’s reappointment?

  2. Professor Johnson says “yet nothing is now happening to prevent a repeat of something similar in the near future.”

    Nothing?? Nothing is a very expansive and encompassing word. What about the work of the FDIC and Sheila Bair?? What about the work of Elizabeth Warren?? What about journalists like Matt Taibbi at Rolling Stone and Bill Moyers??

    It’s interesting to note in Professor Johnson’s diatribe he never mentions ONE politician. Unless you count the retired Alan Greenspan as a politician. If Professor Johnson is afraid to NAME NAMES in his criticisms, how can he expect others to be courageous in their actions??

  3. Daniel Habtemariam

    It’s my understanding that most observers are giving Bernanke the benefit of the doubt.

    After all, there are more than 1 Ben Bernankes (http://baselinescenario.com/2009/08/25/which-bernanke-whose-bubble/#more-4803), and it’s not easy to tell which one we’re getting next.

    And as cynical as this may sound, Bernanke’s shortcomings, when viewed against the strikingly more conspicuous and costly disasters of the last 8 years, are not worth protesting over all that much (yet). The President has bigger fish to fry at the moment, and since there’s still wiggle-room to forge some semblance of sensible re-regulatory legislation out of this, Bernanke’s being given a pass.

    We can criticize his methods, but it’s hard to deny that he put a stop to the bleeding last Fall. He hasn’t done anything to prevent future bleeding, but it took some gutsy moves to do what he did, and it’s more than we can say for most other Republicans in Washington right now.

  4. Bernanke’s Federal Reserve has shown that, when the chips are down, it can save the financial system even in the face of unprecedented global panic.

    This thing ain’t over by a long shot.

    Cheers,
    Carson

  5. Easy enough to pop those bubbles:

    http://www.nakedcapitalism.com/2009/09/a-shot-across-the-bow-debtors-revolt-watch.html

    Intriguing as her isolated call to arms may be, debtor revolt would be more effective if it drew on collective bargaining principles. You don’t have a labor force anymore, but you do have Mongolian hordes of debt peons, and collectively they have life-and-death power over the financial sector. Here’s a simple five-step plan to motivate some actual reform – or at least make lots of shite hit great big fans worldwide.

    1. Publicize the program: collective consumer debt renegotiation with targeted banks. If renegotiation fails, enrolled borrowers will repudiate their entire debt on a specified deadline.

    2. Enroll borrowers, who list the amount of their debts and their lenders.

    3. Identify the first target bank, using criteria that can include:
    • The bank’s financial vulnerability
    • Enrolled borrowers’ aggregate debt
    • The bank profile or notoriety.
    Screen lenders from among FDIC problem banks, bailout beneficiaries, or abusive non-bank lenders.

    4. Choose a percentage chargeoff to demand. Ideally, the reduction demanded in enrolled borrowers’ debts would not bankrupt the institution, but public repudiation of the enrollees’ entire debt would effectively make the institution insolvent.

    5. Announce the first target bank and date: on the specified date, the bank shall forgive X percent of enrollees’ debt or the enrollees will repudiate their entire debt and allow it to proceed to collection, at which point interest will no longer accrue.

    6. The immediate likely result would be disproportionate escalation by banks including government repression and attempts to criminalize the bargaining process. But the target bank is likely to be destabilized anyway, and the threat to other vulnerable banks could trigger another nice little credit event. Consumers will have asserted their power to dictate writeoffs even as government policy tries to defer recognition of losses. Real restructuring could begin with consumers at the table.

  6. “This was the outcome of a political process through which regulators – and their superiors in the legislative and executive branches – were captured intellectually by the financial system. People with power really believed that what was good for Wall Street was great for the country.”

    Oh my God, no, none of this had anything at all to do with convictions honestly held. The capture was financial, not intellectual. The critical people that came to “believe” that what was good for Wall Street was good for the country arrived at this understanding after taking a very hard look at the condition of their campaign war chests. These worms then appointed others who came to share their views, and so on. The sequence is the essence of simplicity, actually. I buy you and you are faithful to the terms of purchase. You come to prosper as a consequence and application of the same principles guides the particulars of your developing prosperity. And there I am at the top of the heap, calling the tune.

  7. I thought Alan Blinder would have been an excellent choice for Federal Reserve Chairman. But I guess with a job that carries so much responsibility, familiarity and on the job experience is a huge factor in the choice.

    By the way, Alan Blinder is one of the voices that has been calling loudly in the New York Times for more sturdy and better financial regulations.

    http://www.nytimes.com/2009/09/06/business/economy/06view.html

  8. When people begin discussing Narrow/Limited Banking, then I’ll take seriously the idea of real change. Absent that, I don’t see any other viable option than supporting any change that might work, however weak. Indeed, we might have to consider Gorton’s idea about guaranteeing everything, since that’s what we will always end up doing if a financial crisis occurs.

    I know that these ideas seem dated to many, but anything less relies on the same underlying principles of our current system, which has its own inevitable logic of drifting towards regulatory ease, and the inability to lean against a breeze, let alone a wind.

  9. Ted K: “It’s interesting to note in Professor Johnson’s diatribe he never mentions ONE politician. Unless you count the retired Alan Greenspan as a politician. If Professor Johnson is afraid to NAME NAMES in his criticisms, how can he expect others to be courageous in their actions??”

    Yeah, that’s why we call him “gentleman Simon”. We don’t want to change him. We want him to keep doing what he does best: be an intellectual leader.

    But we also need another kind of leader: a leader in action, a modern Che Guevara who will organize us and guide us into a long, grueling but in the end rewarding guerrilla against finance and other rent-seeking parasites of our society.

    There’s no other way. They have a tight grip on us and, as prof. Johnson said, “Why would they ever let go?”

  10. If the Bad Version of US health care reform goes through–likely–we will have tens of millions of people required to buy health insurance at unregulated rates. This will be good for us corvids. But you hominds might want to consider the problem of insurance companies sopping up all the income that millions of people might otherwise save or invest.

  11. “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”

    Right. What could possibly go wrong?

  12. Doing my best Italian American accent “Fuget about it!!!”

  13. Alan Greenspan is a total politician. Think Social Security commission and the great condemnation of the budget surplus in 2000 that he said threatened the health of the American economy.

  14. Inciteful comment.

    We probably want someone who manages to not get shot in the jungle by the CIA this time though.

    Btw, I’m a bit of a bungalowbill myself. I think it was just a week or two ago that I advocated a bungalow and yard for every family (that wants one. Some people just prefer yurts.)

    As for the leader. Doesn’t matter who pops up because it will invariably be someone who’s either been captured already, or will soon be. The world will be much better off if we just throw most of our money and brains at eliminating the need for our bodies.

  15. Can we have clawbacks too? Love those clawbacks.

  16. I think the federal government needs to focus on one major issue at a time. They’re working on healthcare now and until they pass that legislation I don’t expect them to work on a coordinated basis to pass comprehensive financial regulation.

    Personally I think the FBI should prosecute people up and down this chain of financial corruption using the RICO Act. There are people at every level that should be prosecuted – from those that approved mortgages to unqualified borrowers to those that bundled the bad debt into investment products to those that rated the investment products AAA. The profits they made should be clawed back and the executives at the top that called the shots should spend time in jail cells next to Ebbers, Madoff, Skilling and Kozlowski.

    I’m glad to see that Calpers filed suit against Moody’s, S&P and Fitch for their part in rating SIV’s triple A. Hopefully the court will severely punish them for the part they played in looking the other way and passing the buck.

  17. Turn over a few rocks at CalPers and their external “consultants” and you’ll probably find plenty of complicit worms.

  18. Let’s not forget his tireless advocacy to deregulate derivatives.

  19. It is a little like Soviet Russia, when people could not talk openly about such things.

  20. That’s not a problem.

  21. Someone hasn’t been paying attention during the past 230 years. These people never go to jail in any numbers. When public pressure gets too great, there may be some token prosecutions.

  22. Something tells me this guy is not even fishing, and if he caught one by mistake, he would definitely not fry it.

  23. Uncle Billy:
    ‘Eliminating the need for our bodies’ (greek to me)

    Won’t that be a little inconvenient? Maybe just a little more elucidation? s’il vous plait (french).

  24. What about Scott Summer’s recent post at VoxEU?

    “Here is a puzzle. Almost everything we have learned from recent research in monetary history, theory, and policy points to the Federal Reserve as the cause of the crash of late 2008. More specifically, an extremely tight monetary policy in the US (and perhaps Europe and Japan) seems to have sharply depressed nominal spending after July 2008. And yet it is difficult to find economists who believe this. More surprisingly, few economists are even aware that their views conflict with the standard model, circa 2009.”

    Basically, monetary economic orthodoxy (which Summer claims most economists are forgetting) states that nominal interest rates are a a very poor indicator of monetary policy. For instance, the Fed heavily cut its discount rate during the Great Depression, but obviously no one would say that money was easy during that period. And in fact, the Fed has been paying banks to hold onto the money that it has been pumping into the financial system:

    “Even worse, most economists ignored the Fed’s 6 October 2008 decision to start paying interest on reserves – which meant the Fed bribed banks to hoard all the extra liquidity they were injecting into the system. If this sounds unfair, consider that the Fed itself indicated that these payments were necessary to prevent market interest rates from falling; an explanation that Woodward and Hall (2008) correctly described as “a confession of the contractionary effect.””

    In short,

    “If I am right, it was a massive intellectual failure within the economics profession, not reckless bankers, that caused the crash of 2008. This was a failure to trust our own models.”

    Thoughts?

  25. The lesson learned seems to be that you can squeeze blood out of stones, but the question remains how much blood and for how long? The current health care fix will increase the squeeze on consumers. Jobs are still being cut, mortgages are not being adjusted in numbers that matter, credit card debt is shrinking not growing. I suspect the Geithner Bernanke claims of victory are premature. Looks like a good trade war recipe.

  26. “The immediate likely result would be disproportionate escalation by banks including government repression and attempts to criminalize the bargaining process.”

    Yes, that would be the response. The banks would undoubtedly, and somewhat cynically, employ antitrust regulation. But it would force the issue, if the movement was large enough. Otherwise it would merely allow the banks to make an example of the organizers.

    That is the nature of rebellions.

  27. À l’avenir, nous serons en mesure de nous-même telecharger lorsque notre cerveau peuvent être numérisés.

    http://www.associatedcontent.com/article/803149/the_ability_to_download_a_human_brain.html

  28. To paraphrase: we caused everything because we were right, but didn’t trust ourselves that we were right.

    Next time, we should have that kind of cocky confidence that comes from being right all the time.

  29. What? To paraphrase, Summers is saying that monetary policy was contractionary, and that this caused the crash in 2008.

  30. Much of this debate has been put off, for better or worse, until after Health Care. I get why, but everyone is right that delay is the enemy. I’m quite certain the banks and their industry groups and their PR groups are quietly lobbying Congress, and preparing their public relations blitzes, for the end of the health care debate. That’s when they’ll kick into high gear. In the meantime…

    The #1 domestic item (in terms of financial regulation) that seems to be on the table right now (even though it’s not at the forefront in Congress) is who gets to own the regulation. Odd as this may seem, and as much as it may look like rearranging the deck chairs on the Titanic and intra-bureaucratic feuding, it’s critical. And I think this is the issue that is being fought right now on Capital Hill (behind closed doors).

    We _know_ Bernanke gets to keep his job another 4 years. That’s a done deal.

    What we don’t know is whether the Fed gets split, or not. And it’s critical that the Fed NOT continue to own all financial regulation. The Fed must not get rewarded for its failure with more power merely because it rose to the occasion at the 11th hour (at tremendous cost to everyone)…

    http://baselinescenario.com/2009/07/21/three-myths-about-the-consumer-financial-product-agency/

    Some suggested post topics:

    “The Fed cannot have two masters”

    “Salvation is Getting More Expensive”

    “What Would James Madison Do?”

    “Super-Bernanke vs. his Evil Twin from Bizarro World”

    (I thought about Green Lantern, but Greenspan reminds me more of Sinestro.)

    The international issues may be even more important than the domestic issues right now, but they don’t seem to resonate with the public. They are shaping up as a massive technocratic clusterfest. a la exactly this…

    http://baselinescenario.com/2009/09/08/g20-summit-imf-meeting-what-to-expect/

    I thought that post was _great_, but note that it only got 31 comments… vs. the typical 80+. Hmmm.

  31. Before Elizabeth Warren’s TARP committee Thursday, Treasury Secy. Tim Geithner said those banks who haven’t aggressively renegotiated morgtages will face specific “consequences,” among them audits. It was a serious threat, seriously made, I believe.

    He also stressed several times that the government needs the ability to unwind TBTFs, as has Bernanke: No bailouts next time is the message there.

    Warren, of course, zeroes in on the poor assets still on bank balance sheets. She asked for a specific number, but Geithner avoided answering. She did get from Geithner a promise to provide her committee with details of the stress tests. Warren wants to have her group run the tests with different assumptions.

    She also wants to apply a modified stress test to, say, the next 100 banks in size. Geithner said, in effect: Not happening. So she wins one and loses one.

    Geithner is flexing some muscle in public. Interesting.

    He also reaffirmed his support for the proposed Consumer Financial Products Agency, a favorite of Prof. Warren, an expert in this area and probably a short list candidate for Chair of the CFPA. But Bernanke is opposed, so far, to the CFPA.

    Interesting cross current speculation(s) seem to be opening up. I sense that, in particular, Geithner is becoming more comfortable with his place in the administration and is starting to publicly nudge things where he wants them to be.

    Maybe he is a regulator after all. That would be nice.

  32. Sumner’s argument is primarily about targeting of norminal GDP growth expectations. If applied, the regime is stablizing to the nominal growth trajectory, which can avoid some serious problems (like debt deflation on one side, and hyperinflation on the other… and probably mitigate unemployment spikes). Even in the absence of August 08, this regime would have yielded MUCH more rapid and purposeful Fed action in October.

    He will argue that nominal GDP negative growth is poisonous, and would also argue that avoiding it is not that hard. It’s a sophisticated argument. But he is also among the first to admit that it does not address the structural issues with the economy – we can have great nominal GDP growth even while life is getting worse for everyone. (But, unlike Baseline, he is quite anti-regulation in most cases and a strong advocate of the EMH.)

    Sumner is right that the Fed did engage a relatively tight monetary policy in summer of 08 (tight relative, for example, to the optimal Taylor rate projections). And this, probably exacerbated existing problems. The degree to which this caused the traumatic events in September/October is debatable.

    Also, Sumner admits that his focus is mostly on the domestic side, and his argument (which faults the Fed for bad monetary management in summer 08 due to strict rules) does not account for the fact that the Fed may have engaged tight policy to defend the dollar against a perceived currency flight during the commodity bubble. In other words, the Fed actually DID (at long, long last) try to pop a bubble – the commodity bubble – but they did it with a big crude sledgehammer.

    The strength of Sumner’s argument lies in generating a semi-automatic mechanism for targeting the _expectation_ (currently, the Fed targets existing inflation, which is backwards/present looking not explicitly forward looking), and also in focusing more on Nominal GDP than on inflation.

    Baseline’s primary counter to Sumner’s argument is the moral hazard created by the knowledge that the Fed is engaging a specific regime that has the goal of always cleaning up messes. Thus, the cleanup cost becomes higher with every iteration, and the incentives reward extremity. Sumner’s riposte would probably be that his regime would prevent the bubbles from growing too big in the first place.

    But again, Sumner’s argument (here) says little about the structure of the economy. We can have 5% nominal GDP growth, and full employment, with everyone engaged in rent-seeking financial innovation. That doesn’t mean life is better. Just that everyone is being kept busy.

  33. Interesting post and comments made on the anniversary of the day the Twin Towers came down.

    To leave bankers blameless is a big crock of BS, however. Plenty of blame to go around.

    As a consumer – a financial illiterate – I simply cannot understand how so many fraudulent loans were made to so many people who could not afford them – and how the very brightest and most highly compensated and most financially literate people in the world would commence to package up junk and sell it off like it’s a AAA commodity without full knowledge of what they were doing.

    They knew what they were doing – they knew it was wrong – but they made enormous profits.

    So they didn’t care. Why should they? There are no penalties for behaving as they did and the feds were there with TARP to catch them as they fell. But if you weren’t a bank, there was nothing propping you up.

    So the economy collapsed as the financial sector was saved.

    How did Henry Paulson, who was CEO of GS when the firm sold off its MBSs, realizing how dangerous they were, remain ill-prepared for the hammer that hit when everyone else realized they were garbage too? In the VF story, he talks about how he felt he was always behind the curve in this crisis. But when he knew just how dangerous those MBSs were to GS’s books – could he fail to see how dangerous they’d be to the rest of the country? Why did he take no action prior to the collapse?

    And what have we seen since Paulson initiated TARP a year ago? TBTF is even bigger. We’ve seen the socialization of their losses and the privatization of their profit.

    All while the economy of the country has been in a freefall.

    Not everyone was engaged in rent-seeking activities. And unfortunately, those people are most likely to be out of a job.

    And we are moving forward without moving outside of the shadow cast by the moral hazard. The financial sector remains a ticking bomb, waiting to blow up again. Though I’m not sure even the feds will have the funds to bail them out next time.

  34. Focusing on health care first, when they’d been handed a bomb by the financial sector, is a crucial error made by the Obama administration, IMHO.

  35. When the incentive is to only get reelected and to hell with what is good for the country..and getting elected in dependent on the banksters cash guess what side wins

  36. Or in immediately pre-Hitlerite Germany, say late 1932, where you could talk openly about it but where the Nazis were already in the Cabinet and you knew that they were taking names.

  37. I’m not hopeful we’ve learned anything at all from the catastrophic collapse of our financial system.

  38. That will never work, Uncle Billy. The parasites need our bodies to extract blood from. Let’s be reasonable, here.

  39. StatsGuy: a thoughtful response, cheers. Be interesting, when this all calms down, to hear Fed decisions makers explain their various responses. I have no idea if the Fed was trying to pop a bubble, and so kept a tight money policy. It certainly doesn’t sound like typical Fed behaviour to me, but that’s not to say it isn’t correct.

    I don’t know if your (baseline) response really holds. Isn’t the Fed creating moral hazard anyway?

    Finally, not sure that Sumner needs to address the structural problems with the US (and other OECD) economy in a single article for VoxEU, though agree that these are significant.

    Anne: There is indeed plenty of blame to go around. But I don’t read Sumner as letting the private sector off (and I think, IIRC, Sumner distinuishes between ’07 and ’08 crashes). Was Fed policy contractionary? If so, what was the effect? Sumner could be right on both points and it still wouldn’t absolve the financial sector for bad decisions, nor would it justify the way that finance is swallowing the rest of our economies. I mean, you could easily make the same argument about the Great Depression…

  40. What do you mean, “we”?

    The banksters learned that when they gamble and win, they get to keep the profits. And when they gamble and lose, the Fed and Treasury let them hand the taxpayers the bill; and then they get bigger at the expense of those who are too small for the Fed and the Treasury to worry about. The banksters orchestrated the largest transfer of wealth in world history through two administrations.

    So the banksters have learned.

    What have WE learned?

  41. Also, I disagree that Sumner is a strong advocate of the EMH. This is Sumner in the comments section to his blog:

    “Thus perhaps those people who don’t believe in the EMH might be precisely those people who make markets irrational.”

    So, markets can be irrational, and furthermore, EMH is performative. This is pure Donald MacKenzie!

  42. In the last couple of weeks, I’ve learned that I need to spend more time thinking about accounting.

  43. Actions speak louder than words.

    Sumner may not be letting the private sector off, but in the year that has followed the collapse of Lehman, the financial sector has been left off the hook for their terrible business decisions.

    And in fact, they’re reaping a nice profit this year.

    Nothing at all has been done to this point to change how the financial sector does business. They still are paying bonuses for short term performance. They are still engaging in risk. They might not be leveraged 35:1 today, but there is nothing stopping them from going crazy with debt in the future.

    And the TBTF institutions are even bigger today, which means tax dollars will continue to pour into belly of the beast – “or else….”

  44. D. Christopher Leonard

    There are at least two analytically distinct problems, one, what kind of new regulatory regime should be constructed and which agencies/institutions (e.g. Fed, Treasury,Office of thrift supervision,SEC) should play what sort of roles – and whether having oversight spread amongst a host of agencies (even assuming they act as they ought) will be effective and desirable. The second problem is more broadly political in that there is an assumption that a significant bloc in the congress actually will support real reform. Looking at the bi-partisan support over the years for (for example) regulating derivatives or hedge funds, the broad support for rescinding Glass-Steagel, and so forth. With the exception of Frank in the house,I don’t see much hope. Dodd is a captive, ditto Schummer, there is no one of any intellectual stature on the other side of the isle. In other words, where is the constituency for real reform? It doesn’t exist. E. Warren, S. Johnson, Stiglitz, Baker and others may testify with sensible policy proposals until the cows come home, senate and house committees will make appropriate hums of apparent cognition and agreement, and nothing will come of it.
    The administration (as with healthcare) may have usable and worthwhile policy initiatives but will be sabotoged by his own party. Think about the demise of the second new deal in 1938. It was a coalition of democrats (lots from south) who broke ranks. The same goes for the Johnson administration’s push towards a more social democratic approach (e.g. the cluster of programs associated with ‘great society’) – again, it’s his own party that knee-capped him. There historically hasn’t been much appetite for serious reform historically. Lots of feather-waving during the crisis, and then back to business. I think the intensity of anti-statist Jeffersonian republicanism melded with populism always gets under-estimated – like not acknowledging a lethal gene.
    The problem at core is political.

  45. Uwe Reinhardt here talks about American “social insurance”. The finanical bailout is — social insurance. — Disaster relief for owners of beachfront homes hit by extreme weather is social insurance. But there is no relief for many Americans in need of a decent health care system. In Uwe’s opinion Americans society is immature. It is like a teenager who refuses to be reined in. But runs home when the going gets tough. Ie, ‘when the going gets tough the tough run to the government.’

  46. Kindly put: immaturity a colollary to irrational exuberance.

  47. It is impossible to disentangle all the forms of capture, here. But I will note this – in a “crude” capture world, we would expect to see the legislature passing unpopular bills that are favored by strong constituencies. Some of this certainly occurred – for example, the 2005 bill that made it more difficult for consumers to clear debt through bankruptcy.

    But much of the legislation that was passed was broadly popular in its deregulatory intentions – not just with politicians, or the general public, but with economists too. EVERYONE loved deregulation. Anyone who spoke out against it was a socialist and a fringe lunatic. Indeed, even in the case of the anti-bankruptcy bill, many Republicans were arguing that it was designed to prevent “abuse” of the system by dishonest consumers.

    That’s why they called it the “Bankruptcy Abuse Prevention and Consumer Protection Act” (lovely bit of Orwellian wordsmithing there)

    The assailants of this bill were primarily attacked as bankruptcy lawyers and leftists, whom everyone despised – try to remember 2004 and 2005, and the haughty attitude of the Congress/Administration at that time (and the party that owned 3 branches of government).

    Here’s a refresher:

    http://www.nysscpa.org/cpajournal/2006/1106/essentials/p36.htm

    So you can argue for “crude” capture, but the fact of the matter is that the US government was far more transparent in 1993 through 2000 (when much of the deregulation was passed), and even in 2001 through 2008, than in the 1950s and 1960s. We’ve _always_ had crude capture, so why the sudden deregulation in the post 1980 world?

    The change was in the terms of the debate, and that’s ideological/intellectual capture. Blaming corrupt politicians is an easy out, but an insufficient explanation.

  48. Anne — but that has nothing to do with Sumner’s article.

  49. Here’s a topic for a future post:

    Can all current economic problems be solved by paying everyone more to work (fewer hours) in more socially valuable occupations?

    Now that we know that “the free market” doesn’t do this automatically…

  50. Or accounting without accountability.

  51. One expects that you would see the next anti-Iranian resolution clearing the House with less than the 95% majority the last one got, eh, and that being simply one of many in the cause of “explanations”, of course. :-)

  52. What the difference between a distinct problem and an analytically distinct problem?

  53. Why do not we in the USA start thinking globally when dealing with the US banking crisis? The UNCTAD Trade and Development Report of 2009 and yesterday’s press conference of Dr. Stiglitz and UN General Assembly President about their Commission’s Report analyze the crisis exhaustively and, more importantly, come up with some outstanding proposals. The two reports together with a blog about it can be found on the website of the International Institute of Monetary Transformation, http://www.timun.net.

  54. vimothy

    As you do, keep in mind that accounting is a business strategy that runs subject to a double-entry bookkeeping framework of rules. It is the proper bookkeeping framework that is missing in today computer driven accounting systems. With the proper double-entry framework missing accountants have a license to steal. Computer records that fail to have double-entry’s audit trail, along with a detailed cost-accounting, becomes as opaque as opaque can be. There is not a regulative genius alive that will come up with sound rules for banks without insisting that the 670 year old bookkeeping technology be enforced first.

  55. In retrospect, I agree. I don’t know that I was wise enough to foresee the extent of the health care quagmire several months ago, however.

  56. We knew last January how sick our financial sector was – so we turned our attention to … health care reform?

    That’s what puzzles me. We cannot afford another financial meltdown. And we’ve done nothing to prevent one from happening again.

  57. CBS from the West

    Let me play devil’s advocate here. I don’t think the following, ironic scenario is likely–but it seems possible:

    “Health care reform” that comes out of Congress is probably going to include an individual mandate to purchase health insurance. It seems unlikely that there will be any substantial or meaningful changes that will control costs or improve care–Congress is not going to bite the insurance and health-care hands that feed it. Yes, there will be some subsidies for the purchase of health insurance–but as Congress tries to hold the costs to something the CBO won’t choke on, those will be meager and only the most destitute few will qualify for them.

    People will wake up a little later and realize that they have been moved from being unable to afford health care to having all the health care they can eat, but unable now to afford housing, food, clothing, education, transportation, energy, etc. This _could_ provoke a huge outcry, stirred up by both cynical political exploiters and people who are genuinely repulsed by this outcome. The pitchforks may come out. The intensity of the uproar could force Congress and the President to actually do something real about the financial system to try to quell the uprising. The financiers could turn out to be the unintended victims of a misguided health care “reform.”

    Again, I don’t really think this is likely–but it’s something less than far-fetched. And it may be the best we can hope for.

  58. To CBS from the West…

    Hopefully your ironic scenario was not the desired goal of the Obama administration’s push for health care reform at this time….

    And the scenario you paint is NOT the best we can hope for.

  59. “Second, we also learned the hard way – after many revelations – that pervasive mismanagement in our financial system was not a series of random accidents. Rather it was the result of perverse incentives – bank executives felt competitive pressure to behave as they did and they were well-compensated on the basis of short-term performance. No one in the financial sector worries too much, if at all, about risks they create for society as a whole – despite the fact that these now prove to be enormous (i.e., jobs lost, incomes lowered, and fiscal subsidies provided).”

    This is news? The short term focus of Wall Street, high finance, and the economics profession is not anything new. As for worrying about the economy as a whole, it is easy to convince yourself, particularly in America, where the business of the country is business, that what is good for you is good for the country. As for why risk was miscalculated, it is partly theoretical, and partly good old fashioned greed.

    “Third, weak government regulation undoubtedly made financial mismanagement possible. But poorly designed regulations and weak enforcement of even the sensible rules were in turn not a “mistake”. This was the outcome of a political process through which regulators – and their superiors in the legislative and executive branches – were captured intellectually by the financial system. People with power really believed that what was good for Wall Street was great for the country.”

    Yes. Despite the wake up call of the S&L crisis, deregulation proceeded apace. It is not clear that even the recent crisis has changed many minds about that. Ex-president Clinton defended the repeal of Glass-Steagal, saying that integrated financial corporations weathered the storm better, missing the systemic point. In addition, the fact that actions by the Fed and the Treasury apparently did prevent a depression means that people can say that the regulatory system worked as intended.

    The U. S. has had welfare capitalism, with, as Garrett Hardin put it so well, privatization of profits and commonization of costs, for so long, that the capitalist recipients of government largesse believe that it is their just due. The populace also believe in the system, casting blame only on certain individuals who appear to be unjustly enriched.

    None of this is particularly new. Unfortunately, reform does not usually result from Cassandra warnings, but from actual disaster. I am afraid that that will be the case here, as well.

  60. Yes, Sumner’s arguments are more about efficiency than justice. He’s a pragmatic libertarian; I do like reading his stuff even if I disagree much of the time.

  61. Yes, Simon, and between the lines in your article one reads that the capture of our government by the financial sector is still complete and threatens to stay that way. The issue of course is, what will the double dip precipice toward which we are heading mean to our global economy. That could be true and uncontrollable catastrophe!! Stiglitz recently speculated that the infamous “W” recovery (non-recovery) is on its way, and I find it hard to argue. Without taking away the infinite powers of the financial oligarchs, thing will absolutely go from absolutely barely mediocre to absolutely abysmal quickly, and then the “L” can become perminent without question. I think that by not letting the biggest financiers fail, we simply postponed the tragedy and guaranteed that when it next happens, the size will be an order of magnitude larger, because the costs to each of us will be too great to bear, and because the government will be completely out of the necessary resources to cope.

  62. I haven’t read much about it (Kurzweil would be a great start) but it basically solves all of our conflict, disease, etc. No more need for neo-con scumbags, or those nutty marxist revolutionaries. Yakkis nailed it below — download our personalities into some sort of stable vessel. This is the end run we need, i think. Got a sick need to wage war? Knock yourself out with thousands of years of scheming and death. Economist who still believes in models? Spend the next millenium running scenarios. A few problems: the upkeep. We’ll have to solve that problem when we get to it as we don’t know what we need to protect and maintain yet. Will it serve any purpose at that point to maintain individual personalities? Or would we be happier functioning as one big brain? My kid mentioned today a practical question to… what do we do with all the meat? (The bodies). We download ourselves, and then we just let the body die off? Presumably it still has a personality, unless we somehow erase it. If we have people still walking around after the download, they will want to procreate and produce more of themselves — what to do about this? Hopefully we’ll find out in the next 5,10,20 years; I’m getting sick of how backwards we are.

  63. Looking at this from a more simplistic and historical view this economic crisis was bound to happen and will happen again until we examine the more fundamental flaws in capitalism and try to overcome them which is not an endorsement of state socialism.

  64. as to uploading our brains (I love mine so I’m adamant about refusing to DOWN-load it – if that’s the wrong term let “them” fume)

    ages ago there was a guy named Joseph Weizenbaum at MIT who wrote a quite simple computer program named ELIZA modelling some kind of psychotherapy question and answer back and forth
    – then the amazing thing happened that people all over the place started to talk to Eliza as if she were the real thing http://en.wikipedia.org/wiki/ELIZA

    – today a lot of the amazement I felt when I first heard of it has faded. Something that seemed once so absurd and idiotic has long long become part of our daily lives
    – so if we manage to be perfectly content with having a programmed partner to talk to, the step to becoming one ourselves should not be such a big one anymore

    – as to the bodies – discard them, after all we get told day after day what a sloppy design they have that will be the greatest benefit to be able to get rid of them – make the machines with our up-loaded stuff in them self-repairing or have them maintained by the machines who are equipped with the up-loaded brains of mechanics. No more procreation of course or only very limited of brains only under controlled lab-conditions – “immoral” action as much as you like of course – solves all the problems – you can fix the population at sustainable levels global warming will heal no more messy agriculture etc. etc.

    I see great potential for a future in that … hopefully it takes enough years to implement for me having left the natural way

    Yakkis: I guess it should be “nos cerveaux peuvent” … ;-) http://fr.wikipedia.org/wiki/Cerveau
    if you scroll down there is a link to something mysterious called “trois cerveaux”

  65. They, the regulators, have yet not learned that since the market prices risk in terms of interest rates spreads when they introduced their “risk weights” immense confusion ensues and signals were obscured since now no one knows for sure whether the low spreads are the result of low risks or the result of low capital requirements for banks.

  66. But that would include a former US Treasury Secretary. Ahem…we can’t have that now.

  67. Verbindlichen dank gnaedige Frau :)

  68. If I want the same capital requirement on all bank lending, so as not to arbitrarily discriminate on risk, and if I want to reduce the credit rating agencies to what they were before, namely pure information providers instead of officially endorsed credit guides, what am I, an anti-statist Jeffersonian republican or a populist?

    And if I do not get the above and therefore request that bank lending be subjected to some capital requirements based on “purpose weights” also; so that we do not finance excessively anything just because it has a low risk, or to help finance what is important though risky, am I then called a socialist?

  69. And then things will really get nasty as some got downloaded upwards on Macs and other on PCs and society degenerated into swapping files and frantically accumulating rams as if these were pure good old gold.

  70. Ted, Tabibi wouldn’t know about a fact if it walked up and punched him in the face. When we have these fourth rate journalists writing nonsense articles which help cause the problem in the first place…