Crisis of Capitalist Democracy [Hardcover]

This is a substantive book, all 400 pages of it, not necessarily an easy read. But that's really okay, because the topics covered and questions addressed are very important ones. As author Richard Posner writes in the book's last chapter, "The question I want to leave the reader with is whether the United States has an institutional structure and a political culture equal to the economic challenges facing it." That's really the big issue at the heart of this book, although there is plenty of supporting economics, discussion and commentary that occupies the book's chapters.

I'm guessing that you may already have heard of Richard Posner. If not, he is Circuit Judge, the Court of Appeals for the Seventh Circuit, and he is a well-known senior lecturer at the University of Chicago Law School. He is often described as a libertarian, although he seems to keep an open mind. (For example, he criticizes Alan Greenspan--a lot--and spends more space writing about John Maynard Keynes than you might have guessed. In his nonpartisan approach, Posner criticizes some of both President Obama's and President George W. Bush's policies and actions.)

This book follows Posner's (slightly) earlier book, A Failure of Capitalism, although he states that this book, The Crisis of Capitalist Democracy, is not intended to be a sequel. A Failure of Capitalism takes readers up through February 2009, and The Crisis of Capitalist Democracy brings us very close to the present time. By the way, Posner says his title, A Failure of Capitalism, was not intended to imply that capitalism has failed us, or that we need something different. (Still, I wish he chose a different title.)

This book is divided into three parts. Part I provides an analytic narrative of the recent financial crisis. I suspect that many readers will find Posner's coverage of the events from late 2001 (when the Fed lowered interest rates dramatically) until mid-September of 2008 (when Lehman Brothers failed and all heck broke loose) to be somewhat repetitive, given all the books that have been devoted to this period. Nevertheless, Part I discusses a lot of relevant history and economics. In addition to the now seemingly obligatory discussion of the interplay between very low interest rates and the housing bubble, the reader gets discussions of Chinese mercantilism, the Fed's open market operations, the Taylor Rule, Say's Law, securitizations, CDOs (collateralized debt obligations), SIVs (structure investment vehicles), and the concepts of leverage, moral hazard and Schumpeterian creative destruction. There's no higher math. As you might expect from a judge, in discussing the development period of the financial crisis, Posner offers criticisms of various individuals and policies--but his arguments are not partisan. They are also not highly personal or insulting (I hate that stuff). His attitude is more one of getting to the facts and letting the chips fall where they may.

Part II of the book addresses the lessons learned from the recent financial crisis. By the way, Posner continually refers to the most recent recession as a "depression," but that's mainly because he likes to call all economic downturns depressions. (He does conclude that the most recent recession--err, depression--was the worst since the Great Depression of the 1930s.) In this part of the book, I enjoyed his portrayal of Treasury Secretary Timothy Geithner's "stress test" as more of a confidence building exercise than anything else--somewhat akin to President Franklin Roosevelt's brief "bank holiday" implemented immediately after his taking office in 1933. Posner considers three of the what-have-we-learned chapters in Part II to be the heart of the book, but I think the governance issues that he saves for the very last chapter are the meatiest.

Part III of this book discusses Posner's way forward--"reform you can believe in." He makes nine recommendations, although he notes, "I am not entirely happy with the suggestions I have made in this chapter." That's okay with me--we need some preliminary suggestions to consider. (Before I summarize Posner's suggestions, I'd like to repeat that they're his suggestions, not necessarily mine.) They include: (1) Establish an executive commission to study the crisis and suggest reforms. (Posner thinks the existing Financial Crisis Inquiry Commission, consisting of six Democrat and four Republican non-economists--most with strong partisan affiliations--is unlikely to remain impartial); (2) Consider limited legal reforms, such as changes to the bankruptcy code; (3) Rotate the staff of the financial regulatory agencies; (4) Consider changing the financing of the financial regulatory agencies; (5) Establish a financial intelligence agency; (6) Regulate off-balance-sheet contingent liabilities; (7) Reform credit ratings (amen, brother); (8) Tie capital requirements to the business cycle; and (9) Return to the Glass-Steagall Act. In the interest of saving space, I am not going to address these recommendations, other than to say they are obviously controversial and I suspect that few people will agree exactly with all of Posner's suggestions. (That doesn't reduce their value as discussion starters, though.)

In the last chapter of the book, Posner addresses some of what seem to me to be the most fundamental issues/problems the U.S. faces, such as our unsustainable entitlement spending trends and, very importantly, how (and whether) a capitalist economic system tied to a democratic political system can successfully address its most critical issues. He also makes an interesting point that the economic analysis of externalities (in pollution control, for example) applies to corporate decision making. That is, "In making business decisions, [corporate executives] don't consider costs they don't bear." Good point, Judge Posner. Frankly, I wish you spent more time on this type of issue. All in all, The Crisis of Capitalist Democracy is informative, thought-provoking, sometimes opinionated, but always interesting. It's worth a careful reading.

Judge Posner was appointed to a Federal Appeals Court position by President Reagan, and has sometimes also been mentioned as a Supreme Court candidate; reportedly he was not selected because of concern that his thinking would change over time, proven through this and his preceding book. During Posner's legal career he has pioneered the inclusion of economic perspectives in interpreting law and now regularly writes a blog on economics. In the preceding "A Failure of Capitalism" he focused his combined talents on our current economic downturn, and reached a surprising (for a conservative, "Chicago-school" proponent) verdict. Those most guilty of contributing to the downturn are Alan Greenspan and George W. Bush - Greenspan for keeping interest rates low, fueling the surge in home prices, and Bush for accelerating deregulation of financial markets and then doing little while the economy began crumbling.

Posner's earlier "A Failure of Capitalism" covered recent events up to February, 2009. His point was not that capitalism has failed and we need something different, but that we also need laws, regulations, and enforcement institutions because competition and financial markets do not permit business leaders to subordinate profit maximization to concern for the welfare of society. Since then (the subject of "The Crisis of Capitalist Democracy"), Posner has become a Keynesian, ready to incorporate psychology into economic reasoning, and agreeing that not all 'investing' or savings increases output - much is actually hoarding. Investment only increases output when it finances creation of productive capital, and this may also be impeded by banks' unwillingness to lend. Posner now also accepts the liberal position that government spending can be just as useful in priming a weak economy as private spending, and probably is necessary because of the prevalence of fear of the future and the overly leisurely pace of private investment vs. the economy's needs.

Thus, Posner is supportive of the stimulus program overall, yet worries about its future effect on inflation and believes some components were misguided - eg. the $8,000 tax-credit for first-time buyers allowed a lot of 'no-down' home purchases and resulted in an 11% default rate for 2009 purchases. On mortgage modifications, Posner explains bank reluctance to participate as due to their having to then recognize losses on both the involved mortgage and other similar ones. As for bank stress tests, Posner believes they only looked to the short-term - the longer-term (starting in 2010) future may bring a return of banking problems as large-scale refinancing becomes needed. On the job-subsidy plan - not very optimistic because it doesn't change product demand. The Fed - essential that it remain independent.

Long-term unemployment is a particular concern for Posner. More than 40% of those now unemployed have been out of work for at least six months, and the longer this continues the less likely they are to obtain a comparable-paying job because their skills atrophy, they age, and employers take this idle period as evidence that they are not that motivated. "Measures that might be effective, such as reforming immigration laws, . . . eliminating agricultural subsidies, fighting protectionism, limiting the power of unions, . . . are off the political radar screen."

President Truman complained that economists always couched their advice with reservations - "on the one hand . . .," and "on the other hand . . ." and wished for a "one-handed economist." Posner is more blunt - "Macroeconomics is a weak field. With but a few exceptions even the most illustrious did not anticipate the great recession. And the profession cannot agree on what to do about it." The reason is their inability to conduct useful experiments, their almost constant assumption of rational and informed decision-making, and their failure to include decision-making psychology. Posner further adds that too often economics has turned into a branch of applied mathematics, detached from real-world events.

Posner, however, has not been completely overcome with Keynesianism. When David Ricardo first proposed his theory that free trade would produce gains for all nations, he assumed that trading partners only had an advantage in some areas - not mostly all, as is now the case with Asia's China and India. Even Keynes began questioning the doctrine of free trade later in life. Posner, however, does not and worries that the Obama administration will limit free trade and immigration in the pursuit of wealth redistribution and creating an aura of prosperity on borrowed money.

Posner's Prescriptions: More effective government regulation, not just expanding the hodgepodge of overlapping partial management spread over myriad state and federal agencies. This should include limits on leverage, changing how credit-rating agencies operate and are compensated, requiring CDS be fully collateralized, limiting payday loans, etc. (I'd also add enforcement of reasonable mortgage requirements.) At the same time, Posner realizes that those being regulated are always a step ahead of the regulators, and that regulators are frequently overly concerned about furthering their career within the industries they regulate.

Bottom-Line: Posner's "The Crisis of Capitalist Democracy" is guilty of sometimes covering the same ground as his "A Failure of Capitalism," and that detracts from the value of his second book. Posner's greatest contribution is recognizing that competition carries the seeds of capitalism's destruction - bankers, etc. realize that if they don't participate in whatever current fad is popular, they risk becoming unemployed and their firm bought out by others who ride a dangerous fad to higher P/E multiples. That's why government regulation is essential, say Posner, and its a message that bears repeating from someone with such enormous conservative credibility. He's also concerned that the strength of our capitalists democracy has been brought into question by modern techniques of political manipulation overlaying an 18th-century constitution. That's an even bigger problem to overcome than the mostly vacuous thinking of conservative idealogue economists, and requires much more coverage than that provided in the final pages of Posner's book. Hopefully his next writing will elaborate.

We're a richer country when the brilliant and original Judge Richard Posner weighs in on the the way forward post-GFC (Global Financial Crisis). Judge Posner, considered by many an American Treasure, does not truly fit into the ideology of any political party. His parents were affiliated with the American Communist Party and he has had courage to write numerous opinions on hot button topics. These include abortion rights and animal rights. He has also expressed unique opinions on drugs, torture and privacy. There is no issue too sensitive for this graduate of both Yale and Harvard, where he was first in his class.

Posner's recommendations for the way forward all make good common sense to me. At some point, there has to be a non-politicized executive committee to study the crisis and identify necessary reforms. Citizens should demand this. Changing the bankruptcy code seems like an inevitablity as it always is in a democracy when so many go bankrupt. This will happen, I firmly believe. Staff at regulatory agencies should be rotated for control purposes. Even the military rotates drill sergeants on the assumption that power corrupts over time. A financial intelligence agency will certainly happen for national security reasons, perhaps within one of the agencies such as Homeland Security. The question will be it's mission, I think. Posner is out ahead with this idea. Surely the credit rating agencies have little credibility nowadays. I wonder if they can be reformed timely or if it's better to start from scratch. Posner's idea to tie capital requirements to the business cycle seems to be what Chinese authorities are trying to do in their own way. Bringing back Glass-Steagall is high on Volcker's agenda and is a solid plan.

One notable attribute of Posner is his honesty regarding his less than confident overall assessment that the right things will or can be done to achieve a good economy without crushing debt. He is nobody's shill. The debt problem, which has been kicked down the road for a long time and now at a much faster rate, seems intractable in our society. We will have a monstrously difficult time getting out of living on governmental debt as a country. Our country has never seen such debt, at least not as a trade deficit nation. And our debt is growing faster than ever with no end in sight. Posner did not offer a platitude to give us hope.

For these reasons, I would urge others to read this book and support Posner's efforts to achieve practical, quality financial reform.