Subscriber Content Preview | Request a free trialSearch  

The Deal Economy 2013

Home    |    Event    |    Blog    |    Awards
Share  |  Discuss  |  Reprint

Posner's 'The Crisis of Capitalist Democracy'

by Robert Teitelman  |  Published August 8, 2010 at 4:30 PM
The Crisis of Capitalist Democracy
by Judge Richard Posner
Judge Richard Posner  must be an impressively fast typist. This is not a criticism of his prose style, which is usually clear and straightforward, or his thinking, which involves a judicious process of weighing and discriminating. It's a fact. Books appear from Posner with terrifying regularity; and he remains, in his day job, a much-respected federal judge with lots of other things on his mind. His facility, his speed, his ability to churn through masses of material, much of which is arcane and at some remove from the law, is astounding. He is an intellectual high-wire man; indeed, in 2001 he wrote a much commented-upon book about the role of public intellectuals. Not surprisingly, Posner has embraced blogging, the contemporary platform of choice for public intellectuals, at which he's been pegging away for some time on

Posner's books revel in their immediacy and in their contingent nature; he is part of a growing trend of other crisis bloggers such as Yves Smith (the Naked Capitalism blog and "Econned") and Simon Johnson and James Kwak (The Baseline Scenario, among others, and "13 Bankers") entering the lists with books, much of which they tried out first on their blogs. Posner recognizes the risk in this venture. In fact, anyone who could wrap up a book about the crisis, "A Failure of Capitalism: The Crisis of '08 and the Descent into Depression," in late 2008, just a few months after Lehman Brothers collapsed, knows well the abyss he dances across. And now, even with recovery and regulatory reform barely taking hold, Posner is back again with another take on the situation, "The Crisis of Capitalist Democracy."

In the press, much has been made of Posner's recantation of his Chicago-style free-market economic ideas in "A Failure of Capitalism." This is true, and it stirs venom, but it's overstated; dismissing the book because of its author's past is straight from the schoolyard. Posner admittedly has professional, academic and social ties to the Milton Friedman wing of economics in Chicago -- he blogs with the University of Chicago's Nobel-prizewinning economist Gary Becker -- but here at least he leavens ideological tendencies with a pragmatic empirical bent. Again, he's a judge -- a Chicago judge. The buildup to the financial crisis clearly shook the foundations of the strong form of the efficient-market hypothesis, particularly when it came to the merits of deregulation and to the perfection of self-correcting markets. In "The Crisis of Capitalist Democracy," Posner extends and articulates those doubts (though he's no true believer in the predictive power of behavioral finance either). In the end, in a late conversion, he rediscovers the power of uncertainty as an economic concept and the wisdom of John Maynard Keynes, who built his economic thinking, culminating in "The General Theory of Employment, Interest and Money," around it. This is not the Keynes who has been absorbed into the New Keynesian orthodoxy, but the Keynes of the essays and "The General Theory," the man of prose and ambiguity rather than of mathematics and models.

"The Crisis of Capitalist Democracy" is a book about origins and causation and, thus, about blame and accountability. As a blogger, Posner has argued that we need a serious investigation into the cause of the crisis, a deep exploration by smart, unblinkered, fair and broad-minded souls, probably resembling, well, himself. He may be right -- in theory. But given the political spectacle currently unfolding, including, as he notes, the not-very-inspiring commission to study the crisis led by former California Treasurer Phil Angelides, no one can be optimistic this will happen soon. (Despite praise for Franklin Roosevelt's leadership in the Great Depression, Posner never mentions the Pecora hearings, probably because they were more political than substantive. Serious exploration of cause had to wait for academics, including Princeton's Ben Bernanke.) Given that, this book is the most rigorous, detailed examination of the subject of origins we have so far.

While Posner writes quickly and processes amazing amounts of material, he still pays a price for playing so close to events. He unrolls his various causes, consequences, arguments and conclusions as if he's an intellectual player piano, pounding out explanations and arguments; he sometimes seems to be writing while simultaneously replying to e-mails. He may not have had time to polish his prose or to engage the reader beyond a display of erudition. This is not a fatal flaw, and Posner apparently views the audience for this book to be intelligent, well-educated readers with an interest in economics if not a deep familiarity with the subject, so a certain amount of boilerplate is necessary; it also allows him to clear away what he views as cant, dogma and falsehoods. But there are times when you wish for a grace note, a witticism, some humor. Instead, he argues and argues and argues some more.

The heart of Posner's argument about origins focuses on the role of the government in creating conditions that encouraged consumers to load up on debt and banks to over-leverage themselves. Posner, no populist, is aware of the charges flying about. He lays out and weighs the various issues: greedy banks, venal consumers, incompetent credit-rating agencies, misaligned government-sponsored enterprises, excessive bonuses, trade imbalances, tax policy, the broad policy of increasing home ownership, malfeasance, speculation. He dismisses none of them. Each of these factors played a role, but none of them, in his view, was primary -- or, as he says, they were "background causes" rather than "choice variables." In many cases, from banks to consumers, behavior was rational, from taking a flyer with a subprime mortgage for a house you'd never be able to get normally, to underestimating the outlier that real estate would fall across America. Rational can still be dumb or fraudulent. As competition increased through deregulation, Wall Street grew larger, faster, more interconnected. Compensation rose as banks battled for talent. Some bonuses did boost the propensity for greater risk. But deeper causes lurk. Posner's focus, for example, on the dysfunctions of the shareholder-as-owner governance model in risky enterprises is a gem of psychological commonsense that effectively undermines the dogma about shareholder monitoring that has so powerfully embedded itself.

What was the primary origin then? Posner turns to the government, particularly (though not exclusively) the Federal Reserve, and to the economics profession. He touches on two broad themes: Overly loose monetary policy and regulatory failures, enabled by an intellectual construct that insisted that markets can self-correct. "On the basis of what we know now (our knowledge may grow with the passage of time), the financial collapse would not have occurred had the Federal Reserve followed the Taylor rule and thus kept interest rates higher in 2001-2004, or if the Fed and other regulatory authorities, and the academic economists and political conservatives from whom they took their cue, had been more inquisitive about changes in the structure and practices of the banking industry and less complacent about the self-regulating capacity of financial markets (and hence the merits of deregulation) and the Federal Reserve's ability to 'mitigate the fallout' (Greenspan's words, which I quoted in chapter 1) from a housing bubble."

Posner is no fan of Bernanke. True, the Fed chief responded effectively when Lehman collapsed, but Posner charges Bernanke with intellectual slipperiness verging on dishonesty. "Bernanke's performance since the Lehman debacle has been marred by his embrace of a theory of the causes of the financial collapse that exonerates him from any responsibility by placing all blame on the private sector and on limitations of regulators' powers, such as the Federal Reserve's supposed lack of legal authority to save Lehman," writes Posner. "Bernanke refuses to acknowledge that failure [of regulation and monetary power]. In defense of his refusal he could point to the importance of public confidence in the nation's economic leadership. The morality of public officials is not that of private persons. They must lie, dissemble, flatter, traduce, pander, to a degree that would appear monstrous in private life. But there are costs to such dishonesty."

Posner is inexorable in ferreting out flaws, not only of regulatory reform in Congress but of Obama administration policies such as the stimulus, the car bailouts or compensation limits. He spends a lot of time on these issues, sometimes arguing convincingly, sometimes not. He has little to say about incendiary public issues like the American International Group Inc. bailout and Goldman, Sachs & Co., which he mostly dismisses as populist demagoguery. Should AIG bailout money have flowed through to Goldman and the other banks? Absolutely, he argues, since the government was trying to save the banking system. That said, he's no particular defender of Goldman Sachs. The firm was saved by government money; the post-crisis insistence that Goldman would have survived without AIG or TARP money is simply, in his view, poppycock. Again, he rejects the easy notion that bonuses are by themselves scandals. But, he says, they should be fairly earned. A firm like Goldman, which was clearly rescued in late 2008, should not have rewarded bonuses in 2009 after the firm was buoyed by $23 billion from AIG and Fed-engineered low interest rates. "Without government aid, no $20 billion-plus in salaries and bonuses for Goldman Sachs' employees in 2009 -- maybe no bonuses; maybe no Goldman Sachs," he writes. "Against that background, the amount set aside for compensation was indeed egregious, and suggests the government drove a bad bargain when it bailed out Goldman -- it should have demanded a big chunk of Goldman's earnings."

Posner uses the Goldman case to reflect on speculation generally. It's a good example of the kind of weighing and balancing he practices. "There is nothing wrong with speculation, as I keep saying," he writes, "but remember that its social value is not equal to the profits of successful speculators." Posner goes on to question how much "information value" speculators provide to the market, and wonders if "too much IQ is being sucked into finance" without proportional social gain. And that brings him back to Goldman and the bonuses. "Goldman Sachs' traders probably are 'overpaid' in the sense that their incomes send a bad signal to the labor market from an economic standpoint." While these traders generally operate risky businesses, their downsides are not nearly as extreme as their upsides. "The worst consequences of the Goldman 'bonuses' (as politicians insist on referring to the entire compensation pool) belong to political economy rather than to economics narrowly understood." In other words, the real issue here is inequality of incomes, which past a certain point may be deleterious socially and economically.

Posner's use of the phrase political economy captures the scope of his ambition and the deficiencies he now sees in so much economic thinking; so too does his linking of "capitalist" and "democracy" in his title. He is scathing about the failures, and pretensions, of macroeconomics, but what he is most interested in are issues that transcend economics. Many economists have piled into the crisis to offer advice and prognostication -- none more visibly than the New York Times' Paul Krugman, with whom Posner jousts throughout -- on issues from bank nationalization to bonuses to regulatory reform, that economics has very little to say about, but that involves trickier ambiguities of politics and psychology. They are truly matters of political economy, the kind of political, social and psychological notions that economics, in its fixation on the rationality of utility-optimizing homo economicus, has not wrestled with since Keynes.

Of course, Posner makes his own missteps. He believes in a practical and informed rationality, in which knowledge and psychological insight come together to shape policy; yet, his default argument is nearly always economic. He talks uncertainty with utter certitude. And he's impatient with passions that sweep the body politic. He praises Roosevelt as the confident leader, but ignores the messiness and muddling that also characterized the New Deal. He is, in the end, fashionably gloomy.

Nobody's perfect, which may be his best argument. Posner is a lawyer and a judge, not a credentialed economist, despite having trafficked in the field for years; here, he mostly displays political predispositions, not ideology, and he lobs criticisms to right and left. Political economy, which has over the past decades often seemed anachronistic (as has Keynes, as he points out), is the true bailiwick of any judge. In markets shot through with uncertainty, a form of informed empiricism may be the only refuge of engaged rationality. Few will agree with every case Posner attacks with such confident bravura, but you have to respect his energy, ambition and open-mindedness as he tries to cope with a real world always wobbling on its axis, not a theoretical one spinning perfectly like a top. 

blog comments powered by Disqus

Meet the journalists

Robert Teitelman

Editor in chief

Bob Teitelman, editor in chief and a member of the company’s executive committee, is responsible for editorial operations of print and electronic products. Contact

Movers & Shakers

Launch Movers and shakers slideshow

French mergers and acquisitions lawyer Laurent Faugerolas joined Dechert LLP. For other updates launch today's Movers & shakers slideshow.


Struggling TeleCommunication Systems is sold

After announcing in July that it was exploring strategic alternatives, TeleCommunication Systems Inc. has agreed to sell to Comtech Telecommunications Corp. in a transaction with an enterprise value of $430.8 million. More video