- The Washington Times - Tuesday, April 20, 2010

THE CRISIS OF CAPITALIST DEMOCRACY

By Richard A. Posner

Harvard University Press, $25.95, 408 pages

Reviewed by Roger Lott

In “The Crisis of Capitalist Democracy,” Richard A. Posner, a judge for the U.S. Court of Appeals for the 7th Circuit and senior lecturer at the University of Chicago Law School, rejects the notion that the financial meltdown of 2008 was the result of greed and recklessness by individual bankers and consumers. “Deregulation made bankers and through them borrowers take risks that were excessive from an overall social standpoint,” he explains.

Judge Posner instead blames the U.S. government and the Federal Reserve for failing to perform necessary regulatory functions in an inherently unstable capitalist economy. “If the consequences of a firm’s bankruptcy for the economy are catastrophic, it is government’s responsibility to force the firm to take fewer risks than are in the firm’s self-interest to take,” he explains.

Bailing out individual banks to prevent others from failing, which Judge Posner advocates, makes banks less worried about relying on each other to an extent that normally would be imprudent. Banks will keep building towering financial schemes with weak foundations if they think the government will be there to keep repairing essential pillars.

While regulators need to be more involved with the operations of private companies, Judge Posner says, he warns against “government-sponsored enterprises” such as Fannie Mae and Freddie Mac, in which the government largely has taken over operations. Given regulators’ proven track records, Judge Posner is naive to think they will start narrowly focusing on certain aspects of operations while refraining from touching others with their power-hungry hands.

Bringing the government and business closer together in their dealings surely won’t help prevent the kind of favoritism Judge Posner perceives in the government’s handling of the financial crisis, whereby some financial institutions essentially were given gifts while Lehman Brothers was left in the cold.

Another important role of government, Judge Posner says, is to “seek to allay fears by projecting an aura of confidence, command and determination,” as Franklin D. Roosevelt did during the Great Depression. “The psychological effect of a stimulus program must not be underestimated,” he says.

You’d think that for someone who cares so much about positive psychology, Judge Posner wouldn’t be so dead set on calling the financial meltdown a “depression.” Yet the judge is unambiguous, saying that the word recession is not a strong enough word for what he deems the worst economic crisis since the 1930s. Perhaps Judge Posner believes the bleakness of the word “depression” will make the “aura” of the government shine more brightly.

According to Judge Posner, thrift is a social ill, especially in economic downturns. Yet it was too much spending and lending - a result of low interest rates by the Federal Reserve - that got us into the crisis in the first place. A crisis is as good a time as any to return to the more fiscally conservative system of a truly free market, and indeed, people naturally tend to do so. But the government uses it as an excuse to spend more and attempt to get others to spend more, thereby going against people’s natural tendencies to want to hold their wealth in forms that they can quickly access and that banks cannot easily lend out.

This “hoarding” of money, says Judge Posner, is harmful to society because it decreases consumption. The reality, however, is that consumption doesn’t create social utility unless the goods or services bought are worth the money spent on them.

Judge Posner points out that crises are politically ripe times to push agendas such as universal health care because the importance of a social safety net is driven home to people. The main problem with spending - and he admits it’s a big one - is the increase in the national debt such legislation would cause. According to Judge Posner, however, “Americans are not so heavily taxed that financing an increase in the national debt by higher taxes would be intolerable.” The judge should speak for himself.

Pointing to the failure of economists to foresee the financial crisis, Judge Posner says the problem with economics is that it assumes people to be “hyperrational” beings. He understands “rational” to indicate some ambiguous degree of reason in one’s thought process. In reality, the word means nothing of the sort in economics and merely means that people will do what they think is in their self-interest.

Economics makes no assumptions regarding the soundness of people’s thought processes, and here the judge shows a simple lack of understanding. Despite being a prodigious legal scholar, Judge Posner seems to think he knows more about economics than he really does.

In his September 2009 article for the New Republic, “How I Became a Keynesian,” Judge Posner said he had just converted to the economic philosophy on the basis of reading John Maynard Keynes’ “The General Theory of Employment Interest and Money” just the year before. Clearly, Judge Posner, despite probably being the most cited legal scholar ever, doesn’t have a deep background in the economic subject matter he deals with in the book. That does not detract from the author’s sharp analytical skills and clear writing - the latter of which is uncommon among those more acquainted with economics.

Judge Posner’s endorsement of Keynesian ideas in “The Crisis of Capitalist Democracy” is disappointing. Increased government spending is not the answer to controlling the national debt and will take valuable money from the private sector. Further regulation will prevent banks from operating efficiently, and bailouts will encourage banks to take imprudent risks.

Judge Posner is right to recognize that the government, not the banks, was responsible for the financial crisis, but is foolish to think that same government can somehow get its act together and prevent another economic collapse. Government is the problem, not the solution.

Roger Lott is a writer in Pennsylvania.