- The Washington Times - Sunday, December 7, 2008

THE ORIGIN OF FINANCIAL CRISES: CREDIT BUBBLES AND THE EFFICIENT MARKET FALLACY
By George Cooper
Vantage Books Paperback, $12.95, 208 Pages

CREATIVE CAPITALISM: A CONVERSATION WITH BILL GATES, WARREN BUFFETT AND OTHER ECONOMIC LEADERS
Edited by Michael Kinsley
Simon & Schuster, $26, 224 pages
REVIEWED BY JAMES SRODES

Economic theory is like some bizarre bus stop where if you stand still long enough, something will come along to take you where you want to go.

Of all the annoyances of the current global economic crisis, surely the greatest has to be the large number of people who pretend to be shocked, yes shocked and bewildered, at how such a thing could have occurred. But close behind, is the slightly smaller group of kibbitzers who claim to have seen the meltdown coming all along and who could have told us how to avoid all this pain if only we had listened.

These two books offer the reader a lavish buffet of this latter group of Monday morning financial wizards. The value of both books, particularly the second one we consider is that so many of them not only had an active role in bringing about the current crisis but they also are hanging around to help us back to our feet if only we will all pay closer attention to them this time.



We look at George Cooper’s “The Origin of Financial Crises” first. Mr. Cooper is a principal in the $11.5 billion BlueCrest Capital Management Ltd. which is Europe’s third largest hedge fund so one might have expected some slight confession of the excesses committed by his colleagues over the recent past. One would be disappointed however.

Instead, Mr. Cooper blames the various central banks (chiefly the U.S. Federal Reserve) for espousing a flawed efficient market philosophy that has had the effect of making normal economic cycles even more unstable. He accurately charges most governments with “bastardizing” the Depression-era prescriptions of John Maynard Keynes in an attempt to guarantee permanent prosperity.

“Keynesian policy is now enacted through two channels. Governments use fiscal stimulus to boost economic activity by spending more than their tax revenue. And central banks use monetary policy to encourage the private sector to borrow, thereby boosting consumption and investment relative to income. Both government deficit spending and the lowering of the private sector savings rate have the effect of boosting spending and therefore demand in the economy,” he writes.

Since that has been the stated policy of industrial nations for most of the post-World War II era Mr. Cooper is correct but does not advance our understanding much. Instead, he seeks to surprise us by his discovery of a Keynes successor, namely Hyman Minsky, a Washington University economist who is famous for his discovery of the “Minsky Moment.” By his analysis speculative investment bubbles result when cash flow rises above what is needed to pay off debts. A speculative euphoria develops and soon debts exceed what borrowers can pay off. At that “Moment” panic sets in and credit, even to those soundly positioned contracts sharply.

All this is true enough. But what are the remedies Mr. Cooper offers to get us out of this and subsequent messes? He poses three possible courses. One, which he instantly and wisely rejects, is to let the contraction take its course with attending bankruptcies, joblessness and economic depression. Second is for Washington to spark “another massive debt-fuelled spending spree, using fiscal and monetary stimulus, in the hope of triggering another self-reinforcing expansion, with sufficient power to negate the current contraction.” This too, he wisely rejects.

The third option, which is what Washington and other industrial powers are trying in concert, is to engage in a massive inflation of credit and liquidity. “This strategy gives borrowers a ‘get out of jail free card,’ paid for at the expense of savers,” he notes. In short, he condemns us to move from one “Minsky Moment” to another in the hopes that the next one won’t be so bad.

“Creative Capitalism,” on the other hand is worth reading but not for the reasons Michael Kinsley, the editor of this collection intended. Mr. Kinsley, who began his public career playing Charlie McCarthy to William F. Buckley on his “Firing Line” television program, has morphed into a Barbara Walters-style interviewer of The Great and Good on Really Important Issues That Matter a Lot.

In this case, the book begins with a speech that Microsoft founder Bill Gates gave in January at the World Economic Forum — a favorite watering hole of the GAG set. Mr. Gates proposed that a way be found to force corporations “to make self-interest serve the wider interest.” In short, he wants to force the private sector to spread the benefits of economic progress to those parts of the world that languish behind the rest in poverty, polluted environments, corrupt governance, hunger and misery.

What Mr. Kinsley did then was put Mr. Gates together with his current partner in charity, Berkshire Hathaway’s financial wizard Warren Buffett to pursue the notion further. Mr. Buffett not only agreed with Mr. Gates but went further with the observation that since most folks don’t trust government to do things very well that the private sector might be altered to become a force for mandatory corporate charity and carry out that function with the same efficiency devoted to the profit motive.

Mr. Buffett summed up, “What if you had three percent or something like that of the corporate income tax totally devoted to a fund that would be administered by some representatives of corporate America to be used in intelligent ways for the long-term benefit of society. … If there are things to be done in society that the market system doesn’t naturally lead to, something like this would be a supplement to the invisible hand. It would be a second hand that would come down for society — administered in a businesslike manner — and it might be interesting to see what a system like that might produce.”

Or, and this is unkind, what is the sound of two invisible hands clapping?

A collection of essays in response to Mr. Gates and Mr. Buffett are added by the A-list of the world’s top economic minds from Abhijit Bannerjee of MIT to Martin Wolfe, the chief economics editor of the Financial Times. Most interesting are the comments of Lawrence Summers who will be President-elect Barack Obama’s economic adviser in chief.

Mr. Summers, who might be expected to put Creative Capitalism to work if he agreed, turns out not to agree with the idea at all. He points to the villains of the current credit market collapse — Fannie Mae and Freddie Mac — as classic examples of using government authority to empower private sector actions in behalf of socially beneficial development — affordable home- ownership in that case.

“What went wrong?” Mr. Summers asks. “The illusion that companies were doing virtuous work made it impossible to build a political case for serious regulation. … Government budget discipline was not appropriate because it was always emphasized that they were private companies. But market discipline was nearly nonexistent given the general perception “now validated” that their debt was government backed. …” So much for Creative Capitalism.

What both of these books illustrate is that you can be very, very smart in one area of human activity and still not understand the way the world works, or doesn’t work.

James Srodes is a former Washington bureau chief for Forbes and Financial World magazines.

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