"Facing mounting criticism from the public and the media, Goldman Sachs announced today that they would cancel plans to dance around a bonfire of thousand-dollar bills." Perhaps Andy Borowitz was exaggerating a tad. But the comedian and political analyst caught the essence of what drives people crazy about "Goldman Calf" and the rest of the surviving financial oligopolies.
In recent weeks, President Obama's increasingly combative tone and the elevated visibility of Paul Volcker, chairman of his of his Economic Recovery Advisory Board and former Fed chairman under Carter and Reagan, seem to signal a serious effort to harness this resentment towards Wall Street smoldering on both the right and the left into financial reform legislation. A Democratic proposal has passed the House, but Senate approval looks problematic.
However justified, though, outrage at the banks' excesses may miss some root causes of the crisis, cautions economic analyst Doug Henwood. "There is no way to separate neatly the monetary from the real. The social problem emanating from the securitization of mortgages isn't only the increasingly baroque development of financial assets but also the commodification of the house and its transformation into a speculative asset. Which is why populist financial reforms can't take you very far: they address symptoms, not pathogens."
My February 9 analysis for Inter Press Service, FINANCE: Fighting Off Looters in the Ruins, goes into more details of financial reform proposals. The piece also discusses the renaissance of Keynesian economics as an explanation of the crisis and guide to recovery.
Democratic plans, while advancing some important reforms, have so far failed to take on one key enabler of the crash: the bond-rating agencies, such as Standard & Poors, Moody and Fitch. Investment banks still routinely pay these private firms to rate their own securities, an obvious conflict of interest that has led to calls for increased regulation and even for nationalization.
Congressional Republicans seem to have few counter-proposals except for more tax cuts and letting financial markets work. Listening to the debate, you could easily forget that a meltdown of the global financial system was averted only by government action.
Bipartisan deficit hawks are circling again, ready to swoop down on re-regulation and stimulus initiatives. Wall Street insider and Nixon's Commerce Secretary Pete Peterson and his Concord Coalition are leading a bipartisan charge to slash government spending, even as unemployment remains near 10 percent and inflation is missing in action.
One encouraging development of the past year, though, has been the broadening international recognition that the global financial system has deep structural flaws and requires global approaches to repair them.
In December, Prime Minister Gordon Brown of the U.K. and President Nicolas Sarkozy published a joint opinion piece in the Wall Street Journal recognizing that "the way the way global financial institutions have operated raises fundamental questions that we must – and can only - address globally." They called for "a long term global compact that will encapsulate both the responsibilities of the banking system and the risk they pose to the economy as a whole." Measures such as resolution funds, insurance premiums, financial transaction levies and a tax on bonuses, they said, should be considered as part of the macroeconomic strategies of the IMF and the G20.
Beneath the political eruptions, as well, some major tectonic plates of economic ideology appear to be thrusting up and subducting.
The Washington Consensus, which the International Monetary Fund once invoked to impose draconian austerity plans on developing countries, is now being questioned more openly in Washington, New York and London, as it long has been in many capitals of Asia, Africa and Latin America. Perhaps the idea of having to slash social spending in the face of a deep recession doesn't look quite as attractive when your own government has to take the political hit.
And there have been some significant defections from the neo-classical orthodoxy that has dominated economics and politics for the past 30 years. And the ideas of British economist John Maynard Keynes, which provided the theoretical underpinnings of the New Deal and post-World War II prosperity, are waxing in influence.
Keynesian prescriptions on the need to create aggregate demand and the key role of government in correcting market failures now seem to make sense to more governments.
The headquarters of academic opposition to Keynes since the 1940's has been the University of Chicago, where Milton Friedman and his successors developed the laissez-faire doctrines that President Ronald Reagan and his revitalized Republican party popularized.
In a piece in The New Yorker magazine, John Cassidy found that the Great Recession has left the Chicago School of economics divided.
The most prominent dissenter, Cassidy reported, is Richard Posner, an influential Reagan judicial appointee and economic thinker who has applied free-market economics to law.
In a recent article, Posner called Keynes's 1936 opus, The General Theory of Employment, Interest, and Money, a "masterpiece" that provides "the best guide we have to the crisis." "Rational expectations and strong views of efficient markets have taken a terrific hit," Posner told Cassidy. "Keynes is back, and behavioral finance is on the march."
Another University of Chicago economist, Raghuram Rajan, told Cassidy that the failure of middle-class purchasing power to keep up with the cost of living stoked a growing demand for credit. Yet to the surprise of much of the economics profession, the side effects of the outpouring of home and auto loans in response ended up being devastating.
Economists could afford to ignore the financial plumbing as long as it didn't back up, said Rajan, who was formerly chief economist for the International Monetary Fund. "Now that the plumbing backed up, you find that loans aren't really made in a pure, pristine market. Things can break down."
Other prominent economic observers as well have set forth kindred Keynesian-tinged explanations of the underlying economic imbalances that led to the housing bubble.
Robert Reich, Secretary of Labor in the Clinton administration, blogged: "In truth, most Americans did not spend too much in recent years, relative to the increasing size of the overall American economy. They spent too much only in relation to their declining portion of its gains." Had their share kept up with that of corporate executives, he argued, they would not have needed to borrow so much.
"As long as income and wealth keep concentrating at the top and the great divide between America's have-mores and have-lesses continues to widen," Reich predicted, "the Great Recession won't end – at least not in the real economy."
One of the most high-profile of the New Keynesians, Nobel Prize-winner Joseph Stiglitz, brings an internationalist perspective to the debate as former chief economist of the World Bank.
Calling for a larger global stimulus package to confront an international crisis, Stiglitz has proposed building stronger automatic stabilizers, such as better unemployment insurance and more progressive tax structures, back into the social safety nets of the U.S. and other countries.
"Markets are at the core of a well-functioning economy, but, by themselves, they are not enough," he wrote. "There needs to be a balance between the role of the market and the role of the government."
"The United States should go and study what good central banks do, in India and elsewhere," Stiglitz wrote recently in the review of the International Labor Organization, "because they actually did avoid the excesses that marred American financial markets. When American banks wanted to sell complex, risky derivatives, one of the central bankers in South-East Asia said, 'Can you explain that?' They said, 'No, we can’t.' She responded, 'Well, if you can’t explain it, you can’t sell it.' Thus, they were protected against the ravages of the derivatives which have had such a negative effect on the United States and Western Europe."
The economist has also broached the idea of a global tax on financial transactions, expanding on the old idea of a so-called "Tobin tax", a tiny levy of a fraction of a percent on foreign exchange transactions. Last October, he told the British paper The Telegraph that "any new tax should be levied on all asset classes – not merely foreign exchange – and would be based on the gross value of the assets, thereby helping to discourage the creation of asset bubbles." British Financial Services Authority Lord Tucker, among others, has also floated the idea of a Tobin tax as a way to damp down international financial speculation.
Stiglitz chairs the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System. The panel's 2009 report calls for understanding and responding to the financial crisis as part of a series of related crises afflicting the earth and its people, bound together by threads of aggressive market fundamentalism. Broadening and democratizing world economic governance, the study suggests, are essential to resolving the crisis.
An extended excerpt from the report follows.
Our global economy is broken. This much is widely accepted. But what it is precisely that is broken and needs to be fixed has become a subject of enormous controversy.
In the view adopted by the Commission, and broadly endorsed in the UN Outcome, the crisis we confront is systemic in the deepest sense and has many facets. On this view, the financial crisis that erupted in the United States in September 2009 is the latest and most impactful of several concurrent crises – of food, of water, of energy, and of sustainability – that are tightly interrelated, connected in important ways by an imperious economic perspective that has been implemented, often under duress, across the globe during the last 35 years.
In this perspective, market logic solves nearly all social, economic and political problems. The well-known staples of economic policy complexity such as the need to address economic and non-economic sources of economic instability (“market failure”), the need to account for costs imposed on others and to redress the unfair appropriation of social benefits (“externalities”), the need for public intervention to provide for the conditions and values of sustainable life (“public goods” and “social equity”) are all regarded as incidental rather than fundamental issues of economic management.
As the Commission stresses with considerable frequency, the present crisis demonstrates failure at many levels – of theory and philosophy, of institutions, policies and practices, and, less overtly, of ethics and accountability. The essential insight of the report is that our multiple crises are not the result of a failure or failures of the system. Rather, the system itself – its organization and principles, and its distorted and flawed institutional mechanisms – is the cause of many these failures.
It is a habit of contemporary speech to refer to the global economy that we have today as “the economy” and, more insidiously, to present it as a natural phenomenon whose putative laws must be regarded with the same deference as the laws of physics. But, as the enclosed report argues cogently, our global economy is but one of many possible economies, and, unlike the laws of physics, we have a political choice to determine when, where, and to what degree the so-called laws of economic behavior should be allowed to hold sway.
An economy is a man-made ecology, or rather the man-made part of our larger ecology of interaction between the man-made and natural worlds. Together the man-made ecology and the natural ecology sustain – or destroy – the conditions of life. It is essential today, as the UN Outcome and this Report both recognize, to view economic and ecological issues as tightly interrelated, and recognize that our global economic system must be adjusted to the requirements of an era in which the risks engendered by centuries of neglect have reached a point of extreme danger and the costs of adjustment must be borne by the present and succeeding generations. The Commission’s Report is forceful on this point: “The conjunction of huge unmet global needs, including responding to global warming and the eradication of poverty, in a world with excess capacity and mass unemployment, is unacceptable.”
As the greatest economic philosophers – whose number surely includes Aquinas, Smith, Marx, and Keynes – have all recognized, homo oeconomicus, the acquisitive, emotionally cardboard, and socially atomistic construct of academic economics is a reductio ad absurdum. They did not merely assume that the ethical vocation of human beings should inform their economic decisions and institutions; they insisted on it, and in ways that today are far out of fashion but are also therefore far more necessary today. It is difficult to read this Report and not come to the conclusion that the Commission members share this perspective.