[Pen-l] another Wall Street view of capitalism's failure

[Jim Devine <jdevine03@xxxxxxxxx>]

New York TIMES / April 19, 2009

Off the Shelf
Free-Market Flaws, Exposed
By HARRY HURT III

THE world is in the throes of an unprecedented economic crisis, and
most mainstream economists and Washington policy makers didn’t see it
coming. In a surprisingly readable new book, “The Cost of Capitalism:
Understanding Market Mayhem and Stabilizing Our Economic Future”
(McGraw-Hill, $27.95), Robert J. Barbera places the blame for this
abject failure in economic forecasting and government policy on a
“misguided confidence in the infallibility of free markets.”

“It is not that we put our faith in the wrong people, but that we
embraced the wrong paradigm,” Mr. Barbera writes. “The events of 2008
revealed that using simple-minded free-market rhetoric as a policy
guide is a recipe for disaster.”

Mr. Barbera is a veteran Wall Street economist with decidedly liberal
leanings. A former staff economist for Paul E. Tsongas, the late
Democratic senator from Massachusetts, Mr. Barbera is executive vice
president and chief economist at the Investment Technology Group, a
financial consulting firm, and an economics department fellow at Johns
Hopkins University.

Although Mr. Barbera did not foresee the full dimensions of the
crisis, he was wise enough to declare that the economy was in a
recession back in January 2008, even as most mainstreamers were still
predicting steady growth.

“The Cost of Capitalism” tries to identify root causes of the current
global recession, the specific mistakes made and possible ways to
avoid future financial catastrophe.

Lest he be mistaken for a radical, Mr. Barbera openly declares his
abiding faith in capitalism.

“The ravages of the 2008 crisis do not justify a violent leftward
lurch,” he writes. “Risk takers are the main drivers in the
free-market machinery. Their efforts go a long way toward explaining
the lofty growth rates capitalist economies have delivered in the
postwar years.”

A proud member of the so-called post-Keynesian economics school, Mr.
Barbera bases his thesis partly on the work of the late Harvard
economist Hyman Minsky, summarizing it in two sentences: “A long
period of healthy economic growth convinces people to take bigger and
bigger risks. When a great many people have risky bets, small
disappointments can have disastrous consequences.”

Mr. Barbera cites the plunge of the American housing market as a
classic example of a “Minsky crisis.” From 1966 to 2002, he notes,
housing prices maintained a continuous upward trend; that, in turn,
prompted both mainstream economists and homeowners to assume that
prices would never fall. In fact, as prices rose, people made ever
larger bets on the housing market, in the form of subprime mortgages,
mortgage refinancings and complex financial derivatives.

Mr. Barbera takes academics to task, saying they created the complex
mathematical models on which those financial derivatives were based.
“The constructs were underpinned by the assumption that people are
well informed and act rationally,” he declares, adding, “They failed
to acknowledge that financial markets periodically go haywire.”

Mr. Barbera is especially critical of Alan Greenspan, the former
Federal Reserve chairman, and his successor, Ben S. Bernanke. He
contends that they were lulled into complacency by the persistently
moderate “Goldilocks” economic period from 1985 to 2002, after the
success of their predecessor, Paul Volcker, in taming inflation. [This
period is sometimes called -- ahem! -- the "Great Moderation."]

As a result, they focused almost exclusively on moderating upward wage
and price pressures. Although Mr. Greenspan worried aloud about
“irrational exuberance” in the late 1990s stock market, he was
ultimately convinced that the economy had entered a “brave new world”
based on computer technology gains, Mr. Barbera asserts.

Last fall, Mr. Greenspan even insisted that the precipitating factor
of the 2008 crisis was “the failure to properly price risky assets” —
evidence, in Mr. Barbera’s view, of a misplaced belief that financial
markets are rational and capable of policing themselves.

IF Mr. Barbera offers a concise analysis of what caused the current
economic mess, he is a bit short on specific remedies for a long-term
cure. Unlike Minsky, he does not advocate a move to socialized
investment or total government control of the financial markets.
Instead, he calls for “an enlightened synthesis” of mainstream and
post-Keynesian economic approaches that “celebrates free-market
risk-taking but establishes policies to rein in inevitable excesses.”

For starters, Mr. Barbera says, government policy makers must respond
to rapidly rising markets with the same urgency they muster in
responding to rapidly falling markets. He also sees a need for
regulations that provide “safety margins for the myriad nonbank
financiers” that arose outside 1930s-era banking industry reforms.

But he cautions that policy makers must recognize that “innovation on
Wall Street, over time, dulls the applicability of a given set of
regulations,” thereby mandating constant vigilance and regular
updating of the rules.

In the end, Mr. Barbera acknowledges that “there is simply no elixir
to be had that will ensure a Goldilocks backdrop” completely free of
boom-and-bust economic cycles.

But heeding the lessons of the last few years, as documented in this
book, may help both financiers and government policy makers find ways
to reduce some future costs of capitalism without sacrificing all the
potential rewards.
-- 
Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own
way and let people talk.) -- Karl, paraphrasing Dante.
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