Six Questions, Washington Babylon — March 17, 2010, 9:57 am

Six Questions for Richard Posner on Capitalism and Crisis

Richard Posner has been a judge on the U.S. Seventh Circuit Court of Appeals since Ronald Reagan appointed him to that position in 1981. He is also a senior lecturer of law at the University of Chicago, and has written close to 40 books on law and economics. Since the crisis, Posner has taken a critical view of free market economics, a movement that was popularized in the U.S. by University of Chicago economists. In his new book, The Crisis of Capitalist Democracy, Posner argues that the current global crisis has proven that market economies suffer from inherent instability, which only smart government regulation can curb. My colleague Spencer Woodman recently asked Posner six questions about his new book. This interview was edited for length and clarity.

1. The general wisdom is that you switched from a laissez-faire approach to one that accepts the role of government regulation to stabilize the economy. What has changed your view of capitalism?

This has really been only since September 2008—since the crisis, when I took another look at everything. There was erroneous monetary policy and much too low interest rates, which encouraged excessive borrowing. And then there’s this very lax regulation of financial institutions, which reflects a failure to recognize that the financial industry is very unstable and requires regulation. It is connected to everything in the economy—consumers and businesses alike depend on it—so when it collapses, you’ve got real problems. A lot of people failed to see that. The financial backbone of the economy is a corner of capitalism that requires more intrusive and careful regulations than a lot of economists thought. Because of the centrality of credit in a capitalist economy, a capitalist economy is inherently unstable. This instability can become catastrophic unless you have something in place to mitigate it. Unfortunately no one seems to have very many great ideas on how to do this.

2. How significant was the Fed’s decision to allow Lehman Brothers to collapse?

I think it was a very serious mistake, because when Lehman Brothers collapsed the investors at hedge funds and other broker dealers got scared. They thought that if Lehman Brothers, which as they all were, was over-invested in mortgage-backed securities, was allowed to go broke, then maybe the government will allow everyone to go broke, and then they started to take their money out of the system. Lehman and these other firms’s capital is furnished to them by these new investment vehicles, which often require repayment over night. If you’re a company who owes your creditors their capital every night, and they get scared, then within 24 hours they can bankrupt you. So when everyone saw Lehman go broke, they started pulling their money out, and you had a run. Then the whole global financial system froze. So I think we ended up paying a lot more than we would have if we bailed out Lehman Brothers.

3. You argue we’re in a depression, not a recession. Is this distinction merely semantic for you, or do you think the current crisis is far deeper than generally believed?

I think it’s far deeper. Just look at our financial situation: we’re like Greece. There is this complete fiscal incontinence, huge deficits and no way of reversing the situation. We’re kept alive by the fact that the dollar is the international reserve currency—even when international companies are not dealing with the United States, a great many transactions around the globe are conducted in dollars rather than in local currency. And their central banks hold dollars, too. So as long as the world is holding loads of dollars, we’ll be okay because we can borrow them back. But it’s a very, very unstable situation. That’s one reason, and another is that unemployment has really frightened people, and it is causing significant political problems. You can see it in all this turmoil in congress and the protests and the emergence of the Tea Party.

4. You mention the Weimar Republic’s collapse into fascism during the Great Depression several times throughout the book, not as a direct parallel to the U.S, but to show that economic conditions affect political outcomes. How will this crisis affect the U.S.?

Normally during a crisis people turn to the government for salvation. In the Thirties, it was a matter of prestige for the government to save the country from what they conceived to be the failures of private enterprise. But now, somehow, people are turning against the government. I think it’s because this administration has not been successful in explaining to people why these bailouts and the deficit spending are central methods of promoting economic recovery. And I don’t think it’s reasonable to expect most Americans to understand the complex workings of macroeconomic policy. But, to some extent, I think their instincts are accurate that there is something wrong with the federal government running these trillion-dollar deficits, or that the total national debt is growing at a rate of over a trillion dollars a year. So people’s sentiments are understandable, but it creates this great turmoil. You have this tremendous mistrust of government that makes it very hard to address these economic problems. We don’t seem to have the political will to raise taxes significantly enough to pay off old spending or even to resist new deficit spending. There don’t seem to be any brakes on this vehicle hurdling toward an ever-greater deficit.

5. What is the current state of the “Chicago School?” Has Milton Friedman fallen from grace?

What happened is that ideas that seemed to be largely confined to the University of Chicago, which were considered rather fringe, conservative ideas—most of those ideas have become orthodox, and the University of Chicago has become indistinguishable from other large schools everywhere. But now there is some reaction against these ideas that there has been excessive government regulation in the economy and that financial markets are self-regulating. I do not think that the economists at the University of Chicago who specialized in macroeconomics and financial structures have contributed very much to the thinking about the current crisis. There’s a major exception to this, which is Raghuram Rajan. He is listened to a lot and has a lot of good ideas. He’s one of the skeptics of excessive deregulation. So he’s riding high now.

6. Did Obama appoint the right people to handle the recovery and also to build regulatory structures?

Yes and no. I think from a substantive standpoint he did, in the sense that he appointed Timothy Giethner, a very experienced and able person. He also reappointed Bernanke, who I said in the book made a really terrible mistake and contributed in a really big way to the collapse, but on the other hand has managed to oversee the recovery, economically. He’s a good economist. So a lot of these appointments i think were good substantively, but not good in terms of public relations—they are not good communicators. They don’t seem to have a handle on the significance of communication. It turns out that communication is quite vital.

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