The crash of the post-WWII debt supercycle will ripple out though our society in ways we cannot now imagine. There are a few who can grasp the trend of events and see what lies ahead.
Like this article by Brad Delong, economics professor at Berkeley: “Today in Financial History“, posted at his blog Grasping Reality with both hands, 29 September 2008. I strongly recommend reading this. It gives a valuable if somewhat long and technical analysis of our situation. More important are his conclusions, of special significance because the Obama administration will hire either DeLong or others like him. So his analysis is academic speculation, but not just academic speculation.
He concludes with some chilling words.
Five more notes:
First, last spring Larry Summers had good arguments that we had then set in motion enough policy moves to resolve the crisis and save the world economy from depression. We had implicitly guaranteed the unsecured debt of every large investment bank in the United States. And we had greatly strengthened the implicit guarantee of Fannie and Freddie. That should have been enough. But clearly it wasn’t.
Second, I don’t believe that after this the price of risk will ever again become a free-market price, just as after the Great Depression the short-term price of liquidity–the short term interest rate–ever became a free-market price. The federal government, in one form or another, is going to be in the business of insuring debt securities against steep declines in value. Securities that are not so insured will simply not be traded. What Fannie Mae did for “conforming” home loans, the Treasury or some other government agency will do for derivative securities. It will offer insurance, charge for that insurance, and supervise and oversee financiers much more strictly.
Third, the market fundamentalists in other sectors will need to be quiet for quite a while. We have just seen financial markets rife with moral hazard, agency, and adverse selection problems crash spectacularly. Is this a situation in which we should move health care–also rife with moral hazard, agency, and adverse selection problems–toward a free market configuration? No. Market regulation needs to be smart. But first market regulation needs to be.
Fourth, there is now no time for tolerance of the three objections to this analysis and this plan of action, roughly:
- it’s immoral,
- it’s unfair, and
- it can’t work in the long run.
To expand a bit:
It’s immoral because people have a right to be treated like adults–which means that they have a right not to be rescued by the government from the consequences of their bad judgment, and we are violating that right.
It’s unfair because feckless greedy financiers who caused the problem ought to lose money and aren’t–or aren’t losing enough money–and because feckless greedy imprudent thriftless borrowers who caused the problem ought to lose money and aren’t–or aren’t losing enough money.
It won’t work–at least not in the long run.
I dismiss objection (1). It is made, mostly, by those who speak for the Princes of Wall Street. … The response to objection (1) is that the people who make it need to grow up. There is no more a John Galt or a Jane Galt than there is a Santa Clause. There are no Randites in a financial crisis–or no even quarter-sane Randites. The fact that there is a safety net in a financial crisis is something that has been obvious to everything with a spinal column for at least a century and a half–that’s what central banks are for, for Jeebus’ssake! The Princes of Wall Street did not earn their fortunes by virtue of their virtue, their intelligence, their nerve, their skill, and their willingness to run great risks, et cetera, et cetera, low animal cunning, glue, money sticks as it blows by.
The response to objection (2) is “tough.” Yes, it is important to design the elements of the rescue package in such a way as to give as few windfalls as possible to the undeserving feckless, greedy, imprudent, thriftless, et cetera. We will do what we can within the law to make sure as few gains ill-gotten survive going forward. But as Federal Reserve vice chair Don Kohn says, it is bad public policy to hold the jobs of tens of millions hostage in an attempt to teach a few feckless financiers (or even somewhat more thriftless borrowers) even a much-deserved lesson.
The response to objection (3) is that it was first made by Karl Marx at the end of the 1840s: that the problem is not overspeculation but rather overproduction, and cannot for long be solved by paliatives that address overspeculation only:
… Fifth, later on we should talk more about the corollary to the refutation of objection (1)–the fact that there has always been a safety net for the rich makes it an obvious matter of simple justice that there be a safety net for the poor and the middle class as well. But for the present the important thing is to make sure that people who argue for tax cuts for the rich or for welfare-state program cutbacks for the poor should not be allowed to disrupt the formulation of public policy when there is serious public business to be done.
This is a manefesto for the greatest expansion of government power since the New Deal, and a large large step away from a free-market system. If the government controls the price of money (the short-term riskless rate of interest) and the price of risk (through government control of markets), then America will have changed. Among the keys to our success are rapid growth, dynamism, and high rate of social mobility. Delong will trade all these away for security and stability. We will be like France.
That is not the apocalypse. But it is a big change.
Note the slick but bizarre rebuttal to objections. If you don’t agree to this expansion of government power, then you are a Marxist! As if there were no reasonable objections.
Delong is unusual in that, perhaps in the heat of the recent market “crash”, he explicitly stated his objectives. The people who will make these changes to our system are unlikely to be so forthright. It will occur with a thousand reforms, each plausible and small, none threatening.
Like many in America’s left — and right — wings, Delong shows strong authoritarian tendencies. Esp. note the intolerance for political beliefs that differ from his own, which he often considers illegitimate — in the sense of being outside the realm of reasonable or even proper political positions. For example:
(a) “Time to Shut the Republican Party Down“, 30 September 2008
(b) His frequent diatribes against any deviation by the mainstream press from leftist orthodoxy, which he headlines as “Why can’t we have a better press corps?” This is absurd given the well-documented liberal bias of the mainstream media. See this, this, this (there are dozens more) — as any pro-Republican articles are signs of dis-functionality, but pro-Democratic Party articles are ignored as right and proper).
Don’t bother posting opposing views in the comments on his site. However well-documented or mildly expressed, they are usually deleted. Must not disturb the faithful by revealing to them that there are reasonable opposing views.
What should we do?
That is a complex question. For a simple answer see A solution to our financial crisis.
Originally published at Fabius Maximus on Oct 2, 2008 and reproduced here with the author’s permission.
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