First Bank of the Living Dead

First Bank of the Living Dead

Mini Teaser: As the Great Recession gnaws at our very belief in the ability of capitalism to raise us to ever-escalating levels of wealth and prosperity, Keynes's no-longer-viable financial prescriptions are being resurrected.

by Author(s): Daniel W. Drezner

Sebastian Mallaby, More Money Than God: Hedge Funds and the Making of a New Elite (New York: Penguin Press, 2010), 496 pp., $29.95.

John Quiggin, Zombie Economics: How Dead Ideas Still Walk Among Us (Princeton, NJ: Princeton University Press, 2010), 216 pp., $24.95.

Robert B. Reich, Aftershock: The Next Economy and America’s Future (New York: Alfred A. Knopf, 2010), 192 pp., $25.00.

Nouriel Roubini and Stephen Mihm, Crisis Economics: A Crash Course in the Future of Finance (New York: Penguin Press, 2010), 368 pp., $27.95.

EARLIER THIS year, Goldman Sachs CEO Lloyd Blankfein attempted to justify his professional existence, proclaiming, “We’re very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. . . . We have a social purpose.” This all sounds good enough, except that finance went from being responsible for 2.5 percent of GDP in 1947 to 7.7 percent in 2005. And at the peak of the housing bubble, the financial sector comprised 40 percent of all the earnings in the Standard & Poor’s 500. The incomes of the country’s top-twenty-five hedge-fund managers exceeded the total income of all the CEOs in that index. And by 2007, just about half of all Harvard graduates headed into finance jobs. If capital markets merely serve as conduits from savers to entrepreneurs, then why does such a large slice of them get siphoned off to compensate people like Lloyd Blankfein? To put it more broadly, what is the role of finance in a good and just society?

These are not merely theoretical questions. They come at the end of an era when Big Finance played an outsize role in the American political economy. Furthermore, the political system is now responding to these perceived ills. I write this sentence on the day that President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, completing the most sweeping overhaul of financial regulation since the 1933 Glass-Steagall Act (which segmented commercial from investment banks in a sweeping reformation). Now the G-20, IMF, Financial Stability Board and the Basel Committee on Banking Supervision are hashing out new financial standards that are ostensibly supposed to prevent a sequel to the Great Recession. Meanwhile, concerns over mounting sovereign-debt loads in the developed world are causing ripples in capital markets and potentially triggering a double-dip recession. The quicker that finance’s role in the world economy is well defined, the better for everyone.

The trouble is that finance now permeates not only the economic but also the political and social fabric of our world. No one can talk about Big Finance without talking about the power of capital in politics. At the same time, Goldman Sachs now possesses all the cultural cachet of a tobacco company. And no matter how Washington attempts to curb the excesses of an industry whose core purpose is the making and reallocation of money, the future of global financial regulation remains unclear.

Even economists are still unsettled about banking’s place in the economy. Paul Volcker, chairman of the President’s Economic Recovery Advisory Board, argues that the value-added of financial innovation is limited to the ATM. Yet, when New York Times columnist Paul Krugman argues that the big banks shouldn’t be broken up, perhaps it means that the world is a bit more complicated than Volcker’s blunt assessment.

Socially, the rise of hedge funds and investment houses has triggered nostalgia for the days when America built things, as if goods are somehow magically different from services. Still, it is not necessarily the best of all worlds when finance drains the brains of physicists, mathematicians and economists from other pursuits. There is a nugget of truth in Blankfein’s plea for the utility of finance—but it’s a much smaller nugget than he realizes.

[amazon 1594202559 full] THE WHYS and wherefores of economic calamities as yet unsolved, four new books attempt to tackle Big Finance from different angles. Robert Reich, Bill Clinton’s first secretary of labor and now a public policy professor at the University of California, Berkeley, focuses on the rise in political and economic inequality over the past few decades, and how that inequality abetted the recent crisis. John Quiggin, an economist at the University of Queensland in Australia, performs a clinical autopsy on the cluster of market-friendly ideas that emerged from the ashes of Keynesianism, asserting that the Great Recession should have exposed market fundamentalism (faith in the power of markets to correct themselves) as a fraud. Quiggin argues that still these ideas continue to lurch around like the undead, moaning “maaaaaaarkets” rather than “braaaaaiiins” because we are intellectually unable to adapt to these changing times. Washington Post columnist Sebastian Mallaby addresses the problem from a different angle entirely by drafting the first history of the hedge-fund industry. New York University economist Nouriel Roubini—who deserves pride of place for warning about the financial meltdown before it happened—has coauthored a book with University of Georgia historian Stephen Mihm that looks at the crisis, the policy response and what to do now.

Some of these books address some of the big questions some of the time. Most of the authors, however, focus on the retrospective at the expense of the prospective. With the partial exception of Roubini and Mihm’s Crisis Economics, these authors seem more concerned with looking back at the halcyon days of the postwar era than looking forward to the twenty-first century. Unfortunately, none of these books recognizes two important facts of life. First, at present, no economic model perfectly captures the interrelationship between the financial sector and the global economy. Second, no matter what regulatory arrangements are put in place, the next global financial order will last no longer than a generation—because whatever ideas replace the current ones will also prove fallible over time.

There were four interrelated factors that led the global economy to the precipice in the fall of 2008. And the truth is, how well any given expert grapples with these conundrums is a pretty good indicator of how seriously we should take their advice as the financial marketplace seemingly sets itself up for yet another economic disaster down the road.

[amazon 0691145822 full] THE EARLIEST and most controversial catalyst to our recent demise finds itself in the aftermath of the Asian financial crisis, which started all the way back in Thailand in July 1997 and rocked much of the developing world. After the budgetary- and monetary-policy strictures placed on those seeking protection from the IMF, governments across the Pacific Rim cried “never again.” To shield themselves, these economies consciously began to amass sizable foreign-exchange reserves to avoid having to turn to international financial institutions in the event of a future crisis. In pursuing this course of action, capital from these countries flooded into asset markets of the Anglosphere. This jump-started what Federal Reserve Chairman Benjamin Bernanke labeled a “global savings glut”—a.k.a., “Bretton Woods II.”

The macroeconomic effects were reinforcing and significant. The capital inflows kept interest rates low and asset prices high in the American, British and Irish economies. This encouraged a decline in American savings and an explosion in the current-account deficit. Surging American consumption, in turn, fueled the export-led growth of the Pacific Rim and energy-exporting economies. Official creditors from these countries—central banks, sovereign-wealth funds and other government investment vehicles—purchased more dollars and more dollar-denominated assets. Foreign purchases of U.S. Treasury bills, Fannie Mae and Freddie Mac mortgage-backed securities, real estate and equities increased. All of this accelerated the boom in asset prices, which further fueled American consumption, widening the trade deficit and reinforcing the cycle.

[amazon 0307592812 full] This growth in imbalances led a few sage economists—most notably, of course, Nouriel Roubini—to predict a major financial crisis in the making. How this disaster would manifest itself, however, was a whole other matter entirely. Here even the few wise nay-saying outliers got it woefully wrong, predicting that official creditors would grow increasingly reluctant to hold even more greenbacks and a crash in the dollar’s value would thus bring down the global economy. That did not happen—and these same economists acknowledge that these imbalances did not in the end directly cause the crisis. Indirectly, certainly, the rush of capital into the United States facilitated lax monetary policy and contributed to the asset-market bubble that, in turn, triggered the meltdown. But though Quiggin notes that having money from the capital-starved developing world rush into the capital-rich developed world does not seem like the most efficient allocation of resources, growing trade imbalances were a backdrop to a much larger story.

Roubini and Mihm do the best job of integrating this part of the story into their analysis and putting its role in the proper perspective. Crisis Economics attributes the proper role to the rise in macroeconomic imbalances, arguing that China and other surplus countries acted as “enablers” for the asset bubble in the Anglo-Saxon economies rather than as the inherent cause of the crash. This is a fair assessment—while capital was sloshing around in the U.S. system, it was the peculiarities of the American financial sector which translated that capital into a housing bubble. Indeed, Crisis Economics outclasses the other books in highlighting both the global origins of and the global fallout from the Great Recession.

Pullquote: The trouble is that finance now permeates not only the economic but also the political and social fabric of our world. No one can talk about Big Finance without talking about the power of capital in politics.Image: Essay Types: Book Review