Slapped by the Invisible Hand

The Crisis of Capitalist Democracy
By Richard A. Posner
Harvard; $25.95; 408 pp

My favorite moment from the so-far listless proceedings of the Financial Crisis Inquiry Commission—appointed by Congress to get to the bottom of this mess—came when Jamie Dimon, CEO of JPMorgan Chase (JPM), quoted his daughter to put events in perspective. "My daughter called me from school one day and said, 'Dad, what's a financial crisis?'" Dimon told the commission on Jan. 13. "And, without trying to be funny, I said, 'This type of thing happens every five to seven years.' And she said, 'Why is everyone so surprised?'"

I took Dimon's point to be that we ought to follow his daughter's wise example and just calm down. By 2015 at the outside, we'll have another near-Depression experience, and, heck, that's just the way it goes. Certainly the Dimon family has no reason to fret.

It is this type of plutocratic insouciance, combined with the government's flaccid attempts at reform, that led Richard A. Posner to sound the alarm once again. In his latest book, The Crisis of Capitalist Democracy, the prolific federal judge and University of Chicago economist argues that competitive forces inspire financiers to take irrational gambles—especially when they're betting other people's money. We cannot trust them to put the common good ahead of profits, says Posner. As a result, government must step in to limit the risks bankers take and, occasionally, repair the damage they inflict.

Posner, who less than a year ago began his dissection of the crisis of 2008 with A Failure of Capitalism (Harvard, May 2009), has enormous credibility when he casts a skeptical eye on Wall Street. As an influential free-market thinker, he helped shape the antiregulatory ideology that inspired so much public policy since 1980. Belatedly he admits error. The Chicago School and all its powerful acolytes blundered, Posner writes, "by persuading themselves that markets were perfect, which is to say self-regulating, and that government intervention in them almost always made things worse."

That was a crude misreading of history. Laws inspired by the Great Depression helped achieve a half-century without catastrophic meltdowns. The dismantling of those laws and emasculating of the agencies established to enforce them—without the enactment of new regulation suited to today's Wall Street—go a long way toward explaining our recent brush with disaster.

Posner regrets the oversight. He concedes that he personally succumbed to the fallacy of market perfection in some of his writings on solving legal disputes with economic analysis. During the Reagan Administration, those writings made him a candidate for a nomination to the U.S. Supreme Court. One reason he didn't get the nod was that some in Reagan's circle had doubts about Posner's restless intellect, fearing he might prove unpredictable on the high court. Those fears were prescient, it turns out; Posner would have been a fascinating justice to follow.

Today he even tips his hat respectfully toward liberal hero John Maynard Keynes, acknowledging that in the face of consumer and business reluctance to spend in 2009, Washington had to open the fiscal spigots. Posner gives two cheers for the emergency stimulus, judging its size as a good guess in dire circumstance but inveighing against any more stimulus as "irresponsible." He frets about the government's ability to deal with the aftereffects: rising public debt and the temptation to inflate the currency.

His deeper fear, however, is that the political system cannot digest the lessons of the crisis. Society tolerates the inherent recklessness of financial markets, he says, to promote growth and innovation. Although the crash has highlighted the need for regulation, legislators—mesmerized by bankers' campaign cash—seem incapable of passing anything but anodyne reforms.

Posner offers solid suggestions for change. He echoes those, including former Fed Chairman Paul Volcker, who would reestablish the Glass-Steagall Act's separation of commercial banking from proprietary trading and other forms of high-risk finance. That would insulate the financing of small and midsized businesses from the gales of Wall Street. He also urges eliminating the semi-official status of the big three bond-rating agencies, paring back their conflicts of interest, and beefing up the beleaguered corps of civil servants who staff federal regulatory agencies.

Good ideas, all. In his final pages, though, the author can't muster much confidence that America will overcome its splintered politics, the "quasi-bribery" of campaign money, or the bipartisan myth that we can thrive indefinitely on low taxes and profligate public spending. Posner may have shaken off old shibboleths—and hurray for that—but at present he sees no reason to expect that courage or fresh thinking will prevail.

    Before it's here, it's on the Bloomberg Terminal.