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February 3, 2009
An extract of Kevin Rudd article in The Monthly on the global financial crisis is online. He rightly sees it as an event of seismic significance, an event that marks a turning point between one epoch and the next, when one orthodoxy is overthrown and another takes its place. The Prime Minister of Australia says:
In the space of just 18 months, this crisis has become one of the greatest assaults on global economic stability to have occurred in three-quarters of a century. As others have written, it "reflects the greatest regulatory failure in modern history". It is not simply a crisis facing the world's largest private financial institutions - systemically serious as that is in its own right. It is more than a crisis in credit markets, debt markets, derivatives markets, property markets and equity markets - notwithstanding the importance of each of these.
The PM is right to suggest that a turning point between one epoch and the next is taking place, when economic and political governance is up for grabs. He continues:
This is a crisis spreading across a broad front: it is a financial crisis which has become a general economic crisis; which is becoming an employment crisis; and which has in many countries produced a social crisis and in turn a political crisis. Indeed, accounts are already beginning to emerge of the long-term geo-political implications of the implosion on Wall Street - its impact on the future strategic leverage of the West in general and the United States in particular.
Rudd positions his government in the classical tradition of social democrats acting to save capitalism from itself; use the state to reconstitute properly regulated markets and to rebuild domestic and global demand whilst avoiding protectionism; and developing a practical policy response to the crisis that rebuilds shattered economic growth while also devising a new regulatory regime for the financial markets of the future.
It's hard to disagree with that account.
Rudd then asks: How was this allowed to happen? What ideology, what policy, what abuses made this possible? Were there any warnings? And if so, why were they ignored? Judging from the online extract, which ends there, the answers is in terms of neo-liberalism, which he understands as free-market fundamentalism. His concern is with the ideology of the Chicago school economic liberal, and their narrative of the retreat of the state and a greater role for markets in allocating resources.
The argument in the online extract does have an affinity with the account by Dean Baker at American Prospect:
The most infuriating aspect of this disaster is that it was completely preventable. The basics of the housing bubble were straightforward. House prices began soaring in the mid-1990s, hugely outpacing the overall rate of inflation. This followed a 100-year-long trend in which nationwide house prices had just kept even with the rate of inflation......Not only did Federal Reserve Board Chairman Alan Greenspan and the other leading lights of the economic profession fail to see the $8 trillion housing bubble, they somehow failed to recognize the explosion of risky mortgages and the highly leveraged chain of finances built on top of these mortgages.
Baker adds that it it is difficult to believe that top US economists could be so incompetent, but among economic policy makers, blindly following the conventional wisdom seems to be a job requirement. Even if this policy leads to yet another disaster, those responsible are unlikely to face any serious consequences. The taxpayers, homeowners, and job losers are the ones who pay the price of the economists' mistakes.
Update
For an account that steps behind ideology and the blindness of economists to an explanation try this speech that argues that proposals for regulatory change are grounded in analysis of what happened – why this crisis occurred. It is an account that argues in terms of the dynamics of the global financial/economic system:
At the core of the crisis was an interplay between macroeconomic imbalances [large surpluses and deficits] which have become particularly prevalent over the last 10-15 years, and financial market developments which have been going on for 30 years but which accelerated over the last ten under the influence of the macro imbalances....A cycle therefore of irrational boom and then bust; and therefore in some ways no different from other cycles which we have seen in markets in the past: in equities, in property, in South Sea project participations, in tulips. But what makes this one different – and potentially more economically destructive to the real economy – is that it is the first major global boom and bust of securitised credit instruments. Because at the core of this story is the development of a new model for delivering credit intermediation – the originate and distribute model of securitised credit.
It is argued that the far big failure – shared by bankers, regulators, central banks, finance ministers and academics across the world – was the failure to identify that the whole system was fraught with market-wide, systemic risk. They failed to piece together the jigsaw puzzle of a large current account deficit, rapid credit extension and house price rises, the purchase of mortgage-backed securities by institutions in the US performing a new form of maturity transformation, and the potential for irrational exuberance in the market price of credit. They failed to realize that there was an increase in total system risk to which financial regulators overall – authorities, central banks and fiscal authorities – needed to respond.
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The American Prospect Roundtable is useful. Josh Bevis says:
The Republicans bail out Wall Street and ignore Main Street. Obama in contrast, is concerned about the pain and suffering on Main Street.