The economic crisis raises a number of questions, "What just happened?" being the most obvious.
Judge Richard A. Posner of the U.S. Court of Appeals for the Seventh Circuit addresses the roots of the financial crisis in his latest book, A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression. A senior lecturer at the University of Chicago Law School and author of more than three dozen books on, among other topics, intelligence reform and various aspects of the law, Posner chatted recently with U.S. News about the crisis, the government's role in fighting it, and the mistakes he and others like him made in espousing the deregulation of the banking industry. Excerpts:
Of all the books explaining the financial crisis, what makes yours stand out?
What I tried to do mainly was to explain everything simply for people who are not familiar with business and economics jargon. I think the business journalists are generally writing for businessmen, who are thoroughly familiar with the special language and concepts of business. But I think they can be explained simply and intuitively. What will surprise readers about your book?
That I'm writing about the banking industry; I haven't done that in the past. But also I do say that we went too far in deregulating the banking industry. I've always been a strong supporter of deregulation, and I should have said deregulation in everything but banking. Why is banking regulation different?
All business and all consumers are involved to some degree in borrowing and lending. So if that process of borrowing and lending gets disrupted because the risks of banking materialize in a crash, then the whole economy can be very seriously damaged. How would you respond to the argument that increased globalization makes banking no different from any other industry?
Take something like the airline industry. It's like banking because it's a risky business because the airlines have very heavy fixed costs, which means that if their revenues plummet—as they do from time to time—they can't reduce their costs proportionately. But even if the entire world airline industry went broke, you'd have a curtailment of service and it would be very disruptive. But most economic activity would simply be unaffected. But banking, not because it's huge in terms of number of employees, is the arterial system of the economy. If you don't have bank borrowing and lending, almost all economic activity will take a severe dive. What will be the crisis's long-term effect?
The concern I have is that the long-term impact will be a substantial increase in [excessive] government intervention in private business, particularly banking. You don't really want government deciding who gets loans and on what terms. If this thing drags on for years and people get very upset and impatient, you might have fundamental change in the line between government and business. Who's to blame for the economic crisis?
Primarily the deregulation movement—people like me who didn't carve out banking from the other industries to be deregulated. But also the Federal Reserve under [Alan] Greenspan and [Ben] Bernanke for having pushed down interest rates so far that it caused a housing bubble. The problem is that houses are the principal assets that are bought with debt—with a mortgage. So the lower the interest rates are, the cheaper it is to buy a house. And a surge in demand leads to housing starts but not enough housing starts to satisfy the entire demand for houses. So house prices rise. You have asset price inflation. And when that bubble bursts, it not only brings down the housing industry but it brings down the banking industry because the banks are almost partners in real estate because so much of the purchase price of a house is in the form of a debt, a loan from a bank. So did the Fed do too much or too little?
It did too much to push interest rates down and keep them down even as the bubble was forming. When they started raising interest rates in 2005, they raised them very slowly, and it didn't have an impact on the house-buying frenzy and the mortgage lending until too late.