[What follows is my reportage of the Panel 1 of the conference, which I attended. I took pretty thorough notes, but they are necessarily incomplete. I welcome corrections. In the coming week I will better type up my notes on Panels 2 and 3. I did not attend Panel 4. The impatient can find the rough notes to Panels 2 and 3 in my earlier stub post.]
Conference on the Financial Crisis
Co-sponsored by the Money, Markets and Consumption Workshop, Economica, and other organizations. Held at the Franke Institute in the Regenstein Library at the University of Chicago, April 10, 2009. It was mighty.
Panel 1: Sources of the Crisis
Moderator: Gary Herrigel (Department of Political Science, University of Chicago)
Douglas Diamond (University of Chicago Booth Graduate School of Business)
Diamond gave a slightly slow-moving but persuasive talk on financial crises in recent historical perspective. He argued that basically such crises are all the same, being caused by runs on short-term debt. Diamond unfortunately did not do a great job dumbing down his talk, so that my sense was that it was difficult for many people in the room to understand it well. (See below my account of the Q&A session at the end of the panel, where I give more detail on Diamond’s ideas. I took bad notes at the beginning and good notes at the end.)
Mark Mizruchi (Sociology Department, University of Michigan)
Mizruchi presented other, perhaps deeper causes than did Diamond. According to Mizruchi, the longer-term causes stretch back into the middle of the 20th century, to the decline of manufacturing in the United States. He described a process in the last several decades that he characterized as a “revolt of the owners.”
First he spoke of the general environment of deregulation over the last twenty-five years. The most famous example of this was the abolition of the Glass-Stiegel act, but he observed that deregulation had begun in the late Carter administration. New financial instruments emerged, but financial and securities regulation did not always follow promptly. Here emerged one of the common themes of the conference presentations, namely the notion that there is a kind of race or competition between regulation and financial innovation. Thus, according to Mizruchi, this apparent absence of regulation is clearly part of the story.
Mizruchi began his story of “the revolt of the elites” (to steal Christopher Lasch’s phrase). American business, he argued, does not act as a unified or singular political actor. Business interests and activities are too uncoordinated and divergent for that. Yet from WW2 to the 1970's, there was an elite that had a "high degree of cohesiveness." They were at odds with traditional American business, which was against labor, against high taxes. This 20th-century elite was more “practical,” by which Mizruchi meant that they were more politically centrist or favorable to the demands of organized labor and Democratic congresses. They opted to cooperate with labor. In Mizruchi’s phrase, for them, the concerns of “the larger society” were more important than were their profits. You cultivate the goose which lays the golden eggs; you don’t kill it.
(I think that I can provide an example of this, although Mizruchi did not discuss this: Consider the handsome settlements made between labor and the auto industry, from whose crippling expenses we will all suffer in the future. This example is the kind of thing that Mizruchi did not mention, but which is the very important downside to his example: The elite, centrist coordination basically has the problems of corporatism, which is that it moderates or adumbrates price-competition in a market, because seller/supplier (of labor, the labor unions) and buyer/demander (the employer, the auto industry) basically agree on a high price, knowing that they are relatively insulated from external market competition for their products, in this case from foreign car manufacturers. Unlike ordinary private-market supply and demand, this is done by a few large monopsonists and quasi-monopolists whose position is guaranteed by the state, in the way of financial aid to the industry and pro-labor-union laws. Their respective seats at the table secure, both sides set comfortable, high prices, which eventually other people have to pay. This happens either through high marketplace car prices or through future liable payments like the pensions. The former is inflationary, meaning that everyone else in society suffers for it. As to future liabilities for pensions, in the future we're all going to pay for the folly of the Motor City.)
This elite coordination broke down in the 1960s and 1970s, under pressure from new inflation, increased foreign competition, and the energy crisis of 1973. For the first time, we saw the emergence simultaneously of high inflation and high unemployment, or stagflation.
In short, Keynesian demand-side policies were failing, and economists, businessmen and policy-makers could increasingly see that. Put very crudely, for I am a crude reporter, Keynesian policies had been to manage economic growth by giving people money to spend. That's why it's called demand-side: The consumer has money to spend, so by spending, consumers increase demand for products. This causes businesses to sell more, and everyone is better off. If I have this right, the problem with this was that by increasing wages, managing competition and keeping comparatively cheaper foreign products out of American domestic markets, policies dampened price competition. So prices rose. Prices rose and rose, meaning that there was inflation.
In response to these problems, there emerged new supply-side arguments. Businesses mounted a new counter-argument, opposed strongly to government regulation. They put pressure on labor. They were so successful in this “counter attack” in the 1970s and 1980s that they no longer needed to be organized as the cozy elite which they had been before. This resulted in the takeover wave in the 1980's. CEOs were increasingly under pressure to return high profits, or they might be out. They were thus encouraged by marketplace frenzy and by their own firms’ governance structures not to worry about the long term. So they didn’t.
In short, this 1970's elite dissolved. There was and remains a leadership vacuum in business.
(This appears to be a rather inaccurate way of expressing his point, however, which is really that there was more coordination of business interests with policy in the 1960’s and 1970’s. The other way to express this is that there was more regulation, which is almost inherently favorable to larger businesses over smaller ones, and probably contributory to the inflation of the 1970's which utterly annihilated the savings of people on fixed incomes and the poor. The irony, in other words, is that while regulation is supposed (i.e. said) to make competition more safe or stable, the inevitable flip side is that is secures the positions of the players already in the game at the expense of newcomers. It works against innovation. It also hurts anyone who is not actively in the labor force, i.e. the poor and retired.)
Duncan Foley (Economics Department, New School for Social Research): It's about Global Neoliberal Capitalism, Stupid!
Foley was the person sent here by the hand of destiny to deliver the message from Karl Marx and Immanuel Wallerstein that the current crisis is one example of many, already in the past and coming in the future, which are endemic to “global neoliberal capitalism.” Things like this have been happening for three decades. Crises, he observed, seem to come along precisely when everyone thinks they're never coming back.
The pattern of such crises, he argued, has emerged over the last three decades. This is a position presented by “heterodox, especially Marxist” economists and other similar social scientists. Economists of this red stripe like Gérard Duménil, Dominique Lévy, and Derek Jeffers (Capital Resurgent: Roots of the Neoliberal Revolution, 2004) argue that the historical origin of this was that in the mid 20th century, a certain system of financial capitalism superseded Fordism and Keynesianism. By contrast, in response to this, Milton Friedman and Friedrich Hayek “invented” neoliberalism.
(The neo in neoliberalism is misleading. It is thus tagged to indicate its newness. But this is not very accurate, since there has been a slowly growing tradition of liberal thought continuously for hundreds of years, from Adam Ferguson and Adam Smith to Friedman and Hayek. Generally, people who use the term neoliberalism are on the left. People who speak of markets or market solutions are more likely to be on the right or classically liberal. And anyone who speaks of global neoliberal capitalism is waaaay out on the left.)
According to Foley, the present crisis should be seen as one in a series of crises, the others being those in Mexico, Brazil, East Asia, Indonesia and Russia. In the US, we got caught in the same pattern.
Foley’s heterodox-Marxist model begins with the freedom of movement of exchange rates. Investors move their investment capital from market to market in different places in the world economy. The drama goes like this: There is an inflow of foreign capital. This bids up the exchange rate in a country, I guess because an investor like Colignius Asset Management needs local national currency in order to buy shares in a country’s market. In India, I need rupee rather than dollars. So I and other investors need to buy rupee, thus increasing the demand for rupee and concomitantly raising the price. This, according to Foley, causes “de-industrialization.” I think he means that because the currency now trades at a higher rate, it is more expensive for foreigners to buy products sold in the country. Thus for instance, if a British firm manufactures widgets, but the pound is trading at increasingly higher rates, then an American or German person who wants to buy widgets made in Britain ultimately must pay the British widget-maker increasingly more pounds. If the pound is trading high, then it is comparatively more expensive for the American or the Hun to buy British widgets. In other words, at a high exchange rate, it's hard for the local firm to compete in foreign markets.
Thus far in Foley’s account everything seemed to make sense, as far as it went. It said little of course for other considerably important factors, such as the production costs of goods in two respective economies. That is, Chinese labor rates are simply far lower than labor prices in the U.S. or Germany for instance. It seems pretty obvious that these are not simply matters of large international investors coming and going, but have to do with decades of market activity and investment growth. Hong Kong and mainland China seem like the perfect comparison to prove this point. Take them as a pair of environments with the same people, mores, prices, etc. a century or so ago, and see how different they had become because of only governance and social inputs over a century.
Anyway, if he had stopped there Foley might have made some sense. But he ran along ahead so fast that he lost most of us. High exchange rates in the victim-country, he continued, “set off a consumption binge of household goods” which he called “tradeables.” This in turn tends to finance a bubble in non-tradeable assets. This leads to inevitable collapse. (If you can follow this or correct my account so that it makes sense, please leave a comment below. You might be the first, and earn a prize. Seriously. I may seem a little snide about this, but I genuinely do not understand this account and think that it is incredibly myopic. I think that a lot of audience members did too.)
Strangely, Foley volunteered that the United States did not actually follow one of the core patterns of the model sketched above, even though the entire premise of his talk was that the United States financial crisis is one of a series. In the United States, there has uncharacteristically not been a devaluation of the currency. This point left much of Foley’s presentation in doubt. After all, in a nutshell he said that a financial crisis typical of global neoliberal capitalism is set off by high foreign investment which bids up the value of the currency, followed by fall and devaluation. This has not happened here.
I didn’t understand very well what Foley suggested about policy remedies for all this. He was clear enough though in general in alleging that the ordinary solutions to such crises “maintain the policies of global financial capitalism.” Generally this involves “putting pressure on the real economy.”
The “real economy” is how people on the left like Foley or his co-ideologist on the following panel Randy Wray characterize business activity in the manufacturing and agricultural sectors and the non-financial services part of the service sector. That is, there are the bankers and then there are all of the “real” people. Typical I think of “heterodox” economics is to argue for a kind of modern economic nationalism, in the form that nations should guarantee some prices (like higher wage rates and price maximums) rather than deregulating most sectors of the society. Such policies are nationalistic because they favor co-nationals within the country. Of course, this is an old argument in economics. The well-known problem with it is that where prices (e.g. wages) are kept high, the policy reduces demand (e.g. causing unemployment or underemployment), and were prices are capped (as in Venezuela, on just about everything besides labor rates), shortages result. The socialist man of the future who would not behave according to these patterns proved a mirage, and a very miserable one at that. The appeal of such economically nationalistic policies seems clear enough--though I don’t think you often hear proponents respond to the criticisms which I have just rehearsed above.
The reason that the IMF opposes such policies when it offers aid to countries is that they dampen domestic economic growth and make the country less attractive to international investment, and make its manufactured goods and services comparatively less price-attractive. For instance, if labor unions with real power were able to organize and raise the level of wages for workers at Chinese factories, much to the personal benefit of Chinese workers, Chinese manufactured products would become more expensive and demand from purchasers abroad (like you and me, in ‘Merica) would decline.
Thus what Foley characterizes as “putting pressure on the real economy” means resisting policies of economic nationalism. As John Cochrane would put it later on during the day’s presentations, what Foley calls “global neoliberal capitalism” has lifted hundreds of millions of people out of crushing poverty over the last couple of decades. This happened precisely as a result of “putting pressure on the real economy” through deregulation of domestic markets and reducing trade restrictions. The evidence on balance seems to be that although cushy labor conditions have become less cushy, the increase in foreign demand for e.g. Chinese manufactured goods has been of overwhelming benefit to huge numbers of humans the world over.
Foley’s last point was to argue that diversifying investments and using derivatives does not allow investors to manage risk. As he put it, “markets themselves are sources of complex endogenous risks.” I gather that he meant to take fluctuating exchange rates as sui generis chaotic movements, and in this sense “endogenous” to a market. It seems to me that this takes an effect (changes in currency prices) for a cause, and a self-moving and chaotic cause, at that.
More broadly, this is part of the view that international capital movements are chaotic, like the ocean in Machiavelli’s metaphor for the swings of Fortune. Thus Foley like Mizruchi ultimately argued in favor of trying to manage economic growth, in this case by fixing or manipulating exchange rates.
This wrapped up the third of the three panelists’ presentations.
There followed a long and rich Q&A session. The moderator, Gary Herrigel, asked, What about regulation? What about political pressure to extend home ownership? And thus the business and political actors? And, you are exaggerating the deindustrialization of the US a lot! And the Fed kept interest rates low.
Diamond recapped by presenting some diagnoses and policy suggestions which follow from both his arguments earlier and some of his recent professional published work.
One big problem, he argued, was “systemic risk externalities,” especially in the form of short-term debt. I believe that his example was of Bear Stearns. Toward the end they had been financing their debt by short-term debt instruments, of about thirty days’ duration. These were highly vulnerable to something like [margin calls.] That is, they gave things like Credit Default Swaps (CDS) as collateral for debt, which they should not have been able to or allowed to do anyway. As investors began to realize that CDS and other little understood credit instruments like mortgage-backed securities (MBS) were overvalued, Bear and other banks suddenly could not raise enough short-term debt to keep itself afloat and there was the equivalent of a large-scale run on banks. Generally speaking, you can say that one big problem was that there was so much similarity among all of these institutions’ positions—they each were “holding positions... identical to everyone else.”
Diamond also added that there should have been “higher capital requirements.” That is, investment banks should have been legally required to keep more cash or other easily convertible assets on hand, rather than financing their [cash flow] via short-term debt. Again, the problem with short-term debt was that if rates went up or the collateral assets (like MBS and CDS) on which it was raised declined in value, suddenly the investment banks would have to sell their other assets fast. And whenever anyone has to sell anything fast, he doesn’t get a good price for it. We call it a fire sale. There were lots of fire sales late in 2008 and the net result was to drive down the value of all sorts of financial assets, including ordinary stocks. It contributed mightily to a decline in prices and confidence in the market.
Finally, Diamond suggested that some kind of an international legal mechanism is needed to resolve problems like the ones just discussed. National bankruptcy laws work well enough domestically (another themes which would recur again and again in the day’s panels, especially in Panel 3), but not for foreign investors. Diamond left this point unexplored. (I noted that Diamond mentioned that he writes for an outfit called the Squam Lake Working Group, a think tank adjunct to the Council on Foreign Relations (CFR).)
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