On the failure of "the invisible hand" to influence our financial sector

In Alan Greenspan's book, The Age of Turbulence, one of the issues he explores is the failure of economic populism in Latin America. Here are his thoughts:
"The dictionary defines 'populism' as a political philosophy that supports the rights and power of the people, usually in opposition to a privileged elite. I see economic populism as a response by an impoverished populace to a failing society, one characterized by an economic elite who are perceived as oppressors. Under economic populism, the government accedes to the demands of the people, with little regard for either individual rights or the economic realities of how the wealth of a nation is increased or even sustained."
So in Greenspan's view as a self-described Libertarian Republican, economic populism comes to life in "failing societies" that have significant income inequality and are dominated by an economic elite. And in Greenspan's mind, it is not the government that can make the required changes to address the failures of the society; it is the markets that are the key to reducing failure.

Our own economy is a mixed economy, market-driven, but with government policy and regulation developed to counterbalance the very real excesses of the markets. Though it is mixed, the US economy is not driven by the visible hand of a government acting as an economic populist, but is instead an economy that predominantly looks to the invisible hand of the markets to address and resolve economic failure.

Or at least, so I thought. 

The Age of Turbulence was published in 2007, prior to the very turbulent collapse of our own economy. What we saw when our economy catastrophically crashed in 2008, was the US government acting to bail out and prop up the numerous failed businesses within our banking sector.

What we learned in 2008 was that in certain sectors - like our financial sector - the markets are not allowed to work their invisible magic. Banks that failed in 2008 were not allowed to fail. They were instead fed a steady stream of income from the federal government that propped them up, kept them going and allowed astronomical bonuses to be paid to the banking executives involved in their failure.

Under the very conservative, pro-business regime of GW Bush/Cheney/Paulson, the invisible hand was quite visibly shoved aside. We were told this had to be done because the consequences of the failure of these many banks would be too much for our economy to bear. Thus we needed to bail out the banks in order to see unemployment only push above 10%, underemployment that added to the burden of the populace, a housing market crippled by overvaluation and over-saturation of product, employees unable to move to better opportunities because of housing lock, banks showing profits as the debt of the US government reached astronomical levels.

Despite these significant problems our economy faces today, little has been done since the crash to wean the financial sector of their impractical and senseless dependence on the federal government. Dodd Frank is exploring the issue, but we do not have a resolution authority in place as of yet that will allow banks to fail in an orderly way. Our banks are as vulnerable to the domino-theory of collapse (if one goes, they all go) as they were back in 2008.

Today in America, rather than having an economy driven by the market, or economic populism, or the invisible hand, we have an economy reliant on a welfare program for bankers that is without question a failure. It is a failure of our banking sector, a failure of political philosophy, a failure of public policy, and most of all, a catastrophic failure of vision from both our business and political leaders.

And it is a failure that has cost our nation far too much.


Anonymous said…
the difference that you are failing to see is banks CAN NOT fail.

Any other company gets the luxory of chapter 11, can clean up their balancesheet and come out just fine.

Look at the autos, major airlines and the countless other companies that have gone "bankrupt" only to emerge and continue business as usual.

With the exception of CIT (but not really a financial) that can't happen to a bank. The second consumer deposits are in jeopardy and there is a run on the bank the economy will collapse.

The loans of 2008 (aside from C & AIG) we not needed for any reason to restore confidence. GS, JPM, MS, WFC, BAC, etc etc had more than enough capital but were bleeding liquidity due to lack of confidence. Thats they the gov't loans did was provide confidence in the financial markets. (C, AIG etc were all another story)

Also, what do you think the capital raising in the summer of 2009 was all about? It was the final stamp where the gov't could say yup these banks are safe! And everyone believed them.

I once heard a story that during the Great Depression FDR ordered all banks to be closed on friday and for only 85-90% be opened on monday and deemed good Banks... his advisors asked how will they know which ones are the good banks and his reply was along the lines of: It does matter, if we let them open their doors on monday they will be perceived as a good bank and the runs will stop at those banks, and aparently they did. Old wives tale or not, it certainly is a similar situation

Also how about a little airtime on FNM... a GSE that at this rate will borrow more than all of Wall St. combine without any ability to pay the loans back. Its quite amazing no one is up in arms about that, especially considering the direct impact the gov't has on them.
To Anonymous,

Banks actually DO fail. But as you note, they cannot be shut down.

What I've learned is that the miserable business decisions of some of the best educated and highly compensated people in the world are propped up with massive infusions of federal money. That's not "capitalism." That's socialism at its worst.

I also think you're underestimating the debt-loaded balance sheets at Citi, BoA and Merrill Lynch. But all the banks had loaded up on leverage, thanks to some clever lobbying by Henry Paulson and others in 2004. Then Hank had to pick up the pieces in 2008. But his firm did quite nicely with TARP, though his nation did not.

So there was a reason that confidence was lacking in the system - it had essentially failed under the weight of bad loans and terrible business decisions made by some of the wealthiest people in the world.

That Alan Greenspan - who knew "banks CAN NOT FAIL" - would allow the mythological "invisible hand" to regulate such a fragile and greed-influenced system shows the utter blindness and stupidity of such thinking. The greediest people in the world end up on Wall Street - clearly, they'll skew the play in their favor whenever possible. And spread risk throughout the system in ways that, as we've seen, can all too easily collapse the global economy. The price we pay for the systemic risk we allow in our financial system has grown too great.

Why must we live with a financial system so systemically that the failure of one bank results in catastrophic collapse of the global economy.
Anonymous said…
The majority of the debt stack on the balance sheets of those companies was secured, granted what it was secured by was questionable I agree but it was still secured. Not to mention all banks were taking active steps to de-leverage but there is only so fast you can unload 100's of billions without a major crisis (which happened anyways). Yes clearly the management and risk management of these companies failed, but whatever they were selling people were buying so both sides need to be held accountable.

Until the secured lines were pulled the banks were not failing. Lehman was sputtering along until JPM demanded $10bn of comfort money just for JPM to let LEH use their bank.

"The greediest people in the world end up on Wall Street - clearly, they'll skew the play in their favor whenever possible"

that type of anger and stereotyping is so laughable I don't know where to begin.

How about the companies that decide to not do a recall because the probably x lawsuit costs less than the recall? That can applie to phrama's autos etc, if there is a shortcut companies will make it.

Corporate greed is EVERYWHERE not just wall street.

How about union employees? You have people working on the auto line with no HS education making 40+ K a year... is that fair? Or greed? How about teachers with tenure that can not be fired? That doesn't seem fair, everyone else can be fired... seems a little greedy to me. Sure it could be argued the stakes that these people deal with are not that as high as wall street but I would argue the opposite. Education cuts, outsourcing etc is running rapid because the costs of all other jobs are so damn high

You speak of the excess leverage on wall street, what about the excess leverage amongst the american people? Apple is making a killing but how many people can actually afford all of these iProducts? Isn't buying that or a house or anything else on borrowed money greedy?

Again I am not trying to say wall street is not to blame but for everyone to blindly point fingers is just insane. There was greed EVERYWHERE in the system and all I am asking is some acknowledgement of the other areas.

Congress dug a ditch, the american people stacked it with kindle as high as you can see, and wall street dumped gasoline on it. All it took was a match from someone to send the whole thing up in flames.
It is interesting that you can point to auto workers and teachers - those with salary in the $40K - $60K range and say they're greedy. But bankers who make astronomical sums for their risk management abilities AND who get bailed out by the feds when their risk management business decisions fail catastrophically - they're just like the rest of us.

They're not. They get rescued. Consumers (who've been experiencing stagnant wages for several decades now) who over-leverage by buying iPods and homes they cannot afford are held accountable. They enter bankruptcy. Their homes are foreclosed. Their credit ratings are trashed.

Totally different scenarios.

For our top banks to be in the "process of deleveraging" means there was some exceptionally risky leveraging going on prior to that. People who make as much as people on Wall Street make really should know better than to leverage their companies 25% or worse. But they do it because, as you noted, their companies cannot fail. They will never be held accountable for failed business decisions. The taxpayer gets that nasty chore.

To point the finger of blame at Wall Street is not done blindly or in anger. I'd love to hear how their business decisions leading up to the crash were dictated by anything other than greed.

Tell me the value of having our systemically risky banks profit by betting against the US housing market.

Or tell me the business value (to the customer, to the economy, etc.) that comes when a bank (like Goldman Sachs) sells an investment instrument to one party and then sells insurance that allows another party to profit when the bank's own instrument blows up.

Translate that kind of hedging to pharma, food processing, toys - it's an unimaginable business model, but one that banks can employ because they get bailed out when they fail.

So they crank up the tunes and dance on as long as the profit pours into the coffers. And when their risks don't pan out, they get bonused anyway.

But getting a federally funded bonus (one that is significantly larger than the annual salaries of auto workers and teachers) is not the kind of success any serious capitalist should be proud of.
Anonymous said…
This is not the first time in american history were wages have been stagnent for a period of time. It is the first time where consumer debt has ballooned out of control! I am not solely blaming them, the cards and loans were there so I get it... my point is always that there are more people involved.

Unquestionably I think those auto workers at 40-60K starting out are being greedy even if their pay is a fraction of what a person on wall street makes. If you can not even make through high school yet still find a job that provides a reasonable starting salary and a full spectrum of benefits (including legal counsel!) then 40-60 in cash plus another 20+ in benefits is being greedy.

You also seem to think that EVERYONE on wall street is making fortunes of money. The average pay on wall street is higher, but it is no where near the amount that people see in the news or averages. The executives at the top, yes they are making millions, the top end banker fine also making millions, the millions of other employed are not earning anywhere near that (but again I admit higher than average, but not astronomical)

What GS did was wrong (ordinarily I would say buyers should have done their due dil, but their role on both sides disrupts that a bit... but everyone should still do their due dil, on the sell AND buy side), no argument but they also took losses on the mortgage market just like everyone else. Maybe not as much as some, but more than nothing. The people who bet against the american public & the housing market was largely the hedgefunds. On the other side was wall street (and AIG) which is where all the losses came from.

You also make it seem like the government money went straight into peoples pockets. It didn't for the most part once the banks received it, it went straight to escrow accounts, sat there until they were allowed to pay it back. Wall street wasn't given a choice in the receipt of this money, nor was it allowed to pay it back when it wanted (usualy Citi & AIG aside, they both needed and probably asked for it).

During those years as well (both pre and post bailouts) you saw may of the CEOs not take pay (granted other members of the exec committee should have followed suit but did not).

The other thing to consider is if you want to fix the financial system don't let a bunch of ex lawyer congressmen lead the charge. The have no clue what they are doing because its not their job to know. This is why so much of reg reform was left for "regulator comment and interpretation"

The pay structure in the past was way out of whack, giving bonuses now on money that could be lost tomorrow was idiotic, which is why so many more companies have increased stock awards, deferred cash compensation and clawbacks.

Overall I agree with a lot of your points and I am not trying to fight that, I am just trying to say for every buyer / user there is a seller somewhere. Every dollar of a wall street loss roots in a mortgage or company default somewhere along the lines.
I appreciate your comments, but I AM going to push back on the assertion that the Wall Street pay isn't extreme. The WSJ had a story last August that said the average salaries for new hires in finance and insurance ran about $12K a month. This in a time of high unemployment/Great Recession, when a family of four's average annual income is about $50K. And teachers and cops, etc. make $40K - $60K a year. http://bit.ly/lvrTvc

Not clear what a 22 yr old knows that's worth the six figure salary, but that's what they pay on Wall Street.

And I also have a hard time understanding why, if the sector was sound (or sound-ish), we spent trillions to help banks alleviate the "confidence" problem. Trillions! (Programs to help banks were far more than just TARP.) And when these trillions were flowing to banks who apparently needed the trillions to stop the runs that would kill them, they turned around and paid themselves billions in bonuses.

That's fortunate for them, but it was bewildering for those of us who were getting hammered by the recession - how do companies that can exist only thanks to federal bailouts get to use federal bailouts to help pay the bonuses. And again, if they all had such capital sitting in their banks that they didn't NEED the bailout, that was far too many trillions wasted in an area that didn't need it.

Also, that GS was betting against the US housing market was something I found on Economics of Contempt blog - here, I express my dismay that one could profit tidily by betting in such a manner. http://bit.ly/iyyPgP. It's a grim way to make a buck, frankly.

Your comments are appreciated! It's always great to see different approaches and thinking about the crisis.

Popular Posts